Is Dividend Expense?

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Blog Author :

WallStreetMojo Team

Edited by :

Ashish Kumar Srivastav

Reviewed by :

Dheeraj Vaidya, CFA, FRM

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Is Dividend an Expense Explained

The dividends are not considered an expense in the income statement due to the following reasons:

  1. Dividends are the distribution of profits to the shareholders as a return on their investments.
  2. 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.
  3. 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. So that answers a common question of is dividend expense on the income statement.
  4. Dividends are neither classified as a direct cost or indirect cost 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.
  5. They are deducted from the profit after taxes to calculate the earnings per share of the company.
  6. 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

Let us understand how a journal entry would be to answer the question of is dividend expense tax deductible through the entries below.

Journal Entries for Dividend Expense

#1 - Cash Dividends Expense

Cash Dividends refer to the direct cash payment made by the company to its stockholders.

Example

ABC Ltd pays its shareholders cash dividends at $1 per share. It has 10,00,000 shares outstanding as on date.

Dividend Expense Example 1
Dividend Expense Example 1-1

#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. The existing outstanding capital is 10,00,000 shares. The face value is $10. The fair value is $25.

Journal Entry:

Dividend Expense Example 2

#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 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.

Dividend Expense Example 3
Dividend Expense Example 3-1
Dividend Expense Example 3-2

#4 - Scrip Dividends

It refers to the promissory note issued by the company to pay its shareholders later since the company is facing liquidity issues.

Example

PQR Ltd declared a scrip dividend of $10,00,000 to its shareholders after one year from the said date. The Interest payable is 10%.

Example 4

After 1 Year:

Example 4-1

#5 - Liquidating Dividends

Liquidating Dividends 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 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 company's equity holders by payment of Dividends. The amount of liquidating dividend is $5,00,000

Example 5
Example 5-1

Advantages

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.

Limitations

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.