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Corporate finance managers want to maximize the availability and minimize the cost of equity capital

Stock splits, stock dividends and Treasury stock

In depth: 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

BALANCE SHEET
Assets Liabilities

INCOME STATEMENT
Revenue

Expenses

Equity

Profit
Debit Credit

or Loss

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Objective 24.1: Explain stock splits

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.

1 Old Share

1 New Share

1 New Share

The corporation calls in all outstanding old shares and issues new ones. O24.1
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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

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Stock splits: No journal entry notation only

Before Stock Split After Stock Split

EQU I TY
Co mmo n St o ck at Par 200,000 (20,000 shares @ $10 par value) Co nt ribut ed Capit al in Ex cess o f Par Ret ained Earnings To t al Equit y

EQU I TY
Co mmo n St o ck at Par 200,000 (40,000 shares @ $5 par value) Co nt ribut ed Capit al in Ex cess o f Par Ret ained Earnings To t al Equit y

130,000 245,000 575,000

130,000 245,000 575,000

BALANCE SHEET
Assets Liabilities

INCOME STATEMENT
Revenue

Expenses

Equity

NO CHANGE IN THE DOLLAR AMOUNTS IN ANY OF THE EQUITY ACCOUNTS

Profit or Loss

Debit

Credit

O24.1

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Objective 24.2: Account for stock dividends

Cash Dividends
Stock Dividends

$
BALANCE SHEET
Assets Liabilities

More shares of stock

INCOME STATEMENT
Revenue

Expenses

Equity

Stock dividends result in no change in total equity

Profit or Loss

O24.1
Debit

Credit

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Stock dividends
Autofil Corporation

STOCKH OLDER EQUITY Common Stock at Par (100,000 shares @ $5 par value) Contributed Capital in Excess of Par Retained Earnings Total Equity

To here

500,000

Stock dividends move dollars from here

250,000 1,000,000 1,750,000

O24.2

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Stock dividends
Autofil Corporation

STOCKH OLDER EQUITY Common Stock at Par (100,000 shares @ $5 par value) Contributed Capital in Excess of Par Retained Earnings Total Equity

500,000

No change in total Equity

250,000 1,000,000 1,750,000

O24.2

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Declaration of stock dividend

We declare a 10% stock dividend

Board of Directors

BALANCE SHEET
Assets Liabilities

INCOME STATEMENT
Revenue

Expenses

Equity

I have 5,000 shares Ill get 500 more!

Profit
Debit Credit

or Loss

O24.2

No change in total Equity

Stockholder

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Stockholders receive more shares

I still own the same % of the corporation

I get 500 more shares but. . .

500 more shares of stock

Before dividend Shares outstanding = 100,000. Penny owned 5,000 or 5,000/100,000 = 5%.

Stockholder

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%
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This size (%) of the stock dividend is important!

*20 -25% or less
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

*20 -25% or more

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 times the number of new shares issued in the dividend
Credit

Common Stock Dividend Distributable for the par value per share times the number of new shares issued in the dividend

Contributed Capital in Excess of Par an amount necessary to balance the journal entry O24.2
* Assume 20%
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Stock dividends
Autofil Corporation
Both large and small stock dividends move amounts from Retained Earnings to Contributed Capital accounts

STOCKH OLDER EQUITY Common Stock at Par (100,000 shares @ $5 par value) Contributed Capital in Excess of Par Retained Earnings Total Equity

500,000

250,000 1,000,000 1,750,000

O24.2

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This size (%) of the stock dividend is important!

*20 -25% or less *20 -25% or more

Small stock dividend moves the market value out of retained earnings
O24.2

Large stock dividend moves par value out of retained earnings

* Assume 20%
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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.
GENERAL JOURNAL
Date Description Stock Dividends Distributable Contributed Capital in Excess of Par, Common Stock 3115
BALANCE SHEET
Assets Liabilities

Page 56
PR Debit 540,000 225,000 315,000 Credit

12/31/11 Retained Earnings

3500 3110

INCOME STATEMENT
Revenue

Expenses

Equity

Profit

O24.2

Debit

Credit

or Loss

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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.
GENERAL JOURNAL
Date Description Stock Dividends Distributable Contributed Capital in Excess of Par, Common Stock 3115 PR 3500 3110 Debit 540,000 225,000 315,000 12/31/11 Retained Earnings

Page 56
Credit

300,000 x .15 x $12 market price 300,000 x .15 x $5 par value 540,000 225,000
O24.2
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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.
GENERAL JOURNAL
Date Description Stock Dividends Distributable Contributed Capital in Excess of Par, Common Stock 3115 PR 3500 3110 Debit 540,000 225,000 315,000 12/31/11 Retained Earnings

Page 56
Credit

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
O24.2
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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
GENERAL JOURNAL
Date 2/15/12 Description PR Debit

Page 56
Credit

O24.2

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Recording small stock dividend- date of distribution

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
GENERAL JOURNAL
Date Description Common Stock, $5 par PR 3110 3005 Debit 225,000 225,000 3/1/12 Stock Dividends Distributable

Page 56
Credit

On the date of distribution the par value of the stock dividend is formally moved to the Common Stock account.
O24.2

BALANCE SHEET
Assets Liabilities

INCOME STATEMENT
Revenue

Expenses

Equity

Profit
Debit Credit

or CourseCollege.com Loss

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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.
GENERAL JOURNAL
Date Description Stock Dividends Distributable PR 3500 3110 Debit 1,500,000 1,500,000 12/31/11 Retained Earnings

Page 56
Credit

BALANCE SHEET
Assets Liabilities

INCOME STATEMENT
Revenue

Expenses

Equity

Profit

O24.2

Debit

Credit

or Loss

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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.
GENERAL JOURNAL
Date Description Stock Dividends Distributable PR 3500 3110 Debit 1,500,000 1,500,000 12/31/11 Retained Earnings

Page 56
Credit

500,000 x .3 x $10 par value

O24.2

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Recording large stock dividend- 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
GENERAL JOURNAL
Date 2/15/12 Description PR Debit

Page 56
Credit

O24.2

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Recording large stock dividend- date of distribution 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
GENERAL JOURNAL
Date Description Common Stock, $10 par PR 3110 3005 Debit 1,500,000 1,500,000 3/1/12 Stock Dividends Distributable

Page 56
Credit

On the date of distribution the par value of the stock dividend is formally moved to the Common Stock account.
O24.2

BALANCE SHEET
Assets Liabilities

INCOME STATEMENT
Revenue

Expenses

Equity

Profit
Debit Credit

or CourseCollege.com Loss

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Why stock dividends? 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. . .

O24.2

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New market price immediately after stock dividend

Tot a l Sha res Ma rk et Price Ma rk et Out st a nding per sha re va lue 400,000 16.00 $ 6,400,000 10% 440,000 $ 14.55

BEFORE STOCK DIVIDEND Sto ck di vi dend AFTER STOCK DIVIDEND

If new market pri ce i s greater than

then sto ckho l ders gai n val ue, i f l ess, they l o se val ue. Exa mples of result ing ma rk et price per sha re No Change i n val ue 440,000 $ 14.55 $ 6,400,000 Sto ckho l ders gai n 440,000 $ 16.00 $ 7,040,000 Sto ckho l ders l o se 440,000 $ 14.00 $ 6,160,000

1 2 3

O24.2

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New market price immediately after stock dividend

Tot a l Sha res Ma rk et Price Ma rk et Out st a nding per sha re va lue 400,000 16.00 $ 6,400,000

BEFORE STOCK DIVIDEND

Management hopes for this to result new stockholders Stothen ck di vi dend 1 0will % pay the issuing firm more for each new share
AFTER STOCK DIVIDEND If new market pri ce i s greater than

440,000 $ 14.55

then sto ckho l ders gai n val ue, i f l ess, they l o se val ue. Exa mples of result ing ma rk et price per sha re No Change i n val ue 440,000 $ 14.55 $ 6,400,000 Sto ckho l ders gai n 440,000 $ 16.00 $ 7,040,000 Sto ckho l ders l o se 440,000 $ 14.00 $ 6,160,000

O24.2

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Objective 24.3: Account for Treasury

stock transactions

Treasury stock is a CONTRA EQUITY

BALANCE SHEET INCOME STATEMENT
Revenue

Account

Assets

Liabilities

Expenses

Equity

Profit
Debit Credit

or Loss

O24.3

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Treasury stock
BALANCE SH EET
Asse t s Cash Acco unt s Receivab le Invent o ry Pro p ert y, Plant & Eq uip ment Invest ment s Liabilit ie s Acco unt s Payab le Lo ng Term Deb t

INCOM E STATEM ENT

Re ve nue Sales

Equit y Co mmo n St o ck at Par Co nt rib ut ed Cap it al in Excess o f Par Ret ained Earning s Treasury St o ck

Expe nse s Co st o f Go o d s So ld Sellling Exp enses General & Ad min. Exp enses

Treasury Stock REDUCES Stockholders Equity

Pro fit

D e bit

Cre dit

or

Contributed Capital and Retained Earnings Treasury Stock

300,000

Lo ss

(40,000)

Net Stockholder Equity

260,000
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Treasury stock
Contributed Capital and Retained Earnings 300,000

Treasury Stock

(40,000)

Authorized Shares Issued Shares Outstanding Shares

Treasury stock purchases result in fewer outstanding shares than issued shares

O24.3

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Treasury stock purchase

Marine Corporation repurchases 2,000 shares of their common stock for $58 per share.
GENERAL JOURNAL
Date Cash
Purchase 2,000 shares treasury stock

Page 17
PR Debit 116,000 116,000 Credit

Description

5/17/12 Treasury Stock

3800 1000

BALANCE SHEET
Assets Liabilities

INCOME STATEMENT
Revenue

Expenses

Equity

Profit

O24.3

Debit

Credit

or Loss

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Resulting change to equity

Marine Corporation BEFORE Treasury Stock Purchase
STOCKH OLDER EQUITY
Co mmo n St o ck at Par
(2 5 0 ,0 0 0 shares @ $ 5 p ar )

Marine Corporation AFTER Treasury Stock Purchase

STOCKH OLDER EQUITY

2,250,000

Co mmo n St o ck at Par

2,250,000

(2 5 0 ,0 0 0 shares @ $ 5 p ar 5 ,0 0 0 in t reasury)

Co nt ribut ed Capit al in Ex cess o f Par, Co mmo n St o ck Ret ained Earnings 11,250,000 3,200,000

Co nt ribut ed Capit al in Ex cess o f Par, Co mmo n St o ck Ret ained Earnings Treasury St o ck To t al Equit y 11,250,000 3,200,000 (116,000) 16,584,000

To t al Equit y

16,700,000

The Treasury Stock purchase reduces Cash and REDUCES TOTAL STOCKHOLDER EQUITY
O24.3
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Treasury stock sale

Marine Corporation sells 1,000 shares of their Treasury stock for $58 per share (same as purchase price)
GENERAL JOURNAL
Date 6/30/12 Cash Treasury Stock
Sale of 1 ,000 shares treasury stock @ $58

Page 19
PR Debit 58,000 58,000 Credit

Description

1000 3800

BALANCE SHEET
Assets Liabilities

INCOME STATEMENT
Revenue

Expenses

Equity

Profit

O24.3

Debit

Credit

or Loss

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Resulting change to equity

Marine Corporation BEFORE Treasury Stock Sale
STOCKH OLDER EQUITY
Co mmo n St o ck at Par
(2 5 0 ,0 0 0 shares @ $ 5 p ar )

Marine Corporation AFTER Treasury Stock Sale

STOCKH OLDER EQUITY

2,250,000

Co mmo n St o ck at Par

2,250,000

(2 5 0 ,0 0 0 shares @ $ 5 p ar 5 ,0 0 0 in t reasury)

Co nt ribut ed Capit al in Ex cess o f Par, Co mmo n St o ck Ret ained Earnings Treasury St o ck To t al Equit y 11,250,000 3,200,000 (116,000) 16,584,000

Co nt ribut ed Capit al in Ex cess o f Par, Co mmo n St o ck Ret ained Earnings Treasury St o ck To t al Equit y 11,250,000 3,200,000 (58,000) 16,642,000

The Treasury Stock sale increases Cash and INCREASES TOTAL STOCKHOLDER EQUITY
O24.3
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Treasury stock sale

Marine Corporation sells 500 shares of their Treasury stock for $74 per share (purchase price was $58)
GENERAL JOURNAL
Date 8/30/12 Cash Contributed Capital, Treasury Stock Treasury Stock
Sale of 500 shares treasury stock @ $7 4

Page 19
PR Debit 37,000 8,000 29,000 Credit

Description

1000 3700 3800

BALANCE SHEET
Assets Liabilities

INCOME STATEMENT
Revenue

Expenses

Equity

Profit

O24.3

Debit

Credit

or Loss

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Treasury stock sale

Marine Corporation sells 500 shares of their Treasury stock for $74 per share (purchase price was $58)
GENERAL JOURNAL
Date 8/30/12 Cash Contributed Capital, Treasury Stock Treasury Stock
Sale of 500 shares treasury stock @ $7 4

Page 19
PR Debit 37,000 8,000 29,000 Credit

Description

1000 3700 3800

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.
O24.3

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Treasury stock sale

Marine Corporation sells 500 shares of their Treasury stock for $74 per share (purchase price was $58)
GENERAL JOURNAL
Date 8/30/12 Cash Contributed Capital, Treasury Stock Treasury Stock
Sale of 500 shares treasury stock @ $7 4

Page 19
PR Debit 37,000 8,000 29,000 Credit

Description

1000 3700 3800

$74 x 500 shares Amount needed to balance

O24.3

500 shares x $58 cost

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Resulting change to equity

Marine Corporation BEFORE Treasury Stock Sale
STOCKH OLDER EQUITY
Co mmo n St o ck at Par
(2 5 0 ,0 0 0 shares @ $ 5 p ar )

Marine Corporation AFTER Treasury Stock Sale

STOCKH OLDER EQUITY

2,250,000

Co mmo n St o ck at Par

2,250,000

(2 5 0 ,0 0 0 shares @ $ 5 p ar 5 ,0 0 0 in t reasury)

Co nt ribut ed Capit al in Ex cess o f Par, Co mmo n St o ck Ret ained Earnings Treasury St o ck To t al Equit y 11,250,000 3,200,000 (58,000) 16,642,000

Co nt ribut ed Capit al in Ex cess o f Par, Co mmo n St o ck Co nt ribut ed Capit al Treasury St o ck Ret ained Earnings Treasury St o ck To t al Equit y 11,250,000

8,000 3,200,000 (29,000) 16,679,000

The sale of Treasury Stock above cost requires the use of a Contributed Capital, Treasury stock account O24.3
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Treasury stock sale

Marine Corporation sells remaining 500 shares of their Treasury stock for $32 per share (purchase price was $58)
GENERAL JOURNAL
Date 11/30/12 Cash Contributed Capital, Treasury Stock Retained Earnings Treasury Stock Description PR 1000 3700 3900 3800 Debit 16,000 8,000 5,000 29,000

Page 19
Credit

BALANCE SHEET
Assets Liabilities

INCOME STATEMENT
Revenue

Expenses

Equity

Profit

O24.3

Debit

Credit

or Loss

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Treasury stock sale

Marine Corporation sells remaining 500 shares of their Treasury stock for $32 per share (purchase price was $58)
GENERAL JOURNAL
Date 11/30/12 Cash Contributed Capital, Treasury Stock Retained Earnings Treasury Stock Description PR 1000 3700 3900 3800 Debit 16,000 8,000 5,000 29,000

Page 19
Credit

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.
O24.3
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Treasury stock sale

Marine Corporation sells remaining 500 shares of their Treasury stock for $32 per share (purchase price was $58)
GENERAL JOURNAL
Date 11/30/12 Cash Contributed Capital, Treasury Stock Retained Earnings Treasury Stock Description PR 1000 3700 3900 3800 Debit 16,000 8,000 5,000 29,000

Page 19
Credit

$32 x 500 shares Available credit balance of 8,000

O24.3

500 shares x $58 cost Amount needed to balance

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Resulting change to equity

Marine Corporation BEFORE Treasury Stock Sale
STOCKH OLDER EQUITY
Co mmo n St o ck at Par 2,250,000

Marine Corporation AFTER Treasury Stock Sale

STOCKH OLDER EQUITY
Co mmo n St o ck at Par 2,250,000

(2 5 0 ,0 0 0 shares @ $ 5 p ar 5 ,0 0 0 in t reasury)

(2 5 0 ,0 0 0 shares @ $ 5 p ar 5 ,0 0 0 in t reasury)

Co nt ribut ed Capit al in Ex cess o f Par, Co mmo n St o ck Co nt ribut ed Capit al Treasury St o ck Ret ained Earnings Treasury St o ck To t al Equit y 11,250,000

Co nt ribut ed Capit al in Ex cess o f Par, Co mmo n St o ck Co nt ribut ed Capit al Treasury St o ck Ret ained Earnings Treasury St o ck To t al Equit y 11,250,000

8,000 3,200,000 (29,000) 16,679,000

0 3,195,000 0 16,695,000

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!

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Objective 24.4: Analysis: Compute and

explain basic earnings per share and price earnings ratio Investors are especially interested in these earnings ratios which allow market comparisons of stock investments
P/E ratio compares earnings for each share to the market price for each share
BALANCE SHEET
Assets Liabilities

INCOME STATEMENT
Revenue

Expenses

Equity

Profit
Debit Credit

or Loss

O24.4

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Basic earnings per share

Earnings available to common stockholders = net income minus preferred dividends Earnings available to common stockholders Average # common shares outstanding

Basic Earnings per share

This calculation can only be compared to the prior periods in the same firm. The following P/E ratio allows comparison to other firms stock.
O24.4
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Price Earnings Ratio

Price = the market price per share Earnings = the basic earnings per share

PE ratio

Market price per share 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
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Example
Asset s Cash Acco unt s receivab le Invent o ry Pro p ert y, Plant , Eq uip . To t al asset s

Balance Sheet -Allway Corporat ion As of 12/ 31 2011

2011 1 1 2 ,4 0 0 4 3 7 ,6 0 0 8 6 6 ,9 0 0 2 ,8 3 6 ,7 0 0 4 ,2 5 3 ,6 0 0 Liab ilit ies To t al liab ilit ies Eq uit y Co mmo n St o ck -No p ar Preferred St o ck -No p ar Ret ained Earning s To t al liab . + eq uit y 2011 9 2 5 ,6 0 0 1 ,9 0 0 ,0 0 0 8 0 ,0 0 0 1 ,3 4 8 ,0 0 0 4 ,2 5 3 ,6 0 0

Income St at ement For t he year ended 12/ 31/ 11

Sales 3 ,4 5 7 ,6 0 0

Preferred d ivid end Market p rice co mmo n Earning s availab le t o co mmo n st o ckho ld ers

$ $

6 ,4 0 0 1 5 p er share

$ 4 2 8 ,8 3 0

Co st o f Go o d s So ld Wag es exp ense Sellling exp enses Ad minist rat ive exp . Miscellaneo us exp . Net Pro fit

2 ,2 4 7 ,4 4 0 3 4 5 ,3 0 0 1 2 3 ,5 0 0 1 9 6 ,5 0 0 1 0 9 ,6 3 0 4 3 5 ,2 3 0

Avg . Co mmo n Shares Out st and ing 2 0 0 ,0 0 0 $ 2 .1 4 Basic Earnings pe r Share (Earning s avail t o co mmo n/ shares o ut st and ing ) 7 .0 x Price Earnings rat io (Market p rice/ EPS)

Investors are paying 7 times the annual earnings per share for 1 share of Allway common stock
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O24.4

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End Unit 15
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