The dividend is that part of 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 company’s profit which 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.
Is Dividend an Income Statement Expense?
The dividends are not considered as 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 net profits or accumulated reserves of the company, 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 account, 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.
- Dividends are neither classified as a direct cost or indirect cost since the amount paid as dividends are not in the normal course of the business operations and are not correlated to the product of the company.
- They are deducted from the profit after taxes in order to calculate the earnings per share of the company.
- In the case of insufficient profits, dividends are paid from the retained earnings that form part of the balance sheet. Hence the retained earnings account is debited, and liability for the dividend payable is created under the head current liabilities. So the profit & loss account does not come into the picture.
Journal Entries for Dividend Expense
Below are the journal entries for different dividend expense:
#1 – Cash Dividends Expense
Cash Dividends refers to the direct cash payment made by the company to its stockholders.
Example
ABC Ltd decides to pay cash dividends to its shareholders at $1 per share. It has 10,00,000 shares outstanding as on date.
#2 – Stock Dividends Expense
It refers to the dividend paid in kind, i.e., issuing additional shares to the company’s shareholders.
Example
XYZ Limited declares a stock dividend of 1,00,000 shares. Existing outstanding capital is 10,00,000 shares. The face value is $10. Fair Value is $25.
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Journal Entry:
#3 – Property Dividends
It is an alternative solution to cash or stock dividends. It is a non-monetary way of paying the stockholders in the form of the assets of the company like real estate, plant & machinery, etc.
Example
XYZ Limited has a real estate investment property @bangalore acquired 10 years ago at 1 crore. The market value of the asset as on date is 5 crores. The company has declared a property dividend to its shareholders since there are liquidity issues in the company.
#4 – Scrip Dividends
It refers to the promissory note issued by the company to pay its shareholders at a later date since the company is facing liquidity issues.
Example
PQR Ltd has declared a scrip dividend of $10,00,000 to its shareholders after one year from the said date. The Interest payable is 10%.
After 1 Year:
#5 – Liquidating Dividends
Liquidating Dividends is 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 company. It has been paid after all the liabilities are settled by the company.
Example
ABC Ltd is going for liquidation and wants to settle the equity holders of the company by payment of Dividends. Amount of liquidating dividend is $5,00,000
Advantages of Dividends
Below mentioned are some of the Advantages of the Dividends to the Shareholders and also to the Company :
- It shows a sign of stability of the company, which pays dividends to its shareholders on a periodic basis. Since it is a tax-free receipt in the hands of the shareholders, they are more interested in companies that pay dividends regularly.
- 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 the return on their investments on a period intervals of 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 of the company without siphoning the funds for personal benefit.
Limitations of Dividends
Below mentioned are some of the disadvantages of the dividends paid to the shareholders and also to the company:
- 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 growth strategy of the company 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 of 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 act are duly followed.
Conclusion
Dividends are one of the most important decisions to be taken by the management since it impacts the growth strategy of the company due to the payment of excess cash to the shareholders on the one hand & keeps the investors happy on the other. Thus, keeping in mind the above-mentioned pros and cons of the dividend to be distributed, the company should consider multiple factors before declaring any dividend policy.
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