ACCOUNTING TREATMENT FOR DIVIDEND

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This piece is inspired from my recent audit experience at a client office. The accountant of the client made two basic errors in accounting for dividend. So, let’s start with the errors. Say the company’s name is XYZ Ltd, and the financial year end I went to audit is 31 December 2015 (so the final audit happened say in April 2016). The two errors are:

1. During the year 2015, the company declared dividend for the financial year 2014. The accountant reasoned that since the dividend declared was for 2014 year results, it should be reported as 2014 transactions. So, he treated the dividend as a prior year adjustment for 2014 (since 2014 accounts have been finalised). 

2. The second error was that during the year 2016 (before our final audit), the company declared dividend for 2015 year results. The accountant, following the rationale explained in error 1 above, reported the dividend as an expense in the financial records for 2015.

Now, before going into the solutions for error 1 and 2 above, let us discuss the basics of what dividend is.

• What is dividend?

Dividend is a distribution of retained earnings of a company to shareholders of the company in their capacity as owners. Dividend can be in two forms: - Cash dividend; and - Stock Dividend. This piece deals with cash dividends. A company is not required to pay dividend except there are preferred shares. Payment of dividends is a business decision having considered the liquidity position, and the investment needs of the company.

• Who declares dividend?

Dividend is determined and declared by the directors, and approved by the shareholders at the annual general meeting. When dividend is declared that is the declaration date. And the date of payment is called the payment date.

• When is dividend recognised in the financial records?

This is where attention needs to be paid. Where a dividend is declared within the same year it relates to i.e 2014 dividend is declared and approved in 2014 (which rarely is the case), then there is little headache with the accounting treatment.

However, since the reality of the day is for dividend of a year to be declared in the following year, then one needs to be careful in the accounting treatment. And since declaration date and payment date are rarely the same, a liability will have to be recognised for dividend declared at the date of declaration. In recognising the liability, a guiding principle is WHEN THE OBLIGATION TO PAY ARISES.

A history of paying dividend does not generate an obligation. For a dividend to be recognised and provided for, it must be approved by the shareholders.

DECISION: Dividend is to be recognised and provided for in the year it is declared and approved by the shareholders irrespective of the year it relates to.

• Accounting treatment for dividend

DIVIDEND IS NOT AN EXPENSE to be reported through the statement of comprehensive income. Dividend, being a distribution to owners of a company, should be reported through the statement of changes in equity.

The double entry when a dividend is declared and approved is:

DEBIT: Dividends (To be reported as reduction in retained earnings in the statement of changes in equity).

CREDIT: Dividend payable account

When dividend is paid:

DEBIT: Dividend payable account

CREDIT: Bank account

So back to the errors listed above, the appropriate treatments for the two errors are thus:

1. Since 2014 dividend is declared and approved in 2015, then it should be reported in 2015 as a transaction and event of 2015. So, it is wrong to treat it as a prior year adjustment.

2. The 2015 dividend was declared and approved in 2016 before the approval of 2015 financial statements. The 2015 dividend should not be reported in 2015 financial statements. However, it could be disclosed as a note under events after the reporting date stating that the directors have declared x amount as dividend per share for the year ended 2015.

I believe that this piece is helpful. Do not forget to comment, share, re-share, and like. Written by Abayomi Samuel.