Question

what are the different types of dividends? What are the accounting issues?

Answer 1

Answer-Types of Dividends:-

There are three types of dividends:-

1-Cash dividend

2-Share dividend

3-Stock repurchase

1-Cash Dividend

When a company shares a portion of its net earnings with its shareholders in the form of cash, we call it a cash dividend. The date on which the board of directors declared the dividend is called the ‘declaration date’. A shareholder is eligible to receive the dividend when his or her name is listed in the shareholder’s register on ‘record date’.

Among the various types of dividend, cash dividend is the one which is most preferred by investors. This is because there is a direct cash flow for the investor which makes the return more lucrative. Investors, looking out for regular income, prefer companies which give regular cash dividend.

Cash dividends are paid out of the residual profit of the company. An investor can expect a payout when the company is making good profits and has enough cash flow.

While receiving cash dividends has its own benefits, these cash dividends attract tax. The tax payout reduces the effective rate of return on the investment.

2-Stock Dividend:-

A stock dividend is a type of dividend, under which instead of paying cash, the company gives out shares. A company gives out a stock dividend when it wants to reward the shareholders but does not want to pay out cash.

Stock dividends are also known as bonus shares. Under the stock dividend issue, the company issues additional shares in a ratio to the investor’s current holding. So if bonus issue is in the ratio of 1:1, an investor holding 50 shares will get additional 50 shares. While the number of shares with an investor increases, the market value of the shares remain the same.

For example, XYZ decides to issue bonus share in the ratio 1:1, the current market price of the share is $100. After the issue, the market price of the share will be $50. An investor holding 1000 shares will now have 2000, but the total value of his investment will remain the same at $100,000.

Another advantage of this type of dividend is that it is tax exempt. The tax is paid only when there is profit on sales.

3-Stock Repurchase

Under this type of dividend, the investor gets an option to sell his shares back to the company at a fixed rate. Generally, the fixed rate is higher than the prevailing market rates. This way the investor gets some money back in his pocket and the promoters/management gets higher shares in the company.

Stock repurchase is a type of dividend which helps the management in showing the market that it believes that the shares are undervalued. It also helps in reducing the price-to-earnings (P/E) ratio of the share. The earnings per share (EPS) of the company will also increase.

After the repurchase, the number of shares will decrease. Thus, when the management pays out the dividend in cash, each shareholder will get a higher percentage of the payout, thereby increasing dividend yield.