Dividend Definition
Dividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company.
In simple words, it is typically the share of profit (after tax) of a company to its shareholders. It is a form of return that the shareholder of the company gets for investing money in the company.
Types of Dividends
Following are the list and details of the various common types which a company can issue –
- Cash DividendCash DividendCash dividend is that portion of profit which is declared by the board of directors to be paid as dividends to the shareholders of the company in return to their investments done in the company. Such a dividend payment liability is then discharged by paying cash or through bank transfer.read more
- Stock Dividend
- Property Dividend
- Scrip DividendScrip DividendA company issues scrip dividends or liability dividends to its shareholders as a certificate with a choice to get dividends later or take shares in place of dividends. Companies issue such dividends when they do not have sufficient cash to pay a dividend.read more
- Liquidating Dividend
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For eg:
Source: Dividend (wallstreetmojo.com)
#1 – Cash Dividend
It is the most common type, and there is the actual cash payment by the company to its shareholders directly. Generally, the former makes the payment to shareholders electronically, but they can also do in the form of cash or check. Thus, the board of directors resolves to pay on the date of the declaration to the investors. These investors must be holding the stock of the company on the specified date.
Example
Midterm international Ltd, on January 1, 2019, held the meeting. Here board of directors declared the cash dividend of $1 per share on outstanding shares of the company. It is to be paid to all the shareholders on June 1, who were there on record on April 1. The total outstanding shares of the companyOutstanding Shares Of The CompanyOutstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet.read more are $3,000,000. On January 1, 2019, the entry that will be recorded by the company will be:
Now on June 1, 2019, when Midterm international Ltd pays the dividends, it will record the transaction and pass the below entry:
#2 – Stock Dividend
It is the type under which the company issues the common stock to the present common shareholders without taking any form of consideration. The treatment depends on the percentage of an issue concerning the number of the total previous share issue. If the issue is less than 25 percent, then the transaction will be treated as the stock dividend, whereas if an issue is more than 25, then it will be treated as the stock splitThe Stock SplitStock split, also known as share split, is the process by which companies divide their existing outstanding shares into multiple shares, such as 3 shares for every 1 owned, 2 shares for every 1 held, and so on. The company's market capitalization remains unchanged during a stock split because, while the number of shares grows, the price per share decreases correspondingly.read more.
To record this type, an amount will be transferred from the retained earnings account to the capital stockCapital StockThe capital stock is the total amount of share capital (including equity capital and preference capital) that has been issued by a company. It is a way of raising funds by the company to meet its various business goals.read more account with the par value and to the additional paid-in capital account for an additional amount to make the total amount equal to the fair value of issued additional shares. The additional shares fair value will be based on the fair market value of share present on the declaration of the dividend.
Example
Midterm international Ltd, on January 1, 2019, declares the stock dividend of 20,000 shares to the shareholders when the par value of the shares is $2, and the fair market value is $3.00, and its par value is $1. ABC records the following entry:
#3 – Property Dividend
The company can give non-monetary dividends like property but has to record the distribution at asset’s fair market value. In case the fair market value of the assets distributed is different from the book value of assets, then the company has to record the variance in the form of the gain or loss as applicable in the case.
So by this company has to opt not to pay the dividend only in the form of cash or the stock as it can pay in the form of other assets like physical assets, real estate, investment securitiesInvestment SecuritiesInvestment securities are purchased by investors, with or without the assistance of a middleman or agent, solely for the purpose of investment and long-term holding. These are recorded in the financial statements as non-current investments and comprise fixed income and variable income bearing securities.read more, etc. Sometimes the company deliberately uses this method as property dividend may help the company to alter its taxable income.
Example
The board of directors of New Sports International Ltd elects to declare the issuance of 1000 identical artwork, which was stored by the company for the last many years. The fair market value of the artwork on the date of declaration of the dividend is $ 6,000,000, which originally the company acquired $ 80,000. The entry to be passed by the New Sports International Ltd on the date of the declaration for recording change in assets value and liability to pay dividends is as follows:
Entry for recording the gain:
Gain = $ 6,000,000 – $ 80,000 = $ 5,200,000
Entry to record the liability
Entry for recording the payment on the date of payment of dividend:
#4 – Scrip Dividend
It is the type under which the Company issues the scrip dividend in a case as per the situation; it is prevailing that soon company might not have sufficient funds for issuing the same. Thus this type is promissory notes to pay the shareholders of the company at a later date. It creates the note payable, which may include interest or may not include.
Example
The Mid Term International declares to its shareholders a $ 150,000 scrip dividend with the interest rate of 10 percent. The entries to record the dividend and its payment is as follows:
Entry on the date of declaration of the dividend:
Now suppose the payment date is after one year, so Mid Term International has to pay the notes payableNotes PayableNotes Payable is a promissory note that records the borrower's written promise to the lender for paying up a certain amount, with interest, by a specified date. read more amount declared as dividend along with interest accrued during the one year from the date of the declaration to the payment of the same.
Interest AccruedInterest AccruedAccrued Interest is the unsettled interest amount which is either earned by the company or which is payable by the company within the same accounting period.read more = $150,000 * 10% = $15,000
On payment date entry will be:
#5 – Liquidating Dividend
This type of dividend is where the shareholders receive the originally contributed capital, mainly at the time of the shutting down of the business.
Example
The board of directors of New Sports International Ltd declares the liquidating dividend of $ 1,000,000
The entry to record the declaration:
The entry to record the payment:
Chronology of Dividends
- Announcement/ Declaration Date: Date on which the company’s management declares the dividend payments. The board decides on the payment amount and also the date of payment.
- Ex-Date: Ex-Dividend Date is the date on which eligibility to receive the dividends expires. For example: If a particular stock declares that the ex-date is March 25, all the shareholders who purchase the stock one day before the ex-date will only be eligible to receive payments.
- Date of Record: Record dateRecord DateThe date of record for dividends is the cut-off date decided by the top management for the investors to get registered as a stockholder in the company's books to get the dividend payment on their security holdings.read more is the date when the company decides on the list of shareholders who will receive the payment.
- Payment Date: Date of issue of dividend payments to the company, and transfer to the shareholder’s account.
Importance
#1 – For Shareholders
They are a regular source of income for a lot of shareholders. For instance, for a person who is retired and holds a significant amount of stocks as a part of his investment portfolio whose prices are increasing, he will not have a regular income from the stock in the form of cash till he sells them off. However, if there is a dividend payment from these stocks at regular intervals, he will have a continuous income source to handle his expenses without selling the stocks.
#2 – For Company
Dividend payments are significant for maintaining the trust of shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares.read more by giving them regular returns from their investment. It has been seen in a lot of cases that when a company decides on cutting on such payments, the company’s share price goes down because of negative sentiments in the market about the company’s stocks.
It might also be necessary for a company to pay dividends to maintain its financial ratiosFinancial RatiosFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on.read more or to maintain the cyclical nature of its business. For example, for a textbook manufacturing firm, the major part of the business happens in Q1 and Q4 of the year. Thus, to maintain the share price of the stock, it may declare such payments in Q2 or Q3.
Conclusion
Thus, it usually helps the company boost the confidence of the investors in the shares of the company. The flip side to it is that the company has to forego its cash income, which it could have invested back in the company. Thus, the prospects of the company should be the basis for the decision on dividend distribution.
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