What type of account is the Dividends account?
What are dividends?
The dividend is the distribution of some of a company’s earnings to a class of its shareholders, as determined by the company’s board of directors
Dividends are payments to reward investors for putting their money into the venture.
Types of dividends
· Cash is the payment of actual cash from the company directly to the shareholders and is the most common payment type.
· Stock – stock dividends paid out to shareholders by issuing new shares in the company.
Accounting for dividends
The journal entry to record the declaration of the cash dividends involves a decrease (debit) to Retained Earnings (a stockholders’ equity account) and an increase (credit) to Cash Dividends Payable (a liability account).
Entry for dividends
- Debit- Retailed earnings Credit- Dividends payable
Which means reducing the retained earnings and increasing the liabilities.
When making the dividend payments:
- Debit- Dividends payable
- Credit- Cash
Dividends are not equity but impact equity when making payments to shareholders.
Example of the accounting for cash dividends
When dividends payments are approved and declared by the board of directors, you will record the following entry:
When dividends payments are approved and displayed by the board of directors, you will register the next entry:
| Debit | Credit | |
| Retained Earnings | 10,000 | |
| Dividends Payable | 10,000 |
After that, the company pays the dividend, so record the following entry:
| Debit | Credit | |
| Dividends Payable | 10,000 | |
| Cash | 10,000 |
What are dividends payable?
Dividends payable are dividends that a company’s board of directors has declared to pay its shareholders.
Dividends are a current liability.
Until the company pays the shareholders, the cash dividend amount in the records within a rewards payable account appears as a current liability.
Cash dividends are taxable income in the year the investor received the payment.
Dividends are usually paid from current years’ retained earnings (after-tax profit) and equity.
The equation is:
Opening Equity + Retained Earnings – Dividends = Closing Equity
When a dividend is declared, the journal entry is
- Debit Retained Equity
- Credit Shareholders Accounts.
Shareholders’ accounts are part of equity and are not a liability to the company.
When paid
- Debit Shareholders Accounts
- Credit Bank Account.
A company that turned a profit at financial year-end can choose to redistribute some of those funds to its shareholders as dividends. Dividends offer a tangible way for companies to show their gratitude to their shareholders for their support and investment.
Ordinary, not guaranteed dividends. However, paying consistent or increasing dividends yearly is considered a sign of financial health, so businesses with great dividend histories tend to be very popular among investors.
Dividends are a balance sheet account. However, it is a temporary account because its debit balance will close in the Retained Earnings account at the end of the accounting year.
What happens when the company cannot afford to pay the dividends?
When people invest in a company, they expect payouts as a dividend at the end of each financial year. However, sometimes some businesses cannot afford to pay for the tips. In that case, the investor will try to sell the shares.
If the director makes the payment regardless of the situation will face the risk of not following the company rules.
Failing to comply with the Companies Act can result in accusations of misconduct. Taking a dividend endangers the company or its creditors at the time of payment or later on; it is likely to view as a breach of the director’s fiduciary duty.