When investors buy shares of stock in a company, they effectively become part-owners of the firm. In return, the company may choose to distribute some of its earnings to these owners, or shareholders, in the form of dividends. This typically happens each quarter for U.S.-based firms, when the company declares a dividend amount at its own discretion. Accountants must make a series of two journal entries to record the payout of these dividends each quarter.
The company pays out dividends based on the number of stock shares it has outstanding and will announce its dividend as a certain amount per share, such as $1.25 per share. When paying dividends, the company and its shareholders must pay attention to three important dates.
The first date is when the firm declares the dividend publicly, called the Date of Declaration, which triggers the first journal entry to move the dividend money into a dividends payable account. The second date is called the Date of Record, and all persons owning shares of stock at this date are entitled to receive a dividend. This does not require any journal entry, but many investors, especially short-term hold or day-trading investors, want to know this date so that they can buy the stock, receive the dividend and then sell the shares.
The third date, the Date of Payment, signifies the date of the actual dividend payments to shareholders and triggers the second journal entry. This records the reduction of the dividends payable account, and the matching reduction in the cash account.
Record the first journal entry as follows: On the Date of Declaration, when the company's board of directors announces the dividend amount, make a journal entry to debit Retained Earnings and credit Dividends Payable, which is a current liability account.
On the Date of Payment, you would record the second journal entry as follows: Debit the Dividends Payable liability account and credit the Cash account.
Sometimes companies choose to pay dividends in the form of additional common stock to investors. This helps them when they need to conserve cash, and these stock dividends have no effect on the company's assets or liabilities. The common stock dividend simply makes an entry to move the firm's equity from its retained earnings to paid-in capital.
When a company declares a stock dividend, this does not become a liability; rather, it represents common stock the company will distribute to shareholders, so it's reflected in stockholders' equity. The company basically capitalizes some of its retained earnings, moving it over to paid-in capital.
This has the effect of reducing retained earnings while increasing common stock and paid-in capital by the same amount. Journalizing the transaction differs, depending on the number of shares the company decides to distribute. To record small stock dividends that represent up to 25 percent of the firm's outstanding shares, you would capitalize a dividend amount that equals the current market price multiplied by the number of shares in the dividend payment.
On the Date of Declaration, you would debit a Stock Dividends account for the total amount (# of shares * market price). You would then credit the equity account Stock Dividends Distributable for the amount of (# of shares x par value) and credit the remainder above par to Paid-In Capital in Excess of Par (Common).
On the Date of Payment, you would make an entry to debit Stock Dividends Distributable and credit the Common Stock account.