On October 31, the stockholders’ equity section of Cullumber Company consists of common stock $370,000 and retained earnings $904,000. Cullumber is considering the following two courses of action: (1) declaring a 6% stock dividend on the 37,000, $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 $16 per share. Prepare a tabular summary of the effects of the alternative actions on the components of stockholders’ equity, outstanding shares, and par value per share. After After Stock Before Stock Action Dividend Split Stockholders’ equity Paid-in capital Common stock In excess of par Total paid-in capital Retained earnings Total
The Correct Answer and Explanation is :
Explanation:
Cullumber Company is considering two actions related to its stockholders’ equity: a 6% stock dividend or a 2-for-1 stock split. Below is an analysis of their effects:
1. Stock Dividend (6%)
- New Shares Issued: 6% of 37,000 = 2,220 shares.
- Common Stock Increase: Since each share has a par value of $10, the common stock increases by $22,200.
- Paid-in Capital in Excess of Par: The market price per share is $16, so the additional paid-in capital per new share is $6 ($16 – $10). This results in an increase of $13,320 (2,220 × 6).
- Retained Earnings: Since stock dividends are recorded at market value, retained earnings decrease by $35,520 (2,220 × $16).
2. Stock Split (2-for-1)
- Shares Outstanding: The number of shares doubles to 74,000.
- Par Value per Share: Reduced from $10 to $5.
- Effect on Common Stock: The total dollar amount of common stock remains $370,000 since the par value decreases proportionally.
- No Effect on Retained Earnings or Paid-in Capital: The total equity remains unchanged.
Key Differences
- A stock dividend redistributes retained earnings into common stock and additional paid-in capital.
- A stock split simply increases the number of shares while reducing the per-share price without impacting the equity structure.
This analysis helps stockholders understand the implications of each action before making a decision.
