Definition: A reverse stock split occurs when a company recalls all of its stock from shareholders and replaces each stock with less than one share. In other words, a reverse stock split is a method to decrease the number of outstanding commons shares and allowing shareholders to maintain their current ownership percentages.
Example
When a reverse stock split is declared, the corporation sets a date that all outstanding common shares will be called in. On the date of occurrence, all the common shareholders’ stock will be called in and exchanged for a lesser amount. For example, a 1-for-2 reverse split will exchange one new share for 2 existing shares. This will decrease the number of outstanding shares in half. In other words, if you owned 1,000 shares before the split, you would only own 500 shares after the split.
The net affect of reverse stock split is nothing because the company is still worth the same amount. It just has half as many outstanding shares. In other words, a 1-for-2 split would decrease the number of outstanding shares in half, but it would also increase the value of each share by 100 percent. So, instead of owning 1,000 $1 shares, you would own 500 $2 shares.
What Does Reverse Stock Split Mean?
Companies often do reverse splits for appearances. Investors might not want to invest in a company that has a low stock price. A reverse split could double or triple the price. It is also used in mergers and ownership consolidations to remove excess stock from the market.
Since there is no real change in value and the accounting equation isn’t affect by a reverse split, no journal entry is required to record it. The financial statements and notes must be updated to reflect the new number of outstanding share, but there is not journal entry to record the split.
