Financial Glossary
Accounting for Dividends
Accounting for dividends is the process of recording distributions a company pays to its shareholders out of retained earnings. When a dividend is declared, the company records a reduction in retained earnings and a corresponding dividend payable liability; when it is paid, the liability is cleared and cash decreases. Dividends are not an expense and do not appear on the income statement, because they represent a distribution of profit rather than a cost of earning it.
Problem & Application
Owners of S-corps and C-corps who pull profit out of the business sometimes record distributions as expenses, which understates taxable income and distorts the books. Treating a dividend or owner distribution as a draw against equity, not a deduction, keeps retained earnings accurate and avoids problems at tax time. For example, declaring a distribution debits retained earnings and credits dividends payable, then paying it debits the payable and credits cash.
In Short
Recording dividends as an equity distribution rather than an expense keeps both the balance sheet and the tax return accurate.