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.

A company's dividend policy can be reversed at any time and that, too, will not show up on its financial statements.

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.