Companies share their profits with shareholders by making cash payments called dividends. Once the company commits to make a dividend payment, it must record this future payment as an obligation in its books. "Stock dividend distributable" is the accounting entry for such an upcoming payment obligation.
Profitable companies may elect to share some of their gains with shareholders by periodically paying them cash. The amount of dividend distributed to shareholders each year is almost always less than the firm's annual profits, because some money must be reinvested into the business for it to remain competitive. Some firms -- especially those operating in growing markets -- choose to pour all their cash back into their businesses to take advantage of promising opportunities. In growing markets, companies that fail to innovate risk losing market share. Stocks of such firms are called growth stocks, because the share price has significant growth potential over the long term. In exceptional circumstances, a firm may distribute shares as dividends instead of cash. Such dividends are referred to as stock dividends.
Declaration and Announcement
The dividend policy is entirely at the discretion of the company's board of directors. After assessing the best use of the cash at hand, the board decides how much, if any, the shareholders will receive as dividends. A corporation can pay dividends one to four times a year. To give investors sufficient time for financial planning, dividends are announced months in advance. Therefore, the official board decision will contain not only a dividend amount but also a dividend payment date. The board releases a statement that provides a rationale for its dividend policy.
Once a dividend has been approved by the board of directors, it becomes a legally binding payment obligation and must be entered into the books, just like any debt. This upcoming payment will appear in the books as "stock dividend distributable." As soon as the board approves a dividend payment, the accountant debits "retained earnings" and credits "stock dividend distributable." In other words, retained earnings will decline and stock dividend distributable will increase by the same amount. The dollar amount of this entry equals dividends per stock, multiplied by the number of shares. The precise name of the accounting entry may vary slightly: Some firms use the term "payable" in place of "distributable" or omit the word "stock."
Assume that the board of a firm decides to pay $2 per share common stock and the company has 1,500,000 common shares outstanding. The total dividend obligation of this company equals $2 multiplied by 1,500,000, or $3 million. The accountant will debit retained earnings by $3 million and credit stock dividend distributable by $3 million. When the cash is sent to stockholders, dividend payable will be credited by $3 million and disappear from the books. At that point, the firm will no longer have a payment obligation and no need for such a line item. At the same time, cash will be credited by $3 million to show the decrease.
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