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 non-owners. Furthermore, the balance will probably not be considered a liability if the firm enters 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 the satisfaction of paid-in capital claims rather than retained earnings, it is known as a liquidating dividend.

Since it is considered a return of the investment rather than on the investment, a liquidating dividend does not represent income to the stockholders.

Frequently Asked Questions

Why is the dividend payable account included under liabilities?

The dividends payable account shows that a company owes money to its shareholders as an amount they will be paid as their return on investment. Therefore, since it is including money owed to others, this means it should fall under liabilities.

What would happen if a company were unable to pay the dividends that they owe to their shareholders?

If a company is unable to pay the dividends owed, this means that their liabilities are greater than their assets. This would be known as insolvency, which is one of the four major balance sheet classifications; others include: asset liquidation or bankruptcy.

What is the difference between declaring a dividend and issuing a stock dividend?

Declaring dividends means that shareholders will receive money as their return on investment, whereas with issuing stock dividends, shareholders will own more shares. If this continues to happen over time, it can result in share dilution. It is important to note that both events are classified under equity, even though one has a return on investment and the other doesn't.

Why is dividends payable account treated as current liabilities?

It is treated as current liabilities because paying out dividends can be completed within 12 months. In addition, since the balance will probably not be considered a liability if the company enters bankruptcy, it is usually appropriate to treat the dividend as a current liability.

Why is there a distinction between legal and accounting dividends?

Legal dividends refer to the amount of money that the company owes its shareholders, which is referred to as dividends payable account. On the other hand, accounting dividends are considered an expense on either income statement or balance sheet.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

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