CFA CFA Level 1 Question on Dividends Payable vs Paid and effect on Retained Earnings

Question on Dividends Payable vs Paid and effect on Retained Earnings

  • This topic has 6 replies, 3 voices, and was last updated Apr-17 by DMC.
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    • DMC
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      Hi all,
      I’m trying to get some clarity on how Dividends Paid vs. Payable affects Retained Earnings.
      Looking at the formula: Ending Retained Earnings = Beginning Retained Earnings + Net Income – Dividends

      I understand that Dividends Payable are a liability for dividends yet to be paid, and that Dividends Paid represents the actual cash outflow to shareholders in the past.
      My assumption is that we use Dividends Payable rather than Paid to calculate Ending Retained Earnings on the basis that the Dividends Paid have already reduced the Dividends Payable account on the Balance Sheet.
      Is this correct?

    • MattyJ
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      There should be a straight ‘Dividends’ figure that you can use, which will consist of Dividends Paid + Dividends Payale. Effectively, you are trying to see how much of your earnings are retained in the business to fund future growth/investment. Therefore you want to take your Net Income for the period, and reduce it by the total amount of Dividends paid for that period, and add the aggregate amount to Beginning Retained Earnings to calculate Ending Reayined Earnings.

      Whether the Dividend has been Paid or is Payale is largely irrelevant, as the company has still declared it and it will still be deducted from Net Income and paid to shareholders. It’s just a timing difference between the dividend having been declared and it actually being paid.

    • MattyJ
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      It’s amazing how many mistakes you can make in spelling when typing quickly on an iPad! Hopefully it makes sense though, but if not let me know!

    • Sophie Macon
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      @Mattjuniper – I call it the banana finger syndrome. Used to use it to describe me playing the piano, nowadays, it’s use for smartphone/tablet typing errors :))

    • DMC
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      I think I’ve got it, and for every other question I can find this has been the case.
      It’s a single question from an Elan mock exam that’s got me, where Dividends Paid were excluded from the calculation of ending Retained Earnings, and Dividends declared were subtracted.
      I was unsure whether this was a mistake.
      Thanks Matt.

    • MattyJ
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      Could it be that the Dividends Paid were taken from the cash flow statement, and actually related to a previous period (I.e. they would have been classed as Dividends Payable in a previous period)? If this was the case, then they would already have been deducted from retained earnings in the prior period and so you would exclude them this time otherwise you would be double counting.

      Just a thought.

    • DMC
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      I think you’re probably right Matt, the question didn’t specify, and that explanation would make sense.
      Thanks for your help, much appreciated!

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