Various Types of Transactions – Collection from Other Source of Revenue and Income, Dividend Income (Part 4b)

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:-

*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:-

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:-

The journal adjustment to recognise the dividend income (ABC Co. has the right to receive this dividend on 31 December 2006) is:-

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: –

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: –

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:-

1. Correction of dividend incorrectly recognised during the financial year ended 31 December 2007

	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.

2. Reversal of dividend income incorrectly recognised in the income statement of ABC Co. Ltd. for the year ended 31 December 2007 and dividend receivable

	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: –

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.