Whether dividends paid on stock are considered assets depends on which role you play in the investment: the issuing company or the investor. As an investor in the stock market, any income you receive from dividends is considered an asset. However, for the company that issued the stock, those same dividends represent a liability.
- For shareholders, dividends are an asset because they increase the shareholders' net worth by the amount of the dividend.
- For companies, dividends are a liability because they reduce the company's assets by the total amount of dividend payments.
- The company deducts the value of the dividend payments from its retained earnings and transfers the amount to a temporary sub-account called dividends payable.
- Accumulated dividends give owners of cumulative preferred stock the right to receive dividends before other shareholders.
What Are Dividends?
At the end of each fiscal year, a company that turned a profit can choose to redistribute some of those funds to its shareholders in the form of dividends. They can pay dividends on a regular schedule, often on a quarterly basis. Dividends basically offer a tangible way for companies to show gratitude to their shareholders for their continued support and investment.
Paying consistent or increasing dividends each year is considered a sign of financial health. Businesses with generous dividend histories tend to be very popular among investors.
While common shareholders have the right to any common dividend payment, they are not guaranteed dividend payments; a company that has paid dividends in the past can suspend payments for a variety of reasons.
Dividends Are Considered Assets for Shareholders
When a company pays cash dividends on its outstanding shares, it first declares the dividend to be paid as a dollar amount per owned share. For example, a company with 2 million shares outstanding that declares a 50-cent cash dividend pays out a total of $1 million to all shareholders.
For Companies, Dividends Are Liabilities
Conversely, the assets of the issuing company are reduced by the payment of a dividend. In fact, the declaration of a dividend creates a temporary liability for the company.
When a dividend is declared, the total value is deducted from the company's retained earnings and transferred to a temporary liability sub-account called dividends payable. This means the company owes its shareholders money but has not yet paid. When the dividend is eventually distributed, this liability is wiped clean and the company's cash sub-account is reduced by the same amount.
The end result is the company's balance sheet reflects a reduction of the assets and stockholders' equity accounts equal to the amount of the dividend, while the liabilities account reflects no net change.
Accrued Dividends vs. Accumulated Dividends
Dividends on common stock that have been declared by a company but not yet paid to shareholders are called accrued dividends. These dividends are now the property of the record-date shareholder, which means those shareholders become creditors of the company.
To be eligible for the dividend, shareholders must buy the stock at least two business days before the record date, which is the cutoff date used to determine which shareholders are entitled to receive dividends. The company books these dividends as a current liability from the declaration date until the day they are paid to shareholders.
But what happens if a company fails to pay dividends to its shareholders? There are various reasons a company might suspend its dividend payments. A company may stop paying shareholder dividends in response to an economic downturn, an unexpected increase in operating expenses, or a need to use the money to fund important projects. In this scenario, owners of the company's common stock will not receive dividend payments.
However, the situation is different for shareholders of cumulative preferred stock. These shareholders own stock that stipulates that missed dividend payments must be paid out to them first before shareholders of other classes of stock can receive their dividend payments. This results in accumulated dividends, which are unpaid dividends on shares of cumulative preferred stock. Accumulated dividends will continue to be listed on the company's balance sheet as a liability until they are paid. If and when the company begins paying dividends again, shareholders of cumulative preferred stock will have priority over all other shareholders.