Account for Stock Split
As the stock price of a company rises, it becomes less affordable for retail investors to purchase. To wit, the price of a share of Berkshire Hathaway Class A stock, which has never undergone a stock split, is recently priced at over $200,000 per share. Round lots of stock are sold at 100 shares per lot, so a round lot of Berkshire Hathaway stock would sell for over $20,000,000, which is more than most retail investors can afford. Most companies routinely carry out 2:1 or 3:1 stock splits to ensure their stock remain liquid and affordable. A 2 for 1 stock split doubles the number of shares outstanding, and, since the value of the company does not change, the per share stock price is reduced in half. The way stock splits are recorded is relatively simple.
Contents
Steps
- Understand the terminology. A stock split is denoted in the form of x-for-y, or x:y, stock split, where x is the number of new shares each investor receives for every y number of old shares held.
- For example, a 2-for-1 split means each investor will now have 2 shares post-split for every 1 share pre-split. If a company had 100,000 shares outstanding pre-split, it will now have 200,000 shares outstanding post-split.
- Determine the new number of shares outstanding. Multiply the number of shares outstanding pre-split by the x:y ratio to get the new number of shares outstanding.
- For example, in the 2-for-1 split example above, you would multiply the 100,000 shares outstanding before the split by 2, to get 200,000 shares outstanding after the split.
- Determine the new par value of the stock. Divide the par value of the stock pre-split by the same x:y ratio to get the new par value.
- For example, in the 2-for-1 split example above, let's say the stock had a par value of $1 pre-split, you would divide the $1 par value before the split by 2, to get $0.50 par value after the split.
- Verify that the stock account balance remains the same. Stock account balance is equal to the par value per share times the number of shares outstanding. Since stock split does not change the value of a company, the stock account balance should remain the same.
- Before the split, the stock account balance was $1 par value times 100,000 shares outstanding equal to $100,000.
- After the split, the stock account balance is $0.50 par value times 200,000 shares outstanding equal to $100,000.
- Since these are the same, we have verified that the stock account balance remained unchanged.
- Write a memorandum entry to note the stock split. A memorandum entry is a short message entered into the general journal and also entered into a general ledger account; it is not a complete journal entry because it does not contain debits and credits. Here is an example: "On May 1, 2017, a 2-for-1 stock split was declared for the common stockholders of record as of the end of the day May 19, 2017. The stock split will result in the number of issued and outstanding shares of common shares increasing from 100,000 shares to 200,000 shares and the par value per share decreasing from $1.00 to $0.50."
Tips
- A reverse stock split is in the form of x-for-y split where y is greater than x. Reverse stock splits are typically carried out by troubled companies whose stock prices have fallen dramatically and do not anticipate them to go back up anytime soon.
Warnings
- Do not write a complete journal entry for stock splits! Stock splits do not change the total dollar amount of any balances on the balance sheet.
