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:-

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:-

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: –

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.

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