When the company issues dividends to its shareholders, dividends may be paid in cash or by issuing additional shares. Two types of dividends affect the balance sheet differently.
What Are The Dividends?
A dividend is a way of redistribution of company profits to shareholders as a reward for their investment. Companies are not required to issue dividends on ordinary shares, although many are proud to pay consistent or growing dividends every year.
When most people think of dividends, they think of cash dividends. However, the company can issue stock dividends. When a company issues stock dividends, it distributes additional shares to existing shareholders according to the number of shares they already own.
What Are Retained Earnings?
Dividends impact equity capital section of the balance sheet of corporations – retained earnings, in particular. Retained earnings is the amount of money that a company has left after all its liabilities have been paid. Retained earnings are generally used to reinvest in the company paying the dividends, or repayment of debt. While net profit is the amount of income that remains after deducting the cost of doing business during a specific period, retained earnings is the amount of income accrued on the years that have not been reinvested in the business or distributed to shareholders.
Cash dividends affect two areas on the balance sheet: cash and equity accounts. Investors won’t find a separate balance sheet account for dividends that were paid. However, after the Declaration of a dividend until the actual payment, the company records a liability of the shareholders for payment of dividends account.
After payment of dividends, subject to the payment of dividends is restored and is no longer present on the side of liabilities. When dividends are paid, the impact on the balance sheet is a reduction to retained earnings of the Company and its cash balance. In other words, retained earnings and cash shall not be reduced by the total amount of dividends.
By the time the financial statements of the company have been released, the dividend has been paid, and a decrease in retained earnings and cash has already been recorded. In other words, investors do not see a record of arrears on the dividend payment account.
For example, suppose a company has $ 1 million. in retained earnings and 50 cents of dividends for all 500,000 shares. The total amount of dividends is $0.50 or 500,000 250,000$, which will be paid to shareholders. As a result, cash and retained earnings is reduced by $ 250,000, leaving $750,000 remaining retained earnings.
The final effect of the cash dividends on the company’s balance sheet is the reduction of cash for 250 000 $in assets and a decrease in retained earnings of $250 000 shares.
Dividends On Shares
While cash dividends have a direct impact on the balance sheet, the issuance of stock dividends is a little more complex. The company’s Executive management may require the issue of shares dividends to its shareholders, if the company has available funds on hand or if they want to reduce the value of existing shares, reducing the price-earnings (P/E) ratio and other financial indicators. Dividends on shares are sometimes called bonus shares or issue.
Dividends on shares will not affect the cash position and the equity balance. If the number of shares outstanding increased by less than 20% to 25% stock dividend is considered small. Big dividends when a stock dividend significantly affect the share price and, as a rule, the increase of shares outstanding by more than 20% to 25%. A large dividend can often be considered a stock split.
When the shares the dividend is declared, the total amount should be written off through retained earnings is calculated by multiplying the current market price per share dividend, the percentage and number of shares outstanding. If the company pays dividends, the dividends reduce the company’s retained earnings and increase common stock account. Of dividends did not lead to changes in the asset balance, but rather affects only the side of justice by reallocating part of the retained earnings on the common stock account.
For example, say a company has 100,000 shares outstanding and wants to give 10% of dividends in the form of shares. If each share is currently worth $20 on market, total dividends will amount to $200,000. Two entries will include a debit 200,000 to retained earnings and credit from 200,000 to a single exchange account. The balance will be balanced next record.