Paying dividends is a way companies share some of the profits made during a period. When a payment of dividends is announced, it is typically not paid for a few weeks. When they are declared however, they must be recorded on the accounting books as a liability. This is a principle used in accrual accounting that states revenues and expenses must be recorded in the period in which they incur or are earned.
Declare a payment of dividends. The first step in recording an adjusting entry for dividends is done on the date of declaration. When this occurs, a company records the declaration as a liability on the books.
Calculate the amount to be recorded. If there are 10,000 shares of stock that are receiving dividends and the dividend amount is $0.20 per share, the amount is calculated by multiplying 10,000 times $0.20. The total amount of dividends to be paid is $2,000.
Record the adjusting entry. The amount of $2,000 is placed in the accounting books as a debit to the Retained Earnings account and a credit to Dividends Payable. Retained Earnings is an account that is part of the Owner’s Equity Account. The profits a company makes are placed in this account. The company then decides how much of the profit they will “retain” and how much they will share with stockholders. Dividends Payable is a liability account. By placing this amount into this account, the company records a liability in the period in which it occurred.
Pay the dividends. When the date for the dividends to be paid arrives, the company must pay the dividends. When this occurs, a journal entry must be recorded.
Record the journal entry for the payment of the dividends. The entry to record the payment of dividends is a debit to Dividends Payable and a credit to Cash. By debiting the Dividends Payable account, the liability is paid off and the account is brought to zero. By crediting cash, cash is reduced which reflects the amount the company paid for dividends. The entry is a debit to Dividends Payable for $2,000 and a credit to Cash for $2,000.