PSIA Accounting Practice Test

What is the effect on the three statements when a company pays $100 in dividends?

Income Statement: No changes. Cash Flow Statement: Cash Flow from Financing down by $100. Balance Sheet: Cash down $100; Shareholders' Equity (Retained Earnings) down $100. Income Statement: Net income decreases by $100. Cash Flow Statement: Cash Flow from Financing down by $100. Balance Sheet: Cash down $100; Equity down $100. Income Statement: No changes. Cash Flow Statement: Cash Flow from Financing up by $100. Balance Sheet: Cash up $100; Equity up $100. Income Statement: Revenue increases by $100. Cash Flow Statement: Cash Flow from Financing down by $100. Balance Sheet: Cash down $100; Equity up $100.

Correct Answer:

Income Statement: No changes. Cash Flow Statement: Cash Flow from Financing down by $100. Balance Sheet: Cash down $100; Shareholders' Equity (Retained Earnings) down $100.

Explanation:

Dividends are distributions to owners and are not expenses, so the income statement isn’t affected. When a company pays a dividend, cash decreases and shareholders’ equity falls by the same amount because retained earnings (a part of equity) are reduced. On the cash flow statement, dividends paid are a financing activity outflow, so cash flow from financing decreases by the dividend amount. Put together, paying 100 in dividends leaves the income statement unchanged, cash flow from financing down by 100, and on the balance sheet cash down 100 with equity down 100.

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