Assuming there is no preferred stock issued, a business does not have to pay dividends, there is no liability until there are dividends declared. As soon as the dividend has been declared, the liability needs to be recorded in the books of account as dividends payable.
Suppose a business had dividends declared of 0.80 per share on 100,000 shares. The total dividends payable liability is now 80,000, and the journal to record the declaration of dividend and the dividends payable would be as follows.
Dividends Declared Journal Entry
The dividends declared journal entry is shown in the accounting records using the following bookkeeping entries:
Dividends Declared Bookkeeping Explained
The debit is a charge against the retained earnings of the business and represents a distribution of the retained earnings to the shareholders. The debit entry is not an expense and is not included as part of the income statement, and therefore does not affect the net income of the business.
The credit entry to dividends payable represents a balance sheet liability. At the date of declaration, the business now has a liability to the shareholders to pay them the dividend at a later date.
The Accounting Equation
The Accounting Equation, Assets = Liabilities + Equity means that the total assets of the business are always equal to the total liabilities and equity of the business This is true at any time and applies to each transaction. For this transaction the accounting equation is shown in the following table.
|None||=||Dividends payable||+||Retained earnings|
With the dividends declared journal entry, a liability (dividends payable) is increased by 80,000 representing an amount owed to the shareholders in respect of the dividends declared. This is balanced by a decrease in the retained earnings which in turn results in a decrease in the owners equity, as part of the retained earnings has now been distributed to them.
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