Final answer:
When a company declares a cash dividend, the retained earnings account is debited, reflecting a decrease in the company's retained profits due to the dividend payout obligation.
Step-by-step explanation:
When a cash dividend is declared by a company, the correct accounting treatment involves making an entry in the company's financial records to reflect the obligation to pay the dividend to shareholders. The correct response to the student's question is:
- b. the retained earnings account is debited.
This is because declaring a dividend reduces the amount of retained earnings available in the company, which are the profits that have been reinvested in the business rather than distributed to shareholders. Since retained earnings is an equity account with a normal credit balance, reducing its balance requires a debit.
Here is the accounting entry that is made when cash dividends are declared:
- Debit the Retained Earnings account for the total amount of the dividends.
- Credit the Dividends Payable account, which is a liability account, for the same amount, indicating the company's obligation to pay the declared dividends.
At the time of the declaration, the Cash account is not affected; it is only debited when the cash dividend is actually paid out to shareholders.