What entry is made when dividends are declared?

When dividends are declared, the appropriate entry involves recognizing a liability on the books. The correct action is to credit dividends payable. This reflects the company's obligation to pay out dividends to its shareholders.

When dividends are declared, the company acknowledges that it owes shareholders a specific amount, which triggers the liability. The entry made would debit retained earnings, as it reduces the equity of the shareholders, and credit dividends payable, indicating that the company now has a legal obligation to remit this payment to the shareholders.

In this context, retaining the earnings is necessary to record the decrease in equity due to the declaration of dividends, which is why debiting retained earnings is part of the process. However, the primary focus of this particular entry being queried is on the establishment of the liability, which is appropriately captured by crediting dividends payable. This reflects the accountability the company holds in relation to the payment of dividends to its shareholders.