©CourseCollege.com 1 24 In depth: Stock splits, stock dividends and Treasury stock Learning Objectives 1.Explain stock splits 2.Account for stock dividends 3.Account for Treasury stock transactions 4.Analysis: Compute and explain basic earnings per share and price earnings ratio Corporate finance managers want to maximize the availability and minimize the cost of equity capital

©CourseCollege.com 2 Objective 24.1: Explain stock splits O “Old” Share 1 “New” Share The corporation “calls in” all outstanding old shares and issues new ones. Stock splits are the process of replacing each single share of outstanding stock with multiple new shares of stock. For example a 2 for 1 stock split would result in every single share of “old” stock being replaced with 2 shares of “new” stock.

©CourseCollege.com 3 Why Stock splits? When stock is split, the market must re-price the new shares. Management hopes that in the re-pricing process, the market will increase the total market value for the stock. Example: With a 2 for 1 split, the hope is that the new price will be greater than half of the previous price This would benefit existing stockholders, their holdings would be worth more. It also helps the corporation. Investors are paying more for the same projected returns than they were prior to the stock split. O24.1

©CourseCollege.com 4 Stock splits: No journal entry –notation only Before Stock Split After Stock Split NO CHANGE IN THE DOLLAR AMOUNTS IN ANY OF THE EQUITY ACCOUNTS O24.1

©CourseCollege.com 5 Objective 24.2: Account for stock dividends Cash Dividends $ More shares of stock Stock Dividends Stock dividends result in no change in total equity O24.1

©CourseCollege.com 6 Stock dividends O24.2 Autofil Corporation Stock dividends move dollars from here To here

©CourseCollege.com 7 Stock dividends O24.2 Autofil Corporation No change in total Equity

©CourseCollege.com 8 Declaration of stock dividend Board of Directors We declare a 10% stock dividend I have 5,000 shares –I’ll get 500 more! Stockholder O24.2 No change in total Equity

©CourseCollege.com 9 Stockholders receive more shares I get 500 more shares but... Stockholder O24.2 I still own the same % of the corporation 500 more shares of stock Before dividend Shares outstanding = 100,000. Penny owned 5,000 or 5,000/100,000 = 5%. After dividend Shares outstanding 100,000 x 1.1 = 110,000. Penny owns 5,000 x 1.1 = 5,500 shares or 5,500/110,000 = 5% Before dividend Shares outstanding = 100,000. Penny owned 5,000 or 5,000/100,000 = 5%. After dividend Shares outstanding 100,000 x 1.1 = 110,000. Penny owns 5,000 x 1.1 = 5,500 shares or 5,500/110,000 = 5%

©CourseCollege.com 10 This size (%) of the stock dividend is important! O24.2 Small Stock Dividend  Debit retained earnings for fair or market value of the stock (#shares in dividend times the market value of each share) on the date of the dividend declaration  Credit Common Stock Dividend Distributable for the par value times the number of new shares issued in the dividend  Credit Contributed Capital in Excess of Par an amount necessary to balance the journal entry Small Stock Dividend  Debit retained earnings for fair or market value of the stock (#shares in dividend times the market value of each share) on the date of the dividend declaration  Credit Common Stock Dividend Distributable for the par value times the number of new shares issued in the dividend  Credit Contributed Capital in Excess of Par an amount necessary to balance the journal entry Large Stock Dividend  Debit retained earnings for the par value per share times the number of new shares issued in the dividend on the date of the dividend declaration  Credit Common Stock Dividend Distributable for the par value per share times the number of new shares issued in the dividend Large Stock Dividend  Debit retained earnings for the par value per share times the number of new shares issued in the dividend on the date of the dividend declaration  Credit Common Stock Dividend Distributable for the par value per share times the number of new shares issued in the dividend *20 -25% or less *20 -25% or more * Assume 20%

©CourseCollege.com 11 Stock dividends O24.2 Autofil Corporation Both large and small stock dividends move amounts from Retained Earnings to Contributed Capital accounts

©CourseCollege.com 12 This size (%) of the stock dividend is important! O24.2 Small stock dividend moves the market value out of retained earnings Large stock dividend moves par value out of retained earnings *20 -25% or less *20 -25% or more * Assume 20%

©CourseCollege.com 13 Recording small stock dividend- date of declaration Billiards Corporation declares a 15% stock dividend. There are 300,000 shares outstanding $5 par value. The market price per share is $12 on the same date. O24.2

©CourseCollege.com 14 Recording small stock dividend- date of declaration Billiards Corporation declares a 15% stock dividend. There are 300,000 shares outstanding $5 par value. The market price per share is $12 on the same date. O ,000 x.15 x $12 market price 300,000 x.15 x $5 par value 540,000 – 225,000

©CourseCollege.com 15 Recording small stock dividend- date of declaration Billiards Corporation declares a 15% stock dividend. There are 300,000 shares outstanding $5 par value. The market price per share is $12 on the same date. O24.2 This is a temporary holding account in the Equity section. When the stock shares are actually distributed, this amount will be moved to Common Stock at Par as shown on the following slides

©CourseCollege.com 16 Recording small stock dividend- date of record Billiards Corporation declares a 15% stock dividend. There are 300,000 shares outstanding $5 par value. The market price per share is $12 on the same date. Date of record 2/15/12; date of distribution 3/1/12 O24.2 No journal entry is necessary on the date of record.

©CourseCollege.com 17 Recording small stock dividend- date of distribution O24.2 On the date of distribution the par value of the stock dividend is formally moved to the Common Stock account. Billiards Corporation declares a 15% stock dividend. There are 300,000 shares outstanding $5 par value. The market price per share is $12 on the same date. Date of record 2/15/12; date of distribution 3/1/12

©CourseCollege.com 18 Recording large stock dividend- date of declaration Bowling Corporation declares a 30% stock dividend. There are 500,000 shares outstanding $10 par value. The market price per share is $23 on the same date. O24.2

©CourseCollege.com 19 Recording large stock dividend- date of declaration Bowling Corporation declares a 30% stock dividend. There are 500,000 shares outstanding $10 par value. The market price per share is $23 on the same date. O ,000 x.3 x $10 par value

©CourseCollege.com 20 Recording large stock dividend- date of record O24.2 No journal entry is necessary on the date of record. Bowling Corporation declares a 30% stock dividend. There are 500,000 shares outstanding $10 par value. The market price per share is $23 on the same date. Date of record 2/15/12; date of distribution 3/1/12

©CourseCollege.com 21 Recording large stock dividend- date of distribution O24.2 Bowling Corporation declares a 30% stock dividend. There are 500,000 shares outstanding $10 par value. The market price per share is $23 on the same date. Date of record 2/15/12; date of distribution 3/1/12 On the date of distribution the par value of the stock dividend is formally moved to the Common Stock account.

©CourseCollege.com 22 Why stock dividends? O24.2 For the same reasons stock splits are used: When stock dividends are distributed, the market must re-price the new shares. Management hopes that in the re-pricing process, the market will increase the total market value for the stock. The following slide demonstrates three scenarios...

©CourseCollege.com 23 New market price immediately after stock dividend O

©CourseCollege.com 24 New market price immediately after stock dividend O24.2 Management hopes for this to result –then new stockholders will pay the issuing firm more for each new share

©CourseCollege.com 25 Objective 24.3: Account for Treasury stock transactions O24.3 Treasury stock is a CONTRA EQUITY Account

©CourseCollege.com 26 Treasury stock O24.3 Net Stockholder Equity260,000 Contributed Capital and Retained Earnings 300,000 (40,000)Treasury Stock REDUCES Stockholders Equity

©CourseCollege.com 27 Treasury stock Authorized Shares Issued Shares Outstanding Shares Outstanding Shares Treasury stock purchases result in fewer outstanding shares than issued shares O24.3 (40,000)Treasury Stock Contributed Capital and Retained Earnings 300,000

©CourseCollege.com 28 Treasury stock purchase Marine Corporation repurchases 2,000 shares of their common stock for $58 per share. O24.3

©CourseCollege.com 29 Resulting change to equity Marine Corporation BEFORE Treasury Stock Purchase Marine Corporation AFTER Treasury Stock Purchase The Treasury Stock purchase reduces Cash and REDUCES TOTAL STOCKHOLDER EQUITY O24.3

©CourseCollege.com 30 Treasury stock sale Marine Corporation sells 1,000 shares of their Treasury stock for $58 per share (same as purchase price) O24.3

©CourseCollege.com 31 Resulting change to equity Marine Corporation BEFORE Treasury Stock Sale Marine Corporation AFTER Treasury Stock Sale The Treasury Stock sale increases Cash and INCREASES TOTAL STOCKHOLDER EQUITY O24.3

©CourseCollege.com 32 Treasury stock sale Marine Corporation sells 500 shares of their Treasury stock for $74 per share (purchase price was $58) O24.3

©CourseCollege.com 33 Treasury stock sale Marine Corporation sells 500 shares of their Treasury stock for $74 per share (purchase price was $58) O24.3 This is a normal credit balance Equity account. It represents the excess over cost received for the resale of Treasury stock held by the firm.

©CourseCollege.com 34 Treasury stock sale O24.3 $74 x 500 shares Amount needed to balance 500 shares x $58 cost Marine Corporation sells 500 shares of their Treasury stock for $74 per share (purchase price was $58)

©CourseCollege.com 35 Resulting change to equity Marine Corporation BEFORE Treasury Stock Sale Marine Corporation AFTER Treasury Stock Sale The sale of Treasury Stock above cost requires the use of a Contributed Capital, Treasury stock account O24.3

©CourseCollege.com 36 Treasury stock sale Marine Corporation sells remaining 500 shares of their Treasury stock for $32 per share (purchase price was $58) O24.3

©CourseCollege.com 37 Treasury stock sale Marine Corporation sells remaining 500 shares of their Treasury stock for $32 per share (purchase price was $58) O24.3 All available credit balances in the Contributed Capital, Treasury Stock account are used (debited) first. If additional debits are necessary to balance the journal entry, the Retained Earnings account is used.

©CourseCollege.com 38 Treasury stock sale Marine Corporation sells remaining 500 shares of their Treasury stock for $32 per share (purchase price was $58) O24.3 $32 x 500 shares Available credit balance of 8,000 Amount needed to balance 500 shares x $58 cost

©CourseCollege.com 39 Resulting change to equity Marine Corporation BEFORE Treasury Stock Sale Marine Corporation AFTER Treasury Stock Sale The Treasury Stock and the Contributed Capital, Treasury stock accounts are zero. Retained Earnings is reduced by $5,000 O24.3 …and total Equity went up by $16,000!

©CourseCollege.com 40 Objective 24.4: Analysis: Compute and explain basic earnings per share and price earnings ratio P/E ratio compares earnings for each share to the market price for each share O24.4 Investors are especially interested in these earnings ratios which allow market comparisons of stock investments

©CourseCollege.com 41 Basic earnings per share Earnings available to common stockholders = net income minus preferred dividends This calculation can only be compared to the prior periods in the same firm. The following P/E ratio allows comparison to other firm’s stock. O24.4 Average # common shares outstanding Earnings available to common stockholders = Basic Earnings per share

©CourseCollege.com 42 Price Earnings Ratio Price = the market price per share Earnings = the basic earnings per share The higher the ratio, the more investors are paying for the annual earnings per share reported by the firm O24.4 PE ratio Basic earnings per share Market price per share =

©CourseCollege.com 43 Example O24.4 Investors are paying 7 times the annual earnings per share for 1 share of Allway common stock

©CourseCollege.com 44 End Unit 15