Dividend to employees
Treatment of Dividend
- Interim dividends announced by the directors but unpaid at the balance sheet date
Interim dividends announced by the directors but unpaid at the balance sheet date are a liability at that balance sheet date where, and only where, the directors do not retain an ability to cancel them. This is because a legal obligation exists to the shareholders to pay the dividend. [IAS 32]. In many jurisdictions, the directors retain the discretion to cancel interim dividends until the dividends are paid.
They are not ‘declared’ (that is, they are not appropriately authorized and are no longer at the discretion of the entity) and, therefore, are not recognized until paid. Interim dividends that are recognized as a liability before payment and where shareholders but not the directors, have a right to waive the interim dividend remain as a liability until waived by the shareholders or are otherwise paid.
- Final dividends proposed by the directors but not declared
Final dividends proposed by directors are not a liability until they are declared. In many jurisdictions, final dividends are proposed by directors but are then subject to approval by shareholders in general meeting, at which point they become formally declared.
In practice, final dividends are usually proposed by the directors, after the balance sheet date, for declaration by the company at the annual general meeting at a date even further removed from the balance sheet date. An entity’s history of paying dividends does not give rise to a liability at the balance sheet date.
There must be a legally binding obligation before a dividend is recognised. [IAS 32]. Therefore, no liability is recognised, at the balance sheet date, for proposed final dividends that are subject to shareholders’ approval.
- Final dividends declared
Final dividends should be recognised as a liability in the period in which they are declared (that is, appropriately authorised and no longer at the discretion of the entity); in many jurisdictions, this binding declaration occurs through the passing of a resolution by the entity. The dividends remain as liabilities until they are paid.
- Dividend paid to employees
It is important that the employees stay motivated in order to have a better work environment as well as performance. Recognizing the employees’ hard work and rewarding them for their performance by sharing the profit is a great method of motivating them. Bonuses, dividends to employees, etc are the different names given to such rewards. Accounting for them is another challenge for the accountants, which we shall overcome in this article.
The first and the most important question is if the employees are acting in the capacity of shareholders.
If the company has given our dividends only as a return to their services, as a part of their remuneration, it cannot be accounted for as a distribution of profit rather it is a profit-sharing plan and falls under IAS 19 Employee benefits.
If the dividend is paid out to the employees based on the number of shares they hold, it is recognized as distribution of profit because the distribution of profit is a transaction with equity holders i.e., shareholders.
IAS 19 on profit-sharing
The expected cost of profit-sharing is recognized upon satisfaction of two conditions:
- a present legal or constructive obligation to make such payments as a result of past events; and
- A reliable estimate of the obligation can be made.
As per company policies or if the employee is promised in the employment contract, payment of ‘dividend’, then it is obligatory on the company. And an estimate can be made for the obligation.
Therefore, while closing of the year-end, the amount of profit-sharing is calculated and recognized as an expense in that period, not in the subsequent period after approval of the shareholders, and not as a distribution of profit via a statement of changes in equity.
The journal entry is to:
- Debit Profit or loss – Employee benefits
- Credit Liabilities to employees
Issues with profit-sharing
Sometimes, the company policies require the employee to work with them for a certain time period after the end of a relevant accounting year in order to be eligible for profit-sharing. There is no clear guidance on the treatment of this issue and there are two basic ways of dealing with the situation:
- Recognizing the cost of profit up to the extended time period until the employee has the right to receive it. Or,
- Recognizing the full profit sharing in the relevant year because the amount of benefit does not increase after the end of the relevant year in which it is earned.
The first approach is more acceptable as the expenses are not overstated in the first year.
Statutory employee benefit schemes
Some countries have laws requiring employers to pay a certain amount of profit after deducting tax to the employees and such bonuses fall under the scope of IAS 19. Accounting for them is similar to accounting for any other type of profit-sharing as it is paid to the employees as a return for the work done by them.
