Dividends are a popular and tax-efficient way for directors and shareholders to extract profits from a company but they must be accounted for properly. Whether you’re paying dividends to directors, individual shareholders, or trusts, accurate bookkeeping ensures compliance and avoids unintended tax consequences.
Accounting for dividends to Directors
The law states that a company must keep a record of any money the directors borrow from or pay into the company. It is therefore important to account for any advances paid to Directors and dividends voted through the director’s loan account.
Typically, the director will take a regular dividend advance from the business. The payment to the director is treated as a drawing or advance. The bank payment is posted to the relevant Director’s Loan Account (rather than the dividends cost). At this stage, the Director’s Loan Account is showing a debit balance or debtor, reflecting the payment made to the Director.
This debtor can either be cleared by the Director repaying the company, or in most cases, a dividend being voted to clear the balance.
A journal is then required to vote the dividend as follows: Dr Dividend (cost in the Profit & Loss Account), Cr Director’s Loan Account. In the simple example of a £10,000 drawing and matching £10,000 dividend, this would then bring the Director’s Loan Account back to a £nil balance.
It is a good idea to have separate dividend accounts in the Profit and Loss Account set up for each director, to easily track the dividends voted against the Director’s Loan Accounts.
It is a good idea to post regular dividend journals, for example monthly or quarterly, to reflect the true cost of the Directors’ remuneration in the Profit and Loss Account throughout the year.
Accounting for dividends to Shareholders, who are not Directors
It is recommended that a shareholder loan account is set up in the same way as the Director’s Loan Account above, to track paid and unpaid dividends. Shareholder dividends are likely to be voted only once or twice a year, with the posting of:
Dr Dividend (cost in the Profit & Loss Account)
Cr Shareholder’s Loan Account.
This produces a liability on the balance sheet – the company owes the shareholder this dividend payment. The subsequent payment will then be posted to the Shareholder’s Loan Account to clear this liability.
Accounting for dividends to Trusts
Dividends paid to Trusts can be treated in Xero as voted at the same time as the payment. In this instance, the payment can be posted to the Dividends cost in the Profit and Loss Account directly.
If you need help with this, or with other advice, then please get in touch with our accounting team.