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CMA Foundation · Fundamentals of Financial and Cost Accounting · Journal and Ledger

Under the accounting equation, a trader pays Rs 20,000 to a supplier in cash to settle an amount owed for goods bought earlier on credit. What is the effect of this transaction?

Assets and liabilities both fall by Rs 20,000. Cash, an asset, goes down when the supplier is paid, and creditors, a liability, go down by the same amount. Capital remains unchanged, so the accounting equation stays balanced after the transaction.

  1. AAssets decrease by Rs 20,000 and liabilities decrease by Rs 20,000Correct
  2. BAssets increase by Rs 20,000 and liabilities decrease by Rs 20,000
  3. CAssets decrease by Rs 20,000 and capital decreases by Rs 20,000
  4. DLiabilities decrease by Rs 20,000 and capital increases by Rs 20,000

Explanation

Paying a creditor reduces cash, an asset, and reduces creditors, a liability, by the same amount. Capital is unchanged, so the equation still balances. Option C wrongly treats the payment as an expense reducing capital, but the purchase was already recorded.

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