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
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 considered a company expense? ›
Dividends are not considered an expense. Instead, they represent a distribution of profits to shareholders. When a company earns profits, it can choose to either reinvest those profits back into the business (retained earnings) or distribute a portion of them to shareholders in the form of dividends.
Are dividends expenses True or false? ›
3. False. Dividends are distributions of earnings in the past and are not expenses.
Why are dividends to shareholders not considered to be an expense? ›
Dividends are not considered an operating expense because they are not required to run the business in normal course of business.
Are dividends good or bad for a company? ›
“Companies that have consistently increased their dividends tend to be more stable, higher quality businesses, which historically have weathered downturns and are more likely to have the ability to pay dividends consistently.”
Is dividend allowed as an expense for a company? ›
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.
Do companies write off dividends? ›
Can a Corporation Deduct Dividends Paid to Shareholders? C corporations pay tax on their income before paying dividends. For them, dividends are not a deductible expense.
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.
How to record dividend expenses? ›
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.
Do dividends go on the balance sheet? ›
A common stock dividend distributable appears in the shareholders' equity section of a balance sheet, whereas cash dividends distributable appear in the liabilities section.
If a company pays a dividend by distributing income from current operations, the transaction is recorded as an operating activity on the cash flow statement. On the other hand, if a company pays a dividend from retained earnings, then it is recorded on the balance sheet as both an asset and liability entry.
Do dividends affect net income? ›
Dividends and net income
Dividends represent a portion of a company's net income. However, dividends don't cause net income to go down. Rather, dividends are just one example of what a company might choose to do with its net income.
Do dividends come out of retained earnings? ›
Are dividends included in retained earnings? Dividends are not included in retained earnings. Net income not paid out as dividends is the retained earning. Retained earnings enhance the value of the equity of the company.
What are the disadvantages of dividends? ›
Despite their storied histories, they cut their dividends. 9 In other words, dividends are not guaranteed and are subject to macroeconomic and company-specific risks. Another downside to dividend-paying stocks is that companies that pay dividends are not usually high-growth leaders.
When should a company not pay dividends? ›
Companies in the growth stage rarely pay dividends. In fact, many of these companies are not even profitable yet. They are focused on acquisitions, expansion, product development and all of these other things that cost a lot of money. As a result, they simply cannot afford to pay a dividend.
Do you pay taxes on dividends? ›
How dividends are taxed depends on your income, filing status and whether the dividend is qualified or nonqualified. Qualified dividends are taxed at 0%, 15% or 20% depending on taxable income and filing status. Nonqualified dividends are taxed as income at rates up to 37%.
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 treated 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 category is a dividend under? ›
Dividends can be considered an operating expense, as they are paid out of the company's profits. This is the most common way to categorize dividends, and is typically used by businesses that have a large number of shareholders.
How are dividends shown on company accounts? ›
Dividends paid out are reported on the statement of cash flows as a use of cash. This is included in the cash flow from financing activities section of the report.
