Cash or stock dividends distributed to shareholders are not recorded as an expense on a company's income statement. Stock and cash dividends do not affect a company's net income or profit. Instead, dividends impact the shareholders' equity section of the balance sheet. Dividends, whether cash or stock, represent a reward to investors for their investment in the company.
While cash dividends reduce the overall shareholders' equity balance, stock dividends represent a reallocation of part of a company's retained earnings to the common stock and additional paid-in capital accounts.
Key Takeaways
- Cash or stock dividends distributed to shareholders are not recorded as an expense on a company's income statement.
- Cash dividends are cash outflows to a company's shareholders and are recorded as a reduction in the cash and retained earnings accounts.
- Stock dividends reallocate part of a company's retained earnings to its common stock and additional paid-in capital accounts.
Understanding Why Dividends are not Expenses
A cash dividend is a sum of money paid by a company to a shareholder out of its profits or reserves called retained earnings. Each quarter, companies retain or accumulate their profits in retained earnings, which is essentially a savings account. Retained earnings is located on the balance sheet in the shareholders' equity section. The cash within retained earnings can be used for investing in the company, repurchase shares of stock, or pay dividends.
The cost of dividends is not included in the company's income statement because they're not an operating expense, which are the costs to run the day-to-day business. A company's dividend policy can be reversed at any time and that, too, will not show up on its financial statements.
Cash Dividends Accounting
Cash dividends represent a company's outflow that goes to its shareholders and increases the shareholders' net worth. Dividend payment is recorded through a reduction in the company's cash and retained earnings accounts as a liability.
Because cash dividends are not a company's expense, they show up as a reduction in the company's statement of changes in shareholders' equity. Cash dividends reduce the size of a company's balance sheet, and its value since the company no longer retains part of its liquid assets.
However, cash dividends also impact a company's cash flow statement. Cash flow refers to the inflows or increases as well as the outflows or reductions in cash. Cash dividends impact the financing activities section of the cash flow statement by showing a reduction in cash for the period. In other words, although cash dividends are not an expense, they reduce a company's cash position.
Stock Dividends Accounting
A stock dividend is an award to shareholders of additional shares rather than cash. Similarly, stock dividends do not represent a cash flow transaction and are not considered an expense.
Companies distribute stock dividends to their shareholders in a certain proportion to their common shares outstanding. Stock dividends reallocate part of a company's retained earnings to its common stock and additional paid-in capital accounts. Therefore, they do not affect the overall size of a company's balance sheet.
How Dividends Are Paid
Whether paid in cash or in stock, dividends generally are announced, or "declared," by a company and are then paid out on a quarterly basis at a specified date. Investors are paid in proportion to their holdings. For example, a company might pay a dividend of .25 cents per share, payable 60 days from the date of the announcement.
A company's history of dividends is an important factor in many investors' decision-making process. Dividends tend to be most prized by relatively conservative investors who buy stocks for the long term, and by investors who value the regular income they provide. Dividend-yielding stocks are a component of most portfolios recommended by professional financial advisers.
As noted, there is never a guarantee that a dividend will be paid each year. However, some companies have earned boasting rights over their history of dividend payments. Coca-Cola, for example, notes on its website that it has paid a quarterly dividend since 1955 and that its annual dividend has increased in each of the last 58 years.
FAQs
Answer and Explanation:
Are dividends considered a company expense? ›
Cash or stock dividends distributed to shareholders are not recorded as an expense on a company's income statement. Stock and cash dividends do not affect a company's net income or profit. Instead, dividends impact the shareholders' equity section of the balance sheet.
Are dividends classified as an expense quizlet? ›
A declared dividend is classified as an expense. The accounts used to record the declaration of a dividend are Dividends Payable and Dividends Expense. When declared dividend is paid, Dividends is debited.
Why are dividends not an expense in the income statement? ›
Dividends are not considered an operating expense because they are not required to run the business in normal course of business.
Are dividend payments a business expense? ›
These types of payments reduce a company's taxable profits, thereby reducing its Corporation Tax bill. Dividends are not tax-deductible business expenses. Generally, however, you will still pay less tax overall by taking higher dividends and a lower salary.
Do companies write off dividends? ›
Specifically, corporations can deduct 50% of the dividends they receive if they own less than 20% of the stock of the corporation distributing the dividend. If they own 20% or more of the distributing corporation's stock, they can deduct 65% of the dividends received.
Is dividend treated as an expense? ›
The dividend is that part of the profits of the company which is distributed to the shareholders of the company and is not considered to be an expense as it is the portion of the company's profit that is returned to the shareholders of the company as a return on their investment done in the company and is deducted from ...
What are dividends considered? ›
Dividends are distributions of property a corporation may pay you if you own stock in that corporation. Corporations pay most dividends in cash. However, they may also pay them as stock of another corporation or as any other property.
How are dividends classified in accounting? ›
Under generally accepted accounting principles (GAAP), dividends are not considered an expense of doing business; instead, they are accounted for as a reduction of equity on the balance sheet and added back to net income to compute earnings per share.
What type of expense is a dividend received? ›
Non-Operating Expenses
Another way to categorize dividends is as a non-operating expense. This is typically used by businesses that have a small number of shareholders, and is less common than the operating expense method.
Dividends are paid out of the company's retained earnings, so the journal entry would be a debit to retained earnings and a credit to dividend payable. It is important to realize that the actual cash outflow doesn't occur until the payment date. This shows the company plans to pay dividends.
Why are dividends declared not recorded as an expense? ›
If a stock dividend is issued instead of cash, this represents a reallocation of funds between the additional paid-in capital and retained earnings accounts. This is simply a reshuffling of amounts within the equity section of the balance sheet. Thus, stock dividends are also not considered an expense.
Where do you record dividends paid? ›
As soon as a company declares a dividend payment, list it as a liability on the company's financial records in the dividend payable account.
How do you avoid tax on dividends? ›
You may be able to avoid all income taxes on dividends if your income is low enough to qualify for zero capital gains if you invest in a Roth retirement account or buy dividend stocks in a tax-advantaged education account.
What is the maximum dividend that can be paid? ›
There's no limit, and no set amount – you might even pay your shareholders different dividend amounts. Dividends are paid from a company's profits, so payments might fluctuate depending on how much profit is available. If the company doesn't have any retained profit, it can't make dividend payments.
Do dividends come out of net income? ›
Dividends Are Earnings Distributed to Shareholders. Dividends are paid from the net income earned from the company. Net income is the earnings of the company. Therefore, dividends are earnings distributed to stockholders.
What category do dividends fall under? ›
Dividends Payable is classified as a current liability on the balance sheet, since the expense represents declared payments to shareholders that are generally fulfilled within one year.
How are dividends shown on company accounts? ›
A cash dividend primarily impacts the cash and shareholder equity accounts. There is no separate balance sheet account for dividends after they are paid. However, after the dividend declaration but before actual payment, the company records a liability to shareholders in the dividends payable account.
Where do dividends go on financial statements? ›
The amount of the dividend is usually based on the number of shares each shareholder holds or a set per-share amount. Dividends affect a company's financial statements in different ways. They show up in the income statement as dividends declared and in the statement of cash flows as dividends paid.
