What it means
When a company's board of directors declares a dividend, the company takes on a legal obligation to pay it. Until the cash leaves the bank account, that obligation is recorded as dividends payable, which is a short-term liability (a debt due within about a year).
Declaration triggers the accounting, not payment. On the declaration date, retained earnings (the profits kept in the business over the years) fall and dividends payable rise by the same amount.
When the payment date arrives, cash and the liability fall together, so the effect on total equity was already taken at declaration. Three dates matter to shareholders.
The record date decides who is on the share register and so who is owed the money, the ex-dividend date is the first day the shares trade without the right to the dividend, and the payment date is when the cash moves. A buyer who purchases before the ex-dividend date receives the dividend, and a buyer who purchases on or after that date does not.
The phrase has a second meaning that matters to lenders and preferred investors. Cumulative preferred shares carry a fixed dividend that builds up if it is skipped, and those skipped amounts are called dividends in arrears.
They are not a balance sheet liability until declared, but they usually must be cleared before ordinary shareholders receive anything, so companies disclose them in the notes to the accounts. Analysts watch unpaid dividends because they compete with other short-term bills for cash.
A large declared dividend with little cash in the bank can strain liquidity (the ability to pay bills as they fall due), and a company that declares and then delays can damage investor trust. Some payments also stay unclaimed because a shareholder moved address, and the company then has to keep tracking them under local rules.
In practice
Real-world examples.
Example
A listed retailer declares its quarterly dividend three weeks before its financial year end, with payment due after the year end. The finance team books dividends payable of $1,200,000 at the year end, and the lender reviewing the accounts sees the short-term debt in the current liabilities. The cash needed is set aside in the treasury forecast for the payment date.
Example
The owner of a family-owned construction company votes herself a dividend of $90,000 but leaves the cash in the business to fund a new excavator. The accountant credits the amount to her shareholder loan account, so the company now owes her $90,000 that she can draw whenever she wishes. The unpaid dividend is therefore a real debt, even though no money moved.
Example
A private equity buyer reviewing a software company finds a dividend declared before the sale date but not yet paid. The buyer treats the $400,000 as a debt-like item and deducts it from the price it agrees to pay. Without that adjustment the buyer would effectively fund a payout that belongs to the sellers.
Formula
Calculation
Dividends payable = shares outstanding x dividend per share declared
Suppose a company has 2,000,000 shares outstanding, which excludes any shares it holds itself as treasury stock because those receive no dividend. On 15 March the board declares a dividend of $0.25 per share, payable on 15 April. Dividends payable = 2,000,000 x $0.25 = $500,000. On 31 March the balance sheet shows $500,000 under current liabilities and retained earnings are $500,000 lower. On 15 April the company pays, so cash falls by $500,000 and the liability returns to $0.Case study
Seen in the real world.
Marlowe Textiles is an illustrative, fictional manufacturer with 5,000,000 shares in issue and a long record of paying an annual dividend. Late in the year the board declared $0.40 per share, a total of $2,000,000, payable in the following February. Cash was tight because a large customer was paying slowly.
The finance director recorded $2,000,000 as dividends payable at the year end and reported a current ratio (current assets divided by current liabilities) that was lower than the previous year. The bank asked about the shortfall, and she showed that a short-term facility of $1,000,000 would cover the gap until the customer paid.
The illustrative lesson is that declaring a dividend commits the company to a payment date, so the cash plan has to be checked before the vote and not after it.
Watch out
Common mistakes.
- Recording the dividend only when the cash is paid, when the liability should be booked on the declaration date.
- Treating dividends in arrears on cumulative preferred shares as a balance sheet liability, when they are normally only disclosed until the board declares them.
- Showing a dividend as an expense on the income statement, when it is a distribution of profit that reduces retained earnings and does not affect profit for the year.
Questions
People also ask.
Can a board cancel a dividend after declaring it?
In most places, once a dividend is properly declared it becomes a debt that the company cannot simply withdraw, though the details depend on local company law and the terms of the declaration.
Who receives the dividend if the shares are sold after the record date?
The seller keeps the right to the dividend in most cases, because ownership on the record date decides who is paid, and the price usually adjusts at the ex-dividend date.
Where does an unpaid dividend appear in the accounts?
It appears under current liabilities as dividends payable, and the movement in retained earnings appears in the statement of changes in equity.
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