On October 31, the stockholders’ equity section of Omar Company consists of comm

Question

On October 31, the stockholders’ equity section of Omar Company consists of common
stock $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

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.

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