Corporations

Stock Splits and Treasury Stock

Stock Splits

The main objective of a stock split is to reduce the market price of each share of stock.

    A stock split is the issuance of a proportional number of additional shares by a corporation that reduces the par value of its common stock. The stock split applies to all shares of common stock, issued shares, unissued shares, and treasury stock. With a reduced market price per share of stock, more investors may be drawn to purchase shares, and the pool of stockholders attracted may become more diverse.

    Stock Split

    When a corporation declares a stock split, the stockholders' shares increase, while the par value of each share decreases. One share that was worth $100 becomes two shares, each worth $50.
    For example, Company ABC has 20,000 shares of $50 par common stock outstanding. The current market price is $100 per share. The board of the organization declares a 5-for-1 stock split. As a result:
    • 100,000 shares (20,000shares×5)\left(20\text{,}000\,\text {shares}\times 5\right) will be outstanding.
    • The par value of each share will be $10 ($50÷5)\left(\$50\,\div\,5\right).

    Number and Value of Shares before and after Stock Split

      Before Stock Split After Stock Split
    Number of shares issued 20,000 100,000
    Par value per share x $50 x $10
    Total value $100,000 $100,000

    The total amount attributed to common stock outstanding is the same before and after the stock split. Each individual stockholder owns the same total amount of the corporation's stock. For example, if a stockholder owns 5 shares of the $50 par stock before the split (total of $250), then this same stockholder would own 25 shares of the $10 par stock after the split (total par value of $250). Essentially, only the number of shares and the par value of each share have changed, but the total value remains the same.

    Based on the stock split, the market price of the share should also decrease. With a previous market price of $100 per share, the new market price should now be about $20 per share ($100÷5)\left(\$100\:\div\:5\right).

    Because stock splits only affect the number of shares outstanding and the par value, there is no need for a journal entry. The total amount in the common stock account remains the same. However, the details of the stock split are typically disclosed on the financial statements as a note.

    Treasury Stock

    Corporations sometimes reacquire their own stock to benefit employees and to help support the market price of its stock.

    Treasury stock is stock that has been issued and then reacquired by the same corporation. Some of the reasons that a corporation may choose to reacquire its own stock are:

    • To resell shares to employees
    • To reissue the shares as bonuses to employees
    • To assist in supporting the stock's market price

    The cost method or the par method may be used to record the transactions associated with buying and selling shares of treasury stock. Under the cost method, the treasury stock account is debited for the purchase of the stock and credited when the stock is sold. When selling treasury stock, the credit is always for the same amount as the purchase price, similar to how we treat the par value for common and preferred stock entries.

    For example, Company ABC has 10,000 shares of $10 par common stock issued and outstanding. On October 1 the corporation purchases 1,000 shares of its own common stock at $25 per share. A journal entry is made by the company to record this change.

    Purchase of Treasury Stock Entry

    Date Description Debit Credit
    Oct 1 Treasury Stock (1,000 shares x $25) $25,000  
      Cash   $25,000
      To record the purchase of 1,000 shares of treasury stock at $25    

    On November 1 the corporation sells 700 shares of the treasury stock for $35. A journal entry is made to record the sale.

    Sale of Treasury Stock

    Date Description Debit Credit
    Nov 1 Cash (700 shares x $35) $24,500  
      Treasury Stock (700 shares x $25)   $17,500
      Paid-In Capital from Sale of Treasury Stock   $7,000
      To record the sale of 700 shares of treasury stock at $35  

    In the event that the treasury stock is sold for an amount less than the purchase amount, a decrease in paid-in capital will result. The credit balance in the paid-in capital from sale of treasury stock account would be debited up to the amount in that account. Once that account has been zeroed out, the retained earnings account would be debited. To illustrate, the corporation sells 300 shares of treasury stock for $20 each on December 1. A journal entry is made to record this transaction.

    Sale of Treasury Stock at Reduced Amount Entry

    Date Description Debit Credit
    Dec 1 Cash (300 shares x $20) $6,000  
      Paid-In Capital from Sale of Treasury Stock $1,500  
      Treasury Stock (300 shares x $25)   $7,500
      To record the sale of 300 shares of treasury stock at $20    

    Based on the November 1 journal entry, the credit balance in the paid-in capital from sale of treasury stock account was $7,000. Therefore, the full $1,500 can be debited to this account on December 1.

    As a reminder, to the extent the corporation holds treasury stock, it does not pay itself a dividend.