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Accountancy
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Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders.[1] When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business (called retained earnings), or it can be paid to the shareholders as a dividend. Many corporations retain a portion of their earnings and pay the remainder as a dividend.

For a joint stock company, a dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a dividend in proportion to their shareholding. For the joint stock company, paying dividends is not an expense; rather, it is the division of an asset among shareholders. Public companies usually pay dividends on a fixed schedule, but may declare a dividend at any time, sometimes called a special dividend to distinguish it from a regular one.

Cooperatives, on the other hand, allocate dividends according to members' activity, so their dividends are often considered to be a pre-tax expense.

Dividends are usually settled on a cash basis, store credits (common among retail consumers' cooperatives) and shares in the company (either newly-created shares or existing shares bought in the market.) Further, many public companies offer dividend reinvestment plans, which automatically use the cash dividend to purchase additional shares for the shareholder.

Contents

History

The word "dividend" comes from the Latin word "dividendum" meaning "the thing which is to be divided among all".[2]

Joint stock company dividends

A dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a dividend in proportion to their shareholding.

Forms of payment

Cash dividends (most common) are those paid out in the form of a cheque. Such dividends are a form of investment income and are usually taxable to the recipient in the year they are paid. This is the most common method of sharing corporate profits with the shareholders of the company. For each share owned, a declared amount of money is distributed. Thus, if a person owns 100 shares and the cash dividend is $0.50 per share, the person will be issued a cheque for $50.

Stock or scrip dividends are those paid out in form of additional stock shares of the issuing corporation, or other corporation (such as its subsidiary corporation). They are usually issued in proportion to shares owned (for example, for every 100 shares of stock owned, 5% stock dividend will yield 5 extra shares). If this payment involves the issue of new shares, this is very similar to a stock split in that it increases the total number of shares while lowering the price of each share and does not change the market capitalization or the total value of the shares held (see also Stock dilution).

Property dividends or dividends in specie (Latin for "in kind") are those paid out in the form of assets from the issuing corporation or another corporation, such as a subsidiary corporation. They are relatively rare and most frequently are securities of other companies owned by the issuer, however they can take other forms, such as products and services.

Other dividends can be used in structured finance. Financial assets with a known market value can be distributed as dividends; warrants are sometimes distributed in this way. For large companies with subsidiaries, dividends can take the form of shares in a subsidiary company. A common technique for "spinning off" a company from its parent is to distribute shares in the new company to the old company's shareholders. The new shares can then be traded independently.

Dates

Dividends must be "declared" (approved) by a company’s Board of Directors each time they are paid. For public companies, there are four important dates to remember regarding dividends. These are discussed in detail with examples at the Securities and Exchange Commission site [1]

The declaration date is the day the Board of Directors announces its intention to pay a dividend. On this day, a liability is created and the company records that liability on its books; it now owes the money to the stockholders. On the declaration date, the Board will also announce a date of record and a payment date.

The in-dividend date is the last day, which is one trading day before the ex-dividend date, where the stock is said to be cum dividend ('with [including] dividend'). In other words, existing holders of the stock and anyone who buys it on this day will receive the dividend, whereas any holders selling the stock lose their right to the dividend. After this date the stock becomes ex dividend.

The ex-dividend date (typically 2 trading days before the record date for U.S. securities) is the day on which all shares bought and sold no longer come attached with the right to be paid the most recently declared dividend. This is an important date for any company that has many stockholders, including those that trade on exchanges, as it makes reconciliation of who is to be paid the dividend easier. Existing holders of the stock will receive the dividend even if they now sell the stock, whereas anyone who now buys the stock will not receive the dividend. It is relatively common for a stock's price to decrease on the ex-dividend date by an amount roughly equal to the dividend paid. This reflects the decrease in the company's assets resulting from the declaration of the dividend. The company does not take any explicit action to adjust its stock price; in an efficient market, buyers and sellers will automatically price this in.

Whenever a company announces a dividend pay-out, it also announces a "Book closure Date" which is a date on which the company will ideally temporarily close its books for fresh transfers of stock. Read "Book Closure" for a better understanding.

Shareholders who properly registered their ownership on or before the date of record, known as stockholders of record, will receive the dividend. Shareholders who are not registered as of this date will not receive the dividend. Registration in most countries is essentially automatic for shares purchased before the ex-dividend date.

The payment date is the day when the dividend checks will actually be mailed to the shareholders of a company or credited to brokerage accounts.

Dividend-reinvestment plans

Some companies have dividend reinvestment plans, or DRIPs. These plans allow shareholders to use dividends to systematically buy small amounts of stock, usually with no commission and sometimes at a slight discount. In some cases the shareholder might not need to pay taxes on these re-invested dividends, but in most cases they do.

Dividend reinvestment plans-in case of mutual funds: When the dividend is paid in cash it will attract the dividend distribution tax (DDT) and the same is not taxable in the hands of the person, but in case of dividend reinvestment plan where the dividend is not paid in cash but distributed as additional units will not attract the DDT and the same will be taxable in the hands of the person as capital gains when he realises the gain by selling the units.

Criticism

Management and the board may believe that the money is best re-invested into the company: research and development, capital investment, expansion, etc. Proponents of this view (and thus critics of dividends per se) suggest that an eagerness to return profits to shareholders may indicate having run out of good ideas for the future of the company. Some studies, however, have demonstrated that companies that pay dividends have higher earnings growth, suggesting that dividend payments may be evidence of confidence in earnings growth and sufficient profitability to fund future expansion.[3] When dividends are paid, individual shareholders in many countries suffer from double taxation of those dividends: the company pays income tax to the government when it earns any income, and then when the dividend is paid, the individual shareholder pays income tax on the dividend payment; in many countries, the tax rate on dividend income is lower than for other forms of income to compensate for tax paid at the corporate level. Taxation of dividends is often used as justification for retaining earnings, or for performing a stock buyback, in which the company buys back stock, thereby increasing the value of the stock left outstanding. In contrast, corporate shareholders often do not pay tax on dividends because the tax regime is designed to tax corporate income (as opposed to individual income) only once. The shareholder will pay a tax on capital gains (which is often taxed at a lower rate than ordinary income) only when the shareholder chooses to sell the stock. If a holder of the stock chooses to not participate in the buyback, the price of the holder's shares should rise, but the tax on these gains is delayed until the actual sale of the shares. Certain types of specialized investment companies (such as a REIT in the U.S.) allow the shareholder to partially or fully avoid double taxation of dividends. Shareholders in companies which pay little or no cash dividends can reap the benefit of the company's profits when they sell their shareholding, or when a company is wound down and all assets liquidated and distributed amongst shareholders. This, in effect, delegates the dividend policy from the board to the individual shareholder. Payment of a dividend can increase the borrowing requirement, or leverage, of a company.

Miscellaneous specific types

In Australia and New Zealand, companies also forward franking credits or imputation credits to shareholders along with dividends. These franking credits represent the tax paid by the company upon its pre-tax profits. One dollar of company tax paid generates one franking credit. Companies can forward any proportion of franking up to a maximum amount that is calculated from the prevailing company tax rate: for each dollar of dividend paid, the maximum level of franking is the company tax rate divided by (1 - company tax rate). At the current 30% rate, this works out at 0.30 of a credit per 70 cents of dividend, or 42.857 cents per dollar of dividend. The shareholders who are able to use them offset these credits against their income tax bills at a rate of a dollar per credit, thereby effectively eliminating the double taxation of company profits. This system is called dividend imputation.

The UK's taxation system operates along similar lines: when a shareholder receives a dividend, the basic rate of income tax is deemed to already have been paid on that dividend. This ensures that double taxation does not take place, however this creates difficulties for some non-taxpaying entities such as certain trusts, charities and pension funds which are not allowed to reclaim the deemed tax payment and thus are in effect taxed on their income.

Reliability of dividends

There are two metrics which are commonly used to gauge the sustainability of a firm's dividend policy.

Payout ratio is calculated by dividing the company's dividend by the earnings per share. A payout ratio of more than 1 means the company is paying out more in dividends for the year than it earned.

Dividend cover is calculated by dividing the company's cash flow from operations by the dividend. This ratio is apparently popular with analysts of income trusts in Canada.[citation needed]

Other corporate dividends

Cooperatives

Cooperative businesses may retain their earnings, or distribute part or all of them as dividends to their members. They distribute their dividends in proportion to their members' activity, instead of the value of members' shareholding. Therefore, co-op dividends are often treated as pre-tax expenses.

Consumers' cooperatives allocate dividends according to their members' trade with the co-op. For example, a credit union will pay a dividend to represent interest on a saver's deposit. A retail co-op store chain may return a percentage of a member's purchases from the co-op, in the form of cash, store credit, or equity. This type of dividend is sometimes known as a patronage dividend or patronage refund, as well as being informally named divi or divvy.[4][5][6]

Producer cooperatives, such as worker cooperatives, allocate dividends according to their members' contribution, such as the hours they worked or their salary.[7]

Trusts

In real estate investment trusts and royalty trusts, the distributions paid often will be consistently greater than the company earnings. This can be sustainable because the accounting earnings do not recognize any increasing value of real estate holdings and resource reserves. If there is no economic increase in the value of the company's assets then the excess distribution (or dividend) will be a return of capital and the book value of the company will have shrunk by an equal amount. This may result in capital gains which may be taxed differently than dividends representing distribution of earnings.

Mutuals

The distribution of profits by other forms of mutual organization also varies from that of joint stock companies, though may not take the form of a dividend.

In the case of mutual insurance, for example, in the United States, a distribution of profits to holders of participating life policies is called a dividend. These profits are generated by the investment returns of the insurer's general account, in which premiums are invested and from which claims are paid. [8] The participating dividend may be used to decrease premiums, or to increase the cash value of the policy. [9] Some life policies pay nonparticipating dividends. As a contrasting example, in the United Kingdom, the surrender value of a with-profits policy is increased by a bonus, which also serves the purpose of distributing profits. Life insurance dividends and bonuses, while typical of mutual insurance, are also paid by some joint stock insurers.

Insurance dividend payments are not restricted to life policies. For example, general insurer State Farm Mutual Automobile Insurance Company can distribute dividends to its vehicle insurance policyholders.[10]

See also

References

  1. ^ Sullivan, arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 273. ISBN 0-13-063085-3. http://www.pearsonschool.com/index.cfm?locator=PSZ3R9&PMDbSiteId=2781&PMDbSolutionId=6724&PMDbCategoryId=&PMDbProgramId=12881&level=4. 
  2. ^ "dividend". Online Etymology Dictionary. Douglas Harper. 2001. http://www.etymonline.com/index.php?search=dividend&searchmode=none. Retrieved 2006-11-09. 
  3. ^ http://papers.ssrn.com/sol3/papers.cfm?abstract_id=390143 Arnott and Asness, Surprise! Higher Dividends = Higher Earnings Growth, Financial Analysts Journal, January/February 2003.
  4. ^ Ace Hardware (2001-03-22). "Annual Report, Section 1, Business, 10-K405 SEC Filing". http://sec.edgar-online.com/2001/03/22/0000002024-01-000003/Section2.asp. 
  5. ^ "Co-op pays out £19.6m in 'divi'". BBC News via bbc.co.uk. 2007-06-28. http://news.bbc.co.uk/1/hi/business/6247926.stm. Retrieved 2008-05-15. 
  6. ^ Nikola Balnave and Greg Patmore. "The History Cooperative". http://www.historycooperative.org/proceedings/asslh/balnave.html. 
  7. ^ Norris, Sue (2007-03-30). "Cooperatives pay big dividends". The Guardian. http://www.guardian.co.uk/business/2007/mar/30/smes.technology. Retrieved 2009-06-09. 
  8. ^ "What Are Dividends?". New York Life. http://www.newyorklife.com/cda/0,3254,10542,00.html. Retrieved 2008-04-29. ""In short, the portion of the premium determined not to have been necessary to provide coverage and benefits, to meet expenses, and to maintain the company's financial position, is returned to policyowners in the form of dividends."" 
  9. ^ Jones, Frank J. (2002). "24, Investment-Oriented Life Insurance". in Fabozzi, Frank J.. Handbook of Financial Instruments. Wiley. pp. 591. ISBN 0471220922. OCLC 52323583. http://books.google.co.uk/books?id=F1hk6UFlsUsC. 
  10. ^ "State Farm Announces $1.25 Billion Mutual Auto Policyholder Dividend". State Farm. 2007-03-01. http://www.statefarm.com/about/media/media_releases/auto_dividends.asp. 

External links


1911 encyclopedia

Up to date as of January 14, 2010

From LoveToKnow 1911

DIVIDEND (Lat. dividendum, a thing to be divided), the net profit periodically divisible among the proprietors of a jointstock company in proportion to their respective holdings of its capital. Dividend is not interest, although the word dividend is frequently applied to payments of interest; and a failure to pay dividends to shareholders does not, like a failure to pay interest on borrowed money,, lay a company open to being declared bankrupt. In bankruptcy a dividend is the proportionate share of the proceeds of the debtor's estate received by a creditor. England, the Companies Act 1862 provided that no dividend should be payable except out of the profits arising from the business of the company, but, in the case of companies incorporated by special act of parliament for the construction of railways and other public works which cannot be completed for a considerable time, it is sometimes provided that interest may during construction be paid to the subscribers for shares out of capital. Dividends (excluding occasional distributions in the form of shares) are ordinarily payable in cash. Most companies divide their capital into at least two classes, called "preference" shares and "ordinary" shares, of which the former are entitled out of the profits of the company to a preferential dividend at a fixed rate, and the latter to whatever remains after payment of the preferential dividend and any fixed charges. Before, however, a dividend is paid, a part of the profits is often carried to a "reserve fund." The dividend on preference shares is either "cumulative" or contingent on the profits of each separate year or half year. When cumulative, if the profits of any one year are insufficient to pay it in full, the deficiency has to be made good out of subsequent profits. A cumulative preferential dividend is sometimes said to be "guaranteed," and preferential dividends payable by all English companies registered under the Companies Acts 1862 to 1908 are cumulative unless stipulated to be otherwise. Certain public companies are forbidden by parliament to pay dividends in excess of a prescribed maximum rate, but this restriction has been happily modified in some instances, notably in the case of gas companies, by the institution of a sliding scale, under which a gas company may so regulate the price of gas to be charged to consumers that any reduction of an authorized standard price entitles the company to make a proportionate increase of the authorized dividend, and any increase above the standard price involves a proportionate decrease of dividend. Dividends are usually declared yearly or half-yearly; and before any dividend can be paid it is, as a rule, necessary for the directors to submit to the shareholders, at a general meeting called for the purpose, the accounts of the company, with a report by the directors on its position and their recommendation as to the rate of the proposed dividend. The articles of association of a company usually provide that the shareholders may accept the director's recommendation as to dividend or may declare a lower one, but may not declare a higher one than the directors recommend. Directors frequently have power to pay on account of the dividend for the year, without consulting the shareholders, an "interim dividend," which on ordinary shares is generally at a much lower rate than the final or regular dividend. An exceptionally high dividend is often distributed in the shape of a dividend at the usual rate supplemented by an additional dividend or "bonus." Payment of dividends is made by means of cheques sent by post, called "dividend warrants." All dividends are subject to income-tax, and by most companies dividends are paid "less income-tax," in which case the tax is deducted from the amount of dividend payable to each proprietor. When paid without such deduction a dividend is said to be "free of income-tax." In the latter case, however, the company has to make provision for payment of the tax before declaring the dividend, and the amount of its divisible profits and the rate of dividend which it is able to declare are consequently to that extent reduced. In respect of consols and certain other securities, holders of amounts of less than £1000 may instruct the Bank of England or Bank of Ireland to receive and invest their dividends. With few exceptions, the prices of securities dealt in on the London Stock Exchange include any accruing dividend not paid up to the date of purchase. At a certain day, after the dividend is declared, the stock or share is dealt in on the Stock Exchange, as ex dividend (or "x. d."), which means that the current dividend is paid not to the buyer but to the previous holder, and the price of the stock is lower to that extent. The expression "cum dividend" is used to signify that the price of the security dealt in includes a dividend which, in the absence of any stipulation, might be supposed to belong to the seller of the security. On the New York Stock Exchange the invariable practice is to sell stock with the "dividend on" until the company's books are closed, after which it is usually sold "ex dividend." (S. D. H.)


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Simple English

Dividends are payments made by a company to its shareholders. When a company earns more money than it spends, the extra money can either be spent on making the company better or it can be given to the people who own stock in the company as a dividend.









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