Do Stock Dividends Affect the Retained Earnings Account?
Dividends are asset distributions made by a corporation to the shareholder owners of the corporation. Dividends may take several forms: payments of cash, distribution of additional equity shares, distribution of the corporation's property or other forms including equity ownership in a subsidiary company. Under U.S. generally accepted accounted principles (GAAP), the accounting treatment of dividends is relatively simple.
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Cash Dividends Declared
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Cash dividends, or a periodic distribution of a corporation's earnings, are by far the most common form of dividends in the United States. As most companies have no mandatory dividend requirements (REITS, or real estate investment trusts, being the most significant exception), dividends are approved by the company's Board of Directors. The company has no obligation to pay dividends until the point when the Board formally declares the dividend, or legally sets a future date at which the cash dividends will be paid.
Accounting Treatment
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On the date of the declaration, the cash dividends become a formal liability of the company under U.S. GAAP. The company records the cash dividends by crediting a "Dividends Payable" account and simultaneously debiting a "Dividends" account. The dividends account is a component of retained earnings. By debiting the dividends account, the company is recording the distribution of the company's profits to the shareholders and reducing the value of the company's retained earnings account.
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Cash Dividends Paid
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Subsequent to declaration, the cash dividends are paid by the company to the shareholders. This is typically done through check or electronic transfer. When the dividends are paid, the company records the cash payment by crediting, or reducing the value of, the company's "Cash" account and debiting the "Dividend Payable" account. Debiting the company's dividend payable account reduces the amount of the liability on the company's books, typically to zero. Retained earnings are not affected by this transaction.
Property Dividends
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The procedures for declaring property dividends is identical to that for cash dividends. The accounting treatment differs slightly in that the cash account is not credited when the dividend is paid. Instead, the general ledger account for the property being distributed is credited, or reduced. Any liabilities related to those assets are debited. The net asset value distributed to shareholders is equal to the debit to the dividends payable account, and is thus equal to the reduction in retained earnings.
Equity Distributions
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The accounting treatment of equity, or stock distributions, is different. When the equity distribution is declared, three accounts are affected. Retained earnings are reduced by the market value of the stock to be distributed, dividends payable are credited by the par value of the stock to be distributed, and the additional paid-in capital account is credited by the difference between the market and par value of the stock. When the equity distribution is subsequently made, dividends payable are debited (typically to zero) and common stock is credited by the par value of the stock.
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References
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