Cash dividends are corporate earnings paid out to stockholders. They are payouts of retained earnings, which is accumulated profit. Therefore, cash dividends reduce both the Retained Earnings and Cash account balances.

There are three prerequisites to paying a cash dividend: a decision by the board of directors, sufficient cash, and sufficient retained earnings.

Four dates are associated with a cash dividend.

• The declaration date is also referred to as the announcement date since a company notifies shareholders and the rest of the market. The declaration date is the date on which a company officially commits to the payment of a dividend. On that date, a liability is incurred and the Cash Dividends Payable is used to record the amount owed to the stockholders until the cash is actually paid.
• The ex-dividend date, or ex-date, is the date on which a stock begins trading without the dividend. To receive the declared dividend, shareholders must own the stock prior to the ex-dividend date.
• The record date usually occurs three business days after the ex-dividend date and is the date on which a company officially determines the shareholders of record, those who owned the stock prior to the ex-dividend date and who are eligible to receive the dividend payment. There is no journal entry on the date of record.
• The payment date for a stock’s dividend is the day on which the actual checks go out—or electronic payments are made—to eligible shareholders. Shareholders owning the stock on the record date will receive the dividend on the payment date.

Cash dividends are only paid on shares outstanding. No dividends are paid on treasury stock, or the corporation would essentially be paying itself.

A company may issue a dividend payment to shareholders made in shares rather than as cash. The stock dividend has the advantage of rewarding shareholders without reducing the company’s cash balance.

These stock distributions are generally made as fractions paid per existing share. For example, a company might issue a 10% stock dividend, which would require it to issue 1 share for every 100 shares outstanding.

Entries for Cash Dividends

When a dividend is declared by the board of directors, the company will credit dividends payable and debit an owner’s equity account called Dividends or perhaps Cash Dividends.

Cash Dividends is a contra stockholders’ equity account that temporarily substitutes for a debit to the Retained Earnings account. Just like owner withdrawals are closed to owner’s equity in a sole proprietorship at the end of the accounting period, Cash Dividends is closed to Retained Earnings.

For example, assume the Board of Directors of Tanya Corp. met on December 10, 20X1 and declared a cash dividend of $.50 per share on 24,000 shares of common stock outstanding (total $12,000) to owners on the date of record of December 31, 20X1, payable on January 20, 20X2.

When cash dividends are declared, if there is any preferred stock outstanding, the dividends have to be applied to the preferred stock first. We’ll tackle that in the next section after you check your understanding of accounting for cash dividends in general.