How to Record Dividends Declared and Paid in Accounting

Dividends represent a common method for companies to distribute value to shareholders, necessitating specific accounting procedures. Accurate recording of dividends is important for maintaining clear financial statements and complying with reporting standards.

Properly documenting both the declaration and payment of dividends helps prevent errors that could misrepresent liabilities or equity. This process, while routine in corporate accounting, requires careful attention to timing and classification.

Let’s examine how this works.

Dividend Classes

Companies can distribute earnings to shareholders in several ways, each classified differently for accounting based on the asset form.

Cash

The most frequent distribution method involves cash. When a company declares a cash dividend, it commits to paying a set amount per share of outstanding stock, typically funded from retained earnings—accumulated profits not yet distributed. Payments usually occur electronically or via check to shareholders registered by a specific record date, reducing the company’s cash balance upon disbursement. The Internal Revenue Service generally classifies these as ordinary dividends, representing a distribution of earnings and profits, as detailed in IRS Publication 550.

Stock

Alternatively, a company might issue a stock dividend, distributing additional shares of its own stock to current shareholders proportionally. Under Generally Accepted Accounting Principles (GAAP), these are often classified as “small” (usually under 20-25% of outstanding shares) or “large.” Small stock dividends are recorded by moving the fair market value of the new shares from retained earnings to paid-in capital accounts. Large stock dividends typically involve transferring only the par or stated value from retained earnings. This distinction reflects whether the transaction is viewed more like an earnings distribution or a stock split. Guidance can be found in the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 505.

Property

Less commonly, companies issue property dividends, distributing non-cash assets like inventory, equipment, or investments. Before distribution, the asset must be adjusted to its fair market value on the declaration date. GAAP, particularly guidance in ASC 845 regarding nonmonetary transactions, requires recognizing any gain or loss from this adjustment in the income statement. The dividend is then recorded based on this fair market value, ensuring the distribution reflects the current economic worth of the assets leaving the company.

Declaration and Liability Recording

The dividend recording process formally starts on the declaration date, when the company’s board of directors approves and announces the dividend. This announcement includes the dividend amount per share, the record date (determining eligible shareholders), and the payment date.

According to GAAP, declaring a dividend creates a legal obligation for the company. This commitment must be recognized in the accounting records immediately. A journal entry is made debiting the Retained Earnings account, reducing equity, and crediting a liability account, usually “Dividends Payable,” establishing the obligation on the balance sheet. This liability is typically classified as current, as payment usually occurs within a year. Recording this liability ensures financial statements accurately reflect the company’s obligations.

Payment Journal Entry

The next accounting event is the payment date, when the company distributes the dividend to shareholders on record. This settles the obligation recognized at declaration.

For cash dividends, the journal entry involves debiting Dividends Payable, removing the liability from the balance sheet, and crediting the Cash account, reflecting the cash outflow.

If paying a property dividend, the Dividends Payable account is debited, but the specific asset account (e.g., Investments) is credited at the fair value established on the declaration date, rather than Cash. Guidance for these nonmonetary asset distributions can be found in ASC 845.

For stock dividends, the entry on the distribution date involves debiting Common Stock Dividends Distributable and crediting the Common Stock account, reflecting the share issuance and converting a temporary equity item into permanent capital, following principles in ASC 505. No assets leave the company in a stock dividend.

Effects on Shareholder Equity

Dividend declaration and payment affect the shareholders’ equity section of the balance sheet, depending on the dividend type. Shareholders’ equity, the owners’ residual claim after liabilities, mainly consists of contributed capital and retained earnings (accumulated, undistributed profits).

Cash and property dividends reduce total shareholders’ equity. Upon declaration, retained earnings are decreased by the cash amount or the fair market value of the property being distributed (as guided by standards like ASC 845 for property), signifying a distribution of accumulated profits.

Stock dividends impact shareholders’ equity differently. They do not decrease total assets or total equity but reclassify amounts within equity. For small stock dividends, the fair market value of issued shares moves from retained earnings to contributed capital accounts (Common Stock and Additional Paid-in Capital), per ASC 505. For large stock dividends, typically only the par value moves from retained earnings to Common Stock. In both cases, retained earnings decrease, but contributed capital increases by an equal amount, leaving total shareholders’ equity unchanged. This reflects the capitalization of earnings rather than a distribution of assets outside the company.