When investors buy shares of stock in a company, they effectively become part-owners of the firm. In return, the company may choose to distribute some of its earnings to these owners, or shareholders, in the form of dividends. This typically happens each quarter for U.S.-based firms, when the company declares a dividend amount at its own discretion. Accountants must make a series of two journal entries to record the payout of these dividends each quarter.

It is useful to note that the record date is the date the company determines the ownership of the shares for the dividend payment. Like in the example above, there is no journal entry required on the record date at all. This journal entry is made to eliminate the dividends payable that the company has made at the declaration date as well as to recognize the cash outflow that is not an expense. Cash dividends are paid out of a company’s retained earnings, the accumulated profits that are kept rather than distributed to shareholders. The treatment as a current liability is because these items represent a board-approved future outflow of cash, i.e. a future payment to shareholders.

1. Therefore, the dividends payable account – a current liability line item on the balance sheet – is recorded as a credit on the date of approval by the board of directors.
2. This is usually the case which they do not want to bother keeping the general ledger of the current year dividends.
3. Thus, four hundred new shares are conveyed to the ownership as a whole (4 percent of ten thousand) which raises the total number of outstanding shares to 10,400.

Some companies choose not to pay dividends and instead reinvest all of their earnings back into the company. One common scenario for situation occurs when a company experiencing rapid growth. The company may want to invest all their retained earnings to support and continue https://www.wave-accounting.net/ that growth. Another scenario is a mature business that believes retaining its earnings is more likely to result in an increased market value and share price. In other instances, a business may want to use its earnings to purchase new assets or branch out into new areas.

Not surprisingly, the investor makes no journal entry in accounting for the receipt of a stock dividend. No change has taken place except for the number of shares being held. As the company has declared a 10% stock dividend, it would be accounted just like a cash dividend. Stock dividends (also called bonus shares) refer to issuance of shares of common stock by a company to its existing shareholders in the proportion of their shareholding without any receipt of cash. In addition, because stock dividends don’t come out of earnings, they don’t trigger the preferred stock dividend liability. When a dividend is paid as cash, then the company will have less cash, reducing its value, and therefore, its value per share (theoretically).

Journalizing Transactions

Since only $20,000 is declared, preferred stockholders receive it all. If a company’s board of directors wants to pay common stockholders a dividend, they must pay the preferred stockholders first. The date of payment is the third important date related to dividends. This is the date that dividend payments are prepared and sent to shareholders who owned shares on the date of record. The related journal entry is a fulfillment of the obligation established on the declaration date – 30th July; it reduces the Dividends Payable account (with a debit) and the Cash account (with a credit). On the dividend payment date, the cash is paid out to shareholders to settle the liability to them, and the dividends payable account balance returns to zero.

Large Stock Dividends

A summary showing the T-accounts for Printing Plus is presented in Figure 3.10. You notice there are already figures in Accounts Payable, and the new record is placed directly underneath the January 5 record. The record is placed on the debit side of the Accounts Receivable T-account underneath the January 10 record. The record is placed on the credit side of the Service Revenue T-account underneath the January 17 record. This is posted to the Cash T-account on the debit side beneath the January 17 transaction.

Cash Dividends

The amount at which retained earnings is debited depends on the level of stock dividend, i.e. whether is a small stock dividend or a large stock dividend. It is important to note that dividends are not considered expenses, and they are not reported on the income statement. As you can see, there is one ledger account for Cash and another for Common Stock. Cash is labeled account number 101 because it is an asset account type. The date of January 3, 2019, is in the far left column, and a description of the transaction follows in the next column.

The debit is the larger of the two sides ($5,000 on the debit side as opposed to $3,000 on the credit side), so the Cash account has a debit balance of $2,000. No dividends are paid on treasury stock, or the corporation would essentially be paying itself. As the business does not have to pay a dividend, there is no liability until there is a dividend declared. As soon as the dividend has been declared, the liability needs to be recorded in the books of account as a dividend payable. This is explained more fully in our retained earnings statement tutorial. Dividends can provide a steady income stream for investors, especially those who rely on their investments for retirement or living expenses.

These stock distributions are generally made as fractions paid per existing share. For example, a company might issue a 10% stock dividend, which would require it to issue 1 share for every 5 things only tiny house living can teach you 100 shares outstanding. For example, on December 14, 2020, the company ABC declares a cash dividend of $0.5 per share to its shareholders with the record date of December 31, 2020.

Record the declaration and payment of the stock dividend using journal entries. However, the main advantage of a stock dividend for the company is that the retained earnings can all be reinvested for greater growth. The main advantage of a stock dividend for the stockholder is that no taxes have to be paid on the stock dividend until the shares are sold. In this example, no dividends were declared on either class of stock in year one.

The board of directors then declares and distributes a 4 percent stock dividend. For each one hundred shares that a stockholder possesses, Red Company issues an additional 4 shares (4 percent of one hundred). Thus, four hundred new shares are conveyed to the ownership as a whole (4 percent of ten thousand) which raises the total number of outstanding shares to 10,400. The day on which the Hurley board of directors formally decides on the payment of this dividend is known as the date of declaration. Legally, this action creates a liability for the company that must be reported in the financial statements.

5 Use Journal Entries to Record Transactions and Post to T-Accounts

Treasury shares are not outstanding, so no dividends are declared or distributed for these shares. Regardless of the type of dividend, the declaration always causes a decrease in the retained earnings account. The company usually needs to have adequate cash and sufficient retained earnings to payout the cash dividend. This is due to, in many jurisdictions, paying out the cash dividend from the company’s common stock is usually not allowed. And of course, dividends needed to be declared first before it can be distributed or paid out.

This is the date that the dividend payment is made to the shareholders. The company makes journal entry on this date to eliminate the dividend payable and reduce the cash in the amount of dividends declared. Therefore, the dividends payable account – a current liability line item on the balance sheet – is recorded as a credit on the date of approval by the board of directors.

Similar to the stock dividends, some companies may directly debit the retained earnings on the date of dividend declaration without the need to have the cash dividends account. This is usually the case which they do not want to bother keeping the general ledger of the current year dividends. At the date the board of directors declares dividends, the company can make journal entry by debiting dividends declared account and crediting dividends payable account.