When a company has shareholders, those individuals need to be factored into accounting practices. If that company issues a dividend to stockholders or reinvests its dividends, it will have no impact on the assets and liabilities of the business itself. However, the dividend payouts will come out of the business’s retained earnings, which is money that company could have reinvested into operations.
Although a stock dividend doesn’t impact a business’s assets and liabilities, it can affect its stock prices. It will also affect the amount of its retained earnings, which refers to the extra money left after liabilities have been subtracted from assets.
Dividends and Stockholders' Equity
Companies value the shareholders who support them by investing in their business. One benefit of being a shareholder is that if you’re with the right business, you’ll eventually see a reward for that loyalty. From time to time, a business will reward its shareholders by issuing dividends, either in the form of cash or additional shares.
For a business’s accounting team, though, this issuance is important because it can have a direct impact on the company’s balance sheet. How it affects that sheet, though, depends on how the dividends were paid. Since some businesses issue dividends at least once a year, the topic comes up often enough that accounting staff must come up with a process for it.
Stock Dividends and Retained Earnings
The declaration and issuance of a stock dividend does not affect the total amount of a corporation's net assets. What they do affect is retained earnings, which is the amount of income remaining after a business has paid out dividends. That means you would determine your net assets and subtract the dividend amount, which would give you your total retained earnings.
Your shareholders will take an interest in your retained earnings, especially if you have a significant amount of net profit and you only made a small dividend payment. Your company’s leadership is allowed to make the decision as to how much to distribute to shareholders when you have a surplus, if you decide to distribute any at all. However, your stockholders always have the right to challenge your actions if the majority decides to do so.
Reducing Liabilities With Retained Earnings
Instead of redistributing earnings, your company can decide to use the excess to pay down debt. This would have a direct impact on your business’s balance sheet since the excess is being redistributed to reduce your liability. This doesn’t have to be an all-or-nothing proposition. In fact, your business could decide to distribute part of the earnings as dividends, while putting the rest toward debt.
Instead of reducing liabilities on this year’s balance sheet, though, your business could decide to set the money aside for future losses. If you anticipate next quarter won’t be quite as lucrative, this could actually be something your shareholders wholeheartedly support. Many early-stage businesses will also hold off on making dividend payments, instead choosing to put any excess toward expenses that will help move the company to the next phase.
Issuing Dividends: Stock Versus Cash
Businesses have two major ways to issue dividends. One is cash, which is paid on a share basis. So, if a shareholder owns 100 shares, and the company agrees to issue $10 per share, you’ll receive a payout of $1,000 in cash dollars. Many businesses choose to issue dividend payouts on a regular schedule, so unless the price changes, you could grow to expect the $1,000 on a quarterly or yearly basis.
The other dividend issuance method is stock. The investor receives the amount of the dividend in the form of new shares in the company. The effect of a stock dividend is to keep investors happy while still maintaining a healthy balance, so generally stock dividends are issued if the business is low on cash reserves.
Dividends and Business Taxes
The declaration and issuance of a stock dividend does not affect the total amount of a corporation's assets, but a company’s profits are taxed. One way to offset this cost is to have liabilities, such as products purchased or travel costs accrued. When a business issues dividends to shareholders, it may feel like an expense, but the Internal Revenue Service doesn’t see it that way.
Your business’s dividends and retained earnings are considered profits. You just chose to distribute those profits to shareholders or put them back into the business. They are, for the IRS’s purposes, considered earnings and therefore need to be reported and taxed.
Dividends and Income Taxes
At tax time, dividends will come back to haunt the investor in the form of income tax. Whether an investor received $10 or $10,000, every dime has to be reported and taxed. At the end of the tax year, your business will issue Form 1099-DIV that will include the amount the investor received. Even if you don’t send a form, your investors will be required to report the amount to the IRS, so it’s important to make sure you report it when you file your business taxes.
Even if the dividends are issued in the form of shares, though, they will still be taxable in the year in which they were earned. This doesn’t apply if they’re in a retirement account, so if you’ve paid dividends to employees in the form of shares, but it’s in a nonretirement account, the payments received will be calculated and provided to shareholders on Form 1099-DIV, where they’ll be taxed.
Reporting Retained Earnings Balances
Before you can see for yourself what the effect of a stock dividend is to your bottom line, you’ll need to determine your total earnings balance. The relevant information will all be in the stockholders’ equity section of your balance sheet.
Your earnings are equal to the amount you have left over after you subtract the liabilities from your assets. So, if you earned $100,000, but you had $80,000 in liabilities, you have $20,000 in earnings. But if you distribute $10,000 of that to shareholders, you’ll have $10,000 in retained earnings that you can put back into the business or hold.
However, retained earnings aren’t the only way you can boost the stockholders’ equity portion of your balance sheet. Contributed capital may also be added to that figure. Contributed capital is money your company received through transactions with your shareholders.
Retained Earnings and Sole Proprietors
If you’re a sole proprietor, you’ll likely have something called owner’s equity on your balance sheet. This serves a similar purpose to stockholders’ equity. Although you probably won’t have to worry about the dividends stockholders’ equity brings, you’ll still need to monitor the money you have left over at the end of each quarter and determine what you’ll do with any excess.
On a sole proprietor’s balance sheet, your equity is your assets minus your liabilities in a specific timeframe. If that number is in the negative, your business is operating at a deficit. If it’s a positive number, you have equity, which means you can decide what to do with the excess. You don’t have shareholders for issuing dividends, although you could still pay yourself before having left over retained earnings that you put into the business or hold for a future deficit.
Impact on Stock Performance
Although the declaration and issuance of a stock dividend does not affect the total amount of a corporation's assets or liabilities, it can impact its stock prices. One way is through the required announcement of the date that the dividend will be issued and the amount. As part of the statement you release, you’ll be required to state a deadline for purchasing stock prior to the issuance of the dividend.
When investors hear that a dividend is about to be issued, a certain percentage will naturally want to take advantage of the opportunity to get a perk. They’ll even pay more per share just because they know a dividend is coming. Because of this drive to purchase, stock prices often will inflate in the days leading up to a dividend. However, those prices will often go down again on the deadline date.
Some investors learn a stock’s calendar and deliberately choose that time of year to invest. They know a dividend will be coming during that timeframe, so they save up and invest at that point. You’ll even see some of those same investors buy, enjoy the dividend and sell the stock immediately afterward, which will directly affect your prices.
Dividend History and Stock Performance
Savvy investors look into the history of a stock before putting money into it. Since your dividends are part of your stock history, they’ll see this, and it will often factor in to whether they choose to invest in your company. In this case, the effect of a stock dividend is to serve as positive marketing for your business.
There’s also the long-term effect. When a company develops a reputation as consistently rewarding investors, it naturally draws interest among those who aren’t yet investing in it. A business that consistently issues dividends is seen as one that is financially healthy, which boosts confidence. Plus, knowing that additional payout is coming on a somewhat regular basis will encourage investors to continue to put money into a company.
Dividend History Harming Performance
Unfortunately, when you pay dividends to stockholders’ equity, you can actually find that it sets you up for problems down the road. If you consistently issue $10 per share dividends at the end of each quarter, for instance, you may lock yourself into that. If you want to adjust it downward, you’ll raise eyebrows from longtime investors, who will wonder why they’re suddenly getting less.
Just as consistently issuing dividends helps boost confidence in anyone looking at your history, that same historical data can drop confidence. You may need to cut back for a year or two as you work on expansion, for instance, but future investors won’t necessarily have that context. They’ll simply see a big reduction in your payouts as a sign you went through tough times.
Stock Splits and Earnings
Stock splits can also affect the value of a company. With a split, a company sees that its share prices have risen too high and chooses to issue more shares to stockholders, therefore increasing the number of shares available. This keeps per-share prices low, ensuring that new investors won’t be scared off.
In the immediate aftermath of a stock split, the stock price can jump up a little as shareholders see the new, lower cost and rush to buy their own shares, driving up price. But that price will go down as interest goes back to normal.
During a stock split, a business will issue additional shares to stockholders, who may then wonder what the tax implications are. If those new shares begin to earn income, you won’t owe taxes on it as long as you leave it in the account. However, when you sell the stock later, you’ll pay taxes on the amount you receive minus your basis in the stock.
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Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.