What are Dividends?

A corporation may issue dividends to its shareholders, which represent a distribution of its retained earnings to them. Dividends may be issued either in the form of cash or as additional shares of stock. In both cases, the amount paid out is in proportion to the number of shares already held by shareholders. These payments impact a firm’s balance sheet.

The Impact of Dividends on the Balance Sheet

Dividends can impact the balance sheet in several ways, as noted below:

Impact of cash dividends. When cash dividends are paid, this reduces the cash balance stated within the assets section of the balance sheet, as well as the offsetting amount of retained earnings in the equity section of the report. As an example, a corporation pays out a $1 dividend to each holder of its 250,000 outstanding shares. The total amount of cash paid out is $250,000, which is the amount by which both the cash and retained earnings accounts are reduced.
Impact of stock dividends. When stock dividends are paid, there is no impact on the cash position of the business. If the corporation issues less than 25 percent of the total amount of the number of previously outstanding shares to shareholders, the transaction is accounted for as a stock dividend. If the issuance is for a greater proportion of the previously outstanding shares, the transaction is instead accounted for as a stock split. When there is a stock dividend, the related accounting is to transfer from retained earnings to the common stock account an amount equal to the fair value of the additional shares issued. This fair value is based on their market value after the dividend is declared. As an example, the same corporation wants to issue a 10% stock dividend to its shareholders. The market value of the stock is $5, so the value of this dividend is $125,000. The related accounting entry would be a $125,000 debit to retained earnings and a $125,000 credit to the common stock account.