A Corporation Records a Dividend-related Liability
16.4 The Issuance of Greenbacks and Stock Dividends
At the finish of this section, students should be able to meet the following objectives:
- Identify the diverse dates associated with a dividend distribution.
- Set all journal entries to written report a cash dividend payment.
- Ascertain the characteristics of a cumulative dividend.
- Explain the rationale for a stock dividend or stock separate.
- Record the issuance of a stock dividend.
Question: As stated in Chapter 1 “Why Is Fiscal Accounting Important?”, a vast majority of investors purchase capital stock for only two reasons: price appreciation and dividends. Dividends and long-term majuscule gains (gains on the auction of sure investments that have been held for over a year) are especially highly-seasoned to individual investors considering they are taxed at a lower charge per unit than most other types of income.
Dividends are unremarkably paid in greenbacks and represent the profits of a business being passed along to the owners. Considering the corporation is finer giving away its assets, dividends require formal approval by the board of directors—known equally a dividend declaration. The board considers current cash balances equally well as the projected needs of the concern earlier deciding on the corporeality, if whatsoever, of a dividend payment.
How does a corporation report the declaration and distribution of a cash dividend?
Answer: Dividends provide a meaningful signal to investors about the financial health of a business. Some corporations even avowal well-nigh having paid a constant or rising annual dividend for many years. Unfortunately, one result of recent economical times has been that a number of businesses have been forced to reduce or even eliminate dividend distributions. Such decisions typically atomic number 82 to a drop in the market place price of a corporation’south stock because of the negative implications.
Other businesses stress rapid growth and rarely, if ever, pay a greenbacks dividend. The board of directors prefers that all profits remain in the business organization to stimulate future growth. For example, Netflix Inc. reported net income for 2008 of over $83 million but paid no dividend.
Chronologically, accounting for dividends involves several dates with approximately two to v weeks passing between each:
date of declaration
date of tape
(and the related ex-dividend appointment)
date of payment
(also known as the appointment of distribution)
To illustrate, assume that the Hurley Corporation has one million shares of authorized mutual stock. To appointment, iii hundred thousand of these shares have been issued only xx one thousand shares were recently bought back equally treasury stock. Thus, 280,000 shares are presently outstanding, in the hands of investors. Hurley earned a reported net income of $780,000 in the current year. After some deliberations, the board of directors has decided to distribute a $1.00 cash dividend on each share of mutual stock.
The day on which the Hurley lath of directors formally decides on the payment of this dividend is known as the date of proclamation. Legally, this action creates a liability for the company that must exist reported in the financial statements. Only the owners of the 280,000 shares that are outstanding will receive this distribution.
Equally discussed previously, dividend distributions reduce the amount reported as retained earnings but accept no affect on reported net income.
When the dividend is declared by the board, the date of record is also set. All shareholders who own the stock on that mean solar day authorize for receipt of the dividend. The ex-dividend date is the first 24-hour interval on which an investor is non entitled to the dividend. Because receipt of the dividend has been lost, the market price of the stock typically drops by approximately the amount of the dividend on the ex-dividend engagement although myriad other market place factors always influence the move of stock prices.
No journal entry is recorded by the corporation on either the appointment of record or the ex-dividend appointment because they do not chronicle to any event or transaction. Those dates but allow Hurley to identify the owners to whom the dividend volition be paid.
On the date of payment, the corporation mails checks to the advisable recipients, an event recorded equally follows.
Question: Presume that Wington Visitor issues a share of $100 par value preferred stock to an investor on January ane, Year Ane. The preferred stock certificate discloses an annual dividend rate of viii per centum. Thus, dividend payment is $8 each year ($100
eight per centum). At the end of Year One, Wington faces a cash shortage and is unable to pay this dividend. Take the owners of the preferred shares lost the correct to the Yr One dividend?
Must a corporation report a liability if a preferred stock dividend is not paid at the appointed time?
Answer: Preferred stock dividends are often identified on the stock certificate equally “cumulative.” This term ways that the obligation for all unpaid dividends on these shares must be met before dividends tin can be distributed on mutual stock. Cumulative dividends are referred to every bit “in arrears” when past due.
If the dividend on the preferred shares of Wington is cumulative, the $8 is in arrears at the end of Year One. In the futurity, this (and any other) missed dividend must be paid before any distribution on common stock tin can be considered. Conversely, if a preferred stock is noncumulative, a missed dividend is simply lost to the owners. Information technology has no impact on the time to come allocation of dividends betwixt preferred and mutual shares.
The existence of a cumulative preferred stock dividend in arrears is information that must be disclosed in financial statements. However, the residuum is not reported as a liability. Just dividends that have been formally declared by the board of directors are recorded as liabilities. If cumulative, a note to the financial statements should explain Wington’south obligation for any preferred stock dividends in arrears.
Question: A corporate press release issued on May xix, 2009, informed the public that “Green Mountain Java Roasters Inc. today announced that its Board of Directors has approved a three-for-two
to be effected in the form of a stock dividend. The Company volition distribute 1 additional share of its mutual stock to all shareholders of record at the shut of business organization on May 29, 2009, for every two shares of common stock held on that date. The shares will be distributed on June 8, 2009.”
Plain, as shown by this press release, a corporation can outcome boosted shares of stock to shareholders instead of distributing only cash dividends. These shares can be issued every bit a
or in a slightly different manner as a stock split
i.No assets are distributed in either of these scenarios—just more than shares of the company’due south ain stock.
Are shareholders better off when they receive additional shares in a stock dividend?
Answer: When a stock dividend is issued, the number of shares held by every investor increases but their pct buying stays the aforementioned. Their ownership interest in the corporation remains proportionally unchanged.
To illustrate, assume that the Red Company reports net assets of $5 1000000. Janis Samples owns one thousand of the outstanding ten thousand shares of this company’south common stock. She holds a x percent ownership interest (1,000/10,000) in a business that holds internet avails of $v million.
The board of directors then declares and distributes a four percent stock dividend. For each 1 hundred shares that a stockholder possesses, Crimson Visitor issues an additional four shares (4 pct of ane hundred). Thus, four hundred new shares are conveyed to the buying every bit a whole (4 pct of ten thousand) which raises the total number of outstanding shares to 10,400. However, a stock dividend has no actual impact on the corporation. At that place are simply more shares outstanding. Nothing else has changed.
Janis Samples receives 40 of these newly issued shares (four pct of k) and then that her holdings take grown to 1,040 shares. Later on this stock dividend, she even so owns 10 per centum (ane,040/10,400) of the outstanding stock of Red Company and it still reports cyberspace assets of $5 million. The investor’s fiscal position has not improved; she has gained nothing as a result of this stock dividend.
Not surprisingly, the investor makes no journal entry in bookkeeping for the receipt of a stock dividend. No change has taken place except for the number of shares beingness held.
However, the corporation does brand a journal entry to record the issuance of a stock dividend although information technology creates no bear on on either assets or liabilities. The retained earnings balance is decreased by the off-white value of the shares issued while contributed capital (common stock and
capital in excess of par value) are increased by the aforementioned amount.
Co-ordinate to U.Southward. GAAP, if a stock dividend is especially large (in backlog of 20–25 percentage of the outstanding shares), the change in retained earnings and contributed capital letter is recorded at par value rather than fair valueii.
If no changes occur in the makeup of a corporation every bit the effect of a stock dividend, why does a board of directors choose to issue ane?
Answer: The primary purpose served by a stock dividend (or a stock split) is a reduction in the market cost of the corporation’due south capital stock. When the toll of a share of stock rises to a high level, fewer investors are willing to make purchases. At some point, market interest wanes. The resulting reduction in demand will likely have a negative impact on the stock price. A growing company might notice that a previously escalating trend in its market value has hit a plateau when the price of each share rises too high
Past issuing a large quantity of new shares (sometimes two to 5 times as many shares as were outstanding), the price falls, frequently precipitously. For instance, an owner who held 1 hundred shares at a market price of $120 per share (full value of $12,000) might at present have two hundred shares selling at $60 per share or three hundred shares selling at $twoscore per share (just with the aforementioned total market value of $12,000). The stockholder’s investment remains unchanged only, hopefully, the stock is now more than bonny to investors at the lower price so that the level of active trading increases.
Stock dividends also provide owners with the possibility of other benefits. For instance, cash dividend payments usually drop after a stock dividend but not ever in proportion to the change in the number of outstanding shares. An owner might hold 1 hundred shares of common stock in a corporation that has paid $1 per share as an annual cash dividend over the past few years (a total of $100 per year). After a 2-for-i stock dividend, this person now owns two hundred shares. The board of directors might then choose to reduce the annual cash dividend to only $0.sixty per share so that future payments go up to $120 per year (two hundred shares × $0.60 each). Such a benefit, though, is not guaranteed. The investors tin simply hope that boosted greenbacks dividends will exist received.
Many corporations distribute cash dividends after a formal declaration is passed by the lath of directors. Journal entries are required on both the appointment of declaration and the engagement of payment. The date of record and the ex-dividend date are important in identifying the owners entitled to receive the dividend but no transaction occurs. Hence, no recording is made on those dates. Preferred stock dividends are often cumulative so that any dividends in deficit must be paid before a common stock distribution tin can be made. Dividends in arrears are not recorded as liabilities until declared. Stock dividends and stock splits are issued to reduce the market price of capital stock and proceed potential investors interested in the possibility of acquiring ownership. A stock dividend is recorded as a reduction in retained earnings and an increase in contributed capital. However, stock dividends have no immediate affect on the financial condition of either the company or its stockholders.
1As can be seen in this press release, the terms “stock dividend” and “stock split” take come up to be well-nigh interchangeable to the public. Both terms were used by Green Mountain. Still, minor legal differences do exist that actually impact reporting. Par value is changed to create a stock split only non for a stock dividend. Interestingly, stock splits take no reportable bear on on financial statements but stock dividends do. Therefore, only stock dividends will exist described in this textbook.
2A stock dividend of betwixt 20 and 25 per centum tin be recorded at either fair value or par value.
A Corporation Records a Dividend-related Liability