Is Dividends an Asset?
Is dividends an asset? Companies make distributions to their shareholders out of their net income otherwise known as retained earnings. This distribution made by the company is known as dividends. When a company declares a dividend, it is obligated to make the payment on the payment date. The investors on the other hand receive this dividend payment which is a cash inflow for them.
Is dividends an asset? Being that once a dividend is declared, it becomes a financial obligation for the company to pay them. In this article, we will discuss dividends and assets to understand whether dividends are considered assets and why.
Related: Is Revenue an Asset or Equity?
What are dividends
It is necessary for the shareholders to approve dividends by voting rights. Cash dividends are the most common but dividends are also issued as shares of stock. Since a dividend usually originates from a company’s net profits, it is a reward that the company pays to the shareholders for their investment in the company’s equity. The company can decide to keep the profits as retained earnings to be used for its ongoing and future business activities. However, a remainder can be allocated to shareholders as dividends. It is possible for companies to still make dividend payments even in situations whereby they do not make suitable profits. This is to maintain their track record of distributions.
The board of directors can decide to issue dividends over different time frames and with different dividend payout rates. It can be paid at a scheduled frequency such as on a monthly, quarterly, or annual basis. Companies can as well issue non-recurring special dividends either on an individual basis or in addition to a scheduled dividend. With this, the dividend payout ratio is important as it tells the number of a company’s earnings after tax has been paid to shareholders as dividends to shareholders.
Startup companies such as those in the biotech and technology sectors may not distribute regular dividends to shareholders. This is because they may be in their early stages of development and because of this, they will want to retain earnings for research and development, business expansion, and other operational activities.
There are important dividend dates as they follow a chronological order of events. These associated dates are important in determining the shareholders that qualify to receive a dividend payment. One of the dates is the announcement date otherwise known as the declaration date. It has to be approved by the shareholders before they can be paid. Another date is the ex-dividend date on which the dividend eligibility expires. The record date is the cutoff date that the company establishes to determine the shareholders that are eligible to receive a dividend payment. Lastly, the payment date is the date on which the company issues the dividend, in other words, credits the money to the investors’ accounts.
A high-value declaration of dividends can be an indication that the company is doing well and has generated good profits. However, it can also be an indication that the company has no suitable projects to generate better returns in the future. It is, therefore, utilizing cash to pay shareholders instead of reinvesting it into growth.
A reduction in dividend amounts or a decision against a dividend payment may not necessarily imply bad news for the company. It may be that the company’s management has a plan to invest the money such as a high-return project that has the potential to magnify returns for shareholders in the long run.
What is an asset?
Assets are reported on a company’s balance sheet and are bought or created the value of a firm as well as benefit its operations. As they represent economic resources controlled by an individual or a company, an economic resource may be something scarce with the ability to produce economic benefit by generating cash inflows or decreasing cash outflows.
An asset can also be a representation of access that other individuals or firms do not have. Furthermore, a right or other forms of access can be legally enforceable, meaning that economic resources are usable at the company’s discretion. The owner can either preclude or limit their use. In order for something to be considered an asset, a company must possess a right to it as of the date of the company’s financial statements.
Assets can broadly be classified under tangible assets and intangible assets. Tangible assets can further be classified under fixed and current assets.
Tangible assets are physical, that is, they can be seen, touched, and felt. Fixed assets which are tangible are resources that have an expected life of greater than a year. Examples are plants, equipment, and buildings. An accounting adjustment known as depreciation is carried out for fixed assets as they age. This allocates the cost of the asset over time. Depreciation may or may not reflect the loss of earning power of an asset.
Current assets are short-term economic resources that are expected to be converted or convertible to cash within one year. Current assets include cash and cash equivalents, accounts receivable, inventory, prepaid expenses, etc.
While it is easy to value cash, accountants periodically reassess how recoverable inventory and accounts receivable are over time. If there is evidence that a receivable might be irrecoverable or uncollectible, it will be classified as impaired. Also, if inventory becomes obsolete, companies write off these assets.
Companies record some assets on their balance sheets using the historical cost concept. This concept represents the asset’s original cost when the company purchased it. It can also include costs that are/were incurred to incorporate an asset into the operations of the company, such as delivery and setup.
Intangible assets as the name implies are economic resources that do not have a physical presence. They include patents, trademarks, copyrights, and goodwill. The accounting for intangible assets varies depending on the type of asset. They can either be amortized or tested for impairment on a yearly basis.
See also: Is Accumulated Depreciation an Asset?
Is dividends an asset?
We shall look at dividends as assets for shareholders and dividends as liabilities to the company.
Dividends as assets for shareholders
When a company is performing well and wants to reward its shareholders for their investment, it issues a dividend. These dividends are paid out either by cash or additional stock. They provide a good way for companies to communicate their financial stability as well as profitability to the corporate sphere generally.
Stocks that issue dividends are quite popular among investors and with this, many companies take pride in issuing consistent and increasing dividends yearly. Aside from rewarding existing shareholders, issuing dividends encourages new investors to purchase stock in a thriving company.
When a company makes a cash dividend payment on its outstanding shares, it first declares the dividend to be paid at a certain amount per owned share. Cash dividends are considered assets because they bring about an increase in the net worth of shareholders by the number of dividends. Remember that cash or cash equivalent is a current asset.
Stock dividends are also assets to the shareholder because they can be converted to cash in the next year. Stocks are treated as current assets on the balance sheet, therefore if one owns stock, he owns a current asset. Stocks are cash equivalents.
Dividends as liabilities to the company
For the issuer of shares, the company, dividends are considered liabilities. This is because their assets are reduced by dividend payments. The declaration of dividends brings about temporary liability for the company.
When a dividend is declared, the total value will be deducted from the company’s retained earnings and transferred to a temporary liability sub-account known as the dividends payable. This means that the company is owing its shareholders or investors money that is yet unpaid. When the company eventually distributes the dividend, this liability will be wiped clean or written off and the cash sub-account of the company is reduced by the same account. The end result is that the company’s balance sheet reflects a decrease in the value of the assets and the shareholders’ equity account equals the amount of the dividend, while the liability account does not reflect any net change.
Dividends as liabilities can come in the form of accrued dividends and accumulated dividends. Accrued dividends are dividends on common stock that a company has declared but has not paid to its shareholders. These dividends become the property of the record-date shareholder, meaning that those shareholders become the company’s creditors.
In this case, for shareholders to be eligible for the dividend, they must buy the stock at least two business days prior to the record date, which is the cutoff date that is used to determine the shareholders that are entitled to receive dividends. The company records these dividends as a current liability from the declaration date until the day they are paid to shareholders.
Questions arise regarding what happens if a company fails to pay dividends to its shareholders. A company may decide to suspend its dividend payments for various reasons. In response to an economic downturn, an unexpected increase in operating expenses or the need to use the money to fund important projects may cause a company to stop paying shareholder dividends. In this case, common stock owners of the company will not receive dividend payments.
The case is however different for shareholders of cumulative preferred stock. These shareholders hold stock that stipulates that a company must pay out missed dividend payments to them first before other classes of shareholders can receive their dividend payments. This brings about accumulated dividends which are dividends that have not been paid on shares of cumulative preferred stock. Until accumulated dividends are paid off by a company, they will continue to be listed on the company,s balance sheet as a liability. When the company resumes paying dividends, cumulative preferred shareholders will be prioritized above other classes of shareholders.
Because dividends are a distribution of a firm’s accumulated earnings, they are not considered an expense. It is for this reason that they never appear on the company’s (issuing entity) income statement as an expense. They are a distribution of a business’s equity.
When cash dividends are paid, they are subtracted from the equity section of the balance sheet and also subtracted from the cash line item in the balance sheet. This results in an overall decline in the size of the balance sheet. As earlier stated, if a company declares dividends but is yet to issue them, they are recorded on the balance sheet as a current liability. Within the reporting period, paid dividends are also listed within the financing section of the cash flow statement as a cash outflow.
If a company issues a stock dividend instead of cash, this will imply a reallocation of funds between the paid-in capital and retained earnings accounts. This simply is a reshuffling of amounts within the equity section of the balance sheet. With this, stock dividends are not treated as an expense.
See also: Types of Preferred Stocks
Dividends on the balance sheet
Cash dividends on the balance sheet
Cash dividends provide a way for companies to return capital to shareholders. Primarily, a cash dividend has an impact on the cash and shareholder equity accounts. No separate balance sheet for dividends is in place after they are paid. However, after the dividend declaration, before the actual payment takes place, the company records a liability to shareholders in the dividends payable account. Stock dividends on the other hand do not have any impact on the cash position of the company, only the shareholders’ equity section of the balance sheet is affected. This will be discussed later.
After the dividends a company declares have been paid, the dividend payable is reversed and will no longer appear on the liability side of the balance sheet. As stated before, when dividend payment takes place, the impact on the balance sheet is a decrease in the company’s dividends payable and cash balance. It is as a result of this that the balance sheet is reduced. If the company has paid the dividend by the end of the year, then no dividend payable liability will be listed on the balance sheet.
Investors can see the total amount of dividends that the company paid for the reporting period in the financing section of the cash flow statement. This cash flow statement shows the amount of cash that is entering or leaving a company. In a case where dividends are paid, it will be recorded as a use of cash for that period.
By the time a company’s financial statements have been released, the dividend has already been paid and the decrease in the value of retained earnings and cash is already recorded. This implies that investors will not see the liability account entries in the dividend payable account.
Let us assume a company has $1 million in retained earnings and issues a 50-cent dividend on all 500,000 outstanding shares. The total value of the dividend will be $0.50 x 500,000 outstanding shares which are $250,000. $750,000 will be remaining as the company’s retained earnings. The ultimate effect that cash dividends have on the company’s balance sheet is the decrease in cash of $250,000 on the asset side and a decrease in retained earnings of $250,000 on the equity side.
Stock dividends on the balance sheet
While the effect of cash dividends on the balance sheet is straightforward, the issuance of stock dividends is slightly more complicated. The executive management of the company might want to issue stock dividends to its shareholders if the company does not have excess cash at hand or if they want to reduce the value of shares that exist, driving the price-to-earnings ratio (P/E ratio) and other financial metrics downwards. Stock dividends can also be referred to as bonus shares or bonus issue.
Stock dividends do not have any impact on a company’s cash position. It only affects the shareholders’ equity section of the balance sheet. If there is an increase in the number of outstanding shares by less than 20% to 25%, then the stock dividend will be considered small. A large dividend is when the stock dividend has a significant impact on the share price and is typically an increase in outstanding shares by more than 20% to 25%. Oftentimes, a large dividend can be considered a stock split.
When a company declares a stock dividend, the total amount that will be debited from retained earnings is calculated by multiplying the current market price per share by the dividend percentage and by the number of outstanding shares. If a company pays stock dividends, the dividends bring about a decrease in the company’s retained earnings and an increase in the common stock account. Stock dividends do not bring about asset changes to the balance sheet, it only affects the equity side by reallocating the part of retained earnings to the common stock account.
Assuming a company has 100,000 outstanding shares and wants to issue a 10% dividend in the form of stock. If the current worth of each share is $20 on the market, the total value of the dividend would be equal to $200,000. The two entries would include a $200,000 debit to retained earnings and a $200,000 credit to a common stock account. Therefore, the balance sheet will be balanced following the entries.
See also: Liabilities vs Asset Differences and Similarities
Dividend journal entry
Before a dividend is paid out, it is usually declared by the board of directors. With this, there is a need for the company to account for dividends by making journal entries properly, especially in cases whereby the declaration date and the payment date are in different accounting periods.
Receiving dividends from the company is one of the ways in which shareholders can earn a return on their investment. In this instance, the company may make dividend payments quarterly, semiannually, annually, or at other times (either fixed or not fixed). This is a result of factors such as earnings, cash flows, or policies. The major factor that facilitates the payment of a dividend may be sufficient earnings, however, the company needs cash to make the dividend payment to shareholders. Even though it is possible for a company to borrow cash to pay dividends, boards of directors may never want to do such.
Journal entry for dividend declared
On the date the board of directors declares dividends, the company can make a journal entry by debiting the dividends declared account and crediting the dividends payable account.
| Account | Debit | Credit |
|---|---|---|
| Dividends declared | 123 | |
| Dividends payable | 123 |
The account for dividend declared is a temporary contra account to retained earnings. The balance in this account will be transferred to retained earnings when the company brings the year-end account to a close. However, there are times that the company does not have a dividend account such as a dividend declared account. If this is the case, it can just directly debit retained earnings. This is usually the case in which the company does not want to bother keeping the general ledger of the current year’s dividends.
Dividend paid journal entry
On the dividends payment date, there is a need for the company to make the journal entry by debiting the dividends payable account and crediting the cash account.
| Account | Debit | Credit |
|---|---|---|
| Dividends payable | 123 | |
| Cash | 123 |
Although the duration that exists between the date on which the dividend was declared and the date on which it was paid is usually not long, it is still important for the company to make two separate journal entries. This is so when the two dates are in different accounting periods.
Example
Assuming that a hypothetical company on December 20th, 2019, declares to pay dividends of $0.50 per share on January 15th, 2020 of $0.50 per share on January 15th, 2020 to the shareholders to shareholders with a record date on December 31st, 2019 and the company has 600,000 shares of common stock.
In this case, the dividend is $300,000 (0.50 x 500,000). On December 20th, 2019, the company made a journal entry as follows;
| Account | Debit | Credit |
|---|---|---|
| Dividends declared | 300,000 | |
| Dividends payable | 300,000 |
With this journal entry, the retained earnings statement for the 2019 accounting period will show a reduction of $300,000 to retained earnings. However, the cash flow statement will not show the $250,000 dividend as the payment has not taken place yet, no cash is involved here.
On January 15th, 2020, the company can make a journal entry for the dividend paid as shown below;
| Account | Debit | Credit |
|---|---|---|
| Dividends payable | 300,000 | |
| Cash | 300,000 |
The journal entry is aimed at eliminating the dividend payable liabilities that the company recorded on December 20th, 2019, which is the dividend,s declaration date.
