What happens when a company declares a cash dividend?

When a company declares a cash dividend, it creates a liability for the amount of the dividend to be paid to shareholders. This is reflected as a current liability on the company's balance sheet because the company is obligated to pay the shareholders within the next accounting period. The declaration of a cash dividend does not immediately affect the cash account, as the actual cash payment occurs at a later date.

As the company recognizes this liability, it also simultaneously decreases its retained earnings, reflecting the distribution of profits to shareholders. Thus, retained earnings are reduced because dividends are typically paid out of those earnings. The impact on total liabilities is significant, as declaring the dividend results in an increase in current liabilities until the dividend is actually paid.

It's important to note that while this action does not impact the company’s assets at the time of declaration, the eventual payment of the dividend will decrease the company’s cash, thereby affecting total assets.