Dividend refers to the portion of profits the company has generated which is distributed to the company’s shareholders. Most people would think that this is an expense from the company’s perspective because the company spends money to pay the investors. This is one of the common misconceptions among people who do not know accounting treatments related to retained earnings and dividends. To avoid problems and inaccuracies arising from such misunderstanding, business owners who do not know accounting well are encouraged to hire an accounting firm in Johor Bahru and let the professionals help them with such tasks.
The dividend that the company distributes to its shareholders is not an expense. It is part of the company’s profit that the company returns to its shareholders as a return on the capital that they have invested in the business (Also see How To Calculate Return on Capital Employed (ROCE)?). Thus, the company should deduct the sum of dividend distributed from its retained earnings.
In the profit and loss statement of the company, the dividends will not appear as an expense due to various reasons. Dividends are the return that the company gives to its shareholders on the investments that they have made in the form of the distribution of the company’s profits and they make up part of the appropriation account. As dividends are not directly related to the company’s revenue, the company should not deduct them as an expense in the profit and loss statement.
Besides, the amount of money that the company has paid to the shareholders as dividends are out of the normal course of the operation of the business. Thus, the dividends are neither considered as the direct costs nor the indirect costs as they are irrelevant to the company’s products or services.
If the company was not able to earn enough profits, it can still pay the dividends from its retained earnings. Therefore, in the balance sheet, the company needs to debit the retained earnings account and create a liability for dividends payable in the current liabilities section. From here, we can see that the profit and loss account does not include in the process of recording the dividends distributed.
The company may choose to distribute dividends in different ways. For example, the company can pay cash to the shareholders directly or it may issue extra shares to the shareholders. There is also a non-monetary method of making the payment, that is to pay the shareholders by using the company’s assets (Also see Introduction to Tangible and Intangible Asset) like the plant and machinery, real estates and so on. Apart from that, the company may distribute dividends by issuing the promissory note or to pay the liquidating dividends to the shareholders if it undergoes liquidation.
In conclusion, the regular distribution of dividends shows that the operations of the company are stable, and the shareholders will be confident that the business is able to generate enough profits. However, the distributions may impede the growth of the business as the company has paid out all the extra cash it has but did not invest them in the non-current assets that can help the business to generate more profits in the long run. Thus, companies should take various factors into consideration when deciding on their dividend policies.