Decrease in retained earnings follows the distribution of dividends. The types of dividends include [1] cash, [2] property, [3] scrip, [4] liquidating, and [5] stock. With the exception of stock dividends, all the other dividends reduce the stockholder’s equity in the corporation. How are they exactly recorded? We discuss in this post. Have a read!

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Cash Dividends

Firms distribute as cash dividends a certain percentage of annual earnings in payout rates. Four dates are crucial to accounting for cash dividends as follows:

  • The date of declaration is the date a resolution to pay cash dividends to stockholders of record on a specific future date is approved by the board of directors. At that date the firm incurs a liability prompting the recognition of a short-term debt—Dividends Payable and the debit to either Retained Earnings or Cash Dividend Declared.
  • The ex-dividend date is the date the stock stops selling with dividends attached. The period between the date of declaration and the ex-dividend date is used by the firm to update its stockholders’ ledger.
  • The date of record is the date at which the stockholders figuring in the stockholders’ ledger are entitled to the cash dividend. No entry is required.
  • The date of payment is the date at which the firm distributes the dividend checks and eliminates the dividend payable as a liability.

Case Example

Let’s assume that the Lie Dharma Corporation, on March 15, 2009, declared a cash dividend of $1 per share on 2,000,000 shares payable June 1, 2009, to all stockholders of record April 15. The following journal entries are required:

1. Date of declaration, March 15, 2009

[Debit]. Retained Earnings [Cash Dividend Declared] = 2,000,000
[Credit]. Dividends Payable = 2,000,000

2. Date of record, April 15, 2009

Memorandum entry that the firm will pay a dividend to all stockholders of record as of today, the date of record.

3. Date of payment, June 1, 2009

[Debit]. Dividends Payable = 2,000,000
[Credit]. Cash = 2,000,000

Note: It is appropriate to note that cash dividend declared is closed at year-end to Retained Earnings.

 

 

Property Dividends

Firms may elect to declare a property dividend that is payable in nonmonetary assets rather than declaring a cash dividend. Because a property dividend can be classified as a “non-reciprocal nonmonetary transfer to owners”, the property distributed is restated at fair market value at the date of declaration and a gain or loss is recognized.

 

Case Example

Let’s assume that the PUTRA Corporation declares a property dividend, payable in bonds of Lie Dharma Company being held to maturity and costing $500,000. At the date of declaration the bonds had a market value of $600,000. The following journal entries are required:

1. Date of Declaration

Investments in Lie Dharma Company

[Debit]. Bonds = 100,000
[Credit]. Gain on Appreciation of Bonds = 100,000
[$600,000 – $500,000]

[Debit]. Retained Earnings [Property Dividend Declared] = $600,00
[Credit]. Property Dividends Payable = $600,000

2. Date of Distribution

[Debit]. Property Dividends Payable = 600,000
[Credit]. Investments in Lie Dharma Company Bonds = 600,000

 

Scrip Dividends

Firms may find themselves with sufficient retained earnings to declare a dividend but not enough liquidity for distribution. In such case, firms may elect to declare ascrip dividend—dividend payable in scrip”—by issuing promissory notes requiring them to pay the dividends at a later date. The accounting treatment at the date of declaration consists of debiting retained earnings or scrip dividends declared and crediting notes payable to stockholders or scrip dividend payable. At the date of distribution, the firm debits the note payable or scrip payable, and the related interest expense and credit cash.

 

Case Example

Let’s assume that the Hugo Company declared, on June 17, 2009, a scrip dividend in the form of a three-month promissory note amount to $1 a share on 3,000,000 shares outstanding. The interest rate on the notes is 10% per year. The following journal entries are required:

1. At the date of declaration, June 17, 2009

[Debit]. Retained Earnings [Scrip Dividends Declared] = 3,000,000
[Credit]. Notes Payable to Stockholders [Scrip Dividends Payable] = 3,000,000
[$1 x 3,000,000]

2. At the date of payment, September 17, 2009

[Debit]. Note Payable to Stockholders = 3,000,000
[Debit]. Interest Expense = 75,000
[$3,000,000 x 0.10 x 3/12]
[Credit]. Cash = 3,075,000

 

Liquidating Dividends

Dividends paid based on other than retained earnings are calledliquidating dividends”, as a return of contributed capital rather than a distribution of retained earnings. They are treated as a reduction of contributed capital, either additional paid-in-capital or a special contracontributed capital account, designated as “Contributed Capital Distributed” as a “Liquidating Dividend”.

 

Case Example

Let’s assume that the Lie Dharma Putra Company issued dividend to its common stockholders of $2,500,000 of which $1,000,000 is considered income and the rest a return of contributed capital. The following journal entries are required:

1. At the date of declaration

[Debit]. Retained Earnings = 1,000,000
[Debit]. Additional Paid-in-Capital = 1,500,000
[Credit]. Dividends Payable = 2,500,000

2. At the date of payment

[Debit]. Dividends Payable = 2,500,000
[Debit]. Cash = 2,500,000

 

Stock Dividends

A firm with adequate retained earnings but insufficient liquidity may elect to issuestock dividendsby a pro rate distribution of additional shares of the firm’s own stock to its stockholders. The transaction is made by a capitalization of retained earnings resulting in a reduction of retained earnings and an increase in some contributed capital accounts. No corporate assets are distributed; the value of the total stockholder’s equity remains unchanged as well as each stockholder’s percentage ownership in the firm.

Accounting for stock dividends differs depending on the size of the issue:

  • For small stock dividend, that is less than 20–25% of the common shares outstanding at the time of the dividend declaration, fair market value is used to capitalize retained earnings and an increase in capital stock and additional paid-in-capital.
  • For large stock dividend, that is more than 20–25% of the common shares outstanding at the time of the dividend declaration, par value is issued to capitalize retained earnings resulting in a reduction of retained earnings and an increase in capital stock.

Case Example

To illustrate the accounting for small stock dividend, let’s assume a corporation that has the following stockholder’s equity prior to the issuance of a small stock dividend:

Common Stock, $20 par
[30,000 shares issued and outstanding] = $   600,000
Additional Paid-in-Capital                     =      300,000
Retained Earnings                                   =      600,000
Total Stockholder’s Equity                      = $1,500,000

Let’s also assume that the firm issued a 20% stock dividend on a date where the stock was selling at $25 per share. The fair value of the 6,000 shares is $150,000. The following journal entries are required:

1. At the date of declaration

[Debit]. Retained Earnings = 150,000
[Credit]. Common Stock Dividend Distributable = 120,000
[Credit]. Additional Paid-in-Capital from Stock Dividend 30,000

2. At the date of issuance

[Debit]. Common Stock Dividend Distribution = 120,000
[Credit]. Common Stock, $20 par = 120,000

Following the issuance the stockholder’s equity is as follows:

Common Stock, $20 par
[36,000 shares issued and outstanding] = $   720,000
Additional Paid-in-Capital                      =      330,000
Retained Earnings                                    =      450,000
Total Stockholders’ Equity                       = $1,500,000

 

Let’s now assume that the firm issued instead a 50% stock dividend. The following journal entries are required at the time of declaration:

[Debit]. Retained Earnings 50% [30,000 share x  $20] = 300,000
[Credit]. Common Stock Dividend Distributable = 300,000

At the time of distribution the following journal entry is required:

[Debit]. Common Stock Dividend Distributable = 300,000
[Credit]. Common Stock, $20 par = 300,000

Following the issuance the stockholder’s equity is as follows:

Common Stock, [$20 par x 45,000] = $  900,000
Additional Paid-in-Capital               =     300,000
Retained Earnings                             =     300,000
Total Stockholder’s Equity                =  1,500,000

 

Note that the large stock dividend is treated as a stock split, that is, a split-up effected in the form of a dividend. In fact, for a stock split no entry is required except a memorandum to notice the increase in the number of shares and the decrease in the par value. For example: a 2-for-1 split of $6,000 shares at $10 par value results in a common stock of $16,000 shares at $5 par value.