What is a Dividend?
A dividend refers to the distribution of profits or earnings to shareholders. It is usually a portion of the income earned by a company over a specific period. In some cases, companies may also pay a dividend from their reserves, known as retained earnings. Some companies may also refrain from making these payments. Therefore, paying dividends to shareholders is not mandatory.
When distributing profits, companies go through a specific process. Usually, it occurs at the end of each financial period or after regular intervals. When a company generates profits, it may decide to distribute them to shareholders. The company’s management must also specify the portion that the shareholders will get. Subsequently, the board will approve the planned dividend. The company then announces and pays the dividends.
What is a Cash Dividend?
When paying dividends, companies may choose between cash and stock options. A cash dividend is a distribution of profits among shareholders in monetary amounts. In other words, it is the money paid to shareholders as a distribution of profits or retained earnings. Alternatively, companies may also distribute these profits through stocks or shares. However, shareholders prefer cash dividends.
Cash dividends are more common than stock dividends. Companies use it as an incentive to provide returns to shareholders on their investments. Usually, these payments occur at the end of each financial period or annually. However, some companies may also use special dividends through cash. Cash dividends also follow the same distribution process stated above.
What is the accounting for Cash Dividends?
The accounting for cash dividends follows a process. This process goes through the several stages that companies undergo when paying dividends. Usually, it starts when a company decides the portion of profits to distribute to its shareholders. However, the company does not have an obligation to pay its shareholders until an announcement.
Once announced, the company must record a liability for the amount it intends to distribute as cash dividends. The announcement creates an obligation for the company to pay its shareholders later. When the company pays its shareholders in the future, it must record the cash dividend. Similarly, it must reduce the liability created before for that amount.
What is the journal entry for Cash Dividends?
When a company announces a cash dividend, it must create a liability. The journal entry for the transaction is as below.
| Dr | Retained earnings |
| Cr | Dividends payable |
When the company pays cash dividends in the future, it must remove that liability. In exchange, it must record a cash payment to shareholders. Consequently, the journal entry will be as follows.
| Dr | Dividends payable |
| Cr | Cash or bank |
Example
A company, Blue Co., generates profits of $1 million during a financial period. The company announces 10% ($100,000) of these profits as cash dividends at a later date. At this stage, Blue Co. records the obligation to pay its shareholders using the following journal entry.
| Dr | Retained earnings | $100,000 |
| Cr | Dividends payable | $100,000 |
Later, Blue Co. distributes the cash to its shareholders through its bank account. Blue Co. uses the following journal entry to record the transaction.
| Dr | Dividends payable | $100,000 |
| Cr | Bank | $100,000 |
Conclusion
Dividends are a distribution of profits or earnings to shareholders. It occurs after a specific period, although it can also be special. Usually, companies decide between distributing these profits through cash or stock. Cash dividends are more common among these methods. The accounting for cash dividends also occurs in several stages.
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