The December 31, 2011, balances in retained earnings and additional paid-in capital for Railway Shippers Company are $135,000 and $50,000, respectively. Five thousand $10 par value common shares are outstanding with a market value of $85 each. The company’s cash position at year-end is lower than usual, so the board of directors is considering issuing a stock dividend instead of the normal cash dividend. They are considering the following options.

Option 1: A 10 percent stock dividend: 500 new shares would be issued.

Option 2: A 20 percent stock dividend: 1,000 new shares would be issued.

Option 3: A 2:1 stock split: 5,000 new shares would be issued.

(a) Prepare the journal entries for Option 1 and 2, and comment on why these alternatives may not be attractive. Why do companies issue stock dividends?

(b) What effect would Option 3 have on the financial statements?

(c) Why do companies split their stock?