Proposed dividends become a liability when declared; paid dividends reduce what?

Proposed dividends become a liability when declared; paid dividends reduce what?

• A. Cash and retained earnings
• B. Revenue
• C. Asset
• D. Retained earnings only

Answer: (A)

Dividends are distributions to owners, so when they are declared the company records a liability to pay the shareholders and reduces retained earnings to reflect that profits have been distributed. When the dividend is actually paid, the liability is settled by dropping cash from the balance sheet, which is an asset. Because retained earnings were already reduced at declaration, the overall effect of paying the dividend is a decrease in both cash and retained earnings. That’s why the best answer is that paid dividends reduce cash and retained earnings. Revenue isn’t affected by dividend payments, and stating it reduces only an asset would miss the fact that equity is reduced as well.

Dividends are distributions to owners, so when they are declared the company records a liability to pay the shareholders and reduces retained earnings to reflect that profits have been distributed. When the dividend is actually paid, the liability is settled by dropping cash from the balance sheet, which is an asset. Because retained earnings were already reduced at declaration, the overall effect of paying the dividend is a decrease in both cash and retained earnings. That’s why the best answer is that paid dividends reduce cash and retained earnings. Revenue isn’t affected by dividend payments, and stating it reduces only an asset would miss the fact that equity is reduced as well.