Dividends refer to the portion of a company’s profits.
Written By Kevin Mil - Author/Founder
What are Dividends?
When a company distributes its profits to shareholders, it’s known as paying dividends.
Dividends can be paid in various forms, such as cash, stock, or property, and are usually distributed on a quarterly or annual basis.
The primary purpose of dividends is to share the company’s success with its owners, retain value, and attract investors.
As a company declares a dividend, it records a dividend expense on the income statement and a dividend payable as a liability on the balance sheet.
Shareholders who receive cash dividends may be subject to taxation as ordinary income.
To illustrate, a company with $1 million in net income might pay a cash dividend of $200,000, which would result in a $200,000 expense on the income statement and a $200,000 liability on the balance sheet.
Is dividend an asset or expense?
When a shareholder receives a cash dividend, the payment can be considered an asset.
This is because the cash dividend is a direct payment to the shareholder, providing them with liquid funds that they can use as needed.
When a company pays a cash dividend, it records the payment as a liability on the balance sheet, specifically a “cash dividend payable” liability.
For example, assume XYZ Inc.
has $1 million in net income and pays a cash dividend of $200,000 to its shareholders.
The payment of the cash dividend reduces XYZ Inc.’s retained earnings by $200,000.
The company does not record a dividend expense, as the cash dividend is a distribution of earnings rather than an expense.
Instead, the dividend is recorded as a deduction from retained earnings.
From the shareholder’s perspective, a stock dividend can not be considered an asset, as they receive additional shares of stock that can be sold or held for investment.
However, the value of each share may be lower due to the increased supply of shares.
From the company’s perspective, a stock dividend does not reduce retained earnings or increase equity.
Instead, it simply increases the number of outstanding shares, without affecting the company’s equity value.
This can result in a lower price per share, making the stock more affordable for individual investors.
Are dividends equity or debt?
In the perspective of the receiver, a cash dividend can be considered as an equity because it’s part of their income.
However, from the company’s perspective, it’s a reduction of retained earnings when the board of directors approves the cash dividend through a board resolution.
This is because the company is essentially transferring equity from its balance sheet to its shareholders.
The accounting entry for this transaction is a debit to retained earnings and a credit to other liabilities.
As a result, a cash dividend can be an equity for the receiver, but a reduction of retained earnings for the payor.