In either case, the company needs the proper journal entry for the stock dividend both at the declaration date and distribution date. For companies, there are several reasons to consider sharing some of their earnings with shareholders in the form of dividends. Many shareholders view a dividend payment as a sign of a company’s financial health and are more likely to purchase its shares. In addition, companies use dividends earnout and how its used as a negotiation tool in m&a as a marketing tool to remind investors that their share is a profit generator. There won’t be a temporary account, such as the dividend decleared account, in the journal entry of the dividend declared in this case. Hence, the company does not have a record of the dividend declared during the accounting period as the amount of the dividend declared will directly deduct the balance of the retained earnings.

• The company can make the cash dividend journal entry at the declaration date by debiting the cash dividends account and crediting the dividends payable account.
• Dividends are typically paid to shareholders of common stock, although they can also be paid to shareholders of preferred stock.
• 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 journal entry to distribute the soft drinks on January 14 decreases both the Property Dividends Payable account (debit) and the Cash account (credit).

To illustrate, assume that Duratech’s board of directors declares a 4-for-1 common stock split on its $0.50 par value stock. 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).

When a dividend is later paid to shareholders, debit the Dividends Payable account and credit the Cash account, thereby reducing both cash and the offsetting liability. If the company owns less than 20% shares of stock of another company, it can record the dividend received as the dividend income. In this case, the dividend received journal entry will increase both total assets on the balance sheet and total revenues on the income statement. Some companies choose not to pay dividends and instead reinvest all of their earnings back into the company.

Holding shares of less than 20%

By issuing a large quantity of new shares (sometimes two to five times as many shares as were outstanding), the price falls, often precipitously. The stockholder’s investment remains unchanged but, hopefully, the stock is now more attractive to investors at the lower price so that the level of active trading increases. To illustrate, assume that the Red Company reports net assets of $5 million. Janis Samples owns one thousand of the outstanding ten thousand shares of this company’s common stock. She holds a 10 percent ownership interest (1,000/10,000) in a business that holds net assets of $5 million. On that date the current liability account Dividends Payable is debited and the asset account Cash is credited.

• Treasury shares are not outstanding, so no dividends are declared or distributed for these shares.
• 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.
• When a cash dividend is declared by the board of directors, debit the retained earnings account and credit the dividends payable account, thereby reducing equity and increasing liabilities.

Of course, the board of directors of the company usually needs to make the approval on the dividend payment before it can declare and make the dividend payment to the shareholders. And the company usually needs to have sufficient cash in order to pay the dividend to its shareholders. If the dividend on the preferred shares of Wington is cumulative, the $8 is in arrears at the end of Year One. In the future, this (and any other) missed dividend must be paid before any distribution on common stock can be considered.

What are Dividends Payable?

(Both methods are acceptable.) The Dividends account is then closed to Retained Earnings at the end of the fiscal year. It is a temporary account that will be closed to the retained earnings at the end of the year. 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. 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.

The increase in the number of outstanding shares does not dilute the value of the shares held by the existing shareholders. The market value of the original shares plus the newly issued shares is the same as the market value of the original shares before the stock dividend. For example, assume an investor owns 200 shares with a market value of $10 each for a total market value of $2,000. 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).

At declaration date of cash dividend

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. GAAP, if a stock dividend is especially large (in excess of 20–25 percent of the outstanding shares), the change in retained earnings and contributed capital is recorded at par value rather than fair value2. A company may issue a dividend payment to shareholders made in shares rather than as cash. The stock dividend has the advantage of rewarding shareholders without reducing the company’s cash balance.

This entry is made at the time the dividend is declared by the company’s board of directors. The amount credited to the Dividends Payable account represents the company’s obligation to pay the dividend to shareholders. 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. When a cash dividend is declared by the board of directors, debit the retained earnings account and credit the dividends payable account, thereby reducing equity and increasing liabilities. Thus, there is an immediate decline in the equity section of the balance sheet as soon as the board of directors declares a dividend, even though no cash has yet been paid out.

Practice Question: Dividends

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. Both small and large stock dividends cause an increase in common stock and a decrease to retained earnings.

Conversely, if a preferred stock is noncumulative, a missed dividend is simply lost to the owners. It has no impact on the future allocation of dividends between preferred and common shares. When the dividend is declared by the board, the date of record is also set. All shareholders who own the stock on that day qualify for receipt of the dividend.

Dividend Dates

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 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. In this case, if the company issues stock dividends less than 20% to 25% of its total common stocks, the market price is used to assign the value to the dividend issued. The date of record establishes who is entitled to receive a dividend; shareholders who own shares on the date of record are entitled to receive a dividend even if they sell it prior to the date of payment.

The difference is the 18,000 additional shares in the stock dividend distribution. No change to the company’s assets occurred; however, the potential subsequent increase in market value of the company’s stock will increase the investor’s perception of the value of the company. In this case, the company can record the dividend paid to the shareholders with the journal entry of debiting the dividend payable account and crediting the cash account. The existence of a cumulative preferred stock dividend in arrears is information that must be disclosed in financial statements.