What is Dividend?
Dividend is that portion of the firm’s earnings which is paid to the shareholders/ owners of the firm. Dividends provides an added incentive (in the form of a return on your investment) to own stock in stable companies even if they are not experiencing much growth.
Dividends are often paid out quarterly, semi-annually or annually and it gives stockholders a steady return regardless of what happens to the stock price. The companies use dividends to pass on their profits directly to their shareholders.
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In every period, the earnings that remain after satisfying the obligation to the creditors, the government and the preference shareholders can either be retained by the company or distributed as dividends or bifurcated between the retained earnings and dividends.
The profits not distributed are known as retained earnings. The retained earnings can be invested in assets or new project that will help the firm to maintain or increase its growth. The dividend decisions require the financial manager to decide the distribution policy of the leftover earnings.
Types of Dividend
A dividend is generally considered to be a cash payment to the holders of company stock. However, there are several types of dividends, depending upon the form in which they are paid to the shareholders.
- Cash dividend
- Stock dividend
- Property dividend
- Scrip dividend
- Liquidating dividend
The cash dividend is by far the most common of the dividend types used. On the date of declaration, the board of directors resolves to pay a certain dividend amount in cash to those investors holding the company’s stock on a specific date. The date of record is the date on which dividends are assigned to the holders of the company’s stock. On the date of payment, the company issues dividend payments. The cash dividend can be the Regular Dividend or the Interim dividend.
Regular dividend is the dividend paid annually, proposed by the board of directors and approved by the shareholders in general meeting. It is also known as final dividend because it is usually paid after the finalization of accounts. It is generally paid in cash as a percentage of paid up capital, say 10 % or 15 % of the capital.
Sometimes, it is paid per share. On the other hand, interim dividend is paid only if Articles of Association (AOA) so permit. It is generally declared and paid when company has earned heavy profits or abnormal profits during the year and directors which to pay the profits to shareholders. Such payment of dividend in between the two Annual General meetings before finalizing the accounts is called Interim Dividend.
A stock dividend is the issuance by a company of its common stock to its common shareholders without any consideration. If the company issues less than 25 percent of the total number of previously outstanding shares, it is treated as a stock dividend. If the transaction is for a greater proportion of the previously outstanding shares, then it is treated as stock split.
The stock dividend is recorded by transferring the from retained earnings to the capital stock and additional paid-in capital accounts an amount equal to the fair value of the additional shares issued. The fair value of the additional shares issued is based on their fair market value when the dividend is declared.
A company may issue a non-monetary dividend to investors, rather than making a cash or stock payment, like the assets or property owned by the company. The distribution is recorded at the fair market value of the assets distributed. Since the fair market value is likely to vary somewhat from the value of the assets, the company will likely record the variance as a gain or loss.
A company may not have sufficient funds to issue dividends in the near future, so instead it issues a scrip dividend, which is essentially a promissory note (which may or may not include interest) to pay shareholders at a later date. This dividend creates a note payable.
When the board of directors wishes to return the capital originally contributed by shareholders as a dividend, it is called a liquidating dividend, and may be an indication to closing down the business. The accounting for a liquidating dividend is similar to the entries for a cash dividend, except that the funds are considered to come from the additional paid-in capital account.