OTHER TRANSACTIONS AFFECTING RETAINED EARNINGS Accounting Help

Cash Dividends Investors buy stock in a corporation in the hope of getting their original investment back with a reasonable return on that investment. The return on a stock investment is a combination
of two forms: (1) the increase in value of the stock (stock appreciation) and (2) cash dividends. Many profitable corporations do not pay dividends.

These corporations are in an early stage of development and must conserve cash for the purchase of plant and equipment or for other needs of the company. These “growth companies” cannot obtain sufficient financing at reasonable interest rates to finance their operations, so they .must rely on their earnings. It is usually only after a significant number of years of The preceding discussion suggests three requirements for the payment of a cash dividend.  These are: 1. Retained earnings.

Since dividends represent a distribution of’ earnings to stockholders, the theoretical maximum for dividends is the total undistributed net income of the company, represented by the credit balance of the Retained Earnings account.

As a practical matter, many corporations limit dividends. to somewhere near 40% of annual net income, in the belief that a major portion of the net income must be retained .in the business if the company is to grow and to keep pace with its competitors. 2. An adequate cash position. The fact that the company reports large earnings does not necessarily mean that it’ has a large amount of cash on hand.

Cash generated from earnings may have been invested in new plant and equipment. or in paying. off debts. or in acquiring a larger inventory. There is no necessary relationship between the balance in the Retained Earnings account and the balance in the Cash account. The traditional  expression of “paying dividends out of retained earnings” is misleading.

Cash dividends can be paid only out of cash. 3. Divideiul action by the board of directors. Even though a company’s net income is substantial and its cash position seemingly satisfactory, dividends are not paid automatically. A formal action by the board of directors is necessary to declare a dividend

OTHER TRANSACTIONS AFFECTING
RETAINED EARNINGS

Cash Dividends Investors buy stock in a corporation in the hope of getting their original investment back with a reasonable return on that investment. The return on a stock investment is a combination
of two forms: (1) the increase in value of the stock (stock appreciation) and (2) cash dividends.

Many profitable corporations do not pay dividends. Generally. these corporations are in an early stage of development and must conserve cash for the purchase of plant and equipment or for other needs of the company. These “growth companies” cannot obtain sufficient financing at reasonable interest rates to finance their operations, so they .must rely on their earnings. It is usually only after a significant number of years of profitable operations that the board of directors will decide that paying cash dividends is appropriate.

The preceding discussion suggests three requirements for the payment of a cash dividend. These are: 1. Retained earnings. Since dividends represent a distribution of’ earnings to stockholders,  the theoretical maximum for dividends is the total undistributed net income of  the company, represented by the credit balance of the Retained Earnings account.

As a practical matter, many corporations limit dividends. to somewhere near 40% of annual  net income, in the belief that a major portion of the net income must be retained .in the business if the company is to grow and to keep pace with its competitors. 2. An adequate cash position. The fact that the company reports large earnings does not necessarily mean that it’ has a large amount of cash on hand.

Cash generated from earnings may have been invested in new plant and equipment. or in paying. off debts. or in acquiring a larger inventory. There is no necessary relationship between the balance in the Retained Earnings account and the balance in the Cash account. The traditional expression of “paying dividends out of retained earnings” is misleading.

Cash dividends can be paid only out of cash. 3. Divideiul action by the board of directors. Even though a company’s net income is substantial and its cash position seemingly satisfactory, dividends are not paid automatically. A formal action by the board of directors is necessary to declare a dividend.
• Other Transactions Affe9ting RetaIned Eamlngs 525 3. Date of record. The date or record always follows the date of declaration, usually by a period of two or three weeks, and is always stated ‘in the dividend declaration. In order to be eligible to receive the dividend. a person must be listed in the corporation’s records as the owner of the stock on this date. 4.

Date of payment. The declaration of a dividend always includes.announcement of the date of payment as well as the date of record. Usually the date of payment comes two to four weeks after the date of record. Journal entries are required only on the dates of declaration and of payment, as these are the only transactions affecting the corporation c: ‘!arillg the dividend. These entries are illustrated below: Dec, 15 record declamtion of a cash dividend of $1 per share on the 100,000 shares of common stock  outstanding, Payable Jan. 25 to stockholders of record on Jan. 10

Entries made on declaration 100,000 . date and Jan. 25 Dividends Payable 100,000 on payment date Cash 100,000 To record payment of $1 per share dividend declared Dec. 15 to stockholders of record on Jan. 10. Notice that no entries are made on either the ex-dividend date or ·the date of record. These date’s are of importance only in determining to whom the dividend checks should be sent. From the stockholder’s point of view, it is the ex-dividend date that determines who receives the’ dividend.

The date of record is of significance primarily to the stock transfer agent and the stock registrar.Just when is the ex-dividend datein our example? It falls three business days before the date of record. Weekends and holidays are not counted as “business days.”

Thus, if .January 10 is a Friday, the ex-dividend date is January 7. But if January 10 falls on a Monday, the ex-dividend date would be January 5. In this case, investors would needto purchase their shares on or before January 4 if they are to receive this dividend.

At the end of the accounting period, a closing entry is required to transfer the debit balance of the Dividends account into the Retained Earnings account. (Some companies follow the alternative .practice of debiting Retained Earnings when the dividend is declared instead of using a Dividends account. Under either method, the balance of the Retained Earnings account ultimately is reduced by all dividends declared during the period.)

Most dividends’ are paid in cash, but occasionally a dividend declaration calls for payment in. assets other than cash.

A large distillery once paid a dividend consisting of a bottle of whiskey for each share ofstock, (This must have posed quite a storage problem to an investor owning several thousand shares.) When a corporation goes out of existence (particularly a small corporation with only a few stockholders), it may choose to distribute noncash assets to its owners rather than first converting these assets into cash liquidating Dividends A liquidating dividend occurs when a corporation pays a dividend that exceeds the balance in the Retained Earnings account.

Thus the dividend returns to stockholders all or part of their paid-in capital investment. Liquidating dividends usually are paid only when a corporation is going out of existence or is making a permanent reduction in the size  of its operations.

Normally dividends are paid as a result of profitable-operations; stockholders may assume that a dividend represents a distribution of profits unless. they are notified by the corporation that the dividend is a return of invested capital

Posted on November 21, 2015 in Income and Changes Retained Earnings

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