Are Dividends Considered an Expense?

Investing comes with plenty of benefits, such as the ability to grow wealth and save for your biggest financial goals, including retirement. Another important benefit of investing is the possibility of earning dividends. Dividend payments can serve as an additional source of income and can help you grow your investment portfolio more quickly.

For investors, dividends are a type of income. But how are they classified for companies? Do they appear on a company’s cash flow statement? We’ll discuss that in this article, as well as share an example of how dividends work and some of their pros and cons.

What are dividends?

Before we dive into how companies account for dividends, let’s first explain what dividends are and how they work for investors.

Dividends are payments that publicly traded companies make to their shareholders. They serve as a way for companies to pass along some of their profits to investors. Not all companies pay dividends, and some do only occasionally. But those companies that regularly pay dividends usually do so quarterly (though they can also pay them monthly or semiannually).

How to earn dividend payments

Generally speaking, for an investor to earn dividends, they must own shares in the company as of the ex-dividend date. If someone buys shares after that date, they won’t be paid dividends. Similarly, even if an investor sells their shares before the dividends are paid, they’ll still receive the dividend because they owned the shares on the ex-dividend date.

Whether a company pays dividends and how much they pay depends on several factors. First, larger and more established companies are more likely to pay dividends. These companies aren’t investing in growth at as high a rate as newer companies or those still in their growth phase. As a result, they’re more willing and able to pass those profits along to shareholders.

Companies are also more likely to pay dividends when they do well. When a company is going through a hard season or when the economy as a whole is struggling, companies may cut back on their dividends to ensure their financial security.

Cash dividends vs. stock dividends

Dividends can come in two primary forms: cash or stock. While cash dividends are more common, some companies prefer to offer a stock dividend.

• Cash. A cash dividend is simply a cash payment a company makes to its shareholders. Cash dividends are usually set at a per-share amount. For example, a company might pay dividends of $1 per share. If an investor owns 100 shares, they’ll be paid $100 in dividends.
• Stock. In this case, the company simply issues new shares of stock to its existing shareholders, usually in proportion to each shareholder’s current holdings. For example, a shareholder that owns 1% of the company’s stock would be paid 1% of the company’s stock dividends.

It’s important to keep in mind that offering dividend payments through cash or stock dividends doesn’t affect a company’s net income.

Are dividends an expense for tax purposes?

It may seem like dividends paid to investors should be considered an expense for a company since it’s money leaving the company. But for accounting purposes, dividends aren’t recorded as an expense on a company’s income statement.

When a company pays dividends, it generally does so from its profits or retained earnings accounts. A company’s retained earnings account holds an amount it sets aside, just as an individual would set some of their income aside in a savings account.

A company’s retained earnings are recorded in the equity section of its balance sheet. Rather than dividends being recorded as an expense on a company’s income statement, they are simply subtracted from that retained earnings amount on the balance sheet. In other words, these dividends are reallocated from the company’s equity to additional paid-in capital accounts and common stock.

Why aren’t dividends considered expenses?

Dividends aren’t considered expenses for a few different reasons. First, dividends simply aren’t an operating expense like the others that would be recorded on the income statement. And unlike true expenses, dividends can’t be deducted for tax purposes.

For example, when a company spends $1,000 on equipment, it can write off that expense to help reduce its tax burden. But if a company pays $1,000 in dividends, it can’t write off that amount. If a company could write off dividends, it would serve as a way for companies and their shareholders to avoid taxation on those profits. In that case, far more companies would probably pay dividends to their investors.

Pros and cons of dividends

Dividends come with some serious advantages, but not all companies offer them. Of course, dividends also have some disadvantages. Below we’ll talk about some of the pros and cons of dividends for both investors and companies.

Erin Gobler

Erin Gobler is a Wisconsin-based personal finance writer with experience writing about mortgages, investing, taxes, personal loans, and insurance. Her work has been published in major outlets, such as SuperMoney, Fox Business, and Time.com.