What is a 'Dividend'

The allocation or distribution of a portion or fraction of the revenues generated by the company to a selected class of shareholders, as unanimously decided by the board of directors, is known as a dividend. Dividends can be issued as cash payments, as shares of stock, or other property.

It is significant to note that the dividends which are declared and paid by a business are not an expenditure of the organization. On the other hand, the dividends are the distribution or sharing and allocation of the earnings of the business or organization. Therefore, it is imperative for the businesses to have a credit balance in Retained Earnings before they pay and allocate the specified dividends to its class of shareholders. But, it must also be taken into account that the business has enough liquidity in form of cash to maintain its day to day requirements.

What is 'Dividend Per Share - DPS'?

Dividend Per Share refers to the sum total of all the declared and allotted dividends that can be attributed to every ordinary share allotted. Dividend Per Share or DPS is the total amount of dividends distributed over the course of an entire year (interim dividend exclusive of special dividend) divided by the number of outstanding ordinary shares allotted. The DPS can be calculated by using the below formula:

Formula of Dividend

DPS = (D-SD)/S

Where,

 D stands for the sum of dividends over a period (this period is usually 1 year)

SD stands for special, one-time dividend, and

S stands for shares outstanding for the period

Let us take an example for understanding the above equation and concept:

ABC company paid a total of $237,000 in dividends over the previous year. For the same year, there was even a special one-time dividend which was totaled up to be $59,250. If ABC Company has 2 million outstanding shares then, calculate the dividend per share for the same.

DPS = (D-SD)/S

According to the formula,

Therefore, DPS = ($237,000-$59,250)/2,000,000

                          = $0.0889 per share.

What is a 'Stock Dividend'?

                The dividend that is paid out additional shares issues to the current shareholders instead of making payment in cash form, then it is known as a ‘Stock dividend’. It is also commonly known as ‘Scrip Dividend’. This is a decision taken by the company to pay the stock dividend to its shareholders when the company’s availability of liquid cash assets is in short supply. These distributions are usually recognized and approved in the form of fractions paid per existing share. For example, if a company issues a stock dividend of 0.05 shares for every single share held by existing shareholders.

Stock Dividend

When a company or organization pays off its dividends in the form of stocks instead of paying it in cash form, it is known as Stock Dividend. This type of dividend payout generally happens when there is a situation that the corporation is wanting to reward or recompense its current shareholders, but is in short supply of liquid cash or in another case, it might decide to hold onto the current liquidity in order to initiate and process another investment opportunity. Along with the benefit of maintaining the cash liquidity for the corporation, stock dividend payout option holds another advantage in form of tax benefit. In this case, no tax is levied until the stocks are sold out by an investor. This option is highly appreciated and preferred by investors who are not in immediate requirement of liquid cash.

It is a mandate that the stock dividends must be 25% or less of the total number of common shares outstanding; otherwise, such a transaction typically corresponds to a stock split.

Let us consider a scenario, where a corporation announces a stock dividend, where 100,000 common shares are paid out to shareholders who have the possession of $1 million of common shares outstanding. The stock is dealt or traded at $20 at the time of dividend announcement and the par value of the stock is $1.

In this case, the stock dividend of the corporation is paid out to its shareholders; the balance sheet of the company will remain the same, but retained earnings will be changed. Taking the above case, the retained earnings of the company are decreased by $2 million the common stock is increased by $100,000 and additional paid-in capital is increased by $1.9 million. This indicates that the size of the balance sheets has remained the same, whereas, there will be a redistribution or reallocation of funds amongst the equity accounts.

How do Dividends Affect the Balance Sheet?

When the dividends are paid out or distributed to the current shareholders in form of cash, then there is a decrease in the cash balance of the corporation on the asset side alongside decreasing the retained earnings of the company on the equity side. It is therefore evident that there is an overall reduction or net decrease in the size of a company’s balance sheet due to a payout of the cash dividends.

When the company pays out its dividend in form of stock dividends, then there is an overall reduction in the company's retained earnings and increment in the common stock and additional paid-in capital accounts. Stock dividends do not result in the asset modifications or alterations of the balance sheet; rather have an effect on only the equity side by redistributing a part of the retained earnings to common stock and additional paid-in capital accounts.

Dividend Yield

The method to measure the amount of cash flow that any investor is getting or deriving in lieu of every dollar invested by him or her in an equity position is known as the Dividend Yield. In simpler words, in the absence of any capital gains, it denotes the return on investment done by the investor on a particular stock and measures how much "bang for your buck" you are getting from dividends. The dividend yield is represented as a percentage and can be calculated by dividing the dollar value of dividends paid in a given year per share of stock held by the dollar value of one share of stock. Below is the formula for calculating Dividend Yield and may be calculated as;

= (Annual Dividends Per Share)/ Price Per Share

The Yield for a particular year is calculated by utilizing the dividend yields of the previous year or alternatively by taking the most recent quarterly yield, multiplying it by 4 and dividing the sum by the current share price.

There are many possibilities that can be inferred if a particular company is paying very high dividends to its shareholders; it might demonstrate that the company is currently undervalued, or that it might be a way to attract or lure potential investors. Alternatively, if a company is paying lesser than estimated dividends, then, it might be inferred that the company is either overvalued or that it is an attempt of the company to grow its capitals. However, it is typically observed that in case of companies that are well established and gaining regular profits, also provide good dividend yields to their shareholders even in a scenario when they are not undervalued.

It might also be a case that a particular company might pay high dividends to its shareholders at a certain point in time and might not be able to do so at other times. During turbulent economic times or any other adverse condition, it might so happen that the company might cut down on the dividends of its shareholders or might stop them altogether. Hence, it is not wise to depend on steady dividends on a regular basis.

Dividend Tax

The tax levied by the tax authorities on the dividends received by the investors ort the shareholders of a particular company is known as Dividend Tax. On the other hand, the double tax levied or imposed on the corporate profit that contributes to a high tax burden on capital is known as the Personal Dividend Tax. In the past, a high amount of dividend taxes resulted in the creation of a distinct tax bias towards corporate retained earnings. Dividend taxes also result in lower savings and investment, a smaller capital stock, lower wages, and slower economic growth.

The governing laws of Taxation of Dividends as levied on its shareholders are different in every country.

For Example, in U.K,

From 6 April 2016, the investor would not have been required to pay tax on the first £5,000 of dividends that he/she gets in the tax year.

Above this allowance, the tax he/she pays depends on which income tax band he is in.

Dividend Taxation in the United States

In the current scenario, the top marginal tax rate on dividend income is 23.8 percent for taxpayers with an adjusted gross income of $200,000 or more ($250,000 or more for married filing jointly). This sum is inclusive of a 20 percent rate on dividend income plus a 3.8 percent tax on unearned income to fund the Affordable Care Act. There are variable top marginal rates for various states in the United States of America; for instance, top marginal rates in states like Alaska, Florida, and Nevada is zero in with no personal income tax, while the same is 13.3 percent in California.

Dividend Taxation In India

In India, it is applicable by law that if an investor receives dividend more than INR 10 lakhs ($1m) per annum, then tax at the rate of 10% is levied on the income along with an additional applicable DDT which is already paid by the corporation.

The Dividend income as given to the investors is previously taxed through Dividend Distribution Tax (DDT). As per the Indian Budget presented and passed in the year 2016, in addition to the Dividend Distribution Tax (DDT), an additional 10% tax of the gross amount of dividend will be owed or paid by the beneficiary, which include individuals, HUFs and firms receiving dividend more than INR 10lakhs ($1m) per annum. On the other hand, if the revenue generated as a dividend for investors is less than INR 10 lakhs, then they are not liable to pay any tax as an individual.