The ex-dividend date is the first day on which an investor is not entitled to the dividend. 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. There are two types of stock dividends—small stock dividends and large stock dividends.
- Journal entries are required on both the date of declaration and the date of payment.
- Dividends payable are part of liabilities, which represent the obligations of the company to others.
- The new shares have half the par value of the original shares, but now the shareholder owns twice as many.
- The treatment as a current liability is because these items represent a board-approved future outflow of cash, i.e. a future payment to shareholders.
This journal entry of recording the dividend declared will increase total liabilities by $100,000 while decreasing the total equity by the same amount of $100,000. Similar to the cash dividend, the stock dividend will reduce the retained earnings at the year-end. However, as the stock usually has two values attached, par value and market value, it considered less straightforward than the cash dividend transaction. Janis Samples receives forty of these newly issued shares (4 percent of one thousand) so that her holdings have grown to 1,040 shares.
Impact of a Stock Dividend on Market Capitalization
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.
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. The company usually needs to have adequate cash and sufficient retained earnings to payout the cash dividend. This is due to, in many jurisdictions, paying out the cash dividend from the company’s common stock is usually not allowed. And of course, dividends needed to be declared first before it can be distributed or paid out.
In this journal entry, there is no paid-in capital in excess of par-common stock as in the journal entry of small stock dividend. This is due to when the company issues the large stock dividend, the value assigned to the dividend is the par value of the common stock, not the market solvency vs liquidity price. Common stock dividend distributable is an equity account, not a liability account. Likewise, this account is presented under the common stock in the equity section of the balance sheet if the company closes the account before the distribution date of the stock dividend.
A company that does not have enough cash may choose to pay a stock dividend in lieu of a cash dividend. In other words, a cash dividend allows a company to maintain its current cash position. Assuming there is no preferred stock issued, a business does not have to pay a dividend, the decision is up to the board of directors, who will decide based on the requirements of the business. To see the effects on the balance sheet, it is helpful to compare the stockholders’ equity section of the balance sheet before and after the small stock dividend. While a few companies may use a temporary account, Dividends Declared, rather than Retained Earnings, most companies debit Retained Earnings directly.
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. When dividends are distributed, they are stated as a per share amount and are paid only on fully issued shares.
Although, the duration between dividend declared and paid is usually not long, it is still important to make the two separate journal entries. This is especially so when the two dates are in the different account period. Dividends declared account is a temporary contra account to retained earnings. The balance in this account will be transferred to retained earnings when the company closes the year-end account. When the company owns the shares between 20% to 50% in another company, it needs to follow the equity method for recording the dividend received. When the company owns the shares less than 20% in another company, it needs to follow the cost method to record the dividend received.
However, the cash dividends and the dividends declared accounts are usually the same. Credit The credit entry to dividends payable represents a balance sheet liability. At the date of declaration, the business now has a liability to the shareholders to pay them the dividend at a later date.
Impact of Dividend on Cash Flow Statement
The debit to Retained Earnings represents a reduction in the company’s equity, as the company is distributing a portion of its profits to shareholders. Stock dividends also provide owners with the possibility of other benefits. For example, cash dividend payments usually drop after a stock dividend but not always in proportion to the change in the number of outstanding shares. An owner might hold one hundred shares of common stock in a corporation that has paid $1 per share as an annual cash dividend over the past few years (a total of $100 per year). The board of directors might then choose to reduce the annual cash dividend to only $0.60 per share so that future payments go up to $120 per year (two hundred shares × $0.60 each). The investors can merely hope that additional cash dividends will be received.
Accounting Business and Society
(Both methods are acceptable.) The Dividends account is then closed to Retained Earnings at the end of the fiscal year. Suppose a corporation currently has 100,000 common shares outstanding with a par value of $10. The announced dividend, despite the cash still being in the possession of the company at the time of the announcement, creates a current liability line item on the balance sheet called “Dividends Payable”.
Many corporations distribute cash dividends after a formal declaration is passed by the board of directors. Journal entries are required on both the date of declaration and the date of payment. The date of record and the ex-dividend date are important in identifying the owners entitled to receive the dividend but no transaction occurs. Preferred stock dividends are often cumulative so that any dividends in arrears must be paid before a common stock distribution can be made.
Dividends are not guaranteed, and they can be reduced or eliminated if the corporation’s profitability declines. However, many corporations have a long history of paying dividends, and shareholders often expect to receive them on a regular basis. For the holding of more than 50% of shares, the company will become a parent company where the investee company that it has invested in becomes the subsidiary company. In this case, the company will need to prepare consolidated financial statements where they present all assets, liabilities, revenues, and expenses of subsidiary companies. When the company makes a stock investment in another’s company, it may receive the dividend from the stock investment before it sells it back.