 Hello and welcome to the session in which we would look at the concept of liquidating dividend. What is the big idea for liquidating dividend? Well, let's talk about dividend first. Where does dividend comes out of from? Well, dividend comes out of retained earnings. What is this account retained earnings? So it's very important that we understand this account retained earnings in order to understand what is dividend, in order to understand what is liquidating dividend. Over the years companies generate net income. So as they generate net income every year, the retained earnings will increase on the credit side. If they for any year they incur the loss, the loss would reduce the retained earnings. Also when the company pays dividend, they pay dividend out of retained earnings. It reduces retained earnings. In many other transactions, it reduces retained earnings. The only thing that technically increases retained earnings is net income. Now, what happens sometime is this. What happened if the company pays dividend in excess of accumulated earnings? Simply put over the years, we have this account that's called retained earnings and we have ten dollars in here in total. What happened if we decided to pay $12 in dividend? Because remember dividend is on it reduces retained earnings. Well, what happened under those circumstances? Technically, this is not a dividend. Why not? Well, remember dividend comes out of earnings. Dividend is a distribution of the profit. So if you don't have the profit, what are you distributing? Well, simply what you are distributing is the capital, the money that the investors invested in the company initially. This is called return of capital or ROC. Is it allowed? Sure it's allowed. Why not? If that's what you want to do, that's fine. But you have to tell the investors that what you are given them now is their money. Why? Because if they get it without knowing it's their money, they may think it's a profit. It's part of the profit. Therefore, it's taxable. If you tell them this is a liquidating dividend, then it's not taxable. Return of capital is not taxable. So what companies do experience this liquidating dividend? Companies extract the natural resources. For example, an oil company that is extracting oil from the ground. And what happened is this? The company is created for the sole purpose of extracting the oil, selling it, making a profit, distributing the profit to the shareholders. Now what happened is this? At some point after they have extracted the majority of the oil, they'll start to close down the company. So what they do, they have no intent of buying another well to extract the oil. So they will start to give all the money back to the shareholders. Some of that money may not be profit. Well, if it's not profit, it's part of the capital, the original capital of the owners. So let's assume Adam Company had a retained earning balance of 800,000. So simply put, they have a balance of 800,000 in the retained earning over the years. The board declared a dividend of one dollar on the one million shares they have. They have one million shares and they're going to pay each shareholder a dollar. Well, guess what? They're paying a million. Well, they only have 800,000 in retained earnings. What does that mean? It means you're going to reduce retained earnings by 800,000. Bring retained earnings down to zero and you're going to pay out cash of a million dollar. Well, we are missing a debit of 200,000. Well, guess what? This 200,000 is return of capital. So what we do is we debit paid in capital in excess of part. Now if the company does not have paid in capital, they only have come in stock, then we debit obviously come in stock. Basically, the company is closing. Therefore, we are returning the money to the capital. We have to let the investors know that of this one million dollar, and usually it's stated in the annual tax sheet, 200,000 is ROC return of capital. In other words, or they indicate it as liquidating dividend. In other words, we tell the investors don't pay taxes. This is not part of the profit. The only part that's taxable coming out of the profit is the 800,000. And you would learn more about this topic in your tax accounting course. This topic is covered in advanced accounting. I'm sorry, in intermediate accounting as well as the CPA exam. Whether you are an accounting student or a CPA candidate, I strongly suggest you take a look at my website, farhatlectures.com. I don't replace your CPA review course if you're studying for your CPA exam. Know your accounting course. I'm a useful addition to those resources. I can help you do better. I can help you understand the material better. By doing so, you can improve your score. Your risk is one month of subscription. Give it a try. 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