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The term “cash dividend” refers to a dividend that is paid to shareholders in cash or a bank account. When a firm does not have enough cash to pay dividends, it pays out dividends in the form of equity, or new shares of the company, to the shareholder. This is known as a stock dividend. Stock splits are a form of Corporate Action. Stock Split and Stock Dividend are two distinct terms that should not be confused.
What Is a Stock Split?
A stock split arises when a firm expands the number of shares it issues to increase the liquidity of its stock. Because a split has no major influence on the company’s value, the overall dollar value of all outstanding shares stays unchanged, even when the number of shares outstanding increases by a specific multiple.2-for-1 and 3-for-1 split ratios are the most prevalent split ratios (sometimes denoted as 2:1 or 3:1). This means that for every share owned before the split, stockholders will receive two or three shares following the split. Forwarding Stock Split refers to a stock split that increases the number of shares issued, while reverse stock split refers to a stock split that decreases the number of shares issued.
Reasons for Stock Splits
Why does the company do a stock split? The following are the reasons:
- When the company’s Board of Directors believes that the share’s market price is excessive. As a result, the share price will be reduced.
- To boost the share’s liquidity.
- As a result of the price reduction, more investors will be able to purchase shares.
How a Stock Split Works?
A stock split is a business operation in which a corporation issues extra shares to shareholders, raising the total number of shares by a set ratio based on the shares they previously held. Firms usually split their stock to decrease the market price to a more sensible level for most investors and to increase the liquidity of trading in their shares. Most investors would choose to buy 100 shares of a $10 stock rather than one share of a $1,000 stock. As a result, many public firms declare a stock split to cut their share price after it has increased significantly. Although a stock split increases the number of existing shares, the overall monetary worth of the shares remains the same compared to pre-split levels because the split does not raise the company’s value.
The board of directors of a firm can split the stock in any ratio they want. A stock split could be 2-for-1, 3-for-1, 5-for-1, 10-for-1, 100-for-1, and so on. A three-for-one stock split indicates that for every share an investor currently has, they will now own three. To put it another way, the total number of outstanding shares on the market will triple. In contrast, the price per share following the 3-for-1 stock split will be lowered by dividing the previous share price by 3. This is because a stock split does not affect the company’s market capitalisation.
Stock Split Journal Entry
A stock split does not need a journal entry. As an alternative, the corporation creates a memo entry in its journal describing the stock split and indicating the new par value. After the stock split, the balance sheet will reflect the new par value and the new number of authorised, issued, and outstanding shares.
What Is a Stock Dividend?
Dividends are the distribution of profits to equity shareholders. Dividends are divided into two categories: cash and stock. A stock dividend is a dividend paid to investors in the form of stock as opposed to cash. Although it reduces earnings per share, the stock dividend has the added benefit of rewarding shareholders while not depleting the company’s cash reserves. These stock distributions are usually paid out in fractions of existing shares.
Stock Dividend Journal Entry
The Common Stock Dividend Distributable account is presented in the equity section of the balance sheet beneath the Common Stock account if the corporation files a balance sheet before distributing the stock dividend. A decrease (debit) to Common Stock Dividend Distributable to remove the distributable amount from that account and an increase (credit) to Common Stock for the same par value amount is required for the journal entry to record the stock dividend distribution.
Reasons for Stock Dividends
The following are the most important reasons for stock dividends:
- The corporation does not have enough funds to pay the dividend.
- To raise the number of shares issued by the company.
- To provide a tax benefit to the shareholder, a dividend paid in cash is taxable as income, whereas a dividend paid in equity shares is taxable only when the shareholder sells the shares. As a result, investors will benefit from tax incentives.
How a Stock Dividend Works?
A stock dividend, often known as a “scrip dividend,” is a distribution of shares to current shareholders instead of a cash dividend. When a corporation wants to reward its shareholders but doesn’t have the cash or wants to save it for other investments, this form of dividend may be paid. Stock dividends are advantageous to investors since they are tax-free. Unless the corporation offers the option of receiving the dividend in cash or stock, the share dividend, like any other stock, is not taxed until the investor sells it. A stock dividend may require newly received shares to be retained for a certain amount of time before being sold. A stock dividend’s holding period generally starts just after it is purchased. It is essential to comprehend the holding period when trying to evaluate qualifying dividend tax treatment.
From both the investor’s and the company’s perspectives, when a stock dividend is paid, the total value of equity remains the same. All stock dividends, on the other hand, necessitate a journal entry for the firm issuing the dividend. The value of the issued shares is transferred from the retained earnings account to the paid-in capital account with this entry.
The amount moved between the two accounts is determined by whether the dividend is a small stock dividend or a large stock dividend. A small stock dividend is one in which the number of shares issued is less than 25% of the total number of shares outstanding before the dividend. A journal entry for a small stock dividend transfers the market value of shares issued from retained earnings to paid-in capital. Large stock dividends are defined as those in which the number of new shares issued exceeds 25% of the total number of shares outstanding before the pay-out. In this circumstance, the par value of the shares issued is shifted from retained earnings to paid-in capital.
Similarities between Stock Split and Stock Dividend
An investor will gain more stock as a result of a stock dividend or a stock split than they did before the dividend or split. Stock dividends and stock splits are both determined by the company’s objectives.
Difference between Stock Dividend and Stock Split
Let’s look at some of the key distinctions between a stock dividend and a stock split:
- A stock dividend is a dividend paid in additional shares, while a stock split is the division of an issue’s shares into a proportion defined by the firm.
- Additional shares are handed to owners in a stock dividend, whereas in a stock split, already issued shares are split in an agreed ratio. There are no more shares available.
- The stock dividend for the most part is driven by a declined cash flow in the establishment, whereas the stock split is chiefly inspired by an aspiration to lower the market price of the shares.
- For a Stock Dividend, a Journal Entry is fashioned by debiting the Reserves (Retained Earnings) and crediting the Issued Share Assets, but for a Stock Split, no Journal Entry is created and just the facts are recorded in the issued share capital.
- Existing shareholders are given more shares in a stock dividend, while the shares they already own are divided.
The difference Between Stock Dividend and Stock Split are listed in the table below.
|Comparison based on
|Division of Equity Shares
|Dividend in the form of Equity Shares
|To reduce the market price of Share
|When there is no Cash Liquidity within the company
|Only increase in the number of shares, no change in Value of Issued Shares.
|Issued from the Free Reserves
|Already Held Shares are divided
|Additional Shares are allotted to existing shares Holder
|Whereas no Journal Entry is passed in
|Amount from Reserves is transferred to issued shares by passing Journal entry
|Two types of Stock Split:
Do Dividends Stay the Same When a Stock Splits?
Any prospective cash dividends can be altered in a handful of ways when a corporation decides to execute a stock split (or stock dividend). The dividend will almost always be adjusted in tandem with the share price. The date of the stock split and the time of the cash dividend’s record date are both important elements to consider.
Is a Stock Split Good for Investors?
A stock split generally points out that an establishment is doing well and that its stock price has ascended. This is a good thing, but it also suggests that the stock is now pricier for investors. In order to make its stock more affordable and enticing to ordinary investors, firms may elect to divide it. While stock splits can boost the liquidity of a stock and make it more accessible to investors, not all corporations do so. Some businesses prefer to keep their stock values as high as possible. There are two kinds of businesses. Growth firms want their stock price to rise.
But, in the end, it has little effect on you as an investor. It’s crucial to keep in mind that the owner is in the same situation as previously. Their ownership percentages are the same. They will possess more shares, but each share will represent a lesser fraction of the company’s ownership. Investors may see a rise as a result of a stock split. The stock’s price may rise as it gets more accessible and more individuals can trade it. Stock splits, on average, are neither beneficial nor detrimental in the long run.
Is it Good to Buy Stock After a Split?
According to a recent Bank of America report, companies that have divided their stocks outperformed the broader market in the 12 months after the split (on average). However, experienced investors understand that stock splits do not impact the inherent value of a stock.
What are The Advantages and Disadvantages of Stock Dividends and Stock Splits?
The benefits of both stock dividends and stock splits are based on the company’s economic forecasts. If the firm is predicted to grow, holding more stock in the company is desirable since an investor can sell the stock at a higher profit in the future.
If a company fails to meet investor expectations, an investor will have a larger portion of his portfolio tied up in an investment that will not produce as much money as projected, or may even lose money. This disadvantage applies to both stock dividends and stock splits because they increase the amount of stock an investor owns.
The primary distinction between a stock dividend and a stock split is the reason for which they are issued, as both produce similar results. Stock dividends are a good choice for short-term cash flow constraints, but many investors prefer the consistent income that only cash dividends can give. Both Stock Dividend and Stock Split are words used to describe corporate actions. Both are comparable, yet they are not the same. The goals of both stock dividends and stock splits are completely different. When these terms are employed, it’s important to keep in mind that they’re not interchangeable. Download the Entri app to learn more topics from the Banking awareness section and ace the bank PO exams of 2022.