Types of Dividends - Meaning, Examples, Advantages, Disadvantages, Methods

Dividends

▶ Dividends are distributions of company earnings to a class of shareholders, as decided by the company’s board of directors.

▶ In general, dividend-paying stocks are eligible as long as the shareholders own them before the ex-dividend date.

▶ Whenever a company generates a profit and accumulates retained earnings, these earnings can either be reinvested in the business or paid out as dividends to shareholders.

▶ Dividend yield is calculated by dividing dividend per share by share price.

▶ Shareholders must approve dividends through their voting rights. The most common dividend is cash, but dividends can also be issued as stock or other property.

▶ In addition to companies, mutual funds and exchange-traded funds (ETFs) pay dividends.

▶ Dividends are an incentive for shareholders to invest in the stock of a company and are usually paid out of the company’s net profits.

▶ Most of the company’s profits are retained as retained earnings, which represent the money that will be used for the company’s ongoing and future operations; the remainder can be distributed as a dividend to shareholders.

▶ When a company does not make the necessary profits, it may still pay dividends. Their goal may be to maintain their established track record of making regular dividend payments.

▶ Various payout rates and timeframes are available to directors when it comes to issuing dividends.

It is possible to pay dividends on a schedule, such as a monthly, quarterly, or annual basis.

Walmart Inc. (WMT) and Unilever (UL) are two companies that offer regular quarterly dividends.

A dividend is the distribution of profit or the portion of net income paid out to shareholders. It is paid to shareholders in cash or stock for making investments and bearing risks.

▶ Dividend distributions are generally based on accumulated profits, i.e. Dividends are not an expense on income statements; they are liabilities at the time of declaration.

▶ If a company has sufficient retained earnings dividends may be declared.

▶ Dividends are not an expense on income statements; they are liabilities at the time of declaration.

▶ Corporations usually pay dividends in cash, but they can also distribute shares of their own capital shares as dividends. An asset or merchandise is paid out as dividends by the company.

▶ Dividends are how shareholders of a corporation share in its earnings, accountants charge them to retained earnings.

▶ Dividend policy is simply concerned with determining the portion of a firm’s earning into dividends and retained earnings in the firm.

Some of the various types of Dividends are explained below:

Types of Dividend

Cash Dividends

➠ A cash dividend is the distribution of accumulated earnings by a company to its shareholders. It is up to the board to decide whether cash dividends are declared.

➠ The board declares a dividend upon approval of the resolution. Nevertheless, the company must prepare a current list of shareholders before paying the dividend.

This is why there is usually a delay between declaration and payment.

➠ As an example, the board of directors might approve a resolution at the January 10 (date of declaration) meeting, and declare it payable on February 5 (date of payment) to all Shareholders of record on January 25 (date of record).

➠ Dividends declared in cash are liabilities. The payment is usually due very soon, so it is typically a current liability.

➠ A company records the declaration and payment of an ordinary dividend payable in cash using the following entries.

There are three significant dates in accounting for dividends:

Date of declaration

The is the date which indicates when the board of directors approved a motion declaring that dividends should be paid.

Date

Particulars

Debit

Credit

Retained Earnings A/C

To Dividend Payable A/C

(Record the declaration of cash dividend)

XXX

Date of Record

This date determines which shareholders receive dividends.

Date	Particulars	PR	Debit	Credit
	No Entry

Date of payment

This is the date that indicates when the corporations will pay dividends to the shareholders.

Date

Particulars

Debit

Credit

Dividend Payable A/C

To Cash A/C

(Record the payment of cash dividend)

XXX

Cash Dividends for Preferred Share

➠ The preference shareholders get to share in corporate income distribution before the common shareholders. As a percentage of the par value of the preferred Share or as a specified amount, companies pay dividends per share.

➠ Cumulative dividends are often included in preference share contracts. Preferred Shareholders will be paid both current-year dividends and any unpaid dividends from the prior year before common Shareholders receive dividends.

➠ Preference dividends not declared in a given period are called dividends in arrears when Preference Shares are cumulative.

Property Dividends

➠ Dividends payable from assets other than cash are called property dividends or dividends in kind. Depending on the board, property dividends may be merchandise, real estate, or investments.

➠ To declare a property dividend, the corporation should restate the property at fair value, and recognize any gain or loss as the difference between the property’s fair value and its carrying value.

➠ It may then record the declared dividend 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.

➠ The corporation debits property dividends payable and credits the account containing the distributed asset (restated at fair value) after the distribution of the dividend.

Liquidating Dividends

➠ Dividends are sometimes computed based on paid-in capital. Shareholders may incorrectly believe that the corporation is profitable if this fact isn’t properly disclosed.

➠ To avoid this type of deception, either intentional or unintentional, a clear statement of the source of every dividend should accompany the dividend check.

➠ Dividends other than retained earnings are sometimes described as liquidating dividends. This term implies that such dividends are a return of the Shareholder’s investment rather than of profits.

➠ In other words, any dividend that is not based on earnings reduces the paid-in capital and in that sense is a liquidating dividend. ➠ Extractive companies may pay dividends equal to their accumulated income and reduction. Dividends in excess of accumulated dividends.

➠ Occasionally, management simply decides to close the business and declares a liquidating dividend. In these cases, liquidation may take place over a number of years to ensue an orderly and fair sale of assets.

Share/Stock Dividends

➠ Management may issue a Share/stock dividend if it wishes to capitalize part of the earnings (i.e., reclassify amounts from earned to contributed capital), and thus retain earnings in the business permanently.

➠ The company does not distribute any assets in this case. Shareholders maintain the same proportionate interest in the company and the same total book value after the company issues a dividend.

➠ By definition, a Share dividend is the issuance by a corporation of its own Shares. All shareholders on a pro rata basis, without consideration.

➠ Some believe that a company should transfer the par value of a Share dividend from retained earnings to capital shares when recording a dividend.

➠ Others believe it should transfer the fair value of the shares-their market value at the declaration date-from retained earnings to capital shares and additional paid-in capital. Share dividends are used by companies for several reasons:

1. Share dividends do not require the use of cash.

2. Share dividends reduce the market price of the Share.

3. Share dividends do not represent taxable income to recipients and may be attractive to some wealthy investors.

➠ The company must transfer the fair value of the Share issued from retained earnings when the dividend is less than 20-25 percent of the common shares outstanding at the time of the dividend declaration.

➠ Based on the assumption that a small Share dividend will have little effect on the market price of the shares previously outstanding, this recommendation is made.

➠ Share dividends of less than 20-25 percent are often referred to as small (ordinary) Share dividends and a large Share dividend greater then 20-25 percent and it to be recorded at par.

➠ Share dividends are handled under the small dividend method since many recipients of Share dividends view them as distributions of corporate earnings in an amount 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) calculation shows how much the company has distributed as dividends to each share of stock.

➠ Investors can find out which companies can grow their dividends over time by monitoring a company’s DPS.

Dividend Yield

➠ Online brokerage platforms and financial websites will report a company’s dividend yield, which is the annual dividend divided by the stock price on a particular date.

➠ Dividend yield, expressed as a percentage (dividend/price), is a measure of a company’s dividend payments in comparison with its stock price.

Dividend Payout Ratio

➠ Dividend advisors say one of the best ways to determine a dividend’s safety is to check its payout ratio, or how much of its net income is allocated to dividends.

➠ A company that pays out more than 100% of its income could have trouble paying its dividends. Dividends might not be covered in tough times if earnings dip too low.

➠ A payout ratio of 80 percent or less is generally considered acceptable by investors. On financial or online broker websites, the company’s payout ratio will be listed just like its dividend yield.

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 makes the announcement of dividends of the company on the declaration date (or announcement date), and payment has to be authorized by the shareholders.

Ex-dividend Date

➠ The ex-dividend date or simply the ex-date is the date on which dividend eligibility expires.

➠ If a stock has an ex-date of Monday, May 5, then shareholders who buy the stock on or after that date will NOT be eligible to receive the dividend, because they are buying it after the dividend expiry date.

Record Date

➠ Generally, the record date is defined by a company as the cutoff date used to determine which shareholders are eligible for dividends.

Payment Date

➠ A dividend payment is issued by the company on the dividend payment date. This is when the money gets credited to investors’ accounts.

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 forever, as dividends are irreversible.

➠ Dividend payments therefore impact stock prices, which may rise on dividend announcements by approximately the amount of the dividend declared and then decline by a similar amount on the ex-dividend date.

➠ In the case of a company that is trading at $60 per share, the company announces a $2 dividend on the announcement day.

➠ As soon as the news is publicized, the share price shoots up by around $2 and reaches $62. One business day prior to the ex-dividend date, the stock trades at $63 per share.

➠ The stock starts trading at $61 at the start of the trading session on the ex-dividend date because anyone buying on the ex-dividend date will not receive the dividend.

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.

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Smirti

(Founder of Management Notes)
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,

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Types of Dividends – Meaning, Examples, Advantages, Disadvantages, Methods | Accounting for Dividend

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