All right. Now, let's discuss stock splits. So a stock split is the splitting of stock. It causes each share of stock to split into multiple shares based on the terms of the split. So a stock split, what we're going to see, it’s going to have no effect on paid-in capital, retained earnings, or total stockholders' equity. All we're doing is changing the pie, right? Where before, we might have had a pie, let's say, cut like this. Well, now, we're just going to cut the pie into different pieces, right? We're going to split the pie into more pieces. So let me do those last two cuts. This is the stock split. Another abstract painting here. So where we before had 4 pieces of 1 pie, the pie stays the same size, we're just splitting it into more pieces. Okay? So a stock split is going to increase the number of common shares and decrease the par value per share.
So let's go ahead and see some terminology that we're going to use here. The terms for a stock split are generally going to be written as X for Y. So the most common one you're going to see is a 2 for 1 stock split. But you can see trickier ones where they'll do something like a 3 for 2 stock split or a 5 for 2 stock split. Well, I'm going to get you ready to handle those kinds of crazy stock splits, but for the most part, you're going to be dealing with something like a 2 for 1 stock split. Okay? So what I like to think about is a stock split ratio. This isn't a real ratio like all the ratios that we learn in this class. The split ratio is something that helps us determine the new number of shares and the new par value. So when we're dealing with the stock split, generally, the questions are going to ask you, How many shares are there outstanding after the stock split? What's the new par value after the stock split? What's the new market price after the stock split? Right? And that all depends on what the terms of the split are. So the first thing we want to do is find that split ratio. It's going to tell you something like X for Y, a 2 for 1 stock split, a 5 for 2 stock split. So notice how easy it is. When it's a 2 for 1 stock split, well, it just equals 2. Right? So it's very simple. That's why you don't really need the ratio in that case. But if it's something like a 5 for 2 stock split, well now 5 for 2, the answer is 2.5. So what does this tell us? This split ratio tells us for each one share, how much are we getting, how much is each one share splitting. So in the case of a 2 for 1 stock split, each one share is splitting into 2 shares. In the case of a 5 for 2 stock split, each one share is splitting into 2.5 shares. Okay?
So what we're going to do is we're going to use that split ratio to calculate the new shares outstanding, the new par value, and the new market price. So for the shares outstanding, we need to multiply by the split ratio. We take the old shares outstanding times the split ratio. But when we're looking at the prices, the par value and the market price, we divide by that split ratio. We're taking that previous market price or the previous par value and we're decreasing it. We're dividing by that split ratio. So the old par value divided by the split ratio is like the old market price divided by the split ratio. Okay?
So, why don't we just go ahead and jump into this example right here and we'll try this first one right now. So I'll leave those on the screen. So the growing company declared a 2 for 1 stock split on their $0.20 par value common stock when 250,000 shares were outstanding. The market price per share at the time of the split was $40. Okay? So when it's a 2 for 1, it's pretty easy. You can imagine that 2 for 1 means that the prices are going to be cut in half and we're going to double the amount of shares. But let's go through it with our split ratio. So the split ratio, and remember, this isn't a real ratio. I made this up because I think it makes it easier to do these problems. So the split ratio would be 2 for 1, 2 divided by 1, it's going to equal 2. So, remember, when we do a stock split, there's no journal entry. All we're doing is we're changing the market price, the par value, and the shares outstanding. There's not going to be any redistribution of retained earnings. There's not going to be more common stock in the common stock account. None of that is changing. Okay? All we're doing is redistributing or changing how we split the pie, right? As I did in my abstract drawing above. So there's no journal entry. Okay? So no journal entry, we might make a memo that'll show the new, new number of outstanding stock, the new par value, etcetera. So let's go ahead and let's calculate each of these. I'm going to get out of the way. So the new shares outstanding, what are we going to do? We're going to take the old shares, so there was 250,000 shares before. Well, each share split into 2. So now there's 500,000 shares outstanding. Okay, so now there are 500,000 shares as the new shares outstanding of this stock, okay? But notice that each of these shares is going to have less value. So, the new par value the new par value is going to be the old par value of 20¢. So $0.20 divided by the split ratio of 2, right? So it's going to be halved to $0.10 par value. So notice even though there are twice as many shares, each of them has half the par value and each of them has half the market price. So the old market price was $40, We're going to divide that by 2, our split ratio, and we're going to get $20 is the new market price. So see what's happened here? All we did was we split the stock into twice as much stock, but the par value per share has decreased to 10¢ per share and the market price has decreased to half as much as well, $20 market price. Okay? So why don't you guys try the next one as a practice problem and see if you guys can figure out the new shares outstanding, new par value, and new market price and then test it in the next video. Cool? Let's try.
