Accounting for Dividends and Retained Earnings

Dividends represent distributions of a company’s profits to shareholders, reducing retained earnings and available cash or other assets.

Proper accounting distinguishes between cash dividends, stock dividends, and property dividends, each requiring specific journal entries.

Retained earnings reflect the cumulative profits retained in the business after dividends and are a key indicator of long-term financial health.

Errors in dividend accounting can lead to misstated equity balances and improper cash flow reporting.

Overview / Definition

Dividends are distributions made by a company to its shareholders, typically from accumulated profits.

Companies may declare dividends in various forms:

✦ Cash Dividends: Payments made in cash to shareholders.

✦ Stock Dividends: Additional shares issued to existing shareholders.

✦ Property Dividends: Non-cash assets distributed instead of cash or stock.

Retained earnings represent the accumulated net income of a company that has not been distributed as dividends.

They are reported in the equity section of the balance sheet and are critical for funding future investments and covering unexpected losses.

Recognition and Measurement

Cash Dividends

✦ Declaration Date: Liability is recognized when the board declares the dividend.

✦ Record Date: No journal entry; identifies eligible shareholders.

✦ Payment Date: Liability is settled, and cash is reduced.

Example – Cash Dividend of $1 per Share on 10,000 Shares:

Declaration Date Entry:

debit Retained Earnings – 10,000

credit Dividends Payable – 10,000

Payment Date Entry:

debit Dividends Payable – 10,000

credit Cash – 10,000

Stock Dividends

✦ If less than 20–25% of shares are issued, treat as a small stock dividend and record at fair market value.

✦ If more than 25%, treat as a large stock dividend and record at par value.

Example – Small Stock Dividend (5% on 10,000 Shares, Market Price $15, Par Value $1):

• Shares Issued: 10,000 × 5% = 500 shares

• Total Value: 500 × $15 = $7,500

Declaration Date Entry:

debit Retained Earnings – 7,500

credit Common Stock – 500

credit Additional Paid-In Capital – 7,000

Issuance Date Entry:

No additional entry required; shares are issued.

Property Dividends

✦ Record at the fair value of the asset on the declaration date.

✦ Recognize any gain or loss on the revaluation of the asset.

Example – Property Dividend (Asset with Carrying Value $8,000, Fair Value $10,000):

Declaration Date Entry:

debit Retained Earnings – 10,000

credit Property Dividends Payable – 10,000

Revaluation of Asset:

debit Asset – 2,000

credit Gain on Asset Revaluation – 2,000

Payment Date Entry:

debit Property Dividends Payable – 10,000

credit Asset – 10,000

Journal Entry Examples

1. Declaring a Cash Dividend:

debit Retained Earnings – 5,000

credit Dividends Payable – 5,000

2. Paying a Cash Dividend:

debit Dividends Payable – 5,000

credit Cash – 5,000

3. Declaring a Large Stock Dividend (30% on 10,000 Shares, Par Value $1):

• Shares Issued: 10,000 × 30% = 3,000 shares

debit Retained Earnings – 3,000

credit Common Stock – 3,000

Disclosure Requirements

Companies must disclose:

✦ The types and amounts of dividends declared and paid during the period.

✦ Any restrictions on retained earnings (e.g., legal or contractual restrictions).

✦ Changes in retained earnings balances, including prior period adjustments and restatements.

Disclosures are typically included in the notes to the financial statements under the Equity or Retained Earnings sections.

IFRS Comparison

Criteria	US GAAP	IFRS
Cash Dividends	Liability at Declaration	Liability at Declaration
Stock Dividends	Small and Large Categories	No Distinction
Property Dividends	Recognize Gain/Loss	Recognize Gain/Loss
Restrictions on Retained Earnings	Disclose if Material	Disclose if Material
Presentation of Retained Earnings	Separate in Equity	Separate in Equity

IFRS does not formally distinguish between small and large stock dividends, but requires that dividends reduce retained earnings appropriately.

Common Errors

✦ Failing to Record Dividends at Declaration Date: Leads to understated liabilities and equity misstatements.

✦ Incorrect Valuation of Stock Dividends: Using par value for small stock dividends instead of fair market value.

✦ Omitting Recognition of Property Dividend Gains/Losses: Not adjusting asset values before distribution.

✦ Misclassifying Dividends Paid as Expenses: Dividends should be recorded as reductions in retained earnings, not operating expenses.

✦ Insufficient Disclosure of Dividend Policies: Not clearly explaining dividend declarations, payment dates, and restrictions in financial statements.