Explain the concept of a proposed dividend and when it becomes a liability.

• A. A declared dividend; becomes liability as soon as declared.
• B. A proposed dividend; becomes a liability when approved by shareholders.
• C. A forecast dividend; never becomes a liability.
• D. An amount recognized as expense; immediately reduces equity.

Answer: (B)

A proposed dividend is a recommendation by the directors to pay a portion of profits to shareholders. Until shareholders approve it, there is no legal obligation, so no liability is recognised. Once approval is given, the company then has a present obligation to pay, and a liability known as dividends payable is recognised, with retained earnings reduced. When the cash is subsequently paid, the liability is discharged. The other options misstate the timing or the nature of dividends, since dividends are distributions of equity, not expenses, and a proposal does not become a liability until it is approved by shareholders.