ACCT 421
DIVIDEND DISTRIBUTION
WHAT ARE DIVIDENDS? WHAT IS DIVIDEND
DISTRIBUTION?
Dividends are payments made by a company to its shareholders out of
its profits. Dividend distribution is the process of distributing these
payments to eligible shareholders in proportion to their shareholding.
IMPORTANCE OF DIVIDEND DISTRIBUTION
• It provides a tangible return to shareholders for their investment in
the company.
• It can also signal the financial health of a company, as consistent
dividend payments may indicate stable profits and cash flow.
• Additionally, dividends can attract investors who are seeking regular
income from their investments, and can potentially boost the stock
price of the company.
DISADVANTAGES OF DIVIDEND DISTRIBUTION
• Tax implications: Dividends are subject to taxes
• Reinvesting profits: Some companies may choose to reinvest their
profits back into the business rather than distributing dividends. This
can be a way to fund growth and expansion opportunities that may
lead to higher profits and potentially larger dividends in the future.
So, by distributing dividends instead of reinvesting the profits, it
may slow down the growth of the business.
TYPES OF DIVIDEND DISTRIBUTION
• Cash Dividends – These are the most common type of dividend,
where a company distributes cash payments to its shareholders out
of its profits. The amount of the cash dividend is typically expressed
as a dollar amount per share.
• Stock Dividends – Also known as bonus shares, these dividends
involve distributing additional shares of the company's stock to its
shareholders. The number of additional shares that each shareholder
receives is typically proportional to their existing shareholding.
TYPES OF DIVIDEND DISTRIBUTION
(continuation)
• Property Dividends – These dividends involve distributing assets
other than cash or stock to the company's shareholders. This could
include physical property such as real estate or equipment, or
financial assets such as bonds or securities.
• Scrip Dividends – These dividends involve issuing shareholders with a
promissory note or "scrip" instead of cash or stock. The scrip can be
redeemed for cash or stock at a later date, depending on the
company's policies. This type of dividend is less common than cash or
stock dividends.
AN ALTERNATIVE TO DIVIDEND DISTRIBUTION
(SHARE REPURCHASE)
• Share repurchase is also known as stock buyback
• It is an alternative way for companies to return capital to their shareholders
instead of distributing dividends.
• Share repurchase involves a company buying back its own shares from the open
market, which can reduce the total number of outstanding shares and increase
the value of the remaining shares.
• Share repurchase can be used to signal to investors that the company believes its
stock is undervalued and is a good investment opportunity.
• However, share repurchase may not be as appealing to some investors as
dividend distribution, especially those who rely on regular income from their
investments.
• Ultimately, the decision to use share repurchase or dividend distribution as a way
to return capital to shareholders should depend on the company's financial goals
and priorities.
ACCOUNTING AND BOOKKEEPING
TREATMENT OF DIVIDENDS
• Journal entries for cash dividends – debit the Retained Earnings account
(or a Dividends account if the company uses one) and credit the Cash
account.
• Journal entries for stock dividends – debit the Retained Earnings account
and credit the Common Stock or Paid-in Capital account.
• Accounting for property dividends – record the fair market value of the
property as a debit to the Retained Earnings account and a credit to a
Property account.
• Accounting for scrip dividends – debit the Retained Earnings account and
credit a Scrip Dividends Payable account.
• Recordkeeping of dividend distribution – Finally, companies need to keep
accurate records of their dividend distributions for tax and regulatory
purposes.
EXAMPLE I. (CASH DIVIDEND)
A company declared a cash dividend of $10,000. The company has a
Retained Earnings account of $100,000 and a Cash account of
$50,000.
The journal entry would be:
Dr. Retained Earnings account by $10,000
Cr. Cash account by $10,000
After the journal entry, the Retained Earnings account would decrease
to $90,000 and the Cash account would decrease to $40,000.
EXAMPLE II. (STOCK DIVIDEND)
Assume the same company declared a stock dividend of 5% on its
outstanding common stock. The company has 10,000 shares of common
stock outstanding at a value of $20 per share.
The journal entry would be:
Dr. Retained Earnings account by $10,000 (5% x 10,000 shares x $20)
Cr. Common Stock account by $10,000 (5% x 10,000 shares x $20)
After the journal entry, the Retained Earnings account would decrease to
$90,000 and the Common Stock account would increase to $210,000.
EXAMPLE III. (PROPERTY DIVIDEND)
Assume the same company declared a property dividend of a machine
with a fair market value of $15,000. The company has a Retained
Earnings account of $100,000 and a Property account of $50,000.
The journal entry would be:
Dr. Retained Earnings account by $15,000
Cr. Property account by $15,000
After the journal entry, the Retained Earnings account would decrease
to $85,000 and the Property account would increase to $65,000.
EXAMPLE IV. (SCRIP DIVIDEND)
Assume the same company declared a scrip dividend of $5,000. The
company has a Retained Earnings account of $100,000.
The journal entry would be:
Dr. Retained Earnings account by $5,000
Cr. Scrip Dividends Payable account by $5,000
After the journal entry, the Retained Earnings account would decrease
to $95,000 and the Scrip Dividends Payable account would increase to
$5,000.
TAX TREATMENT OF DIVIDENDS
• Taxation of dividends at the individual level – In most countries, dividends
are taxable as income at the individual level. The tax rate that applies to
dividends can depend on a number of factors, including the individual's
income level and their tax bracket.
• Taxation of dividends at the corporate level – In some countries,
corporations are also subject to tax on the dividends that they distribute to
their shareholders. The tax rate on corporate dividends can depend on the
country's tax laws and the type of corporation.
• Double taxation of dividends – as a result, double taxation can occur. Both
the corporation and the shareholder are taxed on the same income. This
can happen with dividends if the corporation pays tax on its profits, and
then the shareholders pay tax on the dividends they receive.
DIVIDEND DISTRIBUTION AND BANKRUPTCY /
LIQUIDATION
• What is the impact of bankruptcy or liquidation on dividend distribution?
• Priority of dividend payments during bankruptcy: If a company declares
bankruptcy, it will typically be required to prioritize its payments to creditors in a
specific order.
- In most cases, this will mean that dividends will be suspended or cancelled until
all other debts have been paid.
- Any remaining funds after paying all debts and liabilities will be distributed to
shareholders according to their level of priority.
• Treatment of dividends during liquidation: In the event that a company is
liquidated, its assets will be sold and the proceeds will be used to pay off its
creditors and distribute any remaining funds to shareholders.
- Dividend payments may be suspended or cancelled during the liquidation process,
and shareholders may not receive any dividend payments until all creditors have
been paid in full
IMPACT OF DIVIDEND DISTRIBUTION ON
FINANCIAL STATEMENTS
• Effect on income statement – Dividend distributions are typically recorded as an
expense on a company's income statement, which will reduce the company's net
income for the period in which the dividend was paid. This will lower the
company's earnings per share and can impact the company's stock price.
• Effect on balance sheet – First, the company's retained earnings will decrease,
which is the amount of earnings that have not been paid out as dividends.
Additionally, the company's cash account will decrease, as the cash is used to pay
the dividends. Finally, the company's equity section of the balance sheet will be
reduced, reflecting the distribution of earnings to shareholders.
• Effect on cash flow statement – Dividend distributions will be recorded in the
financing section of a company's cash flow statement, as they represent a cash
outflow to shareholders. The net change in the company's cash balance will be
reduced by the amount of the dividend payment.