Introduction
Dividends, whether cash dividends or stock dividends are not written down as an expense in the company’s financial statements. This is because they do not affect the profit in the income statement of the company.
They are rather written down under the shareholder equity section of the company and hence affect the balance sheet. Dividends are a form of return to the investors for their investment in the company.
The two types of dividends, cash, and stock dividends have a different impact on the overall shareholder equity. While the cash dividends tend to reduce the shareholder’s equity, stock dividends require a portion of the company’s retained earnings to be reallocated to the common stock and additional paid-in capital without any reduction to the shareholder’s equity.
Why are dividends not an expense?
Dividends, particularly the cash dividend, are money paid to the shareholder by the company from retained earnings.
The retained earnings are like a savings account for the company where the company transfers and accumulates its profits to use later. The retained earnings are located in the balance sheet in the shareholder equity section.
The retained earnings are reserved to be used to pay out dividends or to repurchase stock as required by the company. The company’s dividend policy is subject to change, and this change will not be reflected on any of the company’s financial statements.
Further, as the dividends are not a part of costs incurred in the company’s everyday operations, they cannot be deemed as expenses and hence are not written down under the operating costs in the company’s income statement.
Accounting for Cash Dividends
Cash dividends are regarded as an outflow for the company from the company’s retained earnings to its shareholders. For this reason, while recording cash dividends in the accounts, the distribution of such dividends is done by reducing cash and the company’s retained earnings.
The cash dividends are recorded as in the company’s statement of changes at the end of the year, by showing a change in the shareholder equity. Cash dividends result in a reduction of the liquid asset of the company that is cash, and therefore, a distribution of cash dividends results in a reduction of the balance sheet.
Similarly, the cash dividends also have an impact on the cash flow statement of the company. The cash flow statement records any inflows and outflows of cash from the company under the categories of operating activities, investing activities, and financing activities.
The cash dividends are recorded under the financing activities section of the cash flow statement as an outflow of cash. While cash dividends are not an expense, they still have a negative impact on a company’s cash and tend to reduce it.
Accounting for Stock Dividends
Stock dividends differ from cash dividends as these dividends are given to the shareholders in the form of additional shares. For this reason, stock dividends are not an expense and its distribution does not impact the company.
Stock dividends are given to shareholders in proportion to the issued common stock. The distribution of stock dividends is done by allocation of a proportion of retained earnings to common stock and additional paid-in capital.
Therefore, the distribution of common stock does not have any impact on the totals of the balance sheet itself because the amounts are merely reallocated and there is no actual change.
How Dividends Are Paid?
In either case, cash dividends or stock dividends, the company announces or declares them, which is done on a quarterly basis in most cases. In some cases, the board of directors may decide not to declare dividends quarterly. However, after being declared, the dividends are paid out particular date.
For instance, the company might declare a dividend of 50 cents per share for common stockholders, payable in 60 days from the date of declaration.
A company with a good dividend distribution history is particularly important for investors and tends to be more preferred when making investment decisions.
This is because those investors who prefer to have a source of regular income, are most likely recommended by financial advisors to opt for such dividend-yielding stocks. Therefore, dividend-yielding stocks are an important component of the stock portfolio.
However, it is also possible that the companies may sometimes not be able to pay out dividends due to a difficult financial position.
While this may affect the company’s overall standing in comparison to other companies, if the company utilizes the dividend payment by instead investing it into further expansion of its operations, it can perhaps provide greater value to the shareholders by offering an even greater dividend later.
It is important to note that investors consequently more trust companies who continue to provide dividends through good and bad times for their investments. One such company is ExxonMobil, an oil company listed on the New York Stock Exchange, has never failed to pay out a dividend.
With a dividend yield of 3.8%, ExxonMobil has managed to persistently increase the dividend annually each year for the last 35 years.
Conclusion
To conclude what has been explained above, dividends are expenses for the company as they are not a result of the company’s everyday operations. Dividends, whether cash or stock are a form of return to shareholders for their investment.
Cash dividends are paid out from the company’s cash and reduce the retained earnings of the company.
Consequently, they result in the reduction of the total balances of the balance sheet. On the other hand, stock dividends are given in the form of additional shares to the existing shareholders. This distribution does not have any effect on the overall total of the balance sheet.
