Liquidating Dividend: Definition & Example

Instructor: Deborah Schell

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

Shareholders expect to receive dividends from companies in whom they own shares and there are many different types of dividends. In this lesson, you will learn about liquidating dividends.

What Is a Liquidating Dividend?

Sharon owns 1,000 shares in the Tablet Universe Company and the company just announced that it is paying a liquidating dividend. Sharon has only received regular dividends before and is not familiar with a liquidating dividend. Let's see if we can help Sharon with this problem.

Regular dividends are distributions of the company's profit that the company pays to its shareholders or owners. Regular dividends are paid out of a company's retained earnings or the earnings it has accumulated every year since it has been in operation. Liquidating dividends are distributions to shareholders that comes from its capital base or the amount that shareholders invested in the company. A liquidating dividend represents a return of the shareholder's original investment.

How to Calculate Liquidating Dividends

Let's assume that the Tablet Universe Company has a retained earnings balance of $200,000 and a paid-up capital balance of $1,500,000. On May 1, the company declares a dividend of $3.00 per share on the company's 200,000 shares outstanding.

The total dividend is:

= $3.00 x 200,000 shares

= $600,000

The total dividend will be $600,000. The company must use its retained earnings balance of $200,000 first and the remainder of the dividend, $400,000 ($600,000 - $200,000), will come from the company's paid-up capital.

Let's examine the impact of this dividend payment on Sharon. She owns 1,000 shares and would receive a total dividend of $3,000 ($3.00 x 1,000).

The amount of the total dividend representing the regular dividend is:

= $200,000 retained earnings / 200,000 shares

= $1.00 per share

The liquidating dividend of the total dividend is calculated as follows:

= $3.00 total dividend - $1.00 regular dividend

= $2.00 per share

The retained earnings are subtracted from the total dividend balance; and then this amount is divided by the total number of shares to get the regular dividend. After the regular dividend is paid out, whatever is left over is the liquidating dividend balance. Therefore, Sharon receives a regular dividend of $1,000 (1,000 x $1.00) and a liquidating dividend of $2,000 (1,000 x $2.00). Since liquidating dividends represent a return of a shareholder's original investment, they are usually not taxed when received by the shareholder.

Why Do Companies Pay Liquidating Dividends?

A company will pay liquidating dividends if management believes the market is not valuing the business favorably if it is trying to sell it. For example, if Tablet Universe's management believes the company is worth $200 million but the highest offer it receives to purchase the company is $150 million, it may decide to liquidate by selling all of the company assets (items of value that it owns) and pay its liabilities (debts that it owes) instead.

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