29. Cash Dividends Increase the Legal Capital of a Corporation

The board of directors of a company has the exclusive power to declare dividends. The legality of a dividend usually depends on the amount of retained earnings available for dividends – not the net profit for a period. Companies may pay dividends in periods when they have suffered losses, provided that the retained earnings and cash position justify the dividend. And in some states, despite an accumulated deficit, companies can declare dividends on current profits. The financial opportunity to declare a dividend depends on the cash position of the company. Note that while corporations constitute the dividend in small shares at the current market value, they constitute the dividend in shares of 30% at par value (1,500 shares X $10 = $15,000). Due to differences in the accounting of dividends for large and small shares, accountants must determine the relative amount of the stock dividend before making journal entries. To illustrate how these three data relate to an actual situation, we assume that the Board of Directors of Allen Corporation approved a cash dividend on May 5, 2010 (date of filing). The declared cash dividend is $1.25 per share to shareholders of record on July 1, 2010 (record date), payable July 10, 2010 (payment date). Since financial transactions take place both on the day of reporting (a liability arises) and on the day of payment (cash payment is paid), journal entries record transactions on both days. No journal entry is required on the day of registration. Read this chapter, which describes the different sources of paid-up capital and how they are presented on the balance sheet. This chapter also covers own shares, dividends, share splits and price-to-share and price-to-earnings ratios.

A company may repurchase its own share capital as its own shares in order to: (1) delete and withdraw the share; (2) reissue the share later at a higher price; (3) reduce the outstanding shares and thus increase earnings per share; or (4) issue the share to employees. If the intention of the repurchase is destruction and redemption, the own shares exist only until they are cancelled and destroyed by a formal reduction in the share capital. Recording of large stock dividends A stock dividend of more than 20-25% of outstanding shares is a high stock dividend. Because one of the goals of a large stock dividend is to reduce the market value of the stock so that the shares can be traded more easily, companies do not use the current market value of the stock in the listing. They account for these dividends at face value and not at their current market value. The laws of the state of incorporation or the board of directors determine the amounts of shares without par value. In Appendix 21, we summarize several sources of equity and list the titles of the general ledger accounts used to record capital increases and decreases from each of these sources. Chapter 12 covered some of these general ledger accounts. This chapter covers other general ledger accounts that record sources of equity.

It is important to note that there is no entry to enter dividend liabilities until the board has declared it. There is also no entry by the deadline (in this case, April 15). The date of registration determines only the names of the shareholders who receive the dividends. Dividends are paid only on outstanding shares; No dividends are paid on own shares. By issuing a large amount of new shares (sometimes two to five times more shares than outstanding), the price falls, often sharply. For example, an owner who held a hundred shares at a market price of $120 per share (total value of $12,000) could now sell two hundred shares at a price of $60 per share or three hundred shares at $40 per share (but with the same total market value of $12,000). The shareholder`s investment remains unchanged, but I hope that the stock is now more attractive to investors at the lower price, so that the level of active trading increases. If the reissue price of the following shares is lower than the purchase price, the companies impose the difference between the acquisition cost and the reissue price with the paid-up capital – transactions in common shares. However, this account never develops a debit balance.

By definition, no paid-up capital account can have a debit balance. If Hillside reissues another 20 shares at a price of $52 per share on June 12, 2010, the entry would be as follows: Sometimes shareholders give shares to a corporation. Since the data own shares have no cost to the company, accountants only make a memo entry when the shares are received. The only formal registration required is the cash debit and the credit of the paid-up capital – donation account upon reissue of the share. For example, if the given own shares are sold for $5,000, the entry reads as follows: Companies regularly need cash to replace inventory and other assets whose costs have increased or to grow the business. As a result, companies rarely distribute all of their net profit to shareholders. Growing start-ups may not pay dividends at all. Before a company can distribute money to its shareholders, the company`s board of directors must pay a dividend. The date on which the board of directors declares the dividend is called the declaration date, and on that day the dividend liability is established. Shareholder value can become a hot topic for companies, as wealth creation for shareholders does not always or also lead to value for the company`s employees or customers.

The cash recovery rate is measured by revenue ratios, and companies try to increase sales without accumulating more inventory or increasing the average dollar amount of receivables. High inventory turnover and accounts receivable sales increase shareholder value. Typically, dividends are reductions in retained earnings because they are distributions of the company`s net profit. However, dividends can be distributions of contributed capital. These dividends are called liquidative dividends. Figure 22 shows the frequency of dividend payments made by a sample of representative companies for the years 1996-99. Note that cash dividends are much more numerous than stock dividends or dividends in kind (which are paid in commodities or other assets). Of course, as this press release shows, a company can issue additional shares to shareholders instead of simply paying cash dividends. These shares may be issued as a dividend in shares or in a slightly different manner as a share split1. In none of these scenarios are the assets distributed – just more shares of the company`s own shares.

Are shareholders better off if they receive additional shares in a stock dividend? A corporation may declare a stock dividend for several reasons: The distributable share dividend main account is an equity account (paid-up capital) that is credited for the par value or declared value of the distributable shares when a stock dividend is declared. Since a distributable stock dividend is not payable with assets, it is not a liability. If a balance sheet is prepared between the date of the declaration of the 10% dividend and the date of issue of the shares, the correct representation of the impact of the dividend in shares is as follows: The shareholder value of a company depends on the strategic decisions made by its board of directors and management, including the ability to make wise investments and obtain a healthy return on investment. If this value is created primarily in the long term, the share price rises and the company can distribute higher cash dividends to shareholders. Mergers, in particular, tend to result in a sharp increase in shareholder value. For example, suppose on March 15, a corporation`s board of directors approves a proposal to pay its regular quarterly dividend of $0.40 per share on May 1 to shareholders of record on April 15. The following registration is made on the March 15 reporting date assuming that 2,000 common shares are outstanding: The increase in shareholder value increases the total amount in the equity portion of the balance sheet. The balance sheet formula is as follows: assets, net of liabilities, are equity, and equity includes retained earnings or the sum of a corporation`s net income less cash dividends since its inception. The directors of Fleetwood Enterprises, Inc.

(NYSE: FLE) declared the Company`s regular quarterly cash dividend of 19 cents per common share, payable on November 8, 2000 to shareholders on October 6, 2000. Question: As explained in Chapter 1 « Why is financial accounting important? », a large majority of investors buy share capital for only two reasons: price appreciation and dividends. Dividends and long-term capital gains (gains from the sale of certain investments held for more than a year) are particularly attractive to individual investors because they are taxed at a lower rate than most other types of income.