For those business entities who have invested in shares of another company, dividends may be received by these business entities as a way of distributing the earnings or profits made by the investee companies to the shareholders. Dividends could take the form of cash or non-cash (e.g. bonus shares, property etc.). I will only discuss the recording of cash dividend income in this post. Whenever dividends are distributed to the shareholders, enclosed together with the cheques to the shareholders are dividend warrants or vouchers. The dividend warrants or vouchers show the details of the dividends payments. Dividends are classified into two types: 1. Interim dividends, and; 2. Final dividends. It should be noted that it is the Board of Directors of companies that has the power to determine how frequent to declare and how much to declare interim dividends, NOT the shareholders. However, when interim dividends are paid during the financial year, there is a general expectation that final dividends will be proposed by the Board of Directors in the coming Annual General Meeting of members and subject to approval by the shareholders. When a company declares and pays dividends, the relevant financial period would be mentioned in the warrant or voucher and usually, the dividends are declared and paid depending on the profits that have been generated during this financial period. However, the Board of Directors of a company making losses in the current financial year could still declare and paid dividends out of the profits retained or accumulated in the previous financial year. According to International Accounting Standards (IAS) 18, dividends (income) shall be recognised when the shareholders' right to receive payment is established. This is usually easy to identify as the date of the dividend entitlement is stated clearly on the dividend warrants or vouchers. Many small businesses record dividend income on cash basis, i.e. upon receipt. The double entry for recording dividend income is:- Balance Sheet Income Statement DR CR DR CR Cash at bank* XXXX Dividend income XXXX *Business entities usually receive dividend income by way of cheques and not "hard cash". Therefore only the cash at bank account is debited and not petty cash. Example The financial period of ABC Co. Ltd. is from 1 January to 31 December. On 10 January 2007, ABC Co. Ltd. received $5,000 dividend from XYZ Co. Ltd., a company in which ABC Co. Ltd; paid $80,000 to acquire 80,000 ordinary shares of $1.00 each on 1 January 2006. ABC Co. Ltd. records its transactions using cash basis of accounting, The dividend voucher received:- XYX CO. LTD. DIVIDEND NO. TYPE OF DIVIDEND FOR YEAR ENDED ENTITLEMENT DATE DATE OF PAYMENT 01 INTERIM 31 DECEMBER 2006 31 DECEMBER 2006 10 JANUARY 2007 VOUCHER NO. NUMBER OF SHARES HELD OF $1.00 EACH DIVIDEND RATE GROSS DIVIDEND INCOME TAX @ 30% NET DIVIDEND 003 80,000 6.25 CENTS PER SHARE $5,000 TAX EXEMPT $5,000 ABC CO. LTD. 123, GOODLUCK STREET 5678 PROSPER LAND For the financial year ended 31 December 2006, ABC Co. Ltd. would not have recorded the dividend income because this transaction will be recorded in the accounts of ABC Co. Ltd. upon receiving the income on 10 January 2007. In respect of the $80,000 investment in shares of XYZ Co. Ltd. the double entry is:- Balance Sheet Income Statement DR CR DR CR Investment in XYZ 80,000 Cash at bank 80,000 The journal adjustment to recognise the dividend income (ABC Co. has the right to receive this dividend on 31 December 2006) is:- Balance Sheet Income Statement DR CR DR CR Dividend receivable 5,000 Dividend income 5,000 The income statement and balance sheet of ABC Co. Ltd. before and after this adjustment for dividend income recognition are shown below to illustrate the impact of this adjustment: - Example of Income Statement and Balance Sheet of ABC Co. Ltd. Income Statement for the year ended 31 December 2006 BEFORE Adjustment AFTER DR CR $ $ Sales 109,270 109,270 Cost of Sales - 40,875 - 40,875 Gross profit 68,395 68,395 Other income: - Dividend income - 5,000 5,000 Operating expenses: - Accountancy fee - 800 - 800 Depreciation of property, plant and equipment - 2,500 - 2,500 Donation - 500 - 500 Electricity & water - 3,340 - 3,340 Insurance premium - 200 - 200 Printing & stationery - 1,697 - 1,697 Rental of premises - 12,000 - 12,000 Salaries - 27,865 - 27,865 Upkeep of office - 3,547 - 3,547 Telephone charges - 1,285 - 1,285 Travelling, petrol & toll charges - 2,648 2,648 - 56,382 - 56,382 Net profit for the year 12,013 17,013 Retained profits B/F 27,654 27,654 Retained profits C/F 39,667 44,667 Balance Sheet as at 31 December 2006 $ $ Non-current assets Property, plant and equipment 12,500 12,500 Investment in XYZ 80,000 80,000 Current assets Inventories 5,000 5,000 Trade receivables 17,030 17,030 Other receivables, deposits & prepayments: Dividend receivable - 5,000 5,000 Deposits 14,077 14,077 Prepayments 2,200 2,200 Cash and bank balances 30,023 30,023 68,330 73,330 Current liabilities Trade payables - 3,588 - 3,588 Other payables and accruals - 102,575 - 102,575 - 106,163 - 106,163 Net current assets - 37,833 - 32,833 54,667 59,667 Financed by: - Share capital 15,000 15,000 Retained profits 39,667 44,667 54,667 59,667 For the financial year ended 31 December 2007, ABC Co. Ltd. would have recorded the $5,000 dividend received on 10 January 2007 as follow: - Balance Sheet Income Statement DR CR DR CR Cash at bank 5,000 Dividend income 5,000 As the dividend income should be recognised in the financial year ended 31 December 2006 and not 31 December 2007, the following correction journal adjustments are required:- Balance Sheet Income Statement DR CR DR CR Dividend receivable 5,000 Retained profits 5,000 Note: This journal entry is actually the same as the journal entry shown earlier to recognise the dividend income in the financial year ended 31 December 2006. In the context of the financial statements of ABC Co. Ltd. for the year ended 31 December 2007, any adjustments made that affect the profit in earlier years, are now required to be adjusted to the retained profits brought forward. Balance Sheet Income Statement DR CR DR CR Dividend income 5,000 Dividend receivable 5,000 The income statement and balance sheet of ABC Co. Ltd. before and after adjustment No. 1 & 2 are shown below to illustrate the impact of these adjustments: - Example of Income Statement and Balance Sheet of ABC Co. Ltd. Income Statement for the year ended 31 December 2007 BEFORE Adjustment AFTER No. DR No. CR $ $ Sales 159,270 159,270 Cost of Sales - 90,875 - 90,875 Gross profit 68,395 68,395 Other income: - Dividend income 5,000 2 5,000 - Operating expenses: - Accountancy fee - 800 - 800 Depreciation of property, plant and equipment - 2,500 - 2,500 Donation - 500 - 500 Electricity & water - 3,340 - 3,340 Insurance premium - 200 - 200 Printing & stationery - 1,697 - 1,697 Rental of premises - 12,000 - 12,000 Salaries - 35,579 - 35,579 Upkeep of office - 3,547 - 3,547 Telephone charges - 1,285 - 1,285 Travelling, petrol & toll charges - 2,648 - 2,648 - 64,096 - 64,096 Net profit for the year 9,299 4,299 Retained profits B/F 39,667 1 5,000 44,667 Retained profits C/F 48,966 48,966 Balance Sheet as at 31 December 2007 $ $ Non-current assets Property, plant and equipment 10,000 10,000 Investment in XYZ 80,000 80,000 Current assets Inventories 5,200 5,200 Trade receivables 6,000 6,000 Other receivables, deposits & prepayments: Dividend receivable 1 5,000 2 5,000 - Deposits 14,077 14,077 Prepayments 2,200 2,200 Cash and bank balances 52,652 52,652 80,129 80,129 Current liabilities Trade payables - 3,588 - 3,588 Other payables and accruals - 102,575 - 102,575 - 106,163 - 106,163 Net current assets - 26,034 - 26,034 63,966 63,966 Financed by: - Share capital 15,000 15,000 Retained profits 48,966 2 5,000 1 5,000 48,966 Note 1 63,966 63,966 Note 1: All adjustments affecting the income statements have to be repeated again and shown as adjustments to the retained profits account in the balance sheet. This is because all adjustments affecting any income statement items and the retained profits brought forward will eventually be included in the retained profits carried forward to the next financial year. The discussions in this post do not include the explanations on the effect of tax on dividends and the dividend imputation system imposed in some countries. Please refer to my post: Dividend Imputation for further details.
Thursday, 17 January 2008
Various Types of Transactions – Part 4b, Collection from Other Source of Revenue and Income (Dividend Income)
Correction of dividend incorrectly recognised during the financial year ended 31 December 2007
Reversal of dividend income incorrectly recognised in the income statement of ABC Co. Ltd. for the year ended 31 December 2007 and dividend receivable
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