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!