How Cross Corporation's Declaration of Cash Dividend Creates Financial Opportunities

What is the impact of declaring a cash dividend on Cross Corporation's financial position?

a. Increase in assets and decrease in liabilities

b. Decrease in liabilities and increase in expenses

c. Decrease in retained earnings and increase in liabilities

d. Decrease in cash and decrease in retained earnings

Answer:

Decrease in retained earnings $1.96 million and increase in liabilities by $1.96 million.

On declaring a dividend, Cross Corporation should decrease retained earnings by $1.96 million and increase liabilities by the same amount. This represents the distribution of earnings to shareholders (decrease in retained earnings) and the future obligation to pay (increase in liabilities). These changes occur on the declaration date, not on the payment date.

The journal entry for cash dividends involves the decrease of retained earnings and the increase of liabilities, specifically dividends payable, on the date the dividend is declared. In this particular case, Cross Corporation should decrease retained earnings by $1.96 million and increase liabilities by $1.96 million. This action is taken on the declaration date (December 15, 2016) and not on the payment date (January 8, 2017).

When a company declares a dividend, it creates a liability at that time, since it owes the declared amount to its shareholders. The decrease in retained earnings represents the portion of net income or retained earnings that is being distributed to shareholders, while the increase in liabilities symbolizes the company's obligation to pay in the future. Therefore, the correct option is to decrease retained earnings by $1.96 million and increase liabilities by $1.96 million.