Stock dividends dilute the ownership percentage but do not change the total value of equity held by each shareholder. They are often used when companies wish to reward shareholders without reducing cash reserves. Upon the declaration of dividends by the board of directors, the company must make an entry in its journal to reflect the creation of a dividend payable liability. This entry involves debiting the retained earnings account and crediting the dividends payable account. Retained earnings are the cumulative net income less any dividends paid to shareholders over the life of the company.
Accounting for a Cash Dividend
However, the cash dividends and the dividends declared accounts are usually the same. When cash dividends are declared, if there is any preferred stock outstanding, the dividends have to be applied to the preferred stock first. We’ll tackle that in the next section after you check your understanding of accounting for cash dividends in general. The board of directors of a corporation possesses sole power to declare dividends.
How do you record a dividend payment to stockholders?
If a 5-for-1 split occurs, shareholders receive 5 new shares for each of the original shares they owned, and the new par value results in one-fifth of the original par value per share. At the time dividends are declared, the board establishes a date of record and a date of payment. The date of record establishes who is entitled to receive a dividend; stockholders who own stock on the date of record are entitled to receive a dividend even if they sell it prior to the date of payment. Investors who purchase shares after the date of record but before the payment date are not entitled to receive dividends since they did not own the stock on the date of record. The date of payment is the date that payment is issued to the investor for the amount of the dividend declared. Cash dividend is a distribution of earnings by cash to the shareholders of the company.
Example of the Accounting for Cash Dividends
The dividend payout ratio is the ratio of dividends to net income, and represents the proportion of net income paid out to equity holders. On the date that the board of directors decides to pay a dividend, it will determine the amount to pay and the date on which payment will be made. The amount transferred between the two accounts depends on whether the dividend is a small stock dividend or a large stock dividend. There is nothing wrong with this procedure, except that a closing entry must be made to close the Dividends Declared account into Retained Earnings.
Journal Entry Sequences for Stock Dividends
To illustrate how these three dates relate to an actual situation, assume the board of directors of the Allen Corporation declared a cash dividend on May 5, (date of declaration). The cash dividend declared is $1.25 per share to stockholders of record on July 1, (date of record), payable on July 10, (date of payment). This has the effect of reducing retained earnings while increasing common stock and paid-in capital by the same amount. Journalizing the transaction differs, depending on the number of shares the company decides to distribute.
Cash vs. Stock Dividends
Some companies choose not to pay dividends and instead reinvest all of their earnings back into the company. One common scenario for situation occurs when a company experiencing rapid growth. The company may want to invest all their retained earnings to support and continue that growth. Another scenario is a mature business that believes retaining its earnings is more likely to result in an increased market value and share price. In other instances, a business may want to use its earnings to purchase new assets or branch out into new areas. Most companies like Woolworths, however, attempt dividend smoothing, the practice of paying dividends that are relatively equal period after period, even when earnings fluctuate.
What are Dividends Payable?
Accounting practices are not uniform concerning the actual sequence of entries made to record stock dividends. This journal entry is to eliminate the dividend liabilities that the company has recorded on December 20, 2019, which is the declaration date of the dividend. Stock Dividends is calculated by multiplying the number of additional shares to be distributed by the fair market value of each share. The journal entry to https://www.simple-accounting.org/ distribute the soft drinks on January 14 decreases both the Property Dividends Payable account (debit) and the Cash account (credit). The declaration to record the property dividend is a decrease (debit) to Retained Earnings for the value of the dividend and an increase (credit) to Property Dividends Payable for the $210,000. It is a temporary account that will be closed to the retained earnings at the end of the year.
Likewise, the common stock dividend distributable is $50,000 (500,000 x 10% x $1) as the common stock has a par value of $1 per share. In year four, preferred stockholders must receive $75,000 before common shareholders receive anything. Of the $175,000 is declared, preferred stockholders receive their $75,000 and the common stockholders get the remaining $100,000. If the company prepares a balance sheet prior to distributing the stock dividend, the Common Stock Dividend Distributable account is reported in the equity section of the balance sheet beneath the Common Stock account. Note that dividends are distributed or paid only to shares of stock that are outstanding. Treasury shares are not outstanding, so no dividends are declared or distributed for these shares.
On the Date of Payment, you would make an entry to debit Stock Dividends Distributable and credit the Common Stock account. For information pertaining to the registration status of 11 Financial, please contact the state securities regulators for those states in which 11 Financial maintains a registration advance payment filing. Amy is a Certified Public Accountant (CPA), having worked in the accounting industry for 14 years. She is a seasoned finance executive having held various positions both in public accounting and most recently as the Chief Financial Officer of a large manufacturing company based out of Michigan.
From the moment dividends are declared to the point where they impact a company’s balance sheet, every entry must be carefully documented. When a dividend is paid as cash, then the company will have less cash, reducing its value, and therefore, its value per share (theoretically). If the dividend is paid as stock, then there are more shares outstanding, but the value of the company has not increased; therefore, the company’s value per share is reduced. There is no journal entry recorded; the company creates a list of the shareholders that will receive dividends. It is useful to note that the record date is the date the company determines the ownership of the shares for the dividend payment.
The declaration of dividends is a signal to the market, often interpreted as a sign of a company’s strong financial health and future earnings prospects. The correct journal entry post-declaration would thus be a debit to the retained earnings account and a credit of an equal amount to the dividends payable account. For example, on December 20, 2019, the board of directors of the company ABC declares to pay dividends of $0.50 per share on January 15, 2020, to the shareholders with the record date on December 31, 2019.
If a financial statement date intervenes between the declaration and distribution dates, the Stock Dividend Distributable account should be disclosed as part of Paid-In Capital. You should definitely have cash as one of your accounts, and yes, it records cash leaving the business (being credited). The subsequent distribution will reduce the Common Stock Dividends Distributable account with a debit and increase the Common Stock account with a credit for the $9,000. Retained earnings are the increase in the firm’s net assets due to profitable operations and represent the owners’ claim against net assets, not just cash.
This is a method of capitalizing (increasing stock) a portion of the company’s earnings (retained earnings). A small stock dividend occurs when a stock dividend distribution is less than 25% of the total outstanding shares based on the shares outstanding prior to the dividend distribution. To illustrate, assume that Duratech Corporation has 60,000 shares of $0.50 par value common stock outstanding at the end of its second year of operations. Duratech’s board of directors declares a 5% stock dividend on the last day of the year, and the market value of each share of stock on the same day was $9. Figure 14.9 shows the stockholders’ equity section of Duratech’s balance sheet just prior to the stock declaration. When the payment date arrives, the company must record the actual disbursement of dividends.
- Returning to the General Electric Company example, the company paid dividends of $852 million in 1983, which represented 42% of its net income.
- A dividend is a payment of a share of the profits of a corporation to its shareholders.
- This decision is strategic, as it balances the need to reward shareholders with the necessity to fund ongoing operations and future investments.
- This entry is made at the time the dividend is declared by the company’s board of directors.
- The articles and research support materials available on this site are educational and are not intended to be investment or tax advice.
- The debit to retained earnings represents the reduction in the company’s earnings as a result of the dividend declaration.
The board of directors determines the amount of the dividend, and the company must declare a dividend before it can be paid. In this case, the company will just directly debit the retained earnings account in the entry of the stock dividend declared. In the next section, we’ll learn about another more common way for shareholders to acquire additional shares of stock, but first let’s review stock dividends. A stock split is much like a large stock dividend in that both are large enough to cause a change in the market price of the stock. Additionally, the split indicates that share value has been increasing, suggesting growth is likely to continue and result in further increase in demand and value. When a cash dividend is declared, the board of directors specifies an amount that is to be paid per share to stockholders as of specified record date on a specified payment date.
Preferred stockholders are paid a designated dollar amount per share before common stockholders receive any cash dividends. However, it is possible that the dividend declared is not enough to pay the entire amount per preferred share that is guaranteed—before common stockholders receive dividends. In that case, the amount declared is divided by the number of preferred shares.