Corporations distribute earnings to shareholders primarily through dividends and share buybacks (also known as stock repurchases). These financial activities impact a company’s equity section in its balance sheet and must be properly recorded in the financial statements.
Dividends are payments made by a corporation to its shareholders, usually from retained earnings. There are two main types of dividends:
🔹 Cash Dividends – Direct payments to shareholders in cash.
🔹 Stock Dividends – Additional shares issued to existing shareholders instead of cash.
Dividends are not considered expenses since they do not affect net income. Instead, they are a distribution of profits, reducing retained earnings.
Declaration Date – The board of directors announces the dividend and records a liability.
Ex-Dividend Date – The date when new buyers of the stock do not receive the dividend.
Record Date – The corporation identifies shareholders eligible for the dividend.
Payment Date – The company distributes the dividend to shareholders.
Example: A Corporation Declares a $5 per Share Dividend
A company declares a dividend of $5 per share on 10,000 outstanding shares.
Declaration Date Entry: (Creates a liability)
Debit: Retained Earnings .......... $50,000
Credit: Dividends Payable ......... $50,000
Payment Date Entry: (Pays the dividend)
Debit: Dividends Payable .......... $50,000
Credit: Cash ...................... $50,000
After the dividend is paid, cash is reduced, and the liability is removed.
Instead of paying cash, a company may issue additional shares to existing shareholders. Stock dividends do not reduce assets but shift funds within equity.
Types of Stock Dividends:
✅ Small Stock Dividend (< 20–25% of outstanding shares) – Recorded at market value.
✅ Large Stock Dividend (> 25% of outstanding shares) – Recorded at par value.
Example: A Corporation Issues a 10% Stock Dividend
A company has 100,000 shares outstanding at a $10 market price per share. The company declares a 10% stock dividend (10,000 new shares).
Journal Entry:
Debit: Retained Earnings .......... $100,000
Credit: Common Stock Dividend Distributable ... $10,000
Credit: Additional Paid-in Capital ............ $90,000
When the shares are issued:
Debit: Common Stock Dividend Distributable .... $10,000
Credit: Common Stock .......................... $10,000
Stock dividends increase the number of shares but do not impact total equity.
A company may repurchase its own shares to:
✔ Reduce the number of outstanding shares
✔ Increase earnings per share (EPS)
✔ Return value to shareholders
✔ Prevent hostile takeovers
When a company buys back shares, they are recorded in a Treasury Stock account.
Example: A Company Buys Back 5,000 Shares at $20 Each
Debit: Treasury Stock ............. $100,000
Credit: Cash ...................... $100,000
If the company reissues the shares later at a higher price, the difference is credited to Additional Paid-in Capital (APIC).
Example: Reissuing the Shares at $25 Each
Debit: Cash ....................... $125,000
Credit: Treasury Stock ............ $100,000
Credit: Additional Paid-in Capital. $25,000
If the shares are reissued at a lower price, the loss is deducted from APIC or Retained Earnings.
Example: Reissuing the Shares at $18 Each
Debit: Cash ....................... $90,000
Debit: Additional Paid-in Capital.. $10,000
Credit: Treasury Stock ............ $100,000
If a company retires the repurchased shares instead of holding them in treasury stock, the shares are permanently removed from the stockholder’s equity.
📌 Dividends:
✔ Reduce retained earnings
✔ Increase liabilities (dividends payable) until paid
✔ Decrease cash when paid
📌 Share Buybacks:
✔ Reduce total equity
✔ Increase EPS (fewer outstanding shares)
✔ Affect stock price depending on market perception
By understanding dividend payments and stock buybacks, investors can assess how a company returns value to shareholders and how these transactions affect its financial health.