Are Dividends An Expense? - Income Statement Rules Explained

Are Dividends an Expense?

 

Dividends are funds that are paid out to shareholders out of the company’s profits or financial reserves, usually after a specific period of time.

One question that often arises is are dividends an expense, since if they were, that could make it possible to deduct the payouts from the amount of taxes that need to be paid.

So, to figure out how dividends on an income statement should look, let’s answer – are dividends an expense?

Dividends – Expense or Not?

Dividends are paid out by the company out of its profits, and they are not considered a dividend expense for tax purposes.

That’s because they do not affect the company’s net income, and instead, dividend revenue comes from the net income of the company which is the amount after all of the expenses and costs have already been deducted.

In essence, dividends expense is simply the sharing of profits with the shareholders, which is a reward for their investment and trust in the company, rather than a cost that would be associated with running the business itself.

For tax purposes, dividends are basically the redistribution of the profits that the company accumulates, so they cannot be considered an expense since technically, the profits remain in possession of the shareholders, which are part of the company.

If companies would be allowed to write off dividends as an expense, they could technically reduce their profits to zero every year, avoiding the majority of their taxes, since all of the profits could simply be divided among the shareholders.

What Are Dividends?

As briefly mentioned in the beginning, cash dividends are a sum that is paid by the business to its shareholders out of the profits that are accumulated over a period of time.

Instead of being a necessity of running the business, is it rather a reward that the company uses to keep shareholders happy and willing to invest in the company.

Since it’s not essential for running business operations, it does not fall into the category of expenses, and should not appear in the income statement.

There are two types of dividends - cash and stock.

A cash dividend is the more straightforward of the two, as it is paid out in cash to its shareholders and investors, providing tangible economic value to the shareholders instead of the money being used for company operations.

Since cash dividends are paid out of the company’s capital, it will usually result in a decrease in stock prices by a similar percentage.

The receivers of the cash dividends are also required to pay tax, which lowers the final value of the dividends.

Stock dividends, on the other hand, are dividends that are paid out in the form of stocks instead of cash. That means that each shareholder receives an increase in shares in proportion to the percentage of the stock dividend increase.

For instance, if the company decides to issue a 10% stock dividend, each shareholder would receive one additional stock for every ten that he has.

It’s important to note that even though the overall number of stocks increases, their value decreases as well, since the company’s value remains the same even if the number of total stocks increases.

The biggest benefit of a stock dividend is the potential for growth – if the shareholder expects the company’s value to increase, having more stocks can eventually result in a bigger rate of return, as the company can use the funds it did not pay out for growth.

The shareholder may also choose to sell his newly gained stocks for an immediate individual cash dividend.

While you may think that a cash dividend is a more valuable option, that is not always the case.

Stock dividends have the considerable benefit of not requiring any tax to be paid, unlike cash dividends, which always increase taxes to the person receiving the payout.

However, because of market instability, sometimes taking a cash dividend may be a smarter choice, as the stocks are always at risk of becoming worthless if the company goes under.

How Are Dividends Reported Then?

So, since the answer to the question – are dividends an expense – is answered, and we’ve also looked at what dividends are and the different types of dividends, we must now look at income statement dividends and how you should declare them.

As a company, you will likely need to report your dividends on the following:

-        Statement of Retained Earnings

If you have dividends that you plan to pay out but haven’t done it yet, they will need to go on the balance sheet under the current liabilities section.

Final Words

Dividends are an integral part of running a successful business, but to make the most of what they can offer, it’s essential to understand the tax implications that come with different types of dividends.

If you want help with figuring out the best way to declare your dividends, Dave Burton is here to help – call 954.961.1040 or email to hello@burtoncpa.com and let’s find the best solution together!


Cost of Goods Sold: What Expenses Are Included?

Cost of Goods Sold Explained

 

When selling any type of product, the revenue from the sale is rarely, if ever, all profit.

In fact, in almost all cases, there are various expenses that the business has to take on to sell the goods in the first place, and these expenses need to be calculated to get an objective calculation of profits.

That’s where the cost of goods sold comes in.

Let’s explore what is included in cost of goods sold, is cost of goods sold an expense, why it’s important, and how you can find cost of goods sold for your business.

What is Cost of Goods Sold?

Cost of goods sold is a way to measure the expenses that a business accrues when selling products.

It allows you to figure out how much the sale of the product costs the business, so that business owners can not only better understand their profit margins and pricing structure, but also file for taxes according to how the items that make up cost of goods sold impact the bottom line.

In fact, you need to get cost of goods sold numbers precisely calculated for your business tax return, as it will reduce your business income and allow you to lower the tax bill that you’ll eventually have to pay.

The cost of goods sold can be split into two main categories:

Direct costs, which relate to either purchase or the manufacturing of the products that you are selling. Basically, it’s how much you pay the wholesaler for your products, or how much it costs for you to create them yourself.

Indirect costs of goods sold are those costs that come with warehousing, managing, and overseeing the goods sold while they are in your possession.

However, it does not include distribution or sales force costs associated with selling the product.

Still, the answer to the question – is COGS an expense – is a definite yes, and it is treated as such for tax purposes as well.

Why is It Important?

There are many reasons why a business must figure out its cost of goods sold.

Since COGS is an expense, we know that it plays a role in your business tax returns and can help lower the tax bill.

By subtracting the cost of goods sold from your gross income, you can figure out your net income and know from what amount you need to pay taxes.

But it plays a vital role in other areas as well.

For instance, as a business, you need to be able to set pricing that will allow you to maintain sustainable profit margins, which will cover all of the expenses that your business accrues.

By figuring out your cost of goods sold, you can come up with a reliable formula for establishing prices that are both competitive in the marketplace and profitable for you after you add everything up.

How to Calculate the Cost of Goods Sold?

Now that we’ve figured out what is cost of goods sold and why it matters, we need to figure out what goes into cost of goods sold and how to calculate it.

The process starts with establishing the essential components that you will need.

One way is to figure out the beginning inventory costs that you had at the start of the year, the additional costs of the inventory that you purchased throughout the year, minus the ending inventory costs that you had left at the end of the year.

The number that you will be left with is the cost of goods sold.

This number is what you can potentially deduct from your gross revenue, reducing your overall tax bill.

The next step is figuring out direct COGS vs. indirect COGS.

As we briefly discussed, direct costs include the costs of buying the products for resale or raw materials or parts for making the products. They can also include packaging costs, inventory of finished products, supplies for productions, and even overhead costs that relate to manufacturing.

Indirect costs, on the other hand, can be things like storage of products, depreciation of equipment or facilities, salaries of staff overseeing the products, administrative equipment, to name a few.

Another group of potential expenses relating to cost of goods sold is the facility expenses.

We already talked about warehousing, but in this case, you will need to allocate a percentage of your facility costs to each product sold in the period that you are calculating the COGS for.

Final Words

Calculating the cost of goods sold can be a complicated process, especially in larger companies or if you are selling a range of products.

Therefore, it’s best to get help from a professional CPA who can help you work through every hurdle.

Dave Burton is a certified public accountant who can help you calculate your cost of goods and ensure that you account for every important detail. Email us at hello@burtoncpa.com and let’s figure out the best way to move forward.