Which of the following statements about cash dividends is true?

• A. Cash dividends are recorded as an expense on the income statement.
• B. Cash dividends reduce a corporation's retained earnings.
• C. Cash dividends are paid only to bondholders.
• D. Cash dividends increase the total stockholders' equity.

Answer: (B)

Verified step by step guidance

1. Understand the concept of cash dividends: Cash dividends are distributions of a corporation's earnings to its shareholders, typically in the form of cash. They are not considered an expense but rather a reduction in retained earnings, which is part of stockholders' equity.
2. Clarify the role of retained earnings: Retained earnings represent the accumulated profits of a corporation that have not been distributed as dividends or used for other purposes. When cash dividends are declared, they reduce retained earnings because the company is distributing part of its profits to shareholders.
3. Evaluate the incorrect options: Cash dividends are not recorded as an expense on the income statement because they are a distribution of profits, not a cost of operations. Cash dividends are paid to shareholders, not bondholders, as bondholders receive interest payments instead. Cash dividends do not increase stockholders' equity; they reduce it by decreasing retained earnings.
4. Identify the correct statement: The correct statement is 'Cash dividends reduce a corporation's retained earnings,' as this reflects the accounting treatment of cash dividends.
5. Summarize the impact of cash dividends: When cash dividends are declared, they are recorded as a liability (Dividends Payable) until paid. Upon payment, the liability is reduced, and retained earnings decrease, reflecting the distribution of profits to shareholders.