Which statement about dividends and net income is true?

• A. Dividends reduce net income on the income statement
• B. Dividends reduce cash flow from investing activities
• C. Dividends do not affect net income; they affect retained earnings and cash flow from financing
• D. Dividends increase net income

Answer: (C)

Dividends are distributions of profits to shareholders and do not flow through the income statement. Net income comes from revenue minus expenses and is reflected on the income statement; it increases retained earnings through the closing process. Dividends, however, reduce retained earnings and cash when paid, and are shown in the financing section of the cash flow statement rather than in operating or investing activities. So the statement that dividends do not affect net income but do affect retained earnings and financing cash flows is the accurate one.