Stock Splits -- What are surplus and capital accounts?

Question

I just read this in The Intelligent Investor, by Benjamin Graham:

A stock split may be carried out by what technically may be called a stock dividend, which involves a transfer of sums from earned surplus to capital account; or else by a change in par value, which does not affect the surplus account.

I know about the second method of stock splitting: just divide the shares and price! But the first one I never heard of, and haven't been able to find it online. It seems that transferring money "from surplus to capital account" would just make the shares pricier?

Could you please explain this method of stock splitting?

Answer 1

It's just how the dividend is accounted for on the company's financial statements. As a company earns profits, it increases an account on the Balance Sheet called "Retained Earnings" (sometimes called "Earned Surplus"). When a company pays a cash dividend, that amount is removed from both cash and retained earnings (since the earnings are no longer "retained" by the company, but distributed to the owners).

A stock dividend is when a company issues additional shares of stock instead of cash. It also reduces retained earnings, but instead of reducing cash, it is added to two equity accounts - "capital stock" and "additional paid-in capital". The additional paid-in capital is the amount of the stock dividend that exceeded the "par" amount of the stock. It's the same calculation when a company issues shares directly. Since they are both equity accounts, the value of the company does not change (unlike a cash dividend which reduces the value of the company) - it's just divided into more shares.