Dividends

The decision to distribute dividend income of the organization lies with the board of directors. The decision to declare a dividend, whether cash or stock, results in a decrease in the retained earnings of the corporation. Before a dividend can be declared, there are conditions that must be met depending on the type of dividend. When a formal action by the board of directors has been made to announce a dividend, the dividend announcement includes the date of declaration, the date of record, and the date of payment.

1. Date of declaration—Date that the board of directors formally authorizes the dividend payment. At this time, the corporation recognizes it, and the dividend becomes a liability.

2. Date of record—Date on which the corporation will determine which stockholders will receive dividends. Between the date of declaration and the date of record, the cut-off date, anyone who acquires shares of stock during that time will receive an immediate dividend. This increases the value of the stock being bought. There is no transaction on this date, and so there is no journal entry to record.

3. Date of payment—Date the corporation will actually pay the dividends to the stockholders who were owners of stock as of the date of record. Any new stock acquired between the date of record and the date of payment will not receive a dividend. This is referred to as selling ex-dividends.

A cash dividend is a distribution of the corporation's earnings in the form of cash. There must be formal action by the board of directors as well as sufficient retained earnings and cash to declare and distribute a cash dividend. Though there is a need for a sufficient balance in the retained earnings account, it is important to remember that this account is separate from the cash account. If a corporation has sufficient retained earnings but not enough cash, a dividend cannot be paid. Though paying dividends is not a requirement of the board of directors, most companies pay quarterly cash dividends to keep their stock as an attractive investment for potential investors.

For example, based on three dates that are included in the stock announcement, Company ABC makes journal entries. Company ABC's board declares a cash dividend on October 1. The date of record is November 1, and the date of payment is December 1. The corporation had issued 10,000 shares of preferred stock with dividends per share of $3 and 25,000 shares of the common stock with dividends per share of $0.50, set by Company ABC’s board. The first step is to calculate the total dividend.

On October 1, the declaration date, the journal entry includes a debit to dividend expense, which is a contra-equity account, and a credit to cash dividends payable, a liability account. There would be no journal entry on November 1 for the date of record because there is no transaction; this date only determines who will receive a dividend. On the date of payment, December 1, the journal entry would include a debit to cash dividends payable, the liability account previously used, and a credit to cash to show that the payment was made. Note that dividends are reported on the income statement.

A stock dividend is a distribution of the corporation's earnings in the form of additional stock to stockholders. Stock dividends are traditionally declared on common stock and are issued to common stockholders. To declare a stock dividend, there must be a formal action by the board of directors, and the corporation must have sufficient retained earnings. However, because cash is not being distributed, there is no need for a sufficient cash balance. The amount of the stock dividend is transferred from retained earnings to paid-in capital. The amount is usually based on the fair market value of the stock dividend or the current market price of the stock.

For example, Company ABC has approved issuing of up to 20,000 shares of $50 par preferred stock and 50,000 shares of $10 common stock. The corporation then issues 10,000 shares $50 par preferred stock and 25,000 shares of $10 common stock. The corporation also declares a stock dividend of 10%, or 2,500 shares $\left(25\text{,}000\,\text {shares}\times 10\%\right)$, to be issued on December 1. The market price of the corporation's common stock on the date of declaration, October 1, is $15 per share.

On October 1, the declaration date, the journal entry includes a debit to stock dividend expense that is a contra-equity account, and a credit to stock dividends distributable and paid-in excess of par-common stock. Both of these liability accounts are reported in the paid-in capital section of the balance sheet for Company ABC. On December 1, the stock dividends distributable account is converted into common stock for the stockholders.

The stock dividend does not change any section of the balance sheet (assets, liabilities, or owner’s equity). It also does not change the proportional share of a stockholder. To illustrate, a stockholder owns 1,000 shares of the company's 10,000 outstanding shares. With a 5% stock dividend, the stockholder would still own the same percentage of shares before and after the dividend distribution.