Dividends are distributions of a company’s earnings to shareholders, decided by the board of directors. They reward investors for their trust and investment. Shareholders are usually eligible for dividends if they own the stock before the ex-dividend date.
When a company earns a profit, it can reinvest it in the business or distribute a portion as dividends. Dividend yield measures the return from dividends and is calculated by dividing dividend per share by the share price.
Dividends must be approved by shareholders and can be paid in cash, stock, or other property. Mutual funds and ETFs also pay dividends from their income. Dividends incentivize investors and are usually paid from net profits, while most profits are retained for future growth.
Even if profits are low, a company may pay dividends to maintain a regular payout record. Dividend payout schedules vary, including monthly, quarterly, or annually. Companies like Walmart and Unilever offer consistent quarterly dividends.
Dividends are distributions of profit to shareholders and appear as liabilities once declared, not as expenses on income statements. Companies declare dividends when retained earnings are sufficient and can pay in cash, stock, or sometimes assets.
Dividends reflect shareholders’ share of earnings and are charged to retained earnings in accounting. Dividend policy decides how much profit is distributed versus retained for growth, balancing investor returns with long-term company development.
Some of the various types of Dividends are explained below:
Types of Dividends
Cash Dividends
A cash dividend is the distribution of accumulated earnings by a company to its shareholders. The board of directors decides whether to declare a cash dividend.
The dividend is declared after the board approves a resolution. The company must prepare a current list of shareholders before paying, which often causes a delay between the declaration and payment.
For example, the board might approve a resolution on January 10 (declaration date), record shareholders on January 25 (record date), and make the payment on February 5 (payment date).
Cash dividends are considered liabilities. Since payment is usually due soon after declaration, they are recorded as current liabilities.
A company accounts for the declaration and payment of an ordinary cash dividend using standard accounting entries.
| Date | Particulars | PR | Debit | Credit |
| Retained Earnings A/C
To Dividend Payable A/C (Record the declaration of cash dividend) |
XXX
|
XXX |
| Date | Particulars | PR | Debit | Credit |
| No Entry |
| Date | Particulars | PR | Debit | Credit |
| Dividend Payable A/C
To Cash A/C (Record the payment of cash dividend) |
XXX
|
XXX
|
Cash Dividends for Preferred Share
Property Dividends
Dividends payable from assets other than cash are called property dividends or dividends in kind. These can include merchandise, real estate, or other investments, depending on the company’s board decision.
To declare a property dividend, the corporation must restate the property at its fair value and recognize any gain or loss, which is the difference between the fair value and the carrying value of the asset.
The declared dividend is then recorded as a debit to retained earnings (or property dividends deducted) and a credit to property dividends payable at the fair value of the distributed property.
After the distribution, the company debits property dividends payable and credits the account containing the distributed asset, which has been restated at fair value.
Liquidating Dividends
Dividends are sometimes computed based on paid-in capital, which can mislead shareholders into thinking a corporation is profitable if not properly disclosed. To prevent confusion, a clear statement of the dividend’s source should always accompany the payment.
Dividends that are not from retained earnings are called liquidating dividends, meaning they return part of the shareholder’s original investment rather than profits. Any dividend not based on earnings reduces paid-in capital, classifying it as liquidating.
In some cases, extractive companies pay dividends equal to their accumulated income and capital reduction. Occasionally, management may choose to close the business and declare a liquidating dividend, with liquidation carried out over several years to ensure an orderly and fair sale of assets.
Share/Stock Dividends
Management may issue a share or stock dividend to capitalize part of the earnings, reclassifying amounts from earned to contributed capital while retaining earnings permanently in the business.
In this case, the company does not distribute any assets, and shareholders maintain the same proportionate interest and total book value.
By definition, a share dividend is the issuance of a corporation’s own shares to all shareholders on a pro-rata basis without consideration.
Some experts suggest transferring the par value of the shares from retained earnings to capital shares, while others prefer transferring the fair market value at the declaration date to capital shares and additional paid-in capital.
Share dividends offer several advantages: they do not require cash, reduce the market price per share, and are not considered taxable income for recipients, making them attractive to certain investors.
When the dividend is less than 20–25 percent of outstanding shares, the fair value of the shares is transferred from retained earnings, as small dividends are assumed to have minimal impact on market price.
Share dividends below 20–25 percent are called small or ordinary dividends, whereas those above this threshold are considered large and are recorded at par value.
Small share dividends are treated as distributions of corporate earnings equal to the fair value of the additional shares received.
Methods to Evaluate Dividends
Investors can use a variety of methods to learn about a company’s dividend and compare it to similar ones. Some of the methods to evaluate dividends are:
Dividend Per Share (DPS)
During a specified period, the dividend per share (DPS) shows how much a company has distributed as dividends for each share of its stock.
Investors can use DPS to evaluate a company’s dividend history and potential for growth, helping them identify firms that may increase dividends over time.
Dividend Yield
A company’s dividend yield is reported on financial websites and online brokerage platforms. It is calculated by dividing the annual dividend by the stock price on a specific date.
Expressed as a percentage, dividend yield measures the return a shareholder can expect relative to the stock’s current market price.
Dividend Payout Ratio
The dividend payout ratio indicates how much of a company’s net income is allocated to dividends. Financial advisors often suggest checking the payout ratio to assess a dividend’s safety.
Companies paying out more than 100% of their income may struggle to maintain dividends during periods of lower earnings.
A payout ratio of 80 percent or less is generally considered safe by investors. This metric is usually displayed alongside dividend yield on financial websites and brokerage platforms, providing insight into a company’s ability to sustain its dividend payments over time.
Important Dividend Dates
It is important to determine which shareholders are eligible for dividends based on the order in which events occurred. Some of the important dividend dates are:
Announcement Date
The management announces the dividends of the company on the declaration date, also called the announcement date. This announcement informs shareholders about the dividend amount and schedule.
The payment of the dividend must be authorized by the shareholders, ensuring that all stakeholders are aware of and approve the distribution of profits.
Ex-dividend Date
The ex-dividend date, or ex-date, is the date when eligibility for receiving the dividend expires. Shareholders who purchase the stock on or after this date will not receive the upcoming dividend.
For example, if a stock has an ex-date of Monday, May 5, any shareholder buying the stock on or after May 5 will not be eligible for the dividend, as the right to the dividend passes to the previous owner.
Record Date
The record date is set by the company to determine which shareholders are eligible to receive the dividend. It acts as a cutoff date, ensuring that only shareholders on record at that time are entitled to the payout.
This date helps companies organize dividend distributions efficiently and ensures accurate tracking of shareholder entitlements.
Payment Date
The payment date is when the dividend is actually issued to investors. On this date, the dividend amount is credited directly to the shareholders’ accounts.
This final step completes the dividend process, allowing shareholders to receive their share of the company’s profits as cash, stock, or other property.
Advantages of Dividend
Some of the advantages of dividends are:
- During a downturn, dividends can help stabilize the price of a stock and reduce volatility.
- Dividends do not require you to sell shares in order to get a return.
- Investing in cash dividends means you will receive a payment in return.
- Dividends are the most powerful of all dividend advantages, as they offer a total return accelerator during market downturns.
- A dividend acts as a “rod” for the management and makes it more difficult for them to misallocate capital.
Disadvantages of Dividend
Some of the disadvantages of dividends are:
The main disadvantage of paying dividends among stockholders is that companies run out of cash. Investing in the business could have resulted in greater growth with this amount. By paying dividends, a company sacrifices long term growth in favor of short-term gains.
Dividends are paid at management’s discretion. Companies are not under any obligation to pay dividends. A company’s management may choose not to declare a dividend even if it generates good profits.
Dividends paid by companies must be taxed based on the amount of profit they are willing to distribute to stockholders. Thus, dividends result in a higher tax burden for the company.
How dividends affect share prices?
It is common for dividend payments to result in money leaving the company’s books and accounts permanently, as dividends are irreversible. Once declared and paid, these funds cannot be reclaimed by the company.
Dividend payments directly impact stock prices. Typically, the stock price rises when a dividend is announced, roughly reflecting the amount of the dividend declared.
On the ex-dividend date, the stock price usually drops by a similar amount since new buyers are no longer entitled to receive the dividend.
For example, if a company trading at $60 per share announces a $2 dividend, the stock price often rises to around $62 on the announcement day as investors react to the news.
One business day before the ex-dividend date, the stock may trade at $63 per share due to market adjustments.
On the ex-dividend date, the stock typically opens at a lower price, around $61 in this scenario, reflecting the fact that new buyers purchasing the stock on that day will not receive the declared dividend.
This adjustment ensures the dividend payout is properly accounted for in market pricing.
Examples of Dividend
| In some cases, a company may decide to share its wealth with investors if it has a healthy cushion of net profits. Consequently, the board of directors might decide to issue an annual dividend of 5% per share. Dividends issued on a quarterly basis would be valued at $1.25 if the company’s shares were valued at $100, and if they were valued at $5 each if the shares were worth $100. |
References
- Corporate Finance Institute. (n.d.). Retrieved from Corporate Finance Institute: https://corporatefinanceinstitute.com/resources/knowledge/finance/dividend/
- Hyaes, A. (2022, February 26). Investopedia. Retrieved from Investopedia: https://www.investopedia.com/terms/d/dividend.asp#:~:text=A%20dividend%20is%20the%20distribution%20of%20corporate%20profits%20to%20eligible,their%20money%20into%20the%20venture.
MBA,BBA.
I am Smirti Bam, an enthusiastic edu blogger with a passion for sharing insights into the dynamic world of business and management through this website.
I hold a MBA degree from Presidential Business School, Kathmandu, and a BBA degree with a specialization in Finance from Apex College,