Dividend Payable Account
The common practice concerning the Dividends Payable account treats it as a current liability if the amount is to be paid within 12 months. Technically, however, the amount cannot be considered a claim held by nonowners; further, the balance probably would not be considered to be a liability if the firm entered bankruptcy.
As a practical matter, the difficulty of reversing a declaration makes the payment unavoidable for a going concern and the liability treatment is appropriate. This position is also supported by the need to disclose the commitment for a future cash outflow. Thus, the classification of a dividend as a liability provides information that is helpful for evaluating solvency.
Limits on Dividends
Unless the amount of legal capital is very high, the only effective limit on dividends is the need to maintain the firm’s solvency. Thus, dividends are more likely to be limited by the cash needs of the firm for its operations rather than an imposed legal requirement. If a dividend results in satisfaction of paid-in capital claims rather than retained earnings, it is known as a liquidating dividend. Because it is considered a return of the investment rather than on the investment, it does not represent income to the stockholders.