Updated July 12, 2023
What is Cash Dividend?
The term “cash dividend” refers to the dividend distribution in which a fund is paid out to the shareholders from the company’s earnings generated during the year or its accumulated profits as of date.
The most striking feature of a cash dividend is that it is paid in terms of actual money, unlike stock dividends, wherein there is no actual cash outflow. The payment of dividends can be in the form of periodic cash distributions.
Explanation
Typically, companies consider dividends to return capital to shareholders through cash payments, which are usually paid out every quarter. However, many companies prefer paying dividends monthly, semi-annually, or annually. Again, some companies don’t pay regular dividends but create special dividends for the shareholders after certain events.
Examples of Cash Dividends
Following are examples given below:
Example #1
Let us use SDF Inc.’s example to illustrate the computation of dividends and their yield. The company reported a profit in the current financial year that was significantly higher than in other years. So the company’s board decided to distribute some of the profit as dividends to its shareholders. If Mr. X currently owns 50 shares that he purchased at $12 per share and the company declared a dividend of $1.2 per share, then determine the total dividend and its yield.
Solution:
- Given, Dividend per share = $1.2 per share
- Share price = $12 per share
- No. of shares owned = 50
The total cash dividend earned by Mr. X can be calculated as,
Total Cash Dividend = Dividend per Share * No. of Shares Owned
- Total Cash Dividend = $1.2 per share * 50 shares
- Total Cash Dividend = $60
Now, cash dividend, in this case, can be calculated as,
Dividend Yield = Dividend per Share / Share Price
- Dividend Yield = $1.2 per share / $12 per share
- Dividend Yield = 10%
Therefore, the total dividend earned by Mr. X is $60 at a dividend yield of 10%.
Example #2
Let us take another example to illustrate the accounting treatment of dividends. Let us assume that the board of directors at XYZ Inc. declared a dividend of $0.5 per share for each outstanding 15,000 shares. Prepare the journal entry for the dividend at the time of declaration and actual payout.
- Given, Dividend per share = $0.5 per share
- No. of outstanding shares = 15,000
Now, the total cash dividend paid by XYZ Inc. can be calculated as,
Total Cash Dividend = Dividend per Share * No. of Outstanding Shares
- Total Cash Dividend = $0.5 per share *15,000 shares
- Total Cash Dividend = $7,500
The journal entry after the company declares the dividend will be as follows:
| Date | Particulars | Debit | Credit |
| Retained earnings A/C | $7,500 | ||
| Dividend payable A/C | $7,500 |
The journal entry when the company pays the dividend will be as follows:
| Date | Particulars | Debit | Credit |
| Dividend payable A/C | $7,500 | ||
| Cash A/C | $7,500 |
Why Are Companies Paying Cash Dividends?
Companies usually pay dividends when they can generate stable cash flow for several consecutive quarters and are largely considered financially healthy. However, the common belief also states that companies paying high dividends are not growth-oriented. Still, they rather intend to enhance shareholder value by generating a steady flow of income through dividends. The size of dividend payment is decided based on various financial strategies, such as some companies determining dividends based on specific financial ratios. In contrast, others fix the dividend payment as a percentage of the current year’s earnings.
Cash Dividend Journal Entry
When a company declares a dividend, then the Retained earnings A/Cis debited, and the Dividends payable A/C are credited, resulting in a reduction in equity and an increase in liabilities by the same amount. In this case, the income statement is impacted while the balance sheet remains unchanged. The journal entry at the time of the declaration of the cash dividend is as follows:
| Date | Particulars | Debit | Credit |
| Retained earnings A/C | XX | ||
| Dividend payable A/C | XX |
When the company eventually pays off the dividend later, the Dividends payable A/C is debited, and the A/C is credited, which results in a reduction in both cash and the corresponding liability. In this case, the balance sheet is impacted while the income remains unaffected. The journal entry at the time of actual payment of the cash dividend is as follows:
| Date | Particulars | Debit | Credit |
| Dividend payable A/C | XX | ||
| Cash A/C | XX |
Difference Between Cash Dividend and Stock Dividend
The main differences between the dividend and stock dividend are:
- The Stock dividend increases the number of outstanding shares, while the dividend has no effect on the number of outstanding shares.
- Stock dividend prevents the actual distribution of the company’s retained earnings to the stockholders, while in the dividend, the accumulated retained earnings decline by the amount of dividend payment.
Advantages
- The distribution and accounting for taxation purposes of dividends are fairly easy.
- It provides liquidity support for investors who rely on dividend income as a steady cash inflow.
- It doesn’t dilute the shareholding of the current shareholders. As such, the stock price level remains largely unaffected by such payouts.
Disadvantages
- As it impacts the cash position, a company with a short-term liquidity mismatch might face problems and resort to other funding sources.
- Dividends usually come under ordinary income tax rates, which are significantly higher than the capital gains tax rate applicable to other kinds of dividend payout.
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This is a guide to Cash Dividend. Here we discuss the introduction, examples of cash dividends, and their advantages and disadvantages. You may also have a look at the following articles to learn more –
