Describe the accounting for stock splits and reverse stock splits

Answer 1

STOCK SPLITS

Stock splits (or, more technically, split-ups) resemble stock dividends. The corporation issues additional shares of stock to shareholders in proportion to their existing holdings. The firm receives no additional assets. Firms typically execute a stock split following one of two approaches:

1 . Reduce the par value of the common stock in proportion to the new number of shares issued.

2 . Make no change in par value but issue additional shares of the same par value.

A stock split accomplished by altering the par value in direct proportion to the number of new shares does not require a journal entry. If the change in par value is not proportional to the new number of shares or if the firm does not change the par value, the firm decreases Additional Paid-In Capital or Retained Earnings. The amount shown in the Common Stock account represents a different number of shares. Of course the firm must record the new number of shares held by each shareholder in the subsidiary capital stock records.

Distinguishing a stock dividend from a stock split can sometimes cause difficulties. Usually firms treat small-percentage distributions, say less than a 25% increase in the number of shares, as stock dividends and larger ones as stock splits.

Firms may also execute a reverse stock split. In this case, firms reduce the number of outstanding shares, either by increasing the par value of the stock or by simply canceling outstanding shares.
A stock split (or a stock dividend) usually reduces the market value per share, all else equal, in inverse proportion to the split (or dividend). If so, a two-for-one split results in a 50% reduction in the market price per share. Likewise, a reverse stock split usually increases the market value per share in inverse proportion to the reverse split. Therefore, managers and governing boards might use stock splits and reverse stock splits to keep the market price per share within some target trading range. For example, the board of directors might think that a market price of $60 to $80 is an effective trading range for its stock. If the share price has risen to $150 in the market, the board of directors may declare a two-for-one split.