05. Dividends: Cash and Liquidation

📘 Dividends: Cash vs. Liquidation

Dividends are distributions to shareholders from a corporation’s equity. There are two major types tested in FAR:

✅ 1. Cash Dividend

Definition: A distribution of earnings in the form of cash to shareholders.
Source: Declared out of retained earnings.
Impact: Decreases assets (cash) and retained earnings, but does not affect contributed capital.
Journal Entries:

On Declaration Date:

Dr Retained Earnings   $XXX  
    Cr Dividends Payable      $XXX

On Recording Date:

No Entry

On Payment Date:

Dr Dividends Payable   $XXX  
    Cr Cash                    $XXX

✅ 2. Liquidation Dividend

Definition: A return of part of the original shareholder investment, usually when dividends are declared in excess of retained earnings. It may occur even when the company is not being liquidated.
Source: First from retained earnings, and if insufficient, the excess is distributed from paid-in capital (e.g., APIC).
Impact: Reduces retained earnings first (if any), and then contributed capital.

Journal Entries:

When RE is sufficient:

Dr. Retained Earnings    xxx
    Cr. Cash                       xxx

When RE is insufficient:

Dr. Retained Earnings    xxx
Dr. APIC                 xxx
    Cr. Cash                       xxx

🔍 Comparison Table

Feature	Cash Dividend	Liquidation Dividend
Source	Retained Earnings	Retained Earnings (if available), then APIC
Affects RE?	✅ Yes	✅ Yes (first), then ✅ APIC
Affects APIC?	❌ No	✅ Yes (if RE is insufficient)
Considered Income?	❌ No (to company)	❌ No (return of capital to shareholders)

🧠 Practice Questions

🔹 Question 1 (Cash Dividend):

Pine Corp. declared and paid a cash dividend of $200,000 in 2024. At the time of declaration, the company had $1,000,000 in retained earnings. What is the effect of the transaction on the company’s financial position?

A. Total equity increases
B. Total equity decreases
C. Total assets increase
D. No effect on equity

✅ Answer 1:

Correct Answer: B. Total equity decreases

Explanation: A cash dividend reduces both retained earnings (a component of equity) and cash (an asset), thus decreasing both total assets and total equity.

🔹 Question 2 (Liquidation Dividend):

Cedar Inc. declared a dividend of $50,000. Its retained earnings at the time were only $30,000. The excess is considered a return of capital. What journal entry will Cedar make at declaration?

Dr Retained Earnings   $50,000  
    Cr Dividends Payable    $50,000

Dr Retained Earnings             $30,000  
Dr Additional Paid-in Capital    $20,000  
    Cr Dividends Payable              $50,000

Dr Dividends Expense   $50,000  
    Cr Cash                  $50,000

Dr Treasury Stock   $50,000  
    Cr Dividends Payable  $50,000

✅ Answer 2:

Correct Answer: B

Explanation: Since only $30,000 of retained earnings are available, the excess $20,000 is treated as a liquidation dividend and debited to APIC.

📌 Key Takeaways

Cash Dividends reduce retained earnings and cash.
Liquidation Dividends reduce APIC once retained earnings are depleted.
Only cash dividends declared and paid from retained earnings are considered ordinary dividends.
These topics often appear in both multiple choice and task-based simulation formats on the FAR section of the USCPA exam.