What is Cash Dividend?
The term “cash dividend” refers to the dividend distribution in which a fund is paid out to the shareholders from the company’s earnings generated during the year or its accumulated profits as of date. The most striking feature of cash dividend is that it is paid in terms of actual money, unlike stock dividend wherein there is no actual cash outflow. The payment of dividends can be in the form of periodic distributions of cash.
Typically, companies consider dividends as a way of returning capital to the company’s shareholders in the form of cash payments, which are usually paid out every quarter. However, there are many companies that prefer paying dividends on a monthly, semi-annual, or annual basis. Again, there are companies that don’t pay regular dividends but come up with special dividends for the shareholders after certain distinct events.
Examples of Cash Dividend
Following are examples as given below:
Let us take the example of SDF Inc. to illustrate the computation of dividends and their yield. The company reported a profit in the current financial year that was significantly higher than in other years and so the company’s board decided to distribute some of the profit in the form of dividends for its shareholders. If Mr. X currently owns 50 shares that he purchased at $12 per share and the company declared a dividend of $1.2 per share, then determine the total dividend and its yield.
- Given, Dividend per share = $1.2 per share
- Share price = $12 per share
- No. of shares owned = 50
The total cash dividend earned by Mr. X can be calculated as,
Total Cash Dividend = Dividend per Share * No. of Shares Owned
- Total Cash Dividend = $1.2 per share * 50 shares
- Total Cash Dividend = $60
Now, cash dividend, in this case, can be calculated as,
Dividend Yield = Dividend per Share / Share Price
- Dividend Yield = $1.2 per share / $12 per share
- Dividend Yield = 10%
Therefore, the total dividend earned by Mr. X is $60 at a dividend yield of 10%.
Let us take another example to illustrate the accounting treatment of dividends. Let us assume that the board of directors at XYZ Inc. declared a dividend of $0.5 per share for each of its outstanding15,000 shares. Prepare the journal entry for the dividend at the time of declaration and at the time of actual payout.
- Given, Dividend per share = $0.5 per share
- No. of outstanding shares = 15,000
Now, the total cash dividend paid by XYZ Inc. can be calculated as,
Total Cash Dividend = Dividend per Share * No. of Outstanding Shares
- Total Cash Dividend = $0.5 per share *15,000 shares
- Total Cash Dividend = $7,500
The journal entry after the company declares the dividend will be as follows:
|Retained earnings A/C||$7,500|
|Dividend payable A/C||$7,500|
The journal entry when the company pays the dividend will be as follows:
|Dividend payable A/C||$7,500|
Why Are Companies Paying Cash Dividends?
Companies usually pay dividends when they are able to generate stable cash flow for several consecutive quarters and are largely considered to be financially healthy. However, the common belief also states that companies paying high dividends are not growth oriented, but they rather intend to enhance shareholder value by generating a steady flow of income in the form of dividends. The size of dividend payment is decided based on various financial strategies, such as some companies determining dividends based on certain specific financial ratios while others fix the dividend payment as a percentage of the current year’s earnings.
Cash Dividend Journal Entry
When a company declares a dividend, then the Retained earnings A/Cis debited and the Dividends payable A/C is credited which results in a reduction in equity and an increase in liabilities by the same amount. In this case, the income statement is impacted while the overall balance sheet remains unchanged. The journal entry at the time of declaration of the cash dividend is as follows:
|Retained earnings A/C||XX|
|Dividend payable A/C||XX|
When the company eventually pays off the dividend on a later date, then the Dividends payable A/C is debited and the A/C is credited which results in a reduction in both cash and the corresponding liability. In this case, the balance sheet is impacted while the income remains unaffected. The journal entry at the time of actual payment of cash dividend is as follows:
|Dividend payable A/C||XX|
Difference between Cash Dividend and Stock Dividend
The main differences between the dividend and stock dividend are:
- Stock dividend results in an increase in the number of outstanding shares, while the dividend has no effect on the number of outstanding shares.
- Stock dividend prevents actual distribution of the company’s retained earnings to the stockholders, while in the dividend the accumulated retained earnings declines by the amount of dividend payment.
- The distribution and accounting for taxation purposes of dividends are fairly easy.
- It provides liquidity support for investors who rely on dividend income as a form of a steady inflow of cash.
- It doesn’t dilute the shareholding of the current shareholders as such the stock price level remains largely unaffected by such pay-outs.
- As it impacts the cash position, a company with a short-term liquidity mismatch might face problems and might have to resort to other sources of funding.
- Dividend usually comes under ordinary income tax rates, which is significantly higher than the capital gains tax rate applicable to other kinds of dividend payout.
This is a guide to Cash Dividend. Here we discuss the introduction and examples of cash dividends along with their advantages and disadvantages. You may also have a look at the following articles to learn more –