Financial Accounting

Chapter 10: Stockholders’ Equity, Earnings and Dividends

Entries for Cash Dividends

Dividends are distributions of earnings by a

corporation to its stockholders. Usually the
corporation pays dividends in cash, but it may
distribute additional shares of the corporation’s
own capital stock as dividends. Occasionally, a
company pays dividends in merchandise or other
assets. Since dividends are the means whereby
the owners of a corporation share in its earnings,
accountants charge them against retained
earnings. Dividends are always based on shares
outstanding!

Before dividends can be paid, the board of

directors must declare them so they can be
recorded in the corporation’s minutes book. Three
dividend dates are significant:

Date of declaration. The date of declaration

indicates when the board of directors
approved a motion declaring that dividends
should be paid. The board action creates the
liability for dividends payable (or stock
dividends distributable for stock dividends).

Date of record. The board of directors

establishes the date of record; it determines
which stockholders receive dividends. The
corporation’s records (the stockholders’
ledger) determine its stockholders as of the
date of record.

Date of payment. The date of payment

indicates when the corporation will pay
dividends to the stockholders.

To illustrate how these three dates relate to an

actual situation, assume the board of directors of
the Allen Corporation declared a cash dividend
on May 5, (date of declaration). The cash dividend
declared is $1.25 per share to stockholders of
record on July 1, (date of record), payable on July
10, (date of payment). Because financial
transactions occur on both the date of declaration
(a liability is incurred) and on the date of payment
(cash is paid), journal entries record the
transactions on both of these dates. No journal
entry is required on the date of record. The
Dividends Payable account appears as a current
liability on the balance sheet.

Cash dividends are cash distributions of

accumulated earnings by a corporation to its
stockholders. To illustrate the entries for cash
dividends, consider the following example.
On January 21, a corporation’s board of directors
declared a 2% cash dividend on $100,000 of
outstanding common stock. The dividend will be
paid on March 1, to stockholders of record
on February 5. An entry is not needed on the date
of record; however, the entries at the declaration
and payment dates are as follows:

Debit Credit

Jan Retained earnings ($100,000

2,000
21 x 2% dividend)

Dividends payable 2,000

Declared 2% cash dividend to

payable Mar 1 to
shareholders of record Feb 5.

Mar
Dividends payable 2,000
1

Cash 2,000

Paid the dividend declared

on January 21.

Often a cash dividend is stated as so many dollars

per share. For instance, the dividend could have
been stated as $2 per share. When they declare a
cash dividend, some companies debit a Dividends
account instead of Retained Earnings. (Both
methods are acceptable.) The Dividends account is
then closed to Retained Earnings at the end of the
fiscal year.

A company that lacks sufficient cash for a cash

dividend may declare a stock dividend to satisfy its
shareholders. Note that in the long run it may be
more beneficial to the company and the
shareholders to reinvest the capital in the business
rather than paying a cash dividend. If so, the
company would be more profitable and the
shareholders would be rewarded with a higher
stock price in the future.

Preferred Stock Dividends

Stock preferred as to dividends means that the

preferred stockholders receive a specified
dividend per share before common stockholders
receive any dividends. A dividend on preferred
stock is the amount paid to preferred stockholders
as a return for the use of their money. For no-par
preferred stock, the dividend is a specific dollar
amount per share per year, such as $4.40 per
share. For par value preferred stock, the dividend
is usually stated as a percentage of the par value,
such as 8% of par value; occasionally, it is a
specific dollar amount per share. Most preferred
stock has a par value. The formula for calculating
ANNUAL preferred dividends is:

Preferred shares outstanding x preferred par

value x dividend rate

Usually, stockholders receive dividends on

preferred stock quarterly. Such dividends—in full or
in part—must be declared by the board of directors
before paid. In some states, corporations can
declare preferred stock dividends only if they have
retained earnings (income that has been retained
in the business) at least equal to the dividend
declared.

Noncumulative preferred stock is preferred stock

on which the right to receive a dividend expires
whenever the dividend is not declared. When
noncumulative preferred stock is outstanding, a
dividend omitted or not paid in any one year need
not be paid in any future year. Because omitted
dividends are lost forever, noncumulative preferred
stocks are not attractive to investors and are rarely
issued.

Cumulative preferred stock is preferred stock for

which the right to receive a basic dividend
accumulates if the dividend is not paid. Companies
must pay unpaid cumulative preferred dividends
before paying any dividends on the common stock.

For example, assume a company has 10,00 shares

of cumulative $10 par value, 10% preferred stock
outstanding, common stock outstanding of
$200,000, and retained earnings of $30,000. The
company did not pay dividends last year. The
company would pay the preferred stockholders
dividends of $20,000 (10,000 shares preferred
stock x $10 par value x 10% dividend rate =
$10,000 per year x 2 years) before paying any
dividends to the common stockholders. If the
board declares dividends of $25,000, $20,000
would be paid to preferred and the remaining
$5,000 ($25,0000 dividends – $20,000 paid to
preferred) would be shared by common
stockholders. Common stockholders are not
guaranteed dividends and will receie only the
amount left over after paying preferred stock
holders. Keep in mind, you can never pay out
more in dividends than you have declared!

Dividends in arrears are cumulative unpaid

dividends, including the dividends not declared for
the current year. Dividends in arrears never appear
as a liability of the corporation because they are
not a legal liability until declared by the board of
directors. However, since the amount of dividends
in arrears may influence the decisions of users of a
corporation’s financial statements, firms disclose
such dividends in a footnote. An appropriate
footnote might read: “Dividends in the amount of
$20,000, representing two years’ dividends on the
company’s 10%, cumulative preferred stock, were
in arrears as of December 31″.

The board of directors of a corporation possesses

sole power to declare dividends. The legality of a
dividend generally depends on the amount of
retained earnings available for dividends—not on
the net income of any one period. Firms can pay
dividends in periods in which they incurred losses,
provided retained earnings and the cash position
justify the dividend. And in some states, companies
can declare dividends from current earnings
despite an accumulated deficit. The financial
advisability of declaring a dividend depends on the
cash position of the corporation.

LICENSES AND ATTRIBUTIONS

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