You may hear the term, ‘Dividend Declaration’ when your company earns a handsome profit. What does declaring a dividend mean? Does every company need to pay dividends to its shareholders? What impact does it have on my share value?
This article will answer all these questions and more.
Dividend declarations are the means by which shareholders and investors in companies get returns on their investment.
You get dividend distributions only after your company’s Board of Directors approves the date when dividends will be distributed.
We talk more about Dividends in the paragraphs to follow.
Significance of a Dividend Declaration
A Dividend Declaration is a formal announcement made by a company that it is going to pay dividends to certain categories of its shareholders.
The decision to pay dividends is always made by the Board of Directors through a resolution passed under the company’s Memorandum and Articles of Association. This Board Resolution would also specify the time frame and the amount that will be paid as dividends.
In accounting terms, a Dividend Declaration results in a Debit in the Retained Earnings account and a credit in a new ‘Dividends Payable’ account. While Retained Earnings are assets, dividends that must be paid at some future date, are a liability.
Distributing dividends is just a neat way of saying that your company wishes to retain the trust of its shareholders and future potential investors. And so, the Board of Directors decide to distribute a part of the profits that the company has earned to shareholders who own their shares before the specified cutoff date.
This cutoff date is called the Expiry Date, the Ex-Dividend Date, or more popularly, just the Ex-Date.
Important Dates Associated with Dividend Payouts
Dividend Declaration Date
After the Board has passed the resolution and sanctioned the release of dividends, it has to make this information known to investors and the stock market. It does so by formally announcing the payout on the Dividend Declaration Date.
This date must be approved by the shareholders themselves via voting.
The Ex-Date is the date on which new share buyers will cease to expect dividend payouts announced on the Declaration Date.
If you were to buy shares on which dividends were payable, even one business day before the Ex-Date, you would be eligible to receive the announced dividends.
Date of Record
Date of Payment
This is the date on which the payouts are actually made. Note that this day may be one to three months after the Dividend Announcement.
Rise and Fall of Share Prices Around the Ex-Dividend Date
Those who buy the company’s shares on or after the cutoff date won’t receive these dividends. Those buying before will receive dividends.
Note that those who want to buy shares before the Ex-Date will do so in expectation of receiving dividends. This is because the Dividend Declaration Date is at least one business day prior to the Ex-Date.
Because of this expectation, the price of these shares will rise correspondingly. After the Ex-Date, the price will fall because buyers can no longer expect a dividend.
Should you Declare a Dividend Every Time you Earn a Profit?
Companies like Exxon Mobil and AT&T pay yearly dividends on the weight of their reputations and to keep up investor sentiment. Historically, big companies with regular profits have been known to make generous dividend payments.
New companies, startups, especially those in biotechnology, digital products, and new-age tech, caught in a cycle of high-growth, would want to reinvest all their profits into growing the company. So, they may decide not to pay dividends.
In fact, many small and medium-sized companies do not pay dividends at all. As a major shareholder or owner, you should consider how much you value investor confidence against upping the scale of company operations.
Sample Entries in the Accounting Journal
Supposing that X PLC has 155,000 shares and it decides to pay a $2 dividend payment per share. This payment may be made monthly, quarterly, or annually. At the end of the year, the journal entries will look something like this:
In most jurisdictions, including the US and India, companies paying dividends are subject to tax on dividend distributions. This tax component will also have to be added to the Debit on the Retained Earnings account and, accordingly adjusted in the Dividends Payable account.
Dividend Distribution Process
A dividend’s significance is deduced on a per-share basis and is to be repaid equally share-wise or to shareholders of a comparable category (common, preferred, etc.). This expenditure must be ratified by the Board of Directors.
When a dividend is proclaimed, it will then be paid on a specific date, known as the due date.
- The firm produces revenues and retains its dividend.
- The management team determines some additional dividends should be paid out to shareholders
- The board authorizes the calculated dividend for shareholders
- The corporation declares the dividend (the price per share, the date when it will be reimbursed, the record date, etc.)
- The dividend is paid to shareholder
Declared But Not Paid Dividends
Companies may declare dividends but may want to hold on to their cash to meet a contingency. In such a case, the company can set the Dividend Payment Date to a day that falls after the said contingency has been met and dealt with.
Note that positive sentiment has already been established the day the dividend was declared. At the same time, this payout does not interfere with the cash flow for contingencies.
Tax on Dividend Distributions
The Effect of Double Taxation Treaties on Dividend Income
Sometimes, Double Taxation Avoidance agreements between countries allow some dividend income to be exempt from tax. For example, if you are an Indian tax resident but own a Singapore company that decides to pay dividends. Because of the India-Singapore DTA, you will not be subject to any tax on those dividends – one reason why a large number of Indian businessmen set up companies in Singapore.
The UK will levy a withholding tax on income received from a UK company even if they are being passed on to non UK tax residents. The foreign taxpayer can later claim a relief, if allowed under the bilateral DTA agreement, in his/her home country.
Cash – This is the payment of original currency from the association promptly to the profit holders and is the largely familiar classification of income. The payment is usually generated electronically (wire transfer), but may also be paid by cheque or cash model.
Stock – Stock dividends are paid out to shareholders by publishing fresh shares in the firm. These are paid out pro-rata, based on the number of shares the investor already occupies.
Assets – A corporation is not restricted to paying percentages to its shareholders in the form of cash or investments.
Special – A specific dividend is one that’s spent the utmost of a company’s conventional agreement. It is usually the conclusion of amassing the following dividends on hand for one objective or another.
Common – This pertains to the class of shareholders, not what’s being obtained as an expense.
Preferred – This also relates to the class of shareholders accepting the number of shares.
Other – Other, less common, types of economic bargains can be paid out as dividends, such as choices, license, shares in a new spin-out company, etc.
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