Dividends payable definition
/What are Dividends Payable?
Dividends payable are dividends that a company's board of directors has declared to be payable to its shareholders. Until such time as the company actually pays the shareholders, the cash amount of the dividend is recorded within a dividends payable account as a current liability.
Dividends payable is an odd type of liability, since it is an obligation of the company to pay its own shareholders, while other types of liabilities are usually to entirely separate third parties, such as suppliers or lenders. Nonetheless, the result of a dividend payment is the departure of cash from the company and represents a legal obligation to pay, so dividends payable should be considered a valid liability.
Accounting for Dividends Payable
Once dividends are declared by a company’s board of directors, the accountant records the event as debit to the retained earnings account and a credit to the dividends payable account. This entry reduces the amount of retained earnings, while increasing the recorded amount of liabilities that must be paid out. This initial entry does not result in a cash payout, which occurs later. On the dividend payment date, the accountant records a debit to the dividends payable account to offset the original credit to that account, and records a credit to the cash account to reduce it by the amount of cash being paid to investors.
How to Analyze Dividends Payable
A large dividend liability can be construed as a sign of company profitability, since it implies that the company has had such a profitable year that it can afford to make a significant distribution to its shareholders. Thus, though a dividend liability can adversely skew a company's liquidity ratios, it does not imply a long-term problem with a company's financial situation. Nonetheless, the board of directors should be aware of the negative impact of a large dividend payable on a company's current ratio, which could drop enough to breach a loan covenant.
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Example of Dividends Payable
For example, on March 1, the board of directors of ABC International declares a $1 dividend to the holders of the company's 150,000 outstanding shares of common stock, to be paid on July 31. During March, the accounting department of ABC records a credit to the dividends payable account and a debit to the retained earnings account, thereby shifting $150,000 out of the equity part of the balance sheet and into the short-term liabilities section of the balance sheet. This remains a liability until July 31, when ABC pays the dividends. Upon payment, the company debits the dividends payable account and credits the cash account, thereby eliminating the liability by drawing down cash.
Presentation of Dividends Payable
Dividends payable are nearly always classified as a short-term liability, since the intention of the board of directors is to pay the dividends within one year. Thus, dividends payable should be included in any short-term liquidity calculations, such as the current ratio or the quick ratio. A sample presentation of the dividends payable line item in a balance sheet appears in the following exhibit.
