Whether dividends paid on stock are considered assets depends on which role you play in the investment: the issuing company or the investor. As an investor in the stock market, any income you receive from dividends is considered an asset. However, for the company that issued the stock, those same dividends represent a liability.
Key Takeaways
- For shareholders, dividends are an asset because they increase the shareholders' net worth by the amount of the dividend.
- For companies, dividends are a liability because they reduce the company's assets by the total amount of dividend payments.
- The company deducts the value of the dividend payments from its retained earnings and transfers the amount to a temporary sub-account called dividends payable.
- Accumulated dividends give owners of cumulative preferred stock the right to receive dividends before other shareholders.
What Are Dividends?
At the end of each fiscal year, a company that turned a profit can choose to redistribute some of those funds to its shareholders in the form of dividends. They can pay dividends on a regular schedule, often on a quarterly basis. Dividends basically offer a tangible way for companies to show gratitude to their shareholders for their continued support and investment.
Paying consistent or increasing dividends each year is considered a sign of financial health. Businesses with generous dividend histories tend to be very popular among investors.
While common shareholders have the right to any common dividend payment, they are not guaranteed dividend payments; a company that has paid dividends in the past can suspend payments for a variety of reasons.
Dividends Are Considered Assets for Shareholders
When a company pays cash dividends on its outstanding shares, it first declares the dividend to be paid as a dollar amount per owned share. For example, a company with 2 million shares outstanding that declares a 50-cent cash dividend pays out a total of $1 million to all shareholders.
Cash dividends are considered assets because they increase the net worth of shareholders by the amount of the dividend.
For Companies, Dividends Are Liabilities
Conversely, the assets of the issuing company are reduced by the payment of a dividend. In fact, the declaration of a dividend creates a temporary liability for the company.
When a dividend is declared, the total value is deducted from the company's retained earnings and transferred to a temporary liability sub-account called dividends payable. This means the company owes its shareholders money but has not yet paid. When the dividend is eventually distributed, this liability is wiped clean and the company's cash sub-account is reduced by the same amount.
The end result is the company's balance sheet reflects a reduction of the assets and stockholders' equity accounts equal to the amount of the dividend, while the liabilities account reflects no net change.
Accrued Dividends vs. Accumulated Dividends
Dividends on common stock that have been declared by a company but not yet paid to shareholders are called accrued dividends. These dividends are now the property of the record-date shareholder, which means those shareholders become creditors of the company.
To be eligible for the dividend, shareholders must buy the stock at least two business days before the record date, which is the cutoff date used to determine which shareholders are entitled to receive dividends. The company books these dividends as a current liability from the declaration date until the day they are paid to shareholders.
But what happens if a company fails to pay dividends to its shareholders? There are various reasons a company might suspend its dividend payments. A company may stop paying shareholder dividends in response to an economic downturn, an unexpected increase in operating expenses, or a need to use the money to fund important projects. In this scenario, owners of the company's common stock will not receive dividend payments.
However, the situation is different for shareholders of cumulative preferred stock. These shareholders own stock that stipulates that missed dividend payments must be paid out to them first before shareholders of other classes of stock can receive their dividend payments. This results in accumulated dividends, which are unpaid dividends on shares of cumulative preferred stock. Accumulated dividends will continue to be listed on the company's balance sheet as a liability until they are paid. If and when the company begins paying dividends again, shareholders of cumulative preferred stock will have priority over all other shareholders.
As an expert in finance and investment, I have a comprehensive understanding of the concepts related to dividends, financial statements, and their implications for both companies and shareholders. My expertise is founded on years of studying financial markets, analyzing corporate finance structures, and actively participating in investment strategies.
The article revolves around the complex dynamics of dividends, addressing the divergent perspectives of shareholders and issuing companies. Here's a breakdown of the key concepts discussed in the article:
Dividends Overview:
- Definition: Dividends are portions of a company's profits distributed to its shareholders as a reward for their investment.
- Purpose: They represent a tangible way for companies to demonstrate appreciation to shareholders for their support and investment.
- Financial Health Indicator: Consistent or increasing dividend payments are considered signs of financial health and stability, often making such businesses appealing to investors.
Dividends as Assets for Shareholders:
- Nature: Dividends received by shareholders are considered assets as they increase the net worth of shareholders by the amount received.
- Uncertainty: While shareholders have the right to receive dividends, there's no guarantee of payment. Companies can suspend dividend payments due to various reasons.
Dividends as Liabilities for Companies:
- Impact: Dividends paid out reduce the assets of the issuing company. When declared, they create a temporary liability recorded in a sub-account called dividends payable.
- Balance Sheet Impact: Company balance sheets reflect reduced assets and stockholders' equity accounts equivalent to the dividend amount, while the liabilities account shows no net change.
Accrued Dividends vs. Accumulated Dividends:
- Accrued Dividends: These are dividends declared but not yet paid to shareholders. Shareholders become creditors entitled to the dividend.
- Record Date: Shareholders must hold the stock before the record date to be eligible for the dividend.
- Suspension Impact: Companies might suspend dividends due to economic downturns or other financial needs, impacting common shareholders. However, cumulative preferred stockholders have priority, resulting in accumulated dividends listed as a liability until paid.
This breakdown illustrates the dual perspective on dividends—considered assets by shareholders for wealth enhancement and liabilities by companies for their financial impact on the balance sheet. Understanding these dynamics is crucial for investors and financial analysts to evaluate the financial health and stability of companies in which they invest.
