It’s normal for the investor to expect earnings on their investment. The investment can be in any form like investment in debt, investment in equity, investment in commodity, etc. It can be in the form of distributing cash or some assets.
For instance, the return on investment in the stock (dividends) can be paid in multiple forms. Let’s discuss four main types of dividend: cash dividend, stock dividend, property dividend, and liquidating dividend that is commonly known.
1) Cash dividend (A most common type of dividend)
The cash dividend refers to the distribution of the cash to the shareholders as a return on their investment.
The shareholders can also opt to re-invest the dividend and increase the size of their investment. The cash dividend is paid regularly; it may be monthly, quarterly, or yearly.
The dividend-paying companies are usually established companies with strong cash flow (Dividend-paying companies are considered financially stable as per dividend signaling theory).
However, payment of the dividend may restrict the growth of the company as financing problems may arise due to a shortage of funds.
Further, cash dividends can be paid regularly or on some special occasions like some large recovery has been made in the litigation process, some unusual profit has been earned, or there has been excess cash within the company’s financial system.
So, the companies have dividend policies in place and can change the amount of the dividend to be paid from period to period. Further, the board may decide to recommend a special dividend.
In addition to this, different companies have different policies for dividends. For instance, some companies believe in the capital appreciation of the share price and do not pay a dividend while using retained earnings to expand their operations.
On the other hand, some companies consider dividends as a basic need of the shareholders and make regular payments. So, an investor must assess the trend of the dividend payment against their need before making a final investment decision.
Accounting treatment for the cash dividend
Once a dividend is announced, the entry is passed into the accounting system that debits retained earnings and credits the dividend payable.
This entry impacts the financial system by an increase of the liability and decrease of the reserves. Once the dividend is paid in cash, liability is reversed, and cash is credited from the accounting system.
So, the net impact of the cash dividend payment is the decrease of the cash and decrease of the retained earnings.
A decrease in retained earnings may lead to a barrier to the growth of the company’s business. Hence, the companies need to balance the expectation of the shareholders and the expansion/growth of the business.
2) Stock dividend
The stock dividend is when a company issues additional stock to the shareholders instead of the cash. The company may not have cash resources to pay the dividend, or they may have some other preference for cash to be invested.
Hence, a stock dividend is paid when a company wants to give a return/reward to its shareholders but does not have the funds to do so. In another word, not in the form of cash.
Further, the stock dividend has a well-known tax advantage as no tax is payable until the investor sells the shares and realizes the cash.
However, there is one important aspect to understand about the stock issuance in the form of a stock dividend. Once a stock dividend is released, the number of shares increases by a certain percentage.
For instance, if the company rewards a 5% stock dividend, one share will be issued against every 20 shares of the company.
So, an investor with 100 shares will receive five shares, but the market value of the new and old positions of the investor remains the same.
Hence, an increase in the number of shares is a dilution effect, and the real incentive behind the stock dividend is an expectation for the rise in the price of the shares that will lead to a return for the shareholders.
Further, the shareholder doesn’t have to pay transaction costs and commission expenses. This also helps save on the cost as it acts as a form of return for the shareholders receiving a stock dividend.
3) Property Dividend
The property dividend refers to the distribution of the property to the shareholders as a return on their investment. For property dividends, the company has to assess market value and record the dividend on the fair value.
For instance, the company has purchased property A at the cost of USD25,000, and the current market value of property A is USD100,000.
The company will have to record a gain on investment of USD75,000. Hence, the property’s value will be reflected in the books of the accounts by USD100,000, which will be treated as the actual worth of the property dividend.
After valuation entry, the retained earnings are debited with USD 100,000, and liability is credited with the same amount.
In the last entry, the liability is reversed, and property is derecognized from the books of the accounts as it has been given to shareholders, and the company no longer owns it.
4) Liquidating dividend
The liquidating dividend is when the company is winded up, and the company’s assets are distributed among shareholders by paying in the form of a dividend.
It may be a partial or full liquidation which means the company may decide to sell only partial assets of the business or all of the assets.
However, it is important to note that shareholders of the company do not stand first in the line for asset distribution. First of all, creditors are paid from the company’s assets, and then the remaining amount is paid to the equity holders.
Four types of dividends include cash dividend, stock dividend, property dividend, and liquidating dividend. The cash dividend is paid in cash, and it’s a simple distribution of the funds.
The payment of the dividend increases the confidence of the shareholders in the financial performance of the business. However, it restricts the capital growth of the company.
Another well-known type of dividend is the stock dividend. This is when the company distributes additional shares to the shareholders instead of the cash.
The third type of dividend is property dividend; in this type of dividend distribution, the Company distributes some property among shareholders as a return on their investment. However, the property is recorded on the market value in the books of accounts before distribution.
The fourth type of dividend is liquidating dividend, in which the company winds up some partial or full operations and pays off assets to the shareholders. However, creditors of the company stand first in line in case of liquidation.