How Does the Payment of Dividends Affect the Accounting Equation?

The basic accounting equation is spelled out as assets equal liabilities plus owner's equity. When dividends are paid, the payment is made out of the equity account causing a decrease in the owner's equity account, also called retained earnings.

Description

Dividends are payments made from the earnings of a business. Paying dividends is a way a company shares a portion of the profits made throughout an accounting period.

Details

When dividends are paid, an accounting journal entry occurs. Typically prior to dividends being paid, dividends are declared to be paid. This declaration also requires a journal entry. The journal entry for declaring dividends is a debit to retained earnings and a credit to dividends payable which is a liability. The journal entry when the dividends are paid is accomplished by debiting dividends payable and crediting cash.

Explanation

When the dividends are declared, the accounting equation actually remains the same on both sides. On the right side of the equation, the liability amount increases while the equity amount decreases. After the payment is made, cash is paid out causing the assets to decrease, and the liability, dividends payable, is paid, causing the liabilities to decrease. The accounting equation remains in balance through this type of transaction.

References

• Accounting Coach: Accounting Equation
• Principles of Accounting: Welcome to the World of Accounting