Companies that pay out dividends to shareholders must record these transactions in the financial accounting books to be figured in at the end of the fiscal year for tax purposes. Where does this line item go in the accounting ledgers? Are dividends considered an expense for the company? While some may believe that the logical answer is yes, because they are distributed in the form of payments, the classification of dividends may surprise you. After researching the question extensively, here is how dividend transactions are viewed and accounted for.
How are dividends paid?
Dividends may be paid to shareholders as either cash or as stock. An announcement of the dividend is made in advance, then it is sent in the agreed upon form to the shareholders on a certain date. This usually happens on a quarterly basis, or three times annually. Payments are rendered within 60 days of the announcement. Dividends are not a guaranteed type of payment. Some companies pride themselves in making consistent regular dividend payments, but some do not pay dividends each year.
Are dividends considered expenses?
When it comes to recording dividends that are distributed to shareholders on a company’s income statement they are not included in the expense column. The reason for this is because the dividends are simply a reallocations of the retained earnings of a company from common stock. They are classified as an investor reward for participating in the financial support of the company through their investments. While this may seem confusing at first, there are some very good explanations why dividend payments cannot be recognized as a business expense. We take a look at how these payments are viewed and treated by accounting and tax professionals in congruence with established laws and regulations.
How are dividends recognized?
Dividends, whether paid out in stock or cash rewards have no affect on the profit or net income of a company. Payments do affect the equity of shareholders on the companies balance sheet. The payments reduce the shareholder equity balance. This is the area where dividend payments are recorded. They do not represent an expense.
Where are dividends listed on the accounting statement?
Since dividend payments are recognized as an equity distribution of a company, they are included in the balance sheet under the equity section. They are subtracted from the cash line item on the sheet. When done properly, it causes the total number listed on the balance sheet to go down.
When are dividend payments accounted for?
There may be a 60 day period in between the time that the dividend payment is announced and the time that it is actually rendered. Announced dividends are listed on the current liability section of the balance sheet. Only dividends that have been paid for the reporting period of the present balance sheet are listed as paid. They are recorded as a cash outflow in the statement of cash flows in the financing portion of the balance sheet.
What if dividends are paid in stock?
When dividends are rendered to the shareholders in the form of stock, they are still not considered to be an expense. They are recorded in the equity section of the Balance sheet as a reallocation of “additional paid-in capital” and “retained earnings” accounts.
Getting the books ready for tax time
Now that we’ve cleared up the question of dividends and you know that they are not considered as an expense, there are a few more facts about dividends that you need to know. When it comes time to prepare the books for tax season, it’s important to understand what dividends are, what they are not, and where they fit into the larger scheme of the financial accounting process.
Where does dividend revenue come from?
Dividend revenue is generated from the net income of the company, but only after all of the expenses and costs have been deducted from the income. The expense section has already been completed before the dividends are considered and acted upon. To break it down more simply, dividend payments are more akin to sharing the profits of the company with the shareholders who invested capital into the money by purchasing shares of stocks. Dividend payments are not a cost of running the business, they are a reward for investor good faith. The shareholders have in essence, become a part of the company because of their investment in the interests and furthering of the company. Since the dividend payments are made possible through profits they cannot technically be classified as a business expense. Dividend payments are calculated by the value of the stock, the agreements made for dividend payment, and board decisions that affect the distribution of dividend payments.
When a company is in the position to pay dividends to investors it is a very good sign that the business is showing a healthy profit. Not all companies pay dividends every year, but many pay them quarterly. Dividends are paid out in the form of stock or cash as a reward for the investor’s working capital to help the business carry on operations and to grow and develop. They ‘re not considered to be an expense in the larger scheme of things. Dividend payments reduce the amount of equity that shareholders have in their equity balance sheet.
By knowing what dividends are, how they are handled, and how they are recorded in the company’s accounting books, you will be able to track these line items in the proper place and avoid making the mistake of writing them off as a business expense. Although many companies would be happy to treat them as expenses, because it would slash profitability and result in fewer tax liabilities, the IRS has already made their final decision on the matter and it’s not likely that they will ever count as an expense.