Definition
The term liquidating dividend refers to the process of providing shareholders with a partial or full distribution of their capital investment in the company. Liquidating dividends are typically paid when a company is going out of business or has sold a portion of the enterprise.
Explanation
Also known as liquidating distributions, a liquidating dividend is a return of the company's shareholders' capital investment. This concept is different than regular dividends, which are paid from the company's profits or retained earnings.
This difference has income tax implications to shareholders. While regular dividends are taxable, liquidating dividends are not taxable since they are merely the return of the shareholder's investments. Companies will issue IRS Form 1099-DIV, which clarifies the tax implications of the distribution.
Companies will pay liquidating dividends under the following circumstances:
The company has filed for bankruptcy and decided the best course of action would be to liquidate the net assets of the company.
The company has decided to exit a business and has sold the operation's assets to another entity.
Distributions can only be made to shareholders after the money owed to creditors has been paid. Cash can only be paid to shareholders if the company's net assets are positive.
Example
The management team at Company A has decided to declare a dividend of $2.00 per share and has 800,000 shares of common stock outstanding. The company balance sheet shows $400,000 in retained earnings and $5,000,000 in paid in capital in excess of par. The following entry is required:
Cash Paid = Shares of Common Stock x Dividend
= 800,000 x $2.00, or $1,600,000
The journal entry to record the transaction would be:
Debit | Credit | |
Retained Earnings | $400,000 | |
Paid-In Capital in Excess of Par | $1,200,000 | |
Cash | $1,600,000 |
In the above example, shareholders would need to be informed that $400,000 / 800,000, or $0.50 per share were regular dividends, while $1.50 per share represents a liquidating dividend.
Related Terms
The accounting term used to describe an economic resource, which is owned by the corporation and expected to provide future benefits to its operation, is asset. Appearing on the balance sheet, assets are typically broken down into two categories:
Moneyzine EditorNovember 6th, 2024
The term capital stock is used to describe the authorized and issued transferable units of ownership in a corporation. Capital stock can include both common as well as preferred securities. The value of all capital stock issued can be found on the company's balance sheet.Moneyzine EditorNovember 6th, 2024- The financial accounting term owner's equity is used to describe the resources that are owned by the common and preferred stock shareholders of a company. Owner's equity is reported on a company's balance sheet.Moneyzine EditorNovember 6th, 2024
- The financial accounting term retained earnings is used to describe the portion of net income that is not distributed to common or preferred stockholders in the form of dividends, and is held by the company for future use. Retained earnings appear in the owner's equity section of the company's balance sheet.Moneyzine EditorNovember 6th, 2024
The financial accounting term dividends payable is used to describe the cash owed by a company to its stockholders, based on a distribution that has been formally authorized by the company's board of directors. Dividends payable are categorized as a current liability on the company's balance sheet.Moneyzine EditorNovember 6th, 2024
The term dividend refers to the formal distribution of retained earnings, additional paid-in capital, or some other form of capital to shareholders. The payment of dividends to shareholders is approved by the company's board of directors, and can include cash, property, or stock.Moneyzine EditorNovember 6th, 2024
The term cash dividend normally refers to the formal distribution of retained earnings to the holders of preferred or common shares of stock. Typically, the company's board of directors would vote on a declaration of dividends, which is stated in terms of dollars per share or a percentage basis.Moneyzine EditorNovember 6th, 2024- The term property dividend refers to the formal distribution of an asset other than cash to holders of preferred or common shares of stock. A property dividend can take many forms, including real estate, items held in inventory, equipment, and even investments held by the company.Moneyzine EditorSeptember 21st, 2023
- The term scrip dividend refers to the process of providing shareholders with the choice of receiving a cash dividend, a dividend at a future point in time, or common stock. When a corporation issues a scrip dividend, they're allowing shareholders to increase the size of their holdings without incurring any fees.Moneyzine EditorSeptember 21st, 2023
- The term stock dividend refers to the process of reclassifying retained earnings as contributed capital, and the issuing of stock instead of cash to shareholders. When a company pays a stock dividend, there is no distribution of assets. Instead, the total number of shares outstanding increases and the book value per share decreases.Moneyzine EditorNovember 6th, 2024
The term liquidity risk typically refers to the inability of an investor to buy or sell an asset to minimize or avoid a financial loss. Liquidity risk can also refer to a company's inability to meet a debt obligation without incurring a loss.Moneyzine EditorNovember 6th, 2024
The term liquidity spread is used to describe the premium that flows to a party willing to provide liquidity to a party that is demanding it. Liquidity spreads apply to investments such as stocks and bonds, futures contracts, exchange-traded securities, options, commodities as well as other types of assets.Moneyzine EditorJanuary 23rd, 2024
