What Is Declaring a Dividend?

Companies often payout a portion of its profits as dividends to the shareholders. 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. This declaration implies a liability for the dividend payments. The declaration date is the first of four important dates in the dividend payout process.

Key Takeaways

  • The board of directors issues the declaration stating how much will be paid out in dividends to shareholders and over what timeframe.
  • The declaration date is the first of four important dates in the dividend payout process.
  • The three remaining key dates are the ex-date, the record date, and the payment date.

How Declaring a Dividend Works

Before a cash dividend is declared and subsequently paid to shareholders, a company's board of directors must decide to pay the dividend and in what amount. The board must agree on the cash amount to be paid to the shareholders, both individually and in the aggregate. The board must also set a record date to determine which stockholders are entitled to receive the dividend, decide on the payment date, and notify the stockholders.

When the board of directors makes such a decision and declares a dividend for payment to stockholders, the retained earnings account on the company's balance sheet is reduced by the amount of the declared dividend. The retained earnings is an account of equity that shows the net balance of a company's earnings. Since the retained earnings account is an equity account, dividend payments must be deducted from the account, reflecting the reduction in total shareholder equity.

There are four important dates related to dividend payouts. The first, the declaration date, is a commitment by the company to pay the stated amount to shareholders.

The debit to the retained earnings account is balanced by a credit to the dividends payable liability account. The same process applies to declarations of dividend payments for either preferred or common stock.

Key Dividend Dates

There are four key dates involved in the dividend process, of which the declaration date is the first.

  1. The declaration date is also referred to as the announcement date since a company notifies shareholders and the rest of the market. The declaration date is the date on which a company officially commits to the payment of a dividend.
  2. The ex-dividend date, or ex-date, is the date on which a stock begins trading without the dividend. To receive the declared dividend, shareholders must own the stock prior to the ex-dividend date.
  3. The record date occurs three business days after the ex-dividend date and is the date on which a company officially determines the shareholders of record, those who owned the stock prior to the ex-dividend date, who are eligible to receive the dividend payment.
  4. The payment date is the date the company sends out dividend payments to shareholders. The payment date typically occurs a week or two after the date of record.

Fast Fact

Dividend payments must be deducted from the retained earnings account, which is an equity account, to reflecting the reduction in total shareholder equity.