DIVIDENDS

1.1 Definition of dividend: A term dividend refers to the part of profits of a company which is
distributed by the company among its shareholders .

 It is the reward of shareholders for investments made by them in the share of the company.
 A distribution of a portion of a company’s earnings decided by the boards of directors, to a class of
its shareholders.
 It can also be quoted in the terms of percent of a current market price, referred to as a dividend yield.

Companies issuing dividends generally do so on an ongoing basis, which tends to attract investors who
seek a stable form of income over a long period of time. Conversely, a dividend tends to keep growth -
oriented investors from buying a company's stock, since they want the firm to re -invest all cash in the
business, which presumably will jump-start earnings and lead to a higher stock price.

There are several key dates associated with dividends, which are:

 Declaration date. This is the date on which a company's board of directors sets the amount and
payment date of a dividend.
 Record date. This is the date on which the company compiles the list of investors who will be
paid a dividend. You must be a stockholder on this date in order to be paid.
 Payment date. This is the date on which the company pays the dividend to its investors.

1.2Types of dividend: Types of dividends are as follows:

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 Cash dividends: These are dividends payable in terms of cash. It is the most common type of dividend.
Property Dividends: These are dividends that are in the form of other assets other than cash. They could be
in the form of bonds, treasury bills, or shares in other companies. These dividends are recognized at their
fair value when being distributed to the shareholders.

Stock Dividends: The companies issues additional shares on a prorated basis without receiving any
consideration. These dividends increase a shareholders stock share in a company. From the company's
perspective, these stocks assist the company to capitalize some of its earnings.

Liquidating dividends: These dividends reduce the additional paid in capital of a company. They are
issued from the capital reserves.

Scrip dividend: A company may not have sufficient funds to issue dividends in the near future, so
instead it issues a scrip dividend, which is essentially a promissory note (which may or may not include
interest) to pay shareholders at a later date. This dividend creates a note payable.

Bond dividend
A dividend distribution that is paid to shareholders in the form of a bond instead of cash is bond dividend.
1.3 Dividends Declared Journal Entry:

Assuming there is no preferred stock issued, a business does not have to pay dividends, there is no liability
until there are dividends declared. As soon as the dividend has been declared, the liability needs to be
recorded in the books of account as dividends payable.
Suppose a business had dividends declared of 0.80 per share on 100,000 shares. The total dividends payable
liability is now 80,000, and the journal to record the declaration of dividend and the dividends payable
would be as follows.

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Dividends Declared Journal Entry
The dividends declared journal entry is shown in the accounting records using the following bookkeeping
entries:

Account Debit Credit

Dividends 80,000

Dividends payable 80,000

Total 80,000 80,000

Dividends declared journal entry

Dividends Declared Bookkeeping Explained
Debit
The debit is a charge against the retained earnings of the business and represents a distribution of the
retained earnings to the shareholders. The debit entry is not an expense and is not included as part of the
income statement, and therefore does not affect the net income of the business.
Credit
The credit entry to dividends payable represents a balance sheet liability. At the date of declaration, the
business now has a liability to the shareholders to pay them the dividend at a later date.
The Accounting Equation
The Accounting Equation, Assets = Liabilities + Equity means that the total assets of the business are
always equal to the total liabilities and equity of the business. is true at any time and applies to each
transaction. For this transaction the accounting equation is shown in the following table.
Assets = Liabilities + Owners Equity

None = Dividends payable + Retained earnings

0 = 80,000 – 80,000

Dividends declared journal entry accounting equation

With the dividends declared journal entry, a liability (dividends payable) is increased by 80,000 representing
an amount owed to the shareholders in respect of the dividends declared. This is balanced by a decrease in
the retained earnings which in turn results in a decrease in the owner equity, as part of the retained earnings
has now been distributed to them

1.4 How do cash dividends affect the Balance sheet?

When a corporation declares a cash dividend on its stock, its retained earnings are decreased and its current
liabilities (Dividends Payable) are increased. When the cash dividend is paid, the Dividends Payable account
is decreased and the corporation's Cash account is decreased.

The net result of the declaration and payment of the dividend is that the corporation's assets
and stockholders' equity have decreased. Specifically, the balance sheet accounts Cash and Retained

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Earnings were decreased.

The income statement is not affected by the declaration and payment of cash dividends on common stock.
(The cash dividends on preferred stock are deducted from net income to arrive at net income available for
common stock.)

The cash dividends will be reported as a use of cash in the financing activities section of the statement of
cash flows.

Retained Earnings with dividends: The relationships of retained earnings with dividends are
as follows:
 The balance in income summary account is closed to Retained Earnings at period end.
 Dividends are distributed to the share holders.
 To declare dividends there must be adequate retained earnings.
 Retained earnings shows the amount of income allowed to accumulate from the beginning of
the corporation’s life to the present
 Retained earnings represents claim on assets. But it is not cash.

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 BONDS

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Definition of bonds: A bond is a debt investment in which an investor loans money to an entity
(typically corporate or governmental) which borrows the funds for a defined period of time at a variable
or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to
raise money and finance a variety of projects and activities. Owners of bond share debt holders,
or creditors, of the issuer.

BREAKING DOWN 'Bond': Bonds are commonly referred to as fixed-income securities and are one
of the three main generic asset classes, along with stocks (equities) and cash equivalents. Many corporate
and government bonds are publicly traded on exchanges, while others are traded only over-the-
counter (OTC).

Working of bonds:
Bonds have a face value (usually what it is sold for initially), however they also have a market value which
fluctuates.

A way of measuring the return investors are getting on a bond is known as the yield.

to trade

The life of a bond trader

This is the rate of interest it pays, expressed as a percentage of its market value.

For example, if you bought a £100m bond with a 5% coupon, your yield would be 5%. (Coupon divided by
value of bond x 100)

The yield of a bond is inversely related to its current price - meaning that if the price of a bond falls, its yield
goes up.

For example, if our bond with a face value of £100m fell to a market price of £90m, the yield would rise to
5.55% (5/90 x 100).

If the price of our bond rose to £110m then the yield would fall to 4.54%. (5/110 x 100).

Even though the market price of a bond fluctuates, its face value (i.e. what it can be redeemed for at the end
of the fixed period) remains the same - in this case £100m.

The higher the yield of a bond, the riskier it is seen to be and the greater the chance that a company or
government which issued it may not be able to repay the money.

They may be more risky, however, but they do offer higher returns, making them attractive to some
investors.

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 And when it comes to government bonds that are sold at auction, the level of demand for them when they
are offered is seen as a sign of how confident investors are in a particular economy.

Types of bonds:

There are many types of bonds. The following list represents a sampling of the more common types:

 Collateral trust bond: This bond includes the investment holdings of the issuer as collateral.
 Convertible bond. This bond can be converted into the common stock of the issuer at a predetermined
conversion ratio.
 Debenture. This bond has no collateral associated with it. A variation is the subordinated debenture,
which has junior rights to collateral.
 Deferred interest bond. This bond offers little or no interest at the start of the bond term, and more
interest near the end. The format is useful for businesses currently having little cash with which to pay
interest.
 Guaranteed bond. The payments associated with this bond are guaranteed by a third party, which can
result in a lower effective interest rate for the issuer.
 Income bond. The issuer is only obligated to make interest payments to bond holders if the issuer or a
specific project earns a profit. If the bond terms allow for cumulative interest, then the unpaid interest
will accumulate until such time as there is sufficient income to pay the amounts owed.
 Mortgage bond. This bond is backed by real estate or equipment owned by the issuer.
 Serial bond. This bond is gradually paid off in each successive year, so the total amount of debt
outstanding is gradually reduced.
 Variable rate bond. The interest rate paid on this bond varies with a baseline indicator, such as LIBOR.
 Zero coupon bond. No interest is paid on this type of bond. Instead, investors buy the bonds at large
discounts to their face values in order to earn an effective interest rate.
 Zero coupon convertible bond. This variation on the zero coupon bond allows investors to convert their
bond holdings into the common stock of the issuer. This allows investors to take advantage of a run -up in
the price of a company's stock. The conversion option can increase the price that investors are willing to
pay for this type of bond.

The Terminology of Bonds: When examining bonds for your portfolio, you first need to understand
the basic terminology that is used. We'll examine some key bond terms below.

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 Par Value

 The par value is also known as the face value of the bond, which is the amount that is returned to the
investor when the bond matures. For example, if a bond is bought at issuance for $1,000, the
investor bought the bond at its par value. At the maturity date, the investor will get back the $1,000.
The par value of bonds is usually $1,000, although there are a few exceptions.

 Discount

Bonds do not necessarily trade at their par values. They may trade above or below their par
values. Any bond trading below $1,000 is said to be trading at a discount.

Premium

 Bonds may trade at a premium -- that is, more than the $1,000 par value. For example, a bond
trading at $1,086.50 is said to be trading at an $86.50 premium per bond.

Who issues bonds?

A number of different kinds of entity can issue bonds. These include companies, public authorities and
supra-national institutions. The primary market refers to the initial creation and issuing of bonds. Typically,
issuers of the bonds sells an entire issue to an underwriting team, composed of one or more other securities
houses or banks. They form a syndicate and re-sell the bonds to retail or professional investors. Government
bonds are more likely to be sold by auction rather than by syndication.

COUPON RATE:
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WHAT IT IS COUPON RATE:

The coupon rate of a bond is the amount of interest paid per year as a percentage of the face
value or principal. A fixed-income security's coupon rate is simply just the annual coupon payments paid by
the issuer relative to the bond's face or par value. The coupon rate is the yield the bond paid on its issue date.
This yield changes as the value of the bond changes, thus giving the bond's yield to maturity.

HOW IT WORKS (EXAMPLE)

If you own at $1,000 bond with a coupon rate of 4%, you will receive interest payments of $40 a year until
the bond reaches maturity.

Coupon Rate Formula:

The formula for coupon rate is as follows:
C=i/p
where:

 C = coupon rate
 i = annualized interest (or coupon)
 p = par value of bond

WHY IT MATTERS: The term coupon rate used to have a much more literal meaning than it does
today. To receive interest payments in the past, bondholders would have to clip a coupon from their physical
certificate of bond ownership and take it to the bank to obtain the cash. Today, your broker is more likely
to deposit the payments straight into your account. Some bonds, known as zero-coupon bonds, do not pay
coupons, and instead are sold at a price less than par value.

WHY COMPANIES ISSUE BONDS:

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 A corporation has a choice of raising money by selling shares or by issuing bonds. There are specific
reasons why the issuance of bonds is the better choice. These reasons are as follows:

 Boost returns. If the company can generate a positive return by using the funds garnered from the sale
of bonds, its return on equity will increase. This is because the issuance of bonds does not alter the
amount of shares outstanding, so that more profits divided by the company's equity results in a higher
return on equity.
 Interest deduction. The interest expense on bonds is tax deductible, so a company can reduce its
taxable income by issuing bonds. This is not the case when it sells stock, since any dividends paid to
shareholders are not tax deductible. The interest deduction can make the effective cost of debt quite low,
if a company can issue bonds at a low interest rate.
 Known payback terms. The terms under which bonds are to be repaid are locked into the bond
agreement at the time of issuance, so there is no uncertainty about how the bonds will be paid off at their
maturity date. This makes it easier for the company treasurer to plan for bond retirement. This is not the
case with stock, where the company may need to offer a substantial premium to investors to convince
them to sell back their shares.
 Ownership protection. When the existing group of investors does not want to have their ownership
interests watered down by the sale of shares to new investors, they will push for a bond issuance. Since
bonds are a form of debt, no new shares will be sold. However, this is not the case when the bonds are
convertible into the common stock of the issuer; bonds with this feature are called convertible bonds.
 No bank restrictions . A company directly issues bonds to investors, so there is no third party, such
as a bank, that can boost the interest rate paid or impose conditions on the company. Thus, if a company
is large enough to be able to issue bonds, this is a significant improvement over trying to obtain a loan
from a bank.
 Trade in for a better rate . If interest rates fall after bonds are issued, and if the bonds have a call
feature, the company can buy back the bonds and replace them with lower-priced bonds. This allows the
company to lower its financing cost. This is not the case with stock, where the company may be paying
dividends to investors for the life of the company.

SAMPLE OF BOND AND DEBENTURE :

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 TERM FINANCE CERTIFICATE
DEFINITION: A Term Finance Certificate (TFC) is a corporate debt instrument issued by companies
in Pakistan to generate short and medium-term funds.

EXPLAINATION:
There is a need for corporate debt instrument in Pakistan due to the crowding out effect by government
borrowing.

In particular, employee benefit funds and insurance company funds face an acute problem: Unless maturing
assets, and new inflows, are (re) invested in alternative high yield investments, those funds face the risk of
becoming under-funded (present value of funds less than present value of liabilities).

Corporate Term Finance Certificates (TFC's) offer institutional investors, in particular provident funds,
pension funds and insurance companies, with a viable high yield alternative to the NSS and bank deposits.
They are also an essential complement to risk free, lower yielding government bonds such as PIB's. As a
result, the demand for TFC's is growing steadily, and will gather increasing momentum in the future.

Being a relatively new instrument in the Pakistan capital market, corporate bonds in general and TFCs in
particular, are not well understood by the average investor. This booklet, aims to address that problem by
answering questions that are most frequently asked by investors: What is a TFC? Which ones should I buy?
How can I buy and sell them? etc. The booklet is not exhaustive, it is only meant to set investors off on the
road to a better understanding of the instrument.

The booklet is an educational tool. To meet the demand of TFCs in the secondary market, TSL has also
launched a TFC market-making service. The term market-making means TSL will quote daily bid (buy)
and offer (sell) prices for a range of TFCs on Karachi Stock Exchange trading system through TSL. Buyers
and sellers wishing to trade TFCs at those prices may contact TSL to execute their orders. The service
provides a mean by which investors can buy TFCs when they require, and find a ready buyer when the wish
to sell

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