•The net profit or net income reported on the income statement is calculated before the payment of dividends, which is a distribution of profits to shareholders and occurs after the net income for the period has been calculated.
•So, when a company pays a dividend, it does not reduce the net income reported on the income statement for that period; instead, the payment of dividends reduces the amount of the company's retained earnings, which is reported on the balance sheet. The retained earnings balance represents the accumulated profits that the company has not paid out to its shareholders in the form of dividends: you can find it in the equity section of the balance sheet.
•Therefore, the net income reported on the income statement does not include the impact of the dividend payment; however, the reduction in retained earnings resulting from the payment of dividends is reported as a separate line item on the income statement (typically as a component of the statement of changes in equity or a note to the financial statements).
▪︎Example: A company XYZ declares and pays a cash dividend of $1 per share to its 10,000 shareholders, resulting in a total payout of $10,000.
•Journal Entries:
.. Declaration of Dividend:
Retained Earnings
$10,000 (debited)
Dividends Payable
$10,000 (credited)
°This entry records the declaration of the dividend, which reduces the company's retained earnings and creates a liability in the form of dividends payable.
.. Payment of Dividend:
Dividends Payable
$10,000 (debited)
Cash
$10,000 (credited)
°This entry records the payment of the dividend, which reduces the dividends payable liability and the company's cash balance.
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