How does paying a liability in cash affect the accounting equation?
a) Assets increase, liabilities decrease
b) Liabilities decrease stockholders’ equity increases
c) Assets decrease: liabilities decrease
d) Assets increase; liabilities increase
Answer Explanation for Question: How does paying a liability in cash affect the accounting equation?
According to the accounting equation, a company’s total assets equal its total liabilities plus its shareholders’ equity. In double-entry accounting, this straightforward number on the balance sheet is the basis of the balance sheet. The accounting equation ensures that the balance sheet remains balanced. In other words, each debit entry corresponds to a credit entry (or coverage). Accounting equations are also known as balance sheet equations or basic accounting equations.
Accounting equations explain the relationship among assets, liabilities, and equity on a balance sheet. Equity increases when assets increase, and vice versa. The addition of liabilities decreases equity, while the reduction of liabilities (like paying off debt) increases equity. These concepts are fundamental in modern accounting.
Elements of the Accounting Equation
Accounting equations have three components: assets, liabilities, and equity. The formula is straightforward: a company’s total assets equal its liabilities plus its equity. The double-entry bookkeeping system, which has been adopted globally, calculates a company’s total assets correctly.
- Assets: Assets are anything with economic value that a business owns and that can be used now or in the future for its benefit. These include fixed assets such as buildings and plants. They can also include financial assets like stocks and bonds. Also, they may be intangible assets such as patents, trademarks, and goodwill.
- Liabilities: The liabilities of a company include all debt it has incurred, including loans, accounts payable, mortgages, deferred revenues, bond issues, warranties, and accrued expenses.
- Shareholder’s Equity: The shareholders’ equity of a company is defined as the value of the company in dollars. So, if all of the company’s assets are liquidated and all of its liabilities have been paid off, then all of the remaining shares will be returned to the shareholders.
Accounting Equation Formula and Calculation
The formula for calculating accounting equation is:
Assets = Liabilities + Owner’s Equity
I hope after going through this post you might have clearly understood the Question: How does paying a liability in cash affect the accounting equation?