Cash or stock dividends distributed to shareholders are not recorded as an expense on a company's income statement.
This is because stock and even cash dividends do not affect a company's net income. Rather, they represent a part of a company's profits or accumulated cash which is being returned to a company's shareholders as a reward for their investment.
While cash dividends reduce the overall shareholders' equity balance, stock dividends represent a reallocation of part of a company's retained earnings to the common stock and additional paid-in capital accounts.
What Are Dividends?
A cash dividend is a sum of money paid by a company to a shareholder out of its profits or reserves. It is a kind of reward to the shareholder that the company has decided to make rather than a necessary outlay.
Therefore, dividends are not considered to be a part of a company's cash outflow that is necessary to conduct its business operations. The cost is not included in the company's income statement and the outlay is not considered an expense.
Cash Dividends Accounting
Cash dividends represent a company's outflow that goes to its shareholders. It is recorded through a reduction in the company's cash and retained earnings accounts.
Because cash dividends are not a company's expense, they show up as a reduction in the company's statement of changes in shareholders' equity.
Cash dividends reduce the size of a company's balance sheet and its value since the company no longer retains part of its liquid assets.
Stock Dividends Accounting
A stock dividend is an award to shareholders of additional shares rather than cash. Similarly, stock dividends do not represent a cash flow transaction and are not considered an expense.
Companies distribute stock dividends to their shareholders in a certain proportion to its common shares outstanding. Stock dividends reallocate part of a company's retained earnings to its common stock and additional paid-in capital accounts. Therefore, they do not affect the overall size of a company's balance sheet.
How Dividends Are Paid
Whether paid in cash or in stock, dividends generally are announced, or "declared," by a company and are then paid out on a quarterly basis at a specified date. Investors are paid in proportion to their holdings. For example, a company might pay a dividend of .25 cents per share, payable 60 days from the date of the announcement.
A company's history of dividends is an important factor in many investors' decision-making process. Dividends tend to be most prized by relatively conservative investors who buy stocks for the long term, and by investors who value the regular income they provide. Dividend-yielding stocks are a component of most portfolios recommended by professional financial advisers.
As noted, there is never a guarantee that a dividend will be paid next year. However, some companies have earned boasting rights over their history of dividend payments. Coca-Cola, for example, notes on its website that it has paid a quarterly dividend since 1955 and that its dividend has increased in each of the last 55 years.