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Lesson 7 of 9Partnerships and Corporations
Unit 3 · Lesson 7 of 9

Cash Dividends and Preferred Shareholders

A cash dividend becomes a liability on the declaration date, needs no entry on the record date, and is paid on the payment date; preferred shareholders are paid first, including any arrears on cumulative shares.

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Key things to remember

  1. 1Declaration date: Dr Retained Earnings (or Cash Dividends), Cr Dividends Payable. The liability starts here.
  2. 2Record date: no journal entry; it only fixes which shareholders are paid.
  3. 3Payment date: Dr Dividends Payable, Cr Cash.
  4. 4Preferred is paid first: non-cumulative gets only the current year; cumulative gets all arrears plus the current year.
  5. 5Dividends in arrears are not a liability; they are disclosed in the notes until declared.
  6. 6A dividend needs retained earnings, cash, a board declaration, and must pass the solvency test.

A proprietor takes money out of the business whenever she likes and records it as Drawings. Shareholders cannot do that. A corporation's profit belongs to the corporation until the board of directors decides to distribute some of it as a dividend. Shareholders of a public company may number in the thousands and change every day as shares trade, so the corporation needs a precise process: a date the decision is made, a date that fixes who gets paid, and a date the money goes out. It also needs rules for who gets paid first when there are two classes of shares.

Declaration, record and payment dates

Example: the board declares $0.50 a share on 100 000 common shares = $50 000.November 15Date of declarationDecember 1Date of recordDecember 20Date of paymentThe board declares thedividend: a liability nowexists.Dr Retained Earnings50 000Cr Dividends Payable50 000Some companies debit CashDividends Declared, closed toRetained Earnings later.No journal entry. Thecompany lists who ownsshares on this date; onlythey will be paid.no entryThe money goes to theshareholders of record; theliability is settled.Dr Dividends Payable50 000Cr Cash50 000Declaration: retained earnings fall and liabilities rise, so equity drops. Payment: cashand liabilities both fall; equity is not affected again.
Fig 1Declaration creates the liability, the record date fixes who is paid, and the payment date settles the liability.
  1. Date of declaration. The board formally declares the dividend. From this moment the corporation has a legal obligation, so it records a liability (Dividends Payable) and reduces retained earnings.
  2. Date of record. Whoever is listed as a shareholder at the end of this day receives the dividend. Nothing is owed or paid that has not already been recorded, so there is no journal entry; the company only prepares the list of shareholders.
  3. Date of payment. The corporation pays the dividend and removes the liability.
DateAccountDebitCredit
2026 Dec. 1Retained Earnings$19,750
Dividends Payable: Preferred$8,000
Dividends Payable: Common$11,750
Declared $4 per preferred share on 2,000 shares and $0.25 per common share on 47,000 shares
Dec. 15No entry: date of record
2027 Jan. 10Dividends Payable: Preferred$8,000
Dividends Payable: Common$11,750
Cash$19,750
Paid the dividends declared Dec. 1
Maple Ridge Outfitters Ltd. On Dec. 31, 2026, the $19,750 still owed is a current liability on the balance sheet.
Retained Earnings or a Dividends account?
Many companies debit a temporary account called Cash Dividends (or Dividends Declared) instead of Retained Earnings, then close it to Retained Earnings at year-end, the same way a proprietor's Drawings account is closed to Capital. The result is identical. Either way, a dividend is a distribution of profit to owners, not an expense, so it never appears on the income statement.
VideoA Grade 12 accounting lesson on cash dividends; as you watch, check that the liability is recorded on the declaration date, no entry is made on the record date, and the liability is paid on the payment date.Watch on YouTube

Splitting a dividend between preferred and common

When the board declares a total dividend, preferred shareholders are paid their entitlement first and common shareholders receive whatever is left. The entitlement depends on whether the preferred shares are cumulative. Suppose Northern Lights Ltd. has 5,000 $2 preferred shares ($10,000 a year) and 100,000 common shares. It declared no dividend in 2025, and in 2026 the board declares $40,000 in total.

StepNon-cumulative preferredCumulative preferred
Arrears from 2025None: the missed 2025 dividend is lost$10,000
Current year 2026$10,000$10,000
Total to preferred$10,000$20,000
Remainder to common$40,000 - $10,000 = $30,000$40,000 - $20,000 = $20,000
Per common share$30,000 / 100,000 = $0.30$20,000 / 100,000 = $0.20
The same $40,000 declaration is divided differently depending on one word in the articles.

Dividends in arrears are not a liability

When a cumulative preferred dividend is skipped, the unpaid amount is called dividends in arrears. It is not a liability, because no dividend is owed until the board declares one; a corporation might never declare one again. So there is no journal entry for arrears. Instead, the corporation discloses the amount in the notes to the financial statements (for example, "Dividends on the cumulative preferred shares are in arrears by $10,000"), because investors and lenders need to know that this amount must be paid before common shareholders can receive anything.

Quick checkTry it before you read on
1
Kawartha Kitchens Ltd. has 4,000 $3 cumulative preferred shares and no arrears at the start of 2025. In 2025 the board declares only $5,000 of dividends. What are the dividends in arrears at the end of 2025, to the nearest dollar?
$

Worked examples

Reveal one step at a time and try to beat it to the next line.

Example 1
On Dec. 1, 2026, Maple Ridge's board declares the full $4 dividend on its 2,000 preferred shares and $0.25 per share on its 47,000 common shares, to shareholders of record on Dec. 15, payable Jan. 10, 2027. Record all required entries.
Example 2
Northern Lights Ltd. has 5,000 $2 preferred shares and 100,000 common shares. No dividends were declared in 2025. In 2026 the board declares $40,000. Allocate the dividend if the preferred shares are (a) non-cumulative and (b) cumulative.
Example 3
Kawartha Kitchens Ltd. has 4,000 $3 cumulative preferred shares and 60,000 common shares, with no arrears at Jan. 1, 2025. The board declares $5,000 in 2025 and $50,000 in 2026. Allocate each year's dividend.

Where marks get lost

  • Making a journal entry on the date of record. The liability was already recorded at declaration; the record date only fixes who gets paid.
  • Recording dividends in arrears as a liability. Nothing is owed until the board declares a dividend, so arrears go in the notes only.
  • Debiting Dividends Expense. Dividends are distributions of profit to owners, so they reduce retained earnings and never appear on the income statement.
  • Forgetting the arrears for cumulative preferred shares, or adding arrears for non-cumulative shares, when splitting a dividend.
  • Calculating the preferred dividend on authorized shares instead of outstanding shares.

Flashcards 7

Date of declaration
Date of record
Date of payment
Dividends in arrears
+ 3 more

Practice

1
On which date does a corporation first record a liability for a cash dividend?
2
A corporation has 8,000 $2.50 non-cumulative preferred shares and 50,000 common shares. No dividend was declared last year. This year it declares $45,000. How much do the common shareholders receive in total, to the nearest dollar?
$
3
Same facts, but the preferred shares are cumulative. How much do the common shareholders receive in total, to the nearest dollar?
$
4
A corporation has 3,000 $5 cumulative preferred shares. Dividends were last paid in full for 2023; none were declared in 2024 or 2025. In 2026 the board declares $36,000. How much goes to the common shareholders, to the nearest dollar?
$
5
Put the dividend dates in the order they occur.
  1. 1Date of record
  2. 2Date of declaration
  3. 3Date of payment
6
How should a corporation report $12,000 of dividends in arrears on its cumulative preferred shares?
7
Match each date to its journal entry.
Declaration
Record
Payment
8
Name the legal test that stops directors from declaring a dividend that would leave the corporation unable to pay its debts as they come due.

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