A business receives a bill for services rendered from one of its suppliers. The business will pay the supplier next month. When the business receives the bill from its supplier, how does this affect the accounting equation?A) Liabilities increase; owners' equity increases.B) Assets decrease; owners' equity decreases.C) Liabilities increase; owners' equity decreases.D) Assets increase; liabilities increase.
Question
A business receives a bill for services rendered from one of its suppliers. The business will pay the supplier next month. When the business receives the bill from its supplier, how does this affect the accounting equation?A) Liabilities increase; owners' equity increases.B) Assets decrease; owners' equity decreases.C) Liabilities increase; owners' equity decreases.D) Assets increase; liabilities increase.
Solution
The correct answer is C) Liabilities increase; owners' equity decreases.
Here's why:
Step 1: Understand the Accounting Equation The basic accounting equation is Assets = Liabilities + Owners' Equity. This means that the resources owned by the business (assets) are funded either by borrowing (liabilities) or by the owners (owners' equity).
Step 2: Analyze the Situation When the business receives a bill from its supplier, it means the business owes money to the supplier. This is a liability because it's an amount the business has to pay in the future.
Step 3: Apply the Situation to the Accounting Equation Since the business now has an additional liability, the liabilities side of the equation increases.
Step 4: Understand the Effect on Owners' Equity The increase in liabilities without a corresponding increase in assets (because the business hasn't acquired any new resources) means that the owners' equity must decrease to keep the equation balanced.
So, the accounting equation after receiving the bill becomes: Assets = Increased Liabilities + Decreased Owners' Equity.
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