Dividend

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 –

1. Cash Dividend
2. Stock Dividend
3. Property Dividend
4. Scrip Dividend
5. Liquidating Dividend

#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 company 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 split.

To record this type, an amount will be transferred from the retained earnings account to the capital stock 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 securities, 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 payable 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 Accrued = $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

1. 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.
2. 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.
3. Date of Record: Record date is the date when the company decides on the list of shareholders who will receive the payment.
4. 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 shareholders 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 ratios 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.

Recommended Articles

This article has been a guide to what is Dividend & its definition. Here we discuss the chronology of dividends and its types along with practical examples. You can learn more about firms from the following articles –

• Types of Financial Ratios
• Dividends Ex-Date vs Record Date Differences
• Special Dividend
• Franked Dividend