CMA Foundation · Fundamentals of Financial and Cost Accounting · Accounting Principles, Concepts and Conventions
In the double entry system, a firm pays Rs 8,000 to a creditor, Sunrise Suppliers, in full settlement of the amount due. What is the effect on the accounting equation?
Paying a creditor reduces cash, which is an asset, by Rs 8,000 and also removes Rs 8,000 of the liability to creditors. Capital is unchanged, and the accounting equation stays balanced with both assets and liabilities lower by the same amount.
- AAssets decrease by Rs 8,000 and liabilities decrease by Rs 8,000Correct
- BAssets increase by Rs 8,000 and liabilities decrease by Rs 8,000
- CAssets decrease by Rs 8,000 and capital decreases by Rs 8,000
- DLiabilities decrease by Rs 8,000 and capital increases by Rs 8,000
Explanation
Paying the creditor reduces cash, an asset, and reduces creditors, a liability, by the same amount. Capital is unaffected, so the equation stays balanced. Treating it as a fall in capital confuses payment of a liability with an expense.
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