Multiple Choice
Declaring a cash dividend has what effect on total stockholders’ equity?
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12. Stockholders' Equity
Dividends and Dividend Preferences
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Which of the following is an accurate description of the Dividends account?
A
It is a temporary account used to record distributions of earnings to shareholders.
B
It is a contra-asset account that offsets retained earnings.
C
It is a permanent account that appears on the balance sheet as a liability.
D
It is an expense account that reduces net income on the income statement.
Verified step by step guidance1
Understand the nature of the Dividends account: Dividends represent distributions of a company's earnings to its shareholders. They are not considered an expense, nor do they directly reduce net income.
Recognize that Dividends are recorded in a temporary account. Temporary accounts are closed at the end of the accounting period, meaning their balances are transferred to permanent accounts like Retained Earnings.
Clarify that Dividends are not a contra-asset account. Contra-asset accounts, such as Accumulated Depreciation, offset asset accounts, whereas Dividends reduce Retained Earnings, which is part of equity.
Note that Dividends do not appear on the balance sheet as a liability. Instead, they are recorded in the equity section and reduce Retained Earnings when closed.
Conclude that the correct description is: Dividends are a temporary account used to record distributions of earnings to shareholders, and they reduce Retained Earnings in the equity section of the balance sheet.
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