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Cash Dividends

Cash Dividends

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Published by David Ofori-Atta

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Published by: David Ofori-Atta on Jun 18, 2012
Copyright:Attribution Non-commercial

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12/17/2014

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Cash dividendsNet income results from management's activities. The long-term effect of net income is anincrease in the company's resources and its sources of resources (stockholders' equity, retainedearnings). Corporations distribute to owners some of the resources generated by management(net income) in the form of cash dividends. A corporation's board of directors has theresponsibility for declaring cash dividends. If it determines the company should distribute cashdividends to owners, the board of directors declares a cash dividend. The board determines thedollar amount of the dividends and the date on which they will be paid. Because it takes time toidentify all the owners and distribute checks to them, dividends are paid several days or weeksafter they are declared. Assume a corporation's board of directors declares a $2,000 cash dividend on July 10, with thedividend to be paid on August 12. Show the effects on the company's resources and sources of resources.TotalResources =Sources of BorrowedResources +Sources of Owner InvestedResources +Sources of ManagementGeneratedResourcesAssets = Liabilities + Stockholders' Equity
 
+ $2,000 dividends payable + - $2,000  dividends The company's resources (assets) do not change as a result of the July 10 declaration of dividends because the cash will not be paid out until later (August 12). The company's sources of resources increase and decrease by the $2,000 dividends declared. Liabilities increase by $2,000because the company now owes its owners $2,000 more. Stockholders' equity decreases by$2,000 because the owners now have rights to $2,000 less of the company's resources. In effect,the owners have given up their ownership rights to $2,000 of the company's resources for $2,000of rights as creditors: the owners have become creditors. The decrease in stockholders' equity isshown as a decrease in sources of management generated resources because dividends, bydefinition, come out of those resources generated by management. Dividends are not returns toowners of some of the resources they invested in the corporation. Remembering that assets increase with debits and that debits must equal credits, prepare the journal entry to record the $2,000 cash dividend declaration.Date DescriptionPost.Ref. Debits CreditsJuly 10Dividends 2,000  Dividends Payable 2,000  Cash dividends declared 
 
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On August 12, the corporation pays the $2,000 cash dividend declared on July 10. Show theeffects on the company's resources and sources of resources.TotalResources =Sources of BorrowedResources +Sources of Owner InvestedResources +Sources of ManagementGeneratedResourcesAssets = Liabilities + Stockholders' Equity
 
- $2,000 cash = - $2,000  dividends payable The cash dividend payment reduces the company's resources (assets) as the cash flows out toowners. The company's sources of resources (liabilities) decrease by $2,000 because thecompany no longer owes them the $2,000 once the dividends are paid. Remembering that assets increase with debits and that debits must equal credits, prepare the journal entry to record the $2,000 cash dividend payment.Date DescriptionPost.Ref. Debits CreditsAug. 12Dividends Payable 2,000  Cash 2,000  Cash dividends paid As a result of declaring and paying cash dividends, the company's resources and sources of resources both decreased by $2,000. While it is important to management to keep ownerssatisfied by giving them some of the resources generated by the company, cash dividends dodecrease the amount of resources managers will be able to use in the future. Corporations mustcontinually evaluate this need to pay owners versus the need to keep resources for managementto use in the future. Distributing cash dividendsIf a corporation has both preferred stockholders and commonstockholders, the distribution of cash dividends depends upon the number of shares of stock owned by the stockholders (called outstanding shares) and the preferences of the preferredstockholders. For example, consider a company with the contributed capital shown below. 
 
Contributed Capital8% Preferred Stock, $10 par, 5,000 sharesauthorized, 1,000 shares issued $10,000Common Stock, $2 par, 40,000 shares authorized,10,000 shares issued $20,000Additional Paid-in Capital, Preferred Stock $2,000Additional Paid-in Capital, Common Stock $30,000
 
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Total Contributed Capital $62,000The company has both preferred stockholders and common stockholders. The preferredstockholders own 1,000 shares (shares issued by the company) out of a total of 5,000 shares thecompany's articles of incorporation allow it to issue (called authorized shares). The preferredstock has a par value of $10 per share and a dividend rate of 8%. Notice the $10,000 in thepreferred stock account is the par value of the number of shares issued ($10 par x 1,000 sharesissued = $10,000). The 8% dividend rate entitles the preferred stockholders to a dividend of 8%of the preferred stock's par value in the year in which a dividend is declared. Thus, on an annualbasis, preferred stockholders could receive cash dividends of $.80 per share (.08 x $10 par =$.80). In total, preferred stockholders could receive cash dividends of $800 (.08 x $10 par x1,000 shares outstanding = $800). The preferred stockholders would receive the $800 before anycash dividends would be paid to common stockholders. Based on the company's contributed capital, its $2,000 cash dividends would be distributed asfollows. Preferred stock dividends (.08 x $10 par x 1,000 shares) $800  Common stock dividends ($2,000 - $800) $1,200  Total dividends $2,000  Preferred stockholders would receive cash dividends of $.80 per share before dividends would bepaid to common stockholders. This is one of the advantages (preferences) of owning preferredstock. Common stockholders would receive cash dividends of $.12 per share ($1,200 dividends / 10,000 common shares outstanding = $.12). ** You now have the background to do text exercises 12.7, 12.8, and 12.9.Cumulative preferred stock One popular way companies make preferred stock attractive toinvestors is to add the cumulative preference. Remember, preferred stock is issued to obtainresources for management to use. The more attractive the preferred stock is to investors, theeasier it is to obtain resources. The cumulative preference entitles preferred stockholders toreceive dividends before common stockholders, even if the company failed to pay dividends in aprior year. Again, remember that owners receive dividends only after they have been declared bythe board of directors. If dividends are not declared, they cannot be received by owners. Thus,without the cumulative feature, preferred stockholders would not receive dividends for any yearin which the board of directors did not declare them. With the cumulative feature, however,preferred stockholders are guaranteed to receive their dividends for all years before the companycan distribute any dividends to common stockholders. Consider again the $2,000 cash dividend discussed previously. Assume the board of directors didnot declare dividends in the previous year, but instead kept the resources in the company formanagement to use.

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