If a cash dividend is declared but not yet paid, what effects would you expect on the accounts?

• A. Retained earnings decrease; dividends payable increase
• B. Retained earnings increase; dividends payable decrease
• C. Cash increases
• D. No effect on equity

Answer: (A)

Declaring a cash dividend reduces equity and creates a liability. When the dividend is declared, the company commits to paying shareholders, so retained earnings (part of stockholders’ equity) decrease, and a dividends payable liability is recorded. Cash isn’t affected until payment is made, so there’s no increase in cash at this moment.

That’s why the correct effect is a decrease in retained earnings and an increase in dividends payable. Options suggesting cash rises, or no change in equity, don’t fit the timing of a declaration.