On October 31, the stockholders’ equity section of Omar Company consists of comm
ID: 2351306 • Letter: O
Question
On October 31, the stockholders’ equity section of Omar Company consists of commonstock $600,000 and retained earnings $900,000. Omar is considering the following two
courses of action: (1) declaring a 5% stock dividend on the 60,000, $10 par value shares outstanding,
or (2) effecting a 2-for-1 stock split that will reduce par value to $5 per share. The current
market price is $14 per share.
Instructions
Prepare a tabular summary of the effects of the alternative actions on the components of stockholders’
equity and outstanding shares. Use the following column headings: Before Action,After
Stock Dividend, and After Stock Split.
Explanation / Answer
I'll let you worry about the tabular summary, but A stock split does not affect the accounting records, except to change the par value to $5 and the shares outstanding to 120,000. A 5% stock dividend adds 60,000*.05= 3,000 shares to the shares outstanding. It reduces retained earnings by 3,000*14 (market price of stock)= 42,000. Common Stock gets increased by 3,000* 10 (par value)= 30,000 Paid in capital in excess of par gets increases by 3,000 *4= 12,000. So a stock dividend takes out of retained earnings and transfers to paid in capital, essentially adding to the permanent capital of the company. It does not change overall shareholders' equity.