The term cash dividend normally refers to the formal distribution of retained earnings to the holders of preferred or common shares of stock. Typically, the company’s board of directors would vote on a declaration of dividends, which is stated in terms of dollars per share or a percentage basis.
Normally, companies will issue dividends to shareholders from the company’s retained earnings, or profits, on a quarterly basis. Payment is usually quoted in terms of dollars per share for holders of common stock, but can also be quoted in terms of a dividend yield for preferred shares.
The payment of dividends must be formally approved by the company’s board of directors, even if the company has a long history of quarterly payments. Cash is the most common form of dividends paid by a company, and the source of funds is usually retained earnings (the company’s profits).
Once approved by the board of directors, the company must go through a number of steps to determine which shareholders are paid. For example, dividends are paid to shareholders of record on a certain date. Stock that trades after this date is said to be ex-dividend.
Since there is a relatively short delay between the creation of the liability (the board’s declaration) and the payment date, accountants will make journal entries to retained earnings, dividends payable, and cash.
On January 15, Company A’s board of directors approved a cash dividend of $0.25 to holders of common stock; to be paid on February 5 to shareholders of record on January 22. Company A currently has 10,000,000 shares of common stock outstanding.
The journal entry on the date of declaration would be as follows:
|Retained Earnings: Declaration of Cash Dividend||$2,500,000|
|Dividends Payable: $0.25 per share x 10,000,000 shares||$2,500,000|
On February 5, the following journal entry is made to reflect the distribution of the dividend to shareholders: