Final answer:
It is false that a corporation's net income on the income statement is reduced when it declares a dividend. Dividends are paid from retained earnings, not counted as an expense, and thus do not affect the net income figure on the income statement. They are treated as a distribution of profits to shareholders and impact retained earnings within the equity section of the balance sheet.
Step-by-step explanation:
When a corporation declares a dividend, there is a common misconception that its net income on the income statement is reduced; however, this statement is false. Dividends are a distribution of earnings to shareholders and are recorded in the retained earnings account within the equity section of the balance sheet. They are paid out of the corporation's past earnings or current earnings and do not reduce the net income reported on the income statement.
Net income represents the company's earnings after all expenses, including taxes and operating costs, have been deducted during a specific period. It is this figure that is used to calculate earnings per share, which can influence the decision to declare dividends, but the dividend declaration and payments themselves are not considered an expense and thus do not impact net income.
To illustrate further, dividends pass through the statement of retained earnings, which reconciles the opening and closing retained earnings for a particular period. After determining the net income and adding it to the starting retained earnings balance, dividends are then subtracted to calculate the ending retained earnings balance. Therefore, while net income contributes to the ability of a corporation to pay dividends, the act of declaring and paying dividends itself is a separate transaction that reflects the allocation of profits, not the creation of them.