Dividends and Dividend Preferences - Online Tutor, Practice Problems & Exam Prep

Dividends involve three key dates: the declaration date, the date of record, and the payment date. On the declaration date, a company announces dividends, creating a liability recorded as a debit to dividends and a credit to dividends payable. The date of record identifies shareholders eligible for dividends, requiring no journal entry. Finally, on the payment date, the company pays the dividend, debiting dividends payable and crediting cash. Preferred stockholders receive dividends first, followed by common stockholders, ensuring proper allocation based on declared amounts.

Dividend Declaration Date

All right. In this video, we're going to discuss some details about dividends. There are some important dates that we have to remember as well as some ideas about dividend preferences. Let's check it out.

Let's start here with the important dates. There are going to be 3 important dates every time that we talk about dividends, okay? Up to this point, we've just said that dividends were declared and paid on the same day. Well, now we're going to separate it in a more realistic situation. So the first thing that happens is that the company is going to declare dividends. There's going to be the declaration. Okay? So it's not like they're going to say hey, we're going to pay dividends and then they pay them immediately. No. They're going to say hey, we're going to pay dividends and then at a later date, they're going to pay them. So the first entry here is going to be on the declaration date. This is the date that the company publicly announces that there's going to be dividends.

Let's follow through on an example. On March 14th, the board of directors of the Apartment Depot announces a dividend of 300,000. All right, so it's very important to remember that on the declaration date is where we make our journal entry for the dividends. So because we declared that we are going to pay dividends, we are now liable to pay dividends. So, what we need to do is we're going to debit the dividends account at this point on March 14th, the declaration date. We're going to debit dividends for the 300,000 we're going to payout, and we're going to credit our dividends payable. Notice, we've created a liability at this point, right? This payable, dividends payable, is a liability because we've told the public that we're going to pay this dividend of 300,000. Now, we are liable to the public to pay this dividend. Okay?

So now, we have to accrue this liability for these dividends that we declared. Okay? Because we're not just going to be declaring dividends willy nilly. No. We have to declare them because we know that we're capable of paying them. So at this point, on the declaration date, we have to make a journal entry to reduce or yeah, to reduce our equity by taking this dividends entry and increasing our liabilities. So that's exactly what happens here. The dividends is a reduction of our equity that's eventually going to reduce our net, our retained earnings, right? So that reduces our equity, but the dividends payable here, dividends, I'm going to put div payable. That is an increase to our liabilities of 300,000. So we stay balanced here, right? The equation stays balanced, and that's a very important entry, okay? So you're going to want to pay attention. There are going to be 3 dates. Here, the first one is the declaration date and then why don't we pause here and we'll talk about the date of record in the next video.

Dividend Record Date

All right. So the next important date is the date of record. This basically says that whoever owns the stock as of the date of record will receive the dividend. Okay? So the date of record is really just a point that says who's going to get the dividend. Okay? So look at the example. On March 14th, the board of directors of the Apartment Depot announces a dividend of $300,000. That was the declaration date, right, from the previous journal entry. The directors also announced the record date would be April 4th. So these announcements usually go hand in hand, but notice March 14th is the declaration date, but April 4th is the date of record. Because you can imagine, people are going to keep trading the stock every day, right? On the open market, people are going to be buying and selling the stock. So whoever owns the stock on April 4th is the person who is going to receive the dividend. Okay? So whoever is holding the stock on April 4th receives the dividend, but that doesn't mean that they're going to receive the dividend on April 4th. There's going to be another date that we're going to discuss that's the payment date. So April 4th, the journal entry that gets made is no journal entry. There's no journal entry on the date of record. On the date of record, it's just a memorandum that we know, okay, who's going to receive the stock, who's going to receive the dividend is whoever is holding the stock as of April 4th, okay? So it's important to note, we've got three important dates, we've got the declaration date where we make a journal entry, the date of record, we don't make a journal entry, and then the payment date, we are going to make a journal entry. So let's check that out in the next video.

Dividend Payment Date

Okay. So the final important date is the payment date. Let's check it out. The date that the actual cash dividend is paid, right? That makes sense. The payment date is going to be the date that the cash dividend is paid. So notice what we have here. On March 14th, the Board of Directors of the Apartment Depot announces a dividend of $300,000—that was the declaration date, right? March 14th. The directors also announced that the record date would be April 4th. So, whoever owns the stock as of April 4th is going to receive the dividend. On April 11th, the company pays the dividend. So here we have April 11th as the payment date, right? The day that they paid the dividend. Not too complicated there.

So what's the journal entry that the company has to make on the payment date? Well, remember, on the declaration date we had a liability, right? We created a 'dividends payable' because we were liable to pay this dividend. Well, now we've paid it off, we no longer have the liability. So on April 11th, we're going to get rid of the 'dividends payable' liability with a debit, right? Because it had a credit balance as a liability, we get rid of it with a debit. So we paid $300,000, we get rid of the $300,000 liability and how did we pay for it? We paid for it with cash, right? So we're going to reduce our cash with a credit. The entry here is going to be 'dividends payable' debit, 'cash' credit for $300,000, right? What happens? We had our cash reduced by $300,000 which reduces our assets and we reduced our liabilities 'dividends payable' by $300,000, and we stay balanced, right? Our equation just stays balanced there. So these aren't too tricky. All you have to remember, this is kind of a memorization thing of you're going to have these 3 dates, you're going to have the declaration date, record date, and then payment date, okay? So just remember, the declaration date is where we have to make the liability for 'dividends payable'. The record date, there's no journal entry. It's just to know who's going to receive the dividend and then the payment date, the date we make the journal entry to get rid of the liability and pay out the cash. Cool? Alright. Let's move on to the next topic.

Dividend Payment Preferences

So another important concept with dividends is dividend preferences. When we have two classes of stock, when we have common stock and preferred stock, we have to remember that the preferred stock always receives their dividends first. They always receive their dividends first, and whatever is left over goes to the common stockholders.

Let's check it out in this example. The Apartment Depot currently has 5,000 shares of a $100 par value, 8% preferred stock. That's a lot of words there. Let's outline what we have for preferred stock here in blue and 100,000 shares of 50¢ par value common stock. So this is our common stock information right here in red. The Apartment Depot declares and pays a dividend of $220,000. Notice here, we're just saying declares and pays a dividend. They usually try to separate questions of the declaration date, record date, and here we're just focused on how we are going to split the dividends between preferred and common. So they declare and pay a dividend of $220,000. What is the amount received by preferred shareholders and common shareholders?

The first thing we want to do is find out how much the preferred shareholders are due. They're going to be due a certain amount of dividends based on their percentage there. They have a dividend percentage of 8% and that's going to be paid on their par value. So each share of stock, $100 is the par value of the preferred stock times the 8%, 0.08. It comes out to $8 per share. Each share of preferred stock will receive an $8 dividend, and we have to multiply that by the number of outstanding shares. They tell us there are 5,000 shares outstanding, and this will tell us the total amount that should be received by the preferred stockholders. And that's going to come out to 5,000 times 8, which is just $40,000. The preferred shares are only going to receive $40,000, no matter how big the dividend is. We could have paid a $1,000,000 dividend, and the preferred shares would still get only $40,000.

Let's say the dividend had only been $30,000 instead of $220,000. Then that whole $30,000 would have gone to the preferred because they are due the first $40,000 and it didn't reach $40,000, so everything would go to preferred. In this case, we have something greater than their preferred dividend, so the common stockholders will get something as well. Let's find out what the common stockholders get, and this is as easy as just subtracting the total dividend minus what the preferred shareholders get. So, common stockholders are going to receive everything minus what went to the preferred shareholders of $40,000. They're going to receive $180,000. It's as easy as that.

They could ask you this a couple of different ways. They could ask how much is the total amount that goes to each of them, or they could ask for a per-share amount, and you just have to divide. Let's fill this out at the bottom. The total preferred dividend was $40,000. It was $40,000 total preferred dividend for all the preferred shareholders and on a per-share basis, it was $8 per share, as we calculated earlier. Now, what about the common? We see the total dividend for the common is $180,000. They got $180,000 but we don't know the per-share yet. So we just have to take that $180,000 and divide it by the number of common shares, which in this case was 100,000. It comes out to $1.80 per share. So each common share receives a dollar 80 in dividends. This number could change if the total dividend had been different. But the preferred dividend will always be that percentage they receive, 8% on their par value. The only time the preferred wouldn't get their total $8 per share would be if we paid a dividend smaller than $40,000. But that would be pretty rare in a question like this. They would be trying to trick you if they gave you a dividend smaller than the preferred required dividend.

Alright, why don't we pause here and then try some practice problems related to dividends.

On December 12, Year 1, ABC Company declared a cash dividend of $250,000. The date of record was December 28, Year 1. The cash dividend was paid on January 5, Year 2. During which period will the dividend be included on the Statement of Retained Earnings?

• A. The full amount is included in Year 1
• B. The full amount is included in Year 2
• C. The dividend is split between Year 1 and Year 2
• D. Dividends are not included on the Statement of Retained Earnings

ABC Company declared and paid a dividend of $150,000 during the current year. The amount of common stock ($0.50 par value) outstanding was 125,000. The amount of $6 preferred shares (par value of $100) outstanding was 1,000. What is the total dividend received by common stockholders?

• A. $0
• B. $125,000
• C. $144,000
• D. $150,000

Here’s what students ask on this topic:

What are the three important dates to remember when dealing with dividends?

The three important dates to remember when dealing with dividends are the declaration date, the date of record, and the payment date. On the declaration date, the company announces the dividend, creating a liability recorded as a debit to dividends and a credit to dividends payable. The date of record identifies shareholders eligible for dividends, requiring no journal entry. Finally, on the payment date, the company pays the dividend, debiting dividends payable and crediting cash. These dates ensure proper tracking and allocation of dividends to shareholders.

How is the dividend amount for preferred shareholders calculated?

The dividend amount for preferred shareholders is calculated based on the par value of the preferred stock and the dividend percentage. For example, if a company has 5,000 shares of $100 par value, 8% preferred stock, the dividend per share is calculated as follows:

$100\times 0.08=8$

Each share receives $8 in dividends. To find the total dividend for preferred shareholders, multiply the per-share dividend by the number of shares:

$8\times 5000=40000$

So, the total dividend for preferred shareholders is $40,000.

What is the difference between the declaration date and the payment date for dividends?

The declaration date is when the company announces the dividend, creating a liability. On this date, a journal entry is made to debit dividends and credit dividends payable. The payment date, on the other hand, is when the actual cash dividend is paid to shareholders. On the payment date, the company debits dividends payable and credits cash, effectively removing the liability and reducing cash. These two dates are crucial for proper accounting and ensuring that dividends are accurately recorded and paid.

Why is there no journal entry on the date of record for dividends?

There is no journal entry on the date of record because this date is simply used to determine which shareholders are eligible to receive the dividend. It does not involve any financial transactions or changes in the company's accounts. The date of record is a memorandum entry that identifies the shareholders who own the stock as of that date and are therefore entitled to the dividend. The actual financial impact is recorded on the declaration date and the payment date.

How are dividends allocated between preferred and common shareholders?

Dividends are allocated between preferred and common shareholders based on the dividend preferences. Preferred shareholders receive their dividends first, based on a fixed percentage of the par value of their shares. For example, if preferred shareholders are due $40,000 in dividends, they receive this amount first. Any remaining dividend amount is then allocated to common shareholders. For instance, if the total dividend declared is $220,000, after paying $40,000 to preferred shareholders, the remaining $180,000 is distributed to common shareholders. This ensures that preferred shareholders receive their fixed dividend before any distribution to common shareholders.