Dividends are financial rewards a company gives to shareholders. Dividends are not a necessity as part of the reward given to shareholders. When they do occur, however, a company must accurately record and report them on financial statements. Dividends declared and dividends payable are two accounting terms that apply to this business activity.
A company often declares a dividend prior to actually paying investors the cash. Declared dividends are often the amount per share of a particular stock, such as $.25 for each share of common stock held by shareholders. Companies often state that the dividend only applies to shares held by a certain date. This prevents new investors from purchasing shares just to earn the dividends.
Once a company declares a dividend, it must record a liability. This indicates the company has a future cash payout that will occur per management agreement. A payable account is a liability that resides on the company’s balance sheet. The dollar amount included in the account is the cash the company will pay as designated at the dividend declaration date.
Accountants must make a few journal entries to record dividends declared and dividends paid. After the declaration date, accountants will debit retained earnings and credit dividends payable for the declared amount. Once paid, accountants will debit the dividends payable and credit cash. This removes the payable from the books and completes the dividend payable process.
Dividends reduce a company’s value. Retained earnings is an accounting figure that represents the net income a company reinvests into operations. Reducing this figure indicates the company has less cash to improve business operations. In some cases, future business expansion may be impossible when issuing dividends. Shareholders must accept this trade-off when a company issues one-time or multiple dividends.