If you’re working in accounting, or doing your company accounts, you need to know how to distribute dividends to your stakeholders. It can be a complicated process if you’ve never done it before, so this post will explain what dividends are, how you need to account for them and why it’s important to get it right.
What are dividends?
Simply, dividends are a method of distributing a company’s profits to shareholders as a reward for their investment.
There are two main types of dividends you need to be aware of, cash dividends and stock dividends:
- Cash dividend - usually, cash dividends are paid periodically, such as monthly or quarterly. However, they can also be paid as a lump sum, depending on the profits which are being distributed.
- Stock dividend - if you don’t want your cash balance to be affected, then stock dividends could be the option for you. Rather than paying the investor the cash for their dividend, you can reward them with additional shares within the company.
Typically, dividends are paid as cash to the shareholders, so the focus of this post will be cash dividends.
What considerations do you need to keep in mind before distributing a dividend?
There are four key things you need to keep in mind before deciding to distribute a dividend to shareholders:
- The intended dividend is covered by the balance of realised profits within the last annual accounts
- The realised profits have not been subsequently lost
- The dividend payment would not leave the company unable to pay debts should they fall due
- If the company is audited, the legal requirements applying to dividends have been met
Why does it matter that you account for dividends correctly?
There are two key reasons why you need to account for any dividends correctly:
- It keeps track of profit distribution - when you remove the cash from the company’s earnings account, you can track the profits distributed by the company.
- It’s key for maintaining financial records - your company should strive to have balanced and accurate financial records, part of maintaining this balance is through recording dividend payments.
While there are other reasons for keeping your accounting up-to-date in terms of dividend payments, these two reasons are the ones to keep in mind.
What is a dividend voucher?
Dividend vouchers play an important role when the company is issuing a dividend because they validate the dividend by documenting the distribution of company profits to the shareholders.
To be valid, the dividend voucher needs to contain specific information:
- Company name
- Company registration number
- Company address
- Date of issue
- Name and address of the shareholder
- The share class
- Type of dividend
- Dividend amount
- Signature of company officer
Once the dividend voucher has been issued, you can add the dividend to your accounting.
How do you account for the cash dividend?
There are five steps involved in accounting for the dividend and each of them play an important part. If you’re unsure what you’re doing, please seek professional advice from your accountant.
Step 1 - Record the dividend as a liability
By declaring the dividend as a liability, your company is formally held liable for paying the dividend to the shareholders.
Step 2 - Debit the company’s retained earnings account
Debit the company’s retained earnings account for the full amount of the dividend on the date declared. This is a decrease in this account because the money is paid out, rather than being retained.
Step 3 - Credit the company’s dividends payable account
The amount you credit the dividends payable account should be equal to the value of the dividends you are paying. In other words, it should be equal to the amount amount you debited from the retained earnings account.
Step 4 - Distribute the dividends
You need to make the payment to each qualifying shareholder. Once you have made this payment, you need to update the dividends payable account to show you have paid the dividend and settled the liability.
Step 5 - Record the deductions on the date of payment
You need to credit the cash account and debit the dividend payable account with the value equal to the total dividends paid.