Dividends Paid are the distribution of a portion of a company’s profits to its shareholders as a reward for their investment. The process of paying dividends involves declaring the dividend, recording the liability, and ultimately disbursing the funds to shareholders. This example illustrates the accounting and financial impact of dividends paid, highlighting both cash and stock dividends.
1. Example of Cash Dividends Paid
Scenario: ABC Ltd has 100,000 shares outstanding. The board of directors declares a cash dividend of $0.50 per share for the fiscal year. The total cash dividend amounts to $50,000, which will be paid to shareholders.
A. Step 1: Declaration of Cash Dividend
When the dividend is declared, the company records a liability in the form of dividends payable. The retained earnings account is debited to reflect the reduction in profits.
- Debit: Retained Earnings $50,000
- Credit: Dividends Payable $50,000
Explanation: This entry reduces the company’s retained earnings by $50,000 and creates a liability indicating that the company owes this amount to shareholders.
B. Step 2: Payment of Cash Dividend
When the dividend is paid to shareholders, the liability is settled, and the company’s cash reserves are reduced.
- Debit: Dividends Payable $50,000
- Credit: Cash $50,000
Explanation: This entry eliminates the dividends payable liability and reduces the company’s cash balance by $50,000.
C. Financial Impact
- Reduction in Retained Earnings: The company’s retained earnings decrease by $50,000, reflecting the distribution of profits to shareholders.
- Cash Outflow: The company’s cash balance decreases by $50,000, impacting liquidity.
- Shareholder Benefit: Shareholders receive $0.50 per share as a return on their investment.
2. Example of Stock Dividends Paid
Scenario: XYZ Ltd decides to issue a 10% stock dividend to its shareholders. The company has 200,000 shares outstanding with a par value of $1 per share and a market value of $5 per share. The stock dividend results in the issuance of 20,000 new shares.
A. Step 1: Declaration of Stock Dividend
When the stock dividend is declared, the company reduces retained earnings and increases common stock and additional paid-in capital.
- Debit: Retained Earnings $100,000 (20,000 shares × $5 market value)
- Credit: Common Stock $20,000 (20,000 shares × $1 par value)
- Credit: Additional Paid-In Capital $80,000 (the difference between market value and par value)
Explanation: This entry reduces retained earnings by the market value of the shares issued and increases the common stock and additional paid-in capital accounts accordingly.
B. Financial Impact
- Reduction in Retained Earnings: Retained earnings decrease by $100,000, reflecting the distribution of equity to shareholders.
- No Cash Outflow: Unlike cash dividends, stock dividends do not reduce the company’s cash balance.
- Increase in Share Capital: The company’s total shares outstanding increase, which may dilute the value of existing shares but retains funds within the company.
3. Combined Example of Cash and Stock Dividends Paid
Scenario: DEF Ltd declares a cash dividend of $0.25 per share and a 5% stock dividend. The company has 150,000 shares outstanding.
A. Cash Dividend
Total Cash Dividend: 150,000 shares × $0.25 = $37,500
- Debit: Retained Earnings $37,500
- Credit: Dividends Payable $37,500
Upon payment:
- Debit: Dividends Payable $37,500
- Credit: Cash $37,500
B. Stock Dividend
Stock Dividend: 5% of 150,000 shares = 7,500 new shares
Market Value of Shares: $3 per share (assumed market value)
Total Stock Dividend Value: 7,500 × $3 = $22,500
- Debit: Retained Earnings $22,500
- Credit: Common Stock $7,500 (7,500 shares × $1 par value)
- Credit: Additional Paid-In Capital $15,000
C. Combined Financial Impact
- Total Reduction in Retained Earnings: $60,000 ($37,500 cash + $22,500 stock dividend).
- Cash Outflow: $37,500 for the cash dividend, reducing liquidity.
- Increase in Share Capital: 7,500 new shares issued, diluting the ownership percentage of existing shareholders.
4. Understanding Dividends Paid
These examples illustrate how companies distribute profits to shareholders through cash and stock dividends. While cash dividends result in immediate cash outflows, reducing liquidity, stock dividends increase the company’s share capital without affecting cash reserves. Both types of dividends reduce retained earnings and have significant implications for a company’s financial position, shareholder value, and overall corporate strategy.