Accounting for Cash Dividends

Dividend payment has three important dates: declaration, record, and payment.

  • Date of declaration is the date the directors vote to declare and pay a dividend. This creates a legal liability of the corporation to its stockholders.
  • Date of record is the future date for identifying those stockholders to receive dividends. Persons who own stock on the date of record receive dividends.
  • Date of payment is the date when the corporation makes payment.

To illustrate, the entry to record a January 3 declaration of a $2 per share cash dividend by the directors of ABC Tech, Inc., with 2.500 outstanding shares is

An alternative entry is to debit Dividends instead of Retained Earnings

The period-end balance in Dividends must then be closed to Retained Earnings at period-end. The effect is the same: Retained Earnings is decreased and a Dividend Payable is increased. For simplicity, all assignments in this chapter use the Retained Earnings account to record dividend declarations. Common Dividend Payable is a current liability. The date of record for the ABC Tech dividend is January 22. No journal entry is needed on the date of record.

The date of payment requires an entry to remove the liability and reduce cash.

Deficits and Cash Dividends

A corporation with a debit (abnormal) balance for Retained Earnings has a retained earnings deficit, which occurs when a company has cumulative losses and/or pays more dividends than total earnings from current and prior years. A deficit is reported as a deduction on the balance sheet, as shown

Most states prohibit a corporation with a deficit from paying a cash dividend. This restriction protects creditors by preventing distributions to stockholders when the company is in financial difficulty.

Stock Dividends

A stock dividend, declared by a corporation’s directors, is a distribution of additional shares of its own stock to its stockholders without any payment in return. Stock dividends and cash dividends are different. A stock dividend does not reduce assets and equity but instead transfers a portion of equity from retained earnings to contributed capital. Reasons for Stock Dividends

  • First, directors use stock dividends to keep the market price of the stock affordable.
  • Show management’s confidence that the company is doing well and will continue to do well.

Accounting for Stock Dividends

Five Steps to Record Stock Dividends

A stock dividend transfers part of retained earnings to contributed capital accounts, sometimes described as capitalizing retained earnings. Accounting for a stock dividend depends on whether it is a small or large stock dividend.

A small stock dividend is a distribution of 25% or less of previously outstanding shares. It is recorded by capitalizing retained earnings for an amount equal to the market value of the shares to be distributed. A large stock dividend is a distribution of more than 25% of previously outstanding shares.

Diego Fornazier Gozer

Written by

SAP Consultant https://www.linkedin.com/in/diegogozer/

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