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Impact of Dividend Distribution on Retained Earnings

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  • 0:03 What Is a Dividend?
  • 0:59 Cash Dividends
  • 2:08 Property Dividends
  • 3:10 Scrip Dividends
  • 4:08 Liquidating & Stock Dividends
  • 6:05 Lesson Summary
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Lesson Transcript
Instructor: Deborah Schell

Deborah teaches college Accounting and has a master's degree in Educational Technology.

There are many types of dividends that an investor can receive based on his/her shareholding in a company. In this lesson, you will learn about these dividends and their impact on retained earnings.

What Is a Dividend?

When investors purchase a share in a company, they are doing so for two reasons. Firstly, they hope to enjoy an increase in the value of the purchased shares as the market value increases, and they want to receive a steady income from dividends. Dividends represent a distribution of a company's retained earnings to its shareholders. Retained earnings represent the accumulation of all of the earnings that a company has earned and not distributed to its shareholders (owners) since the business started. Dividends are declared by a company's Board of Directors and paid to shareholders shortly after.

Mr. I.N. Vest has recently purchased shares in the Phones 4 You company and is looking forward to receiving his first dividend payment. He has heard about five different types of dividends, but he isn't sure what the difference is between them. Let's learn about the different dividends that Mr. I.N. Vest could receive.

Cash Dividends

This is the most common type of dividend, and it involves a company paying its shareholders a cash amount that is declared by its Board of Directors. Cash dividends are expressed as a dollar amount per share, and three dates are important for cash dividends: date of declaration, date of record, and date of payment.

Date of declaration is the date that the Board of Directors approves the dividend and the company has committed itself to an obligation to pay its shareholders. As a result, accounting is required. Date of record reflects the date that you must have been a shareholder to be entitled to receive a dividend. No accounting is needed on this date. Date of payment represents the date that dividend checks are sent to shareholders. Since it involves a use of company cash, an accounting entry is required.

Let's assume that Phones 4 You has 10,000 shares outstanding. It declared a dividend of $0.25 per share on June 1st to shareholders of record on June 15th to be paid on June 30th. The accounting entries would be this:

Cash Dividend
Cash Dividend

Payment of cash dividends reduces the company's cash balance as well as retained earnings.

Property Dividends

A property dividend represents a non-cash alternative to dividend payment, and investment securities are the usual tool used. The transaction is valued using the fair market value of the asset that is given up. Fair market value represents the amount that a knowledgeable buyer would pay on the open market. The same dates (date of declaration, date of record, and date of payment) apply to a property dividend. Let's assume that Phones 4 You declared a property dividend on April 15th to shareholders on record as of April 22nd with a payment on April 30th. The cost of the investments on April 15th was $500,000 and the fair market value on that date was $625,000. The entries would be:

Property Dividend
Property

Note that the gain of $125,000 ($625,000 - $500,000) is recognized first. Payment of property dividends reduces the company's assets (investments) and retained earnings. An asset is something of value that a company owns.

Scrip Dividends

A company may have sufficient retained earnings to pay a dividend but may find itself short on cash. Since investors expect to receive a dividend as part of their compensation for purchasing and holding shares, the company may decide to issue a scrip dividend instead. A scrip dividend represents a promise to pay the dividend at a future date when the company's cash flow is more favorable. The promise to pay is recorded as a promissory note that contains details about the amount, term, and interest rate.

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