Retained earnings are created for the most part by the earnings of the corporation. These earnings (referred to as net income) are closed into the retained earnings T-account.
Royal Bali Corporation earned $100,000 of net income.
The closing journal entry would be:
[Debit]. Income summary = 100,000
[Credit]. Retained Earnings = 100,000
Is only “net earning” in the “retained earning” account? Of course not, it also contains many other items, as shown on the following T-account:
I am going to talk about those items one by one on my next posts….
For now, I am going to talk about “Cash Dividends” at first….
In a sole proprietorship, when the owner decides to withdraw cash for his or her own personal use, that is called a drawing. In a corporation, this decision must be made by the board of directors and is called a dividend. Usually dividends are paid from the earnings that have accumulated in the retained earnings account, but occasionally, they may be paid out of other accounts.
There are three dates associated with dividends:
- The date of declaration
- The date of record
- The date of payment
On the date of declaration the board of directors holds a meeting and decides how much to pay out as a dividend. This is called “declaring a dividend“.
But who is entitled to receive the dividend? As we know, ownership of the shares changes from day to day since shares are bought and sold daily on the stock market. To resolve this problem, the board of directors must decide on a cut-off date called “the date of record“.
On June 1, the board of directors declares a dividend of $100 per share to all stockholders owning the shares on July 1. The date of declaration is June 1. The date of record is July 1. Anyone not owning shares on July 1 is not entitled to a dividend. Therefore, if someone owned shares on June 29 but sold them before July 1, he or she will not get a dividend. Conversely, if someone bought shares at the last minute of June 30, he or she thus owns them on July 1 and will be entitled to a dividend.
If in the above example the dividends will actually be paid on August 1, that is the date of payment. Journal entries need to be made on the date of declaration and date of payment. But no entry is made on the date of record.
Let’s construct a numbered example for easier understanding:
Suppose that, as in the above example, on June 1 the board of directors declared a dividend of $100 per share payable on August 1 to all common stockholders of record on July 1. Also assume that on the date of record there are 1,000 shares of common stock outstanding, plus 200 shares of treasury stock.
The journal entries would be:
June 1 (date of declaration):
[Debit] Retained Earnings 100,000
[Credit] Cash Dividends Payable 100,000
(Note: 1,000 shares @ $100 = $100,000)
July 1 (date of record): No entry
August 1 (date of payment):
[Debit]. Cash Dividends Payable = 100,000
[Credit]. Cash = 100,000
- No dividends are declared or paid on shares in the treasury.
- The Cash Dividends Payable account is a liability account, and since it is usually paid within a few months, it is a current liability.
In the previous example the dividend was expressed as a fixed dollar amount per share. Sometimes (as in the case of preferred stock) it is expressed as a percentage of par. If the preferred stock is, say, $100 par and the dividend is 6% of par, then each share will receive $6.00.
Is it a cash the only form of dividends? No.
Up-coming Post: Property Dividends and Liquidating Dividends. What is property and liquidating dividends? what is the treatment? joint me on the next post.