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ACCA Applied Knowledge · Financial Accounting · Double-entry bookkeeping principles including the maintenance of accounting records

Lumen Co pays a $4,000 loan instalment from its bank account, of which $3,200 is capital repayment and $800 is interest. What is the effect on the accounting equation?

Assets fall by $4,000 because cash is paid out. Liabilities fall by $3,200 for the capital repaid, and equity falls by $800 because the interest is an expense reducing profit. The equation balances, as the $4,000 decrease equals $3,200 plus $800.

  1. AAssets decrease by $4,000, liabilities decrease by $3,200 and equity decreases by $800Correct
  2. BAssets decrease by $4,000, liabilities decrease by $4,000 and equity is unchanged
  3. CAssets decrease by $3,200, liabilities decrease by $3,200 and equity decreases by $800
  4. DAssets decrease by $4,000, liabilities decrease by $800 and equity decreases by $3,200

Explanation

Cash falls by the full 4,000. The loan liability falls by the capital portion, 3,200. Interest of 800 is an expense that reduces profit and so equity. Check: -4,000 = -3,200 + -800. Option B ignores the expense.

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