After preparing the financial statements for the current year, the accountant for Exquisite Gems closed the Dividends account at year-end by debiting Income Summary and crediting the Dividends account. What is the effect of this entry on current-year net income and the balance in the Retained Earnings account at year-end?
A) Net income is overstated and the balance in the Retained Earnings account is correct.
B) Net income is correct and the balance in the Retained Earnings account is overstated.
C) Net income is understated and the balance in the Retained Earnings account is understated.
D) Net income is understated and the balance in the Retained Earnings account is overstated.

Question

Quizplus · Accepted Answer

Closing the Dividends account by debiting Income Summary and crediting the Dividends account does not affect current-year net income because dividends are not an expense but a distribution of profits. By crediting the Dividends account, the entry reduces the balance of this account to zero, which in turn reduces the balance of the Retained Earnings account since dividends are a reduction of retained earnings. However, by debiting Income Summary, the accountant is transferring the net income of the current year to Retained Earnings, which will result in an overstatement of the ending balance in Retained Earnings. Therefore, the balance in Retained Earnings account is overstated, but net income is correct.

After Preparing the Financial Statements for the Current Year, the Accountant