Stock Splits

A stock split occurs when a company issues x number of shares for each y number of outstanding shares of common stock without receiving any cash and reduces the par value per share such that there is no change in any component of shareholders' equity.

A stock split effectively ‘splits’ a share of common stock of a company so as to increase the number of shares of common stock without impacting the company’s market capitalization.

Companies typically engage in stock-splits when they believe that their share price is too high. For example, if a company’s stock price is $500, it might be hard for an investor with a $20,000 portfolio to arrive at precise allocation to the stock. Such a company may issue a 10-for-1 stock split to increase its outstanding stock 10-fold and reduce its stock price to $50.

Stock splits are designed by companies keeping in view their intended market price target. If a company wants to reduce its market price by half, it issues a 2-for-1 stock split which involves issuing 1 share per 1 share currently issued. Similarly, a company wanting to reduce its stock price to ⅔ shall issue a 3-for-2 stock split, thereby issuing 3 shares per each 2 shares currently held.

Stock split vs stock dividend

A stock split is like a stock dividend in that both increase the number of shares without any related cash inflow but they differ in how they impact the shareholders’ equity. A stock dividend increases paid-up capital and reduces shareholders equity but most often does not result in any change in par value, but a stock split does not affect any shareholders’ equity account but does change the par value.

Example

Z Ltd. has 2 million 10-par shares of common stock outstanding. The company’s management believes that the current stock price of $300is too high and intends to reduce it to its 1/3.

The company needs to issue a 3-for-1 stock split. This would involve issuing 3 shares for each of the currently issued common shares of the company. It will increase the total number of shares issued and outstanding to 6 million (2 million × 3) but reduce the par value to $3.33 ($10 ÷ 3) and market price to $100 ($300 ÷ 3). The stock-split will not affect balance in any of the shareholders equity accounts.

by Obaidullah Jan, ACA, CFA and last modified on

XPLAIND.com is a free educational website; of students, by students, and for students. You are welcome to learn a range of topics from accounting, economics, finance and more. We hope you like the work that has been done, and if you have any suggestions, your feedback is highly valuable. Let's connect!

Copyright © 2010-2021 XPLAIND.com