Financial Statements - Accounting for Dividends

Dividends
Dividends are payments to stockholders that can be made regularly (monthly, quarterly or annually) or occasionally.

  • Companies are not required to issue a dividend to their common stockholders.
  • Companies may have an obligation to issue a dividend to preferred shareholders (see definition and properties of preferred shareholders).
  • A company's board of directors must approve of a dividend before it can be declared and issued.

There are two basic dividend forms:

  1. Cash dividends - These are cash payments made to stockholders of record. Retained earnings are reduced when dividends are declared.
  2. Stock dividends - These are dividends paid in the form of additional stock of the issuing company to shareholders of record in proportion to their current holdings. A stock dividend does not increase the wealth of the recipient nor does it reduce the net assets of the firm. It is a permanent capitalization of retained earnings to contributed capital.

Dividend Terminology

  • Date of Declaration: This is the date the board approved and declared a dividend.
  • Date of record: This is thedate set by the issuer that determines who is eligible to receive a declared dividend or capital-gains distribution.
  • Ex-dividend date: This is the first day of trading when the selling shareholder is entitled to the recently announced dividend payment. Shares purchased as of the ex-dividend date will not receive the previously declared dividend.
  • Date of payment: This is the date on which the company will pay the declared dividend to its stockholders of record as of the date of record.

Accounting for a Cash Dividend
Let's examine the payment process of a cash dividend. We'll use XYZ company again for this example.

XYZ declares a dividend on Jan 1, 2005, for its common shareholders of $400,000 payable to shareholders of record on Feb 1, 2005, and payable on Feb 31, 2005.

Accounting Impact on the Date of Declaration, Jan 1, 2005:

Accounting Impact on the Date of Payment, Feb 31, 2005:

Stock Dividends
Stock dividends involve the issuance of additional shares of stock to existing shareholders on a proportional basis. Stock dividends are issued to stockholders of record as of the record date. The dividends are not paid in cash but are paid as additional shares.

Since a company does not pay out any cash when it declares a stock dividend, the company's cash account (current assets) is not affected. The only account that is affected is the company's contributed capital (paid-up capital). When a company issues a stock dividend, the company's retained earnings are reduced by the value of the stock dividend, and the company will increase its common stock and paid-up capital accounts.

Note that the size of the dividend declared is important. If the company declares a 25% or less stock dividend (as a percentage of the company's previous total outstanding shares) then the value of the stock dividend declared is equal to the market value of the shares issued. (Common shares are increased to reflect value of dividend.) If the stock dividend is larger than 25%, the company will transfer 100% of the par or stated value of the common shares to the common-stock account.

Examples:
Stock dividends are best learned by considering an example of a situation where the stock dividend is 25% or less of previously outstanding shares, and where the stock dividend is 25% or more of the previously outstanding shares.

Situation 1: Twenty-five percent or less of previous outstanding shares
XYZ declares a stock dividend on Jan 1, 2005, for its common shareholders. On Feb 31, 2005, one share for every five shares will be paid to shareholders of records of Feb 1, 2005. XYZ shares have a market value of $10 and a par value of $40. The company has 2 million shares outstanding. What does this mean? A shareholder that has 100 shares of XYZ will receive 20 additional shares for a total of 120. Furthermore, the company will issue 400,000 additional stocks to stockholders. After the dividend is issued, the company will have 20% more shares outstanding.

Accounting impact on date of declaration:

Accounting impact on date of issuance:

Situation 2: More than 25% of previous outstanding shares.
XYZ declares a stock dividend on Jan 1, 2005, for its common shareholders. On Feb 31, 2005, three shares for every five shares will be paid to shareholders of records of Feb 1, 2005. XYZ shares have a market value of $10 and a par value of $40. The company has 2 million shares outstanding. What does this mean? A shareholder that has 100 shares of XYZ will receive 60 additional shares for a total of 160. Furthermore, the company will issue 1.2 million additional stocks to stockholders. After the dividend is issued, the company will have 60% more shares outstanding.

Accounting impact on date of declaration:

Accounting impact on date of issuance:


Look Out!

The most common mistake students make in this section is that they forget to calculate if the stock dividend is less than or higher than 25% of the shares outstanding and the reporting effect it will have.

Stock Split
Stock splits are events that increase the number of shares outstanding and reduce the par or stated value per share of the company's stock. For example, a two-for-one stock split means that the company stockholders will receive two shares for every share they currently own. This will double the number of shares outstanding and reduce by half the par value per share. Existing shareholders will see their shareholdings double in quantity, but there will be no change in the proportional ownership represented by the shares (i.e. a shareholder owning 2,000 shares out of 100,000 would then own 4,000 shares out of 200,000).

Most importantly, the total par value of shares outstanding is not affected by a stock split (i.e. the number of shares times par value per share does not change). Therefore, no journal entry is needed to account for a stock split. A memorandum notation in the accounting records indicates the decreased par value and increased number of shares.

Stocks that are trading on the exchange will normally be re-priced in accordance to the stock split. For example, if XYZ stock was trading at $90 and the company did a 3-for-1 stock split, the stock would open at $30 a share.

Stock splits are usually done to increase the liquidity of the stock (more shares outstanding) and to make it more affordable for investors to buy regular lots (regular lot = 100 shares).

Accounting for Equities


Related Articles
  1. Professionals

    Dividends and Stock Splits

    Series 7 - Equities Section 3: Dividends and Stock Splits
  2. Investing Basics

    How Dividends Affect Stock Prices

    Find out how dividends affect the price of the underlying stock, the role of market psychology and how to predict price changes after dividend declaration.
  3. Investing Basics

    How Dividends Affect Stockholders' Equity

    Find out how dividends affect a company's stockholders' equity and how the accounting process changes based on the type of dividend issued.
  4. Term

    The Truth About Dividends

    Dividends may seem like money for nothing, but they have several implications.
  5. Professionals

    Dilutive Effect of Splits and Dividends

    CFA Level 1 - Dilutive Effect of Splits and Dividends. This section highlights the dilutive effects of stock splits and dividends. Provides an example showing how splits and dividends affect ...
  6. Professionals

    Cash Dividends And Dividend Payment

    Learn how to dividends work.
  7. Professionals

    Accounting for Equities

    CFA Level 1 - Accounting for Equities. A look at the characteristics and attribrutes of preferred stock. Also learn how issuing or repurchasing stock affects the balance sheet.
  8. Forex Education

    Dividend Yield

    Investing is a complex and often daunting experience, these equations are actually quite simple.
  9. Bonds & Fixed Income

    What Are Corporate Actions?

    Be a savvy investor - learn how corporate actions affect you as a shareholder.
  10. Investing Basics

    What Are Corporate Actions?

    Corporate actions are processes that change a company’s stock. Here are a few examples.
RELATED TERMS
  1. Accrued Dividend

    An accounting term referring to the balance sheet item that accounts ...
  2. Cash-And-Stock Dividend

    A corporation distributing earnings to its shareholders as both ...
  3. Dividend

    A distribution of a portion of a company's earnings, decided ...
  4. Accumulating Shares

    Common stock given to current shareholders of a company in place ...
  5. Dividend Yield

    A financial ratio that shows how much a company pays out in dividends ...
  6. Payment Date

    The date on which a declared stock dividend is scheduled to be ...
RELATED FAQS
  1. Does a stock dividend dilute the price per share as would a forward stock split?

    Every corporation has the same goal in mind: to maximize shareholder wealth. This goal is fulfilled in two different ways, ... Read Answer >>
  2. Who actually declares a dividend?

    Understand who actually declares a dividend when a company makes a dividend payment and how the payments of dividends appear ... Read Answer >>
  3. Are dividends considered an asset?

    Find out why dividends are considered an asset for investors but a liability for the company that issued the stock, and learn ... Read Answer >>
  4. What is a dividend?

    When a company makes a profit and decides not to reinvest the profit in the business, it can pay out a portion to each of ... Read Answer >>
  5. Where can I find the past record dates for a company's cash or stock dividend?

    Learn more about dividend record dates and how they are used to determine the recipient of dividends. Find out how to locate ... Read Answer >>
  6. How do dividends affect the balance sheet?

    Learn how different types of dividends, such as cash dividends and stock dividends, affect a company's balance sheet, based ... Read Answer >>
Hot Definitions
  1. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  2. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  3. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  4. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  5. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  6. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
Trading Center