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Question P15-10

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Found in: Page 821

### Intermediate Accounting (Kieso)

Book edition 16th
Author(s) Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield
Pages 1552 pages
ISBN 9781118743201

# (Stock Dividends and Stock Split) Oregon Inc. $10 par common stock is selling for$110 per share. Four million shares are currently issued and outstanding. The board of directors wishes to stimulate interest in Oregon common stock before a forthcoming stock issue but does not wish to distribute capital at this time. The board also believes that too many adjustments to the stockholders’ equity section, especially retained earnings, might discourage potential investors. The board has considered three options for stimulating interest in the stock:The board has considered three options for stimulating interest in the stock: A 20% stock dividend. A 100% stock dividend. A 2-for-1 stock split.InstructionsActing as financial advisor to the board, you have been asked to report briefly on each option and, considering the board’s wishes, make a recommendation. Discuss the effects of each of the foregoing options.

To stimulate the most interest in Oregon Inc., opts for a 2-for-1 stock split.

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## Meaning of Stock Dividend

A stock dividend can be referred to as a dividend that is preferably paid in shares in comparison to cash. The number of stock dividends to be distributed and also when the stock is distributed is decided by the board of directors.

## Putting in order on the effects of a stock dividend and a stock split

To: Oregon Inc. Board of Directors

From: Financial Advisor

Subject: Report on the effects of a stock dividend and a stock split

INTRODUCTION

As a financial adviser to Oregon Inc.'s Board of Directors, I've been requested to report on the implications of the following choices for increasing interest in Oregon Inc. shares: a 20% stock dividend, a 100% stock dividend, and a 2-for-1 stock split. The board desires to keep shareholders' equity as it appears on the most recent balance sheet. The Board also wants to promote interest in stock purchases, although the present market price of the stock ($110 per share) may deter potential investors. Finally, the Board believes that a cash dividend at this time would be inappropriate. RECOMMENDATION To address the demands of Oregon Inc., the board should decide on a 2-for-1 stock split. The only alternative that would not modify the dollar amounts in the shareholders' equity portion of the company's balance sheet is a stock split. DISCUSSION OF OPTION All three of the forenamed choices would lead to a rise in the number of outstanding common shares. As shares intend to be allocated to present shareholders on a pro-rata basis, every stockholder of record intends to retain his/her proportionate ownership following the declaration. All three choices would almost certainly create a lot of interest in the stock. A 20% STOCK DIVIDEND This option would raise the number of shares outstanding by 20%, resulting in 800,000 more shares of$10 par value common stock.

The issue with this form of a stock dividend is that GAAP requires these shares to be recorded at their current fair value if it is much greater than par.

Preparing Journal entries to record the dividend

 Date Particular Debit ($) Credit ($) Retained Earnings 88,000,000 Common Stock Dividend Distributable 8,000,000 Paid-in Capital in Excess of Par common stock 80,000,000 To record the issue of the stock dividend

Despite a rise in the Common Stock Dividend Distributable and Paid-in Capital accounts, Retained Earnings falls considerably. This decrease in Retained Earnings may jeopardize Oregon's success with the upcoming stock offer.

A 100% STOCK DIVIDEND

This option would quadruple the number of common shares with a par value of $10 that is currently issued and outstanding. As this sort of payout is essentially a stock split, shares are not required to be accounted for at fair value. Instead, only par value of extra shares is deducted from Retained Earnings, while Common Stock Dividend Distributable and, subsequently, Common Stock are increased by the same amount. When there are already 4,000,000 shares issued and outstanding, the loss in Retained Earnings due to the equity dividend is still significant:$40,000,000. Furthermore, there is no rise in any Paid-in Capital account.

Preparing Journal entries to record Dividend

 Date Particular Debit ($) Credit ($) Retained Earnings 40,000,000 Common Stock Dividend Distributable 40,000,000 To record the issue of the stock dividend

A 2-FOR-1 STOCK SPLIT

This option doubles the number of issued and outstanding shares, but it also reduces the par value of each share by half. Because the effect of dividing the par value balances out the effect of doubling the number of shares, the split requires no accounting treatment other than a memorandum entry. As a result, Retained Earnings, as well as the Common Stock and Paid-in Capital Accounts, remain unaltered. Furthermore, the lower fair value will entice investors who would otherwise think the company is overpriced.

CONCLUSION

One should choose the 2-for-1 stock split to stimulate the most interest in Oregon Inc. stock while retaining the present balances in the shareholders' equity column of the balance sheet.

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