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 the retained earnings of the company.
Dividends are one of the most important decisions to be taken by the management since they impact the company’s growth strategy due to the payment of excess cash to the shareholders on the one hand & keep the investors happy on the other. Thus, keeping in mind the pros and cons of the dividend to be distributed, the company should consider multiple factors before declaring any dividend policyDividend PolicyDividend policy is the policy that the company adopts for paying out the dividends to the company's shareholders, which includes the percentage of the amount at which the dividend is to be paid out to the stockholders and how frequent the company pays the dividend amount..
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Is Dividend an Expense Explained
The dividends Dividends Dividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.are not considered an expense in the income statement due to the following reasons:
- Dividends are the distribution of profits to the shareholders as a return on their investments.
- Dividends are paid out of the company’s net profits or accumulated reserves, which are calculated after deducting all the expenses and paying the corporate income taxes as per the regulatory laws.
- Since they are a part of the profit & loss appropriation accountAppropriation AccountAn appropriation account shows how the firm's net profit is divided, i.e., how much goes to pay income taxes, how much goes to shareholders as a dividend, and how much goes to retained earnings. The partnership firm, the Limited Liability Company (LLC), and the government are primarily prepare it., they are not allowed to be deducted as an expense in the income statement as they are not directly related to the revenue of the company and are the distribution of the profits. So that answers a common question of is dividend expense on the income statement.
- Dividends are neither classified as a direct costDirect CostDirect cost refers to the cost of operating core business activity—production costs, raw material cost, and wages paid to factory staff. Such costs can be determined by identifying the expenditure on cost objects. or indirect costIndirect CostIndirect cost is the cost that cannot be directly attributed to the production. These are the necessary expenditures and can be fixed or variable in nature like the office expenses, administration, sales promotion expense, etc. since the amount paid as dividends is not in the normal course of the business operations and is not correlated to the company’s product.
- They are deducted from the profit after taxes to calculate the earnings per share of the companyEarnings Per Share Of The CompanyEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is..
- In the case of insufficient profits, dividends are paid from the retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.that form part of the balance sheet. Hence the retained earnings account is debited, and liability for the dividend payableLiability For The Dividend PayableDividend payable is that portion of accumulated profits that is declared to be paid as dividend by the company's board of directors. Until the dividend declared is paid to the concerned shareholders, the amount is recorded as a dividend payable in the head current liability. is created under the head current liabilities. So the profit & loss account does not come into the picture.
Let us understand how a journal entry would be to answer the question of is dividend expense tax deductible through the entries below.
#1 – Cash Dividends Expense
Cash DividendsCash DividendsCash dividend is that portion of profit which is declared by the board of directors to be paid as dividends to the shareholders of the company in return to their investments done in the company. Such a dividend payment liability is then discharged by paying cash or through bank transfer. refer to the direct cash payment made by the company to its stockholders.
ABC Ltd pays its shareholders cash dividends at $1 per share. It has 10,00,000 shares outstanding as on dateShares Outstanding As On DateOutstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet..
#2 – Stock Dividends Expense
It refers to the dividend paid in kind, i.e., issuing additional sharesIssuing Additional SharesShares Issued refers to the number of shares distributed by a company to its shareholders, who range from the general public and insiders to institutional investors. They are recorded as owner's equity on the Company's balance sheet. to the company’s shareholders.
XYZ Limited declares a stock dividendStock DividendA stock dividend refers to bonus shares paid to shareholders instead of cash. Companies resort to such dividends when there is a cash crunch. Shareholders are allotted a certain percentage of shareholding. of 1,00,000 shares. The existing outstanding capital is 10,00,000 shares. The face value is $10. The fair value is $25.
#3 – Property Dividends
It is an alternative solution to cash or stock dividends. It is a non-monetary way of paying the stockholdersStockholdersA stockholder is a person, company, or institution who owns one or more shares of a company. They are the company's owners, but their liability is limited to the value of their shares. in the form of the assets of the company like real estate, plant & machinery, etc.
XYZ Limited has a real estate investment propertyInvestment PropertyInvestment property refers to the real estate acquired to earn returns on the investment through rental income, royalties, dividends or future appreciation, usually in the name of an individual investor, a group of investors or an investment company for a short-term or a long-term investment. @bangalore acquired ten years ago at one crore. The market value of the asset as of date is five crores. The company has declared a property dividend to its shareholders since there are liquidity issues.
#4 – Scrip Dividends
It refers to the promissory notePromissory NoteA promissory note is defined as a debt instrument in which the issuer of the note promises to pay a specified amount to a party on a particular date. issued by the company to pay its shareholders later since the company is facing liquidity issues.
PQR Ltd declared a scrip dividendA Scrip DividendA company issues scrip dividends or liability dividends to its shareholders as a certificate with a choice to get dividends later or take shares in place of dividends. Companies issue such dividends when they do not have sufficient cash to pay a dividend. of $10,00,000 to its shareholders after one year from the said date. The Interest payableInterest PayableInterest Payable is the amount of expense that has been incurred but not yet paid. It is a liability that appears on the company's balance sheet. is 10%.
After 1 Year:
#5 – Liquidating Dividends
Liquidating DividendsLiquidating DividendsWhen a business is completely closed, the shareholders will get a residual payment in the form of cash or other assets after all creditors and lenders obligations have been paid. These dividends are usually paid when management believes the business is no longer a going concern. are paid at the time of liquidating the company. It’s a distribution of cash, stock, or other assets to the shareholders with the intent of closing down the business operations of the companyBusiness Operations Of The CompanyBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation.. It has been paid after all the liabilities are settled by the company.
ABC Ltd is going for liquidation and wants to settle the company’s equity holders by payment of Dividends. The amount of liquidating dividend is $5,00,000
Below mentioned are some of the Advantages of the Dividends to the Shareholders and also to the Company:
- It shows a sign of the company’s stability, which pays its shareholders dividends periodically. Since it is a tax-free receipt in the hands of the shareholders, they are more interested in companies that pay dividends regularly. Therefore, this clears the air around is dividend expense tax deductible.
- It gives the shareholder the belief that the company is earning sufficient profits to take care of its investors in the long term.
- The shareholders get a return on their investments for some time without selling the stocks in the open market. This improves the holding capacity of the unitholders for more capital gains in the future.
- The rating of the company improves as compared to its peers since it shows the intent of the management to distribute the excess cash or surplus profits to the owners without siphoning the funds for personal benefit.
Despite the various advantages mentioned above, there are a few factors from the other end of the spectrum that prove to be a disadvantage. Let us understand the disadvantages through the limitations below.
- Since the shareholders are used to regular dividend payments, any gap in the same may result in panic among the unitholders forcing them to sell the shares in the open market in pressure, thus pulling down the stock price at the end.
- Regular dividend payments hamper the company’s growth strategy since all the excess cash available is paid out without investing the same in long-term assets that may reap extra benefits to the company.
- Monitoring the unpaid dividend account and ensuring all the compliances for the same with regards to the payment & transfer of unpaid dividends as per the company’s activities are duly followed.
This article is a guide to Is Dividend an Expense? Here, we explain its explain its examples, journal entries, advantages, and disadvantages in detail. You can learn more about accounting from the following articles –