MANAGEMENT ACCOUNTS - 27.06.2014

Accounting for directors’ dividends

Confusion

For tax reasons, owner managers are often paid a mixture of salary and dividends. For statutory accounts purposes, these dividends are not shown in the profit and loss account along with the other costs incurred by the business.

Problem. Most accounting packages are designed to follow statutory accounting rules as far as dividends are concerned. But the omission of dividends paid to directors from the profit and loss account can cause confusion within management accounts. Unadjusted, the company will appear more profitable than it actually is and standard business ratios reliant on profits or staff costs won’t work.

Compensation

Before any adjustments can be made the first thing to do is establish what the director’s compensation for doing their role, as distinct from being an owner, ought to be.

Tip 1. Review job vacancy sites and industry salary surveys to work out the market rate the company would have to pay someone to do the director’s role.

Tip 2. Where other directors are employed who are not owner managers, a comparison against the salaries paid to these could be used.

Tip 3. Alternatively, if the dividend is a standard monthly amount, perhaps only enhanced at the year-end, then this sum could be considered as the salary element.

Tip 4. Reduce the monthly compensation amount by the actual monthly salary paid to the director - the balance is the amount of dividends paid to the director that can be viewed as pay for work done.

Adjustments

As accounting packages generally account for dividends in accordance with statutory requirements, which is quite right, the simplest way of resolving the confusion caused by owner-managed dividends is by amending your reports rather than changing your accounting software.

Having established the level of compensation appropriate for the director’s role, the adjustments required to monthly management accounts can now be made.

Tip 1. Download the management accounts profit and loss account into Excel, or a similar spreadsheet, utilising the export module within your accounts package.

Tip 2. Adjust the salary cost in the Excel profit and loss account by the amount of dividend deemed to be compensation for the work done.

Tip 3. If you would rather not maintain adjusted Excel spreadsheets, a monthly recurring journal covering the compensation adjustment could be made to debit the salary cost and credit dividends paid. If you go down this route, make sure an adjustment is made at the year end to credit the dividends debited to salary cost and debit dividends paid, otherwise the statutory accounts won’t show the correct level of dividends paid.

Tip 4. Remember that, despite these adjustments, employers’ National Insurance is not due on dividends so it shouldn’t be adjusted for.

For a sample adjusted dividend profit and loss, visit http://tipsandadvice-financialcontroller.co.uk/download (FC 06.10.03).