When they declare a cash dividend, some companies debit a Dividends account instead of Retained Earnings. (Both methods are acceptable.) The Dividends account is then closed to Retained Earnings at the end of the fiscal year. The journal entry to distribute the soft drinks on January 14 decreases both the Property Dividends Payable account (debit) and the Cash account (credit).
A special dividend is paid to shareholders outside of the regular dividend schedule. It may result from a windfall earnings, spin-off, or other corporate action that is seen as a one-off. In general, special dividends are rare but larger than ordinary dividends. Cash dividends are a common way for companies to return capital to shareholders. The statement of cash flows will report the amount of the cash dividends as a use of cash in the financing activities section.
The impact on the financial statement usually does not drive the decision to choose between one of the stock dividend types or a stock split. Large stock dividends and stock splits are done in an attempt to lower the market price of the stock so that it is more affordable to potential investors. A small stock dividend is viewed by investors as a distribution of the company’s earnings.
Dividend payouts are a way to provide shareholders with a return on their investment. The board of directors issues a declaration stating how much will be paid out and over what timeframe. The declaration date is the first of four important dates in the dividend payout process. A company that lacks sufficient cash for a cash dividend may declare a stock dividend to satisfy its shareholders.
There is no change in total assets, total liabilities, or total stockholders’ equity when a small stock dividend, a large stock dividend, or a stock split occurs. Both types of stock dividends impact the accounts in stockholders’ equity. A stock split causes no change in any of the accounts within stockholders’ equity.
Note that in the long run it may be more beneficial to the company and the shareholders to reinvest the capital in the business rather than paying a cash dividend. If so, the company would be more profitable and the shareholders would be rewarded with a higher stock price in the future. A stock dividend distributes shares so that after the distribution, all stockholders have the exact same percentage of ownership that they held prior to the dividend.
This computation standardizes the measure of cash dividends concerning the price of a common share. However, they shrink a company’s shareholders’ equity and cash balance by the same amount. Firms must report any cash dividend as payments in the financing activity section of their cash flow statement. You have just obtained your MBA and obtained your dream job with a large corporation as a manager trainee in the corporate accounting department. Briefly indicate the accounting entries necessary to recognize the split in the company’s accounting records and the effect the split will have on the company’s balance sheet.
Both small and large stock dividends cause an increase in common stock and a decrease to retained earnings. This is a method of capitalizing (increasing stock) a portion of the company’s earnings (retained earnings). Instead, the company prepares a memo entry in its journal that indicates the nature of the stock split and indicates the new par value. The balance sheet will reflect the new par value and the new number of shares authorized, issued, and outstanding after the stock split. To illustrate, assume that Duratech’s board of directors declares a 4-for-1 common stock split on its $0.50 par value stock.
The related journal entry is a fulfillment of the obligation established on the declaration date – 30th July; it reduces the Dividends Payable account (with a debit) and the Cash account (with a credit). The date of record establishes who is entitled to receive a dividend; shareholders who own product costs – types of costs and examples shares 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 share on the date of record.
Stock investors are typically driven by two factors—a desire to earn income in the form of dividends and a desire to benefit from the growth in the value of their investment. Members of a corporation’s board of directors understand the need to provide investors with a periodic return, and as a result, often declare dividends up to four times per year. However, companies can declare dividends whenever they want and are not limited in the number of annual declarations. They are not considered expenses, and they are not reported on the income statement. They are a distribution of the net income of a company and are not a cost of business operations. Such dividends—in full or in part—must be declared by the board of directors before paid.
These shareholders do not have to pay income taxes on stock dividends when they receive them; instead, they are taxed when the investor sells them in the future. This section explains the three types of dividends—cash dividends, property dividends, and stock dividends—along with stock splits, showing the journal entries involved and the reason why companies declare and pay dividends. Some companies choose not to pay dividends and instead reinvest all of their earnings back into the company.
There are two types of stock dividends—small stock dividends and large stock dividends. The key difference is that small dividends are recorded at market value and large dividends are recorded at the stated or par value. In February 2022, the sportswear brand announced a $0.305 per share quarterly cash dividend payable Apr. 1, 2022. For fiscal year 2021, the company saw year-over-year (YOY) increased revenues of 19.3%. Cash dividends are a common way for companies to return capital to their shareholders in the form of periodic cash payments—typically, quarterly—but some stocks may pay these bonuses on a monthly, annual, or semiannual basis.
Just before the split, the company has 60,000 shares of common stock outstanding, and its stock was selling at $24 per share. The split causes the number of shares outstanding to increase by four times to 240,000 shares (4 × 60,000), and the par value to decline to one-fourth of its original value, to $0.125 per share ($0.50 ÷ 4). After the distribution, the total stockholders’ equity remains the same as it was prior to the distribution. The amounts within the accounts are merely shifted from the earned capital account (Retained Earnings) to the contributed capital accounts (Common Stock and Additional Paid-in Capital). The difference is the 3,000 additional shares of the stock dividend distribution. The company still has the same total value of assets, so its value does not change at the time a stock distribution occurs.
An investor who bought common shares before the ex-dividend date is entitled to the announced cash dividend. There is no journal entry recorded; the company creates a list of the shareholders that will receive dividends. Cumulative preferred stock is preferred stock for which the right to receive a basic dividend accumulates if the dividend is not paid.
To illustrate, assume that Duratech Corporation’s balance sheet at the end of its second year of operations shows the following in the stockholders’ equity section prior to the declaration of a large stock dividend. The date of record determines which shareholders will receive the dividends. There is no journal entry recorded; the company creates a list of the stockholders that will receive dividends. For corporations, there are several reasons to consider sharing some of their earnings with investors in the form of dividends. Many investors view a dividend payment as a sign of a company’s financial health and are more likely to purchase its stock. In addition, corporations use dividends as a marketing tool to remind investors that their stock is a profit generator.
J.B. Maverick is an active trader, commodity futures broker, and stock market analyst 17+ years of experience, in addition to 10+ years of experience as a finance writer and book editor. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
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. The board of directors of a corporation possesses sole power to declare dividends. The legality of a dividend generally depends on the amount of retained earnings available for dividends—not on the net income of any one period. Firms can pay dividends in periods in which they incurred losses, provided retained earnings and the cash position justify the dividend. And in some states, companies can declare dividends from current earnings despite an accumulated deficit.
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