Cash dividends refer to distribution of cash by a company to its common shareholders. Cash dividends are one of the means through which shareholders earn return on their investment in a company, the other being capital appreciation of shares or repurchase of shares by the company.
In case of companies, shareholders elect the board of directors which appoints the company's management and takes decisions related to the company's strategic direction. One critical decision is whether to reinvest the company's earnings or pay them back to the shareholders. When the board of directors think that the company has cash in excess of the profitable opportunities of growth, they may decide to pay dividends to the shareholders. Further, in some industries, such as utilities, companies have a history of declaring dividends which make them attractive investment for shareholders who prefer liquidity. A company can pay dividends only where it has enough cash balance and enough retained earnings.
Dividend payment timeline
Following dates are important with reference to declaration and payment of cash dividends:
Declaration date is the date on which the board of directors declare a dividend. It is the date on which they communicate their decision regarding the timing and amount of dividends to the shareholders and the capital markets.
Ex-dividend date is the date on which shares are sold without the right to receive dividends. It is normally two-business days before the holder-of-record date. For example, if Company A declares dividend of $0.5 per share on 1 April 20X5 and the ex-dividend date is 15 April 20X5, shareholders who purchase shares on 15 April 20X5 will not receive the $0.5 per share dividend, rather it will be paid to the shareholders who held those shares before the ex-dividend date.
Since a company's shareholding changes in the sense that investors buy and sell shares continuously on the stock exchange, a certain cut-off date is announced when the share transfer books are closed and a list of shareholders eligible to receive dividends is prepared. This date is called the holder-of-record date.
Dividends are paid to shareholders on the list prepared on the holder-of-record date.
Example: Accounting for cash dividends
A recent news story reads as follows:
MILWAUKEE, April 16, 2015
The boards of directors of Wisconsin Energy Corporation (NYSE:WEC) and Wisconsin Electric Power Company today declared quarterly dividends.
The Wisconsin Energy board of directors today declared a quarterly cash dividend of 42.25 cents a share on the company's common stock.
The dividend is payable June 1, 2015, to stockholders of record on May 14, 2015. This marks the 291st consecutive quarter – dating back to 1942 – that the company will have paid a dividend to its stockholders.
Identify the declaration date, ex-dividend date and holder-of-record date and journalize the transactions.
The board of directors decision is made public on 16 April 2015, hence this is the declaration date.
A liability is recognized at the declaration date for the total amount of cash dividends to be paid to all eligible shareholders. The amount determined is a product of number of common shares outstanding (i.e. total shares issued less treasury shares) and dividend declared per share. In this case dividend declared per share is $0.4225 and the number of shares outstanding is 225.51 million, hence the amount of dividends to be paid is $95.3 million. The declaration of dividends is journalized as follows:
Ex-dividend date is normally two business days before the holder-of-record date. Record date is 14 May 2015, hence the ex-dividend date must be 12 May 2015. No journal entry is passed on the ex-dividend date.
Record date is 14 May 2015. No journal entry is required to be made on this date too.
At the payment date, which is 1 June 2015, the liability related to dividends is extinguished by sending checks or making bank transfers to the shareholders. The payment is recognized as follows: