Financial Accounting: Cash Dividends

A dividend is a distribution to stockholders on a
proportional basis. The most common type of dividend is a cash
dividend, but it could also be a property and stock
dividends as well. The focus of this video will accounting for cash
dividends The Board of Directors decides whether or not a
company will declare a dividend, since they are the body representing the
stockholders. However, in order to declare a cash dividend, a company must have enough retained earnings
and enough cash. There are three important dates when it comes
to dividend payments. The first is the Date of Declaration. This is the day a company announces the
dividend details. Dividends are not liabilities until this day. In fact, they are possible contingent liabilities
until the Date of Declaration. The next important date is the Date of Record. This is usually a few weeks after the Date of
Declaration. The purpose of the Date of Record is establish
which shareholders will receive a dividend. Only shareholders at the close of business on
the Date of Record receive a dividend. Finally, the Date of Payment is the day the
dividend checks are mailed out. Again this is usually a few weeks after the Date
of Record. This slide shows the journal entries made on
each of the important dates. The Date of Declaration results in Retained
Earnings being debited and Dividends Payable being credited. You can see why this is the day a liability
exists, because the liability account in used in the
journal entry. There is no journal entry for the Date of Record. Finally, the Date of Payment is a debit to
Dividends Payable and a credit to Cash. Let’s look at an example. On December 1, the directors of Hazy Fantazy
Corporation declare a $1 per share cash dividend on 100,000
shares of $.01 par value common stock. The dividend is payable on Jan. 20th to
shareholders of record on Dec. 22nd. Assume Hazy Fantazy has no preferred stock. You can see the three dates highlight on the
slide. So the total amount of dividend is $100,000. I arrived at the amount by taking 100,000
shares times $1. On December 1, Retained Earnings is debited and Dividends Payable is credited for $100,000. No journal entry is recorded on December 22nd
as none is required with the Date of Record. On January 20th, Dividends Payable is debited
and Cash is credited for $100,000. But what if Hazy Fantazy also had preferred
stockholders? Well preferred stockholders get paid all
dividends they are entitled to before common stockholders get anything. When learning about preferred stock, there are
two terms you’ll want to be familiar with: cumulative and non-cumulative. When preferred stock is cumulative, and this is
the most common type, these stockholders must be paid any unpaid
prior-year dividends, which is called “dividends in arrears”, before common shareholders receive dividends. When preferred stock is non-cumulative, and
this is somewhat rare, these stockholders are only paid the current
year’s dividend. Any unpaid prior-year dividends are lost. This slide shows how to calculate the maximum
preferred stock dividend. Generally, the maximum dividend is shown either as a percentage of the stock value, like the first example, or it lists the amount of dividend per share, as
shown in the second example. Let me show you what to do with this information. Here is an example of a company that has both
preferred stock and common stock. We are asked how to split the total dividend
between them. I find it easiest to list the information in a simple
table as shown here. I list the year, the total dividend declared,
the maximum preferred stock dividend, the actual preferred stock dividend. This is the amount the preferred stockholders will get. I list a column for dividends in arrears And finally I list the actual common stock dividend. This is the amount the common stockholders will get. Finally in this example, the total dividend declared in 2015 is $5,000. The next step then is to figure out the maximum preferred stock dividend, which I’ve calculated as $8,000. You can see the calculation is at the bottom of the slide. Since the maximum dividend is greater than the declared dividend, the preferred stockholders will have dividends in arrears. In this example, the preferred stockholders receive all $5,000 of the declared dividend, and have $3,000 dividends in arrears, and the common stockholders will receive no dividend this year. So what if the following year the company declares a $15,000 dividend? Our steps would be the same. We’d calculated the maximum preferred stock dividend as $8,000 plus any dividends in arrears. So the maximum preferred stock dividend in this year is $11,000. Note: had this been non-cumulative preferred stock, the maximum preferred stock dividend would have been $8,000, because the dividends in arrears would have been lost. Finally, that leaves $4,000 for common stockholders and you can see the journal entry to record that.

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