Typically, when a company decides to distribute some of its retained earnings to eligible shareholders as dividends, it debits the total value to a temporary sub-account called a dividends account or dividends payable. But, at the end of the day, it should record the entry to close the dividends account.
The account is named this because it indicates that the company owes its shareholders money on outstanding shares that it has not paid yet. So, to companies, dividend accounts are a liability. However, to shareholders, dividends are an asset that improves their net worth.
Understanding Accounting for Dividends
Companies should account for dividends within their balance sheet. They can do that by recording that their cash assets within the balance sheet have been reduced by the total value of the dividends. But that can only happen once the money is paid to the shareholders. Also, the stockholder’s equity will show a decrease of a similar amount, but the liabilities account will reflect a zero net change.
First, when the company declares it will distribute dividends, it will create a journal entry and debit the retained earnings account with the value of the dividends.
For example, if a company has 300,000 outstanding shares and announces on September 1 that it will pay dividends of $0.55 per share on October 1, it will debit $165,000 to its retained earnings account. It will then credit the dividends payable account. So, the company equity will decrease while its liabilities increase.
Next, the company will check through its records and develop a list of who gets the dividends. Anyone who buys company stock before the ex-dividend date will get dividends.
Usually, companies come up with a record date that acts as the cut-off point for investors who want the current year’s dividends. And the ex-dividend date is set at one business date before the record date. Anyone who buys shares after that date would have to wait for the next period’s dividends.
Once the company puts its books in order, it then distributes the dividends on the said date. Therefore, on October 1, after the payment of the dividends, the company will create another journal entry. This time around, it will debit the dividends payable account to the tune of $165,000 while crediting the cash account with a similar value.
As a result, the company’s cash and equity will reduce. In addition, the company will offset its liabilities.
Closing a Dividend Account
A closing entry is a journal entry that companies make at the end of the accounting period to enable them to transfer their temporary account balances to a permanent account on the balance sheets. Permanent accounts include equity, liabilities and assets accounts.
In this case, the company will record the entry to close the dividends account, thus enabling them to start afresh on the next accounting period. That happens when the company closes the debit balance to the retained earnings account.
If you keep track of every company transaction, closing a dividend account is much easier. The process involves transferring the dividends account debit balance to the company’s retained earnings account.
So, based on our example above, the company will transfer the $165,000 it paid as dividends to the retained earnings account. You will do that by creating a closing entry, crediting your dividends entry section and then debiting your retained earnings account section. That shows the company’s retained earnings have reduced, and so has the shareholders’ equity.
Once you record the entry to close the dividends accounts it will have zero balance in the end, and your work in that regard will be complete.
Final Thoughts on Dividend Accounting
Accountability is crucial for any business. For that reason, you need to be careful when creating dividend entries for your company. Ensure that the company accounts for every cent to enable you to keep up with liabilities, assets and shareholders’ equity.
- Accounting Coach: What type of account is the Dividends account?
- YCharts: Dividends Payable
- Investor.Gov: Ex-Dividend Dates: When Are You Entitled to Stock and Cash Dividends
- AccountingTools: How to account for cash dividends
- Corporate Finance Institute: Closing Entry
- PatriotSoftware: Wrap up Your Accounting Period With Closing Entries
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