Each of the following transactions has the effect of reducing retained earnings except ________.
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A. B. C. D.B
Stock splits have no effect on retained earnings. They are simply a redistribution of the same equity of the company but with a different number of outstanding shares.
In this question, we are asked to identify the transaction that reduces retained earnings. Retained earnings represent the accumulated profits of a company that have not been distributed to shareholders in the form of dividends.
Let's examine each of the options provided:
A. Cash dividends: When a company pays cash dividends, it distributes a portion of its earnings to its shareholders. Cash dividends reduce retained earnings because the profits are being transferred out of the company and given to shareholders. Therefore, cash dividends have the effect of reducing retained earnings. This option is a correct answer to the question.
B. Stock splits: A stock split is a corporate action where a company divides its existing shares into multiple shares. For example, a 2-for-1 stock split would double the number of outstanding shares, but the individual shares would be worth half of their original value. Stock splits do not directly affect retained earnings because they only change the number and price of shares. Retained earnings are not affected by the stock split itself, as the overall value of the company remains the same. Therefore, stock splits do not reduce retained earnings. This option is not the correct answer to the question.
C. Stock dividends: Stock dividends are similar to stock splits in that they involve distributing additional shares to existing shareholders. Instead of splitting existing shares, the company issues new shares to shareholders as a dividend. Stock dividends do not reduce retained earnings because they do not involve a direct outflow of cash from the company. The company essentially capitalizes a portion of retained earnings by converting them into additional shares. While stock dividends increase the number of shares outstanding, the overall value of the company remains the same. Therefore, stock dividends do not reduce retained earnings. This option is not the correct answer to the question.
D. Dividends in kind: Dividends in kind, also known as property dividends, refer to the distribution of non-cash assets to shareholders as dividends. Instead of distributing cash or additional shares, the company may distribute assets such as inventory, investments, or other property. Similar to stock dividends, dividends in kind do not reduce retained earnings because they do not involve a direct cash outflow from the company. The assets distributed retain their original value, and retained earnings are not affected. Therefore, dividends in kind do not reduce retained earnings. This option is not the correct answer to the question.
To summarize, the transaction that has the effect of reducing retained earnings is cash dividends (option A). Stock splits, stock dividends, and dividends in kind do not directly reduce retained earnings.