Dividends

Dividends are a portion of a company's earnings distributed to the holders of its common and/or preferred stock. In other words, a dividend represents the shareholders' return on investment just as interest represents the return on investment on checking and money market accounts, certificates of deposit, bonds, and other fixed-rate debt investments. The company's board of directors declares the dividend on a “per share” basis, so the distribution to each shareholder is in direct proportion to the amount of stock the shareholder possesses. The dividend itself can be paid in cash, property, or additional shares of the company's own stock. Dividends received by the shareholders are generally considered fully taxable income by the Internal Revenue Service.

Whether or not a dividend is declared and paid depends on the type of stock held by the shareholder (that is, preferred stock or common stock). Dividends must be paid to holders of preferred stock before they can be paid to holders of common stock, although there is no legal requirement that the company pay dividends to common stock shareholders at all. The amount of dividends paid to holders of preferred stock depends on whether the preferred stock is cumulative or noncumulative. If a dividend was declared for cumulative preferred stock in a previous year, but not paid, then that dividend is considered in “arrears” and must be paid before any current or future dividends can be paid. If the preferred stock was noncumulative, then the current year dividend is all that is owed. If there is any cash, property, or stock available after the preferred shareholders are paid, the remaining amount can be distributed to the common stock shareholders.

There are three important dates to remember related to the payment of dividends: the date of declaration, the date of record, and the date of payment. The date of declaration is the date at which the board of directors actually declares a dividend is to be paid. The date of record is the date on which all shareholders of that date are paid the declared dividend. The date of payment is the date at which the dividend is paid. For example, on May 13, 200X, the board of directors of XYZ Corporation declares that they will pay a $2 per share dividend on June 15, 200X, to all individuals holding shares of their stock as of May 31, 200X. May 13 is the date of declaration, May 31 is the date of record, and June 15 is the date of payment.

From a financial statement standpoint, dividends declared are shown as a reduction in retained earnings on the statement of changes in stockholders' equity. If a cash dividend is paid, then it would be included as a cash outflow on from financing activities on the statement of cash flows. If the dividend was paid with property or stock, then [Page 145]the dividend is disclosed as a noncash item on the statement of cash flows. If the dividend has not been paid, the dividend payable is generally included as a liability on the statement of financial position (balance sheet).

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