Changes in Equity
A dividend is an amount decided by directors to pay to shareholders as their share of the company's profit. The amount of dividends received is proportionate to the number of shares owned by each shareholder. Most public companies pay dividends twice a year. The dividend paid during the financial year is known as the INTERIM dividend, and the dividend paid at the end of the year is called the FINAL dividend.
Entries for FINAL Dividends
Once the directors decide on the amount of profit that will be allocated to the payment of dividends, the amount is proportionately divided amongst the shareholders based of the number of shares owned.
Usually, an Annual General Meeting (AGM) is held where the directors would recommend the amount of dividend per share to be paid, which would then be approved, reduced or rejected by the shareholders. The proposed amount can never be increased. However, it is becoming increasingly more popular for companies to include in their constitution the power of directors to recommend a dividend amount without the need of an AGM for shareholder approval. Once a dividend has been declared by directors or through an AGM, the dividend becomes payable and is recorded as a liability.
When a Dividend is Declared:
Debit the Retained Earnings( Equity) to decrease the amount in this account. This is done as Final Dividends are usually paid out of the Retained Earnings Account: this account contains the profit transferred and previous profit kept in the reserve. When a dividend is declared, this account is reduced.
Credit the Ordinary Dividend Payable (Liability) to increase the amount in this account. It is recorded as a liability as this is the amount the company OWES to their shareholders.
When a Dividend is Paid:
Debit the Ordinary Dividend Payable (Liability) to decrease the amount in this account. This is because the dividend has been paid and is no longer a liability owing for the company.
Credit the Cash at Bank (Asset) to decrease the amount in this account to record the payment of dividends out of the company. Note: Despite directors having the right to declare dividends without consultation from shareholders, they will seldom declare a dividend right before the end of the financial year to avoid a recorded liability and to avoid recording it against the Retained Earnings account at the end of the year.
Entries for INTERIM Dividends
Many companies include in their Constitution the ability of directors to declare dividends during the year at their discretion. It is recognised that it is unreasonable to make shareholders wait till end of the financial year to receive a dividend, so directors usually declare a single (paid halfway through the year) or multiple interim dividends paid throughout the course of the financial year.
When an Interim Dividend is Declared:
Debit the Interim Dividend (- Equity) to account.
Credit the Interim Dividend Payable (Liability) account to record the amount the company owes in dividends.
When the Dividend is Paid:
Debit the Interim Dividend Payable (Liability) to decrease the account as the liability is no longer existing after the dividend has been paid.
Credit the Cash at Bank (Asset) to decrease the account to record payment of the dividends.
The Interim Dividend ( - Equity) account is closed to the Retained Earnings (Equity) account at the end of the financial year (30th June). This action will decrease the amount in the Retained Earnings account.
Credit the Interim Dividends ( - Equity) to decrease the amount in the account to be offset against Retained Earnings.
Debit the Retained Earnings (Equity) to decrease the amount from this account. Note: Despite the slight difference in accounting entries for the treatment of FINAL and INTERIM dividends, both dividends are ultimately offset against the Retained Earnings account.