Machinery is purchased on credit. What effect does this transaction have on the accounting equation?

Question

BlackTom AI · Accepted Answer

Consider the basic accounting equation: Assets = Liabilities + Shareholders' Equity. When machinery is purchased on credit, two effects occur at once. First, the asset 'machinery' increases because the company now owns more equipment. Second, a liability increases because the company has an obligation to pay the supplier in the future.

Option 1: 'Assets and liabilities increase' — This aligns with the dual effect of the transaction: an increase in assets (machinery) and an increase in liabilities (accounts payable or other payable).

Option 2: 'Assets and shareholders' equity increase' — This would imply the financing came from the owners or from retained earnings, but a credit purchase creates a liability, not an immediate equity increase. Therefore this is incorrect.

Option 3: 'Liabilities increase and shareholders' equity decreases' — While liabilities do increase, there is no direct decrease in shareholders' equity from the act of purchasing on credit. The change in equity would occur only if there were expenses or distributions, not simply by buying on credit.

Option 4: 'Assets and liabilities decrease' — This would suggest an outflow or reduction of both an asset and a liability, which does not describe a credit purchase. The machinery asset increases, and the related liability also increases, not decreases.

In summary, the only option that correctly reflects both sides of the transaction within the accounting equation is that assets and liabilities increase.

BACC012 Week 2: Practice Quiz

Machinery is purchased on credit. What effect does this transaction have on the accounting equation?

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