Dividends must be paid out of distributable profits and directors must prepare relevant accounts to confirm the position. If it later transpires there are not enough distributable profits and relevant accounts were not prepared then the dividend is illegal and repayable, and should be disclosed as such.
When to pay a dividend
If a dividend is paid in the year then, as long as there are distributable reserves, there is little to debate in terms of the accounting. This payment could be in terms of an actual bank payment or it could be an entry in the accounting records to the director’s loan account. For dividends paid after the year-end, it must be approved by the shareholders before the year-end. Payment options are similar as above.
Documents that need to be prepared are the board minutes of the meeting where the decision was taken and the dividend vouchers for each of the shareholders. When documenting the decision to include dividends in the accounts, one must take great care that they document when decisions were made. For example, director/shareholders decide at a meeting at year end to declare a final dividend but do not ask the accountant to prepare documentation and journals until January. It would be acceptable for the accountant to date these documents and accounting entries on the date the decision was made. However if, having reviewed the year end accounts prepared by the accountant, the director/shareholders decide to declare a dividend in January then this cannot be put into the accounts.
Interim and Final dividends
Interim dividends are declared and distributed before the company’s annual earnings are known. These interim dividends are paid out of undistributed profits (reserves) brought from previous periods or from the predicted profits if interim management accounts have been drafted. Final dividends are declared at the end of the financial period when the directors are aware of the company's profitability and financial health. Final dividends are declared before the books are closed and will be paid the following year. Thus final dividends will appears as dividend payable or proposed dividends under current liabilities in the Balance Sheet of that period.
As directors are clearly related parties, then dividends paid to them should be disclosed as related party transactions. However it should be noted that disclosure is only required if the transactions are material. Furthermore, disclosure is only required in the full accounts and not in the abbreviated accounts.