Accounting Equation Transactions Quiz (50 MCQs with Answers and Explanations)

Introduction

The accounting equation is the foundation of double-entry accounting:

Assets = Liabilities + Owner’s Equity

Every business transaction affects at least two accounts while keeping the accounting equation balanced. This Accounting Equation Transactions Quiz helps students preparing for CPA, CMA, ACCA, CIA, FMVA, accounting exams, and job interviews strengthen their understanding of transaction analysis.

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1. Owner Investment

Question 1

A business owner invests $50,000 cash into the company. What is the effect on the accounting equation?

A. Assets +$50,000; Equity +$50,000
B. Assets +$50,000; Liabilities +$50,000
C. Assets -$50,000; Equity +$50,000
D. Liabilities +$50,000; Equity +$50,000

Answer: A

Explanation:
When the owner contributes cash to the business, the company receives an asset (cash), increasing total assets by $50,000. Since the contribution comes from the owner rather than a creditor, owner’s equity also increases by $50,000. No liability is created because the business does not owe this amount to anyone. The transaction keeps the accounting equation balanced by increasing both assets and equity by the same amount.

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Question 2

A company purchases equipment for $15,000 cash. What is the effect?

A. Assets increase $15,000
B. Assets decrease $15,000
C. One asset increases and another asset decreases by $15,000
D. Liabilities increase $15,000

Answer: C

Explanation:
The company exchanges one asset (cash) for another asset (equipment). Cash decreases by $15,000 while equipment increases by $15,000. Total assets remain unchanged because the increase and decrease offset each other. Neither liabilities nor equity are affected. This transaction demonstrates that not all transactions change the total amount of assets; some simply alter the composition of assets.

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Question 3

A business borrows $20,000 from a bank. What happens?

A. Assets +$20,000; Equity +$20,000
B. Assets +$20,000; Liabilities +$20,000
C. Assets -$20,000; Liabilities +$20,000
D. Equity +$20,000; Liabilities +$20,000

Answer: B

Explanation:
When the company receives a bank loan, cash increases by $20,000, resulting in an increase in assets. At the same time, the company incurs an obligation to repay the loan, creating a liability of $20,000. Owner’s equity remains unchanged because borrowing money does not represent earned income or owner investment. The accounting equation remains balanced with equal increases in assets and liabilities.

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Question 4

The company pays $5,000 of an outstanding bank loan. What is the effect?

A. Assets -$5,000; Liabilities -$5,000
B. Assets -$5,000; Equity -$5,000
C. Liabilities -$5,000; Equity -$5,000
D. Assets +$5,000; Liabilities -$5,000

Answer: A

Explanation:
Loan repayment reduces cash, which is an asset, by $5,000. Simultaneously, the loan payable liability decreases by the same amount because part of the debt has been settled. Since the transaction only affects assets and liabilities, owner’s equity remains unchanged. This transaction illustrates how liabilities are reduced when obligations are paid and how the accounting equation remains in balance.

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Question 5

The company provides services and immediately receives $3,000 cash. What is the effect?

A. Assets +$3,000; Equity +$3,000
B. Assets +$3,000; Liabilities +$3,000
C. Assets -$3,000; Equity +$3,000
D. Assets +$3,000; Liabilities -$3,000

Answer: A

Explanation:
Cash received from providing services increases assets because the business now holds more cash. At the same time, revenue increases owner’s equity through retained earnings. Since the service has already been performed, no liability exists. This transaction demonstrates how revenues increase equity while often increasing assets such as cash or accounts receivable.

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Question 6

A company provides services on account for $8,000. What is the effect?

A. Assets +$8,000; Equity +$8,000
B. Assets +$8,000; Liabilities +$8,000
C. Assets -$8,000; Equity +$8,000
D. Liabilities +$8,000; Equity +$8,000

Answer: A

Explanation:
The company earns revenue even though cash has not yet been received. Accounts receivable, an asset, increases by $8,000 because customers owe the company money. Revenue increases owner’s equity by the same amount. The transaction reflects accrual accounting, where revenue is recognized when earned rather than when cash is collected.

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Question 7

A customer pays $2,000 toward an existing accounts receivable. What happens?

A. Assets increase $2,000
B. Assets decrease $2,000
C. Cash increases and Accounts Receivable decreases $2,000
D. Equity increases $2,000

Answer: C

Explanation:
The collection of receivables converts one asset into another. Cash increases by $2,000, while accounts receivable decreases by $2,000. Since the revenue was recognized earlier when the sale occurred, there is no effect on equity. Total assets remain unchanged because the increase in one asset equals the decrease in another asset.

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Question 8

The company purchases inventory on credit for $12,000.

A. Assets +$12,000; Liabilities +$12,000
B. Assets +$12,000; Equity +$12,000
C. Assets -$12,000; Liabilities +$12,000
D. Equity +$12,000; Liabilities +$12,000

Answer: A

Explanation:
Inventory is an asset and increases by $12,000. Because the purchase was made on credit, accounts payable also increases by $12,000, creating a liability. No cash is paid at the time of purchase, and equity remains unchanged. The transaction illustrates how acquiring assets through credit creates an equal increase in liabilities.

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Question 9

A company pays $4,000 cash for rent expense.

A. Assets -$4,000; Equity -$4,000
B. Assets -$4,000; Liabilities -$4,000
C. Assets +$4,000; Equity -$4,000
D. Liabilities +$4,000; Equity -$4,000

Answer: A

Explanation:
Rent is an operating expense that reduces net income and therefore decreases owner’s equity. The payment also reduces cash, which is an asset. Because expenses lower profitability, they decrease retained earnings. This transaction demonstrates how expenses affect both the income statement and the accounting equation through reductions in equity.

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Question 10

The owner withdraws $1,500 cash for personal use.

A. Assets -$1,500; Equity -$1,500
B. Assets -$1,500; Liabilities -$1,500
C. Assets +$1,500; Equity -$1,500
D. Equity +$1,500; Liabilities -$1,500

Answer: A

Explanation:
Owner withdrawals (drawings) reduce business cash and decrease owner’s equity. Withdrawals are not expenses because they do not relate to business operations. Instead, they represent distributions of company resources to the owner. Therefore, assets decrease through reduced cash, and equity decreases by the same amount, maintaining balance in the accounting equation.

Question 11

A company purchases office supplies for $900 cash. What is the effect on the accounting equation?

A. Assets +$900; Equity +$900

B. Assets -$900; Equity -$900

C. One asset increases $900 and another asset decreases $900

D. Liabilities +$900; Assets +$900

Answer: C

Explanation:

Office supplies are considered an asset when purchased because they provide future economic benefits. In this transaction, the supplies account increases by $900 while cash decreases by $900. Since both accounts are assets, total assets remain unchanged. There is no impact on liabilities or owner’s equity because the supplies have not yet been used. This transaction demonstrates an exchange between two asset accounts while maintaining the balance of the accounting equation.

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Question 12

A company pays $2,500 toward its outstanding accounts payable balance. What is the effect on the accounting equation?

A. Assets -$2,500; Liabilities -$2,500

B. Assets +$2,500; Liabilities -$2,500

C. Assets -$2,500; Equity -$2,500

D. Liabilities -$2,500; Equity +$2,500

Answer: A

Explanation:

Accounts payable represents amounts owed to suppliers. When the company pays part of this balance, cash decreases by $2,500, reducing assets. At the same time, accounts payable decreases because the obligation has been partially settled. Owner’s equity is not affected because the expense was recognized when the goods or services were originally acquired. This transaction reduces both assets and liabilities by the same amount while keeping the accounting equation balanced.

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Question 13

A company receives a utility bill for $700 that will be paid next month. What is the effect on the accounting equation?

A. Assets -$700; Equity -$700

B. Liabilities +$700; Equity -$700

C. Assets +$700; Liabilities +$700

D. Assets +$700; Equity +$700

Answer: B

Explanation:

The utility service has already been consumed, so the company must recognize a utility expense. Expenses reduce net income and therefore decrease owner’s equity. Because payment has not yet been made, a liability such as Utilities Payable is recorded. As a result, liabilities increase by $700 and equity decreases by $700. No asset account changes at the time the bill is received. The accounting equation remains balanced despite the accrual.

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Question 14

A customer pays $4,000 in advance for services that will be provided next month. What is the effect on the accounting equation?

A. Assets +$4,000; Equity +$4,000

B. Assets +$4,000; Liabilities +$4,000

C. Assets -$4,000; Liabilities +$4,000

D. Assets +$4,000; Equity -$4,000

Answer: B

Explanation:

When cash is received before services are performed, the company has not yet earned the revenue. Therefore, the amount received is recorded as Unearned Revenue, which is a liability. Cash increases by $4,000, increasing assets, while liabilities increase by the same amount. Owner’s equity does not increase until the service is actually provided. This transaction illustrates the revenue recognition principle and proper treatment of advance customer payments.

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Question 15

A company completes services that were previously paid for by customers in advance. What is the effect on the accounting equation?

A. Assets + Revenue

B. Assets – Liability

C. Equity – Liability

D. Liabilities -; Equity +

Answer: D

Explanation:

When services are performed after receiving advance payment, the company has now earned the revenue. Unearned Revenue decreases because the obligation to provide services has been fulfilled. At the same time, revenue is recognized, increasing owner’s equity. No cash is received at this point because it was collected earlier. Therefore, liabilities decrease while equity increases by the same amount, maintaining balance in the accounting equation.

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Question 16

A company purchases land for $25,000 cash. What is the effect on the accounting equation?

A. Assets +$25,000

B. Assets -$25,000

C. One asset increases $25,000 and another asset decreases $25,000

D. Liabilities +$25,000

Answer: C

Explanation:

Land is a long-term asset. When land is purchased with cash, the land account increases while cash decreases by the same amount. Since both accounts are classified as assets, the total amount of assets remains unchanged. Neither liabilities nor owner’s equity are affected. This transaction is a common example of an asset exchange where the composition of assets changes without affecting total assets.

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Question 17

A corporation issues common stock for $100,000 cash. What is the effect on the accounting equation?

A. Assets +$100,000; Equity +$100,000

B. Assets +$100,000; Liabilities +$100,000

C. Assets -$100,000; Equity +$100,000

D. Liabilities +$100,000; Equity +$100,000

Answer: A

Explanation:

When investors purchase common stock, the company receives cash. Cash increases assets by $100,000. In exchange, shareholders receive ownership rights, which increase shareholders’ equity. No liability is created because the company is not obligated to repay the investment. This transaction demonstrates how owner financing affects the accounting equation by increasing both assets and equity simultaneously.

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Question 18

A company pays employees $6,000 for salaries earned during the month. What is the effect on the accounting equation?

A. Assets -$6,000; Equity -$6,000

B. Assets -$6,000; Liabilities -$6,000

C. Equity +$6,000; Assets -$6,000

D. Assets +$6,000; Equity -$6,000

Answer: A

Explanation:

Salary payments reduce cash, which decreases assets. Salaries are operating expenses, and expenses reduce net income. Since net income ultimately affects retained earnings, owner’s equity decreases by the same amount. No liabilities are affected if the salaries were paid immediately. This transaction highlights the relationship between expenses and reductions in owner’s equity within the accounting equation.

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Question 19

A company earns $1,200 of interest revenue and receives cash immediately. What is the effect on the accounting equation?

A. Assets +$1,200; Equity +$1,200

B. Assets +$1,200; Liabilities +$1,200

C. Assets -$1,200; Equity +$1,200

D. Liabilities +$1,200; Equity +$1,200

Answer: A

Explanation:

Interest revenue increases the company’s earnings and therefore increases owner’s equity. Because the cash is received immediately, cash also increases by $1,200. Since revenue represents an increase in economic benefits resulting from business operations, it contributes positively to equity. No liabilities are involved in this transaction. Both assets and equity increase by the same amount.

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Question 20

A corporation declares and pays cash dividends of $5,000 to shareholders. What is the effect on the accounting equation?

A. Assets -$5,000; Equity -$5,000

B. Assets -$5,000; Liabilities -$5,000

C. Equity +$5,000; Assets -$5,000

D. Liabilities +$5,000; Equity -$5,000

Answer: A

Explanation:

Dividends represent distributions of company earnings to shareholders. When cash dividends are paid, cash decreases, reducing assets. Dividends also reduce retained earnings, which is a component of shareholders’ equity. Unlike expenses, dividends do not affect net income, but they still decrease total equity. Therefore, both assets and equity decrease by $5,000, maintaining the balance of the accounting equation.

 

Question 36

A company purchases a building valued at $250,000 by signing a mortgage payable. What is the effect on the accounting equation?

A. Assets +$250,000; Equity +$250,000

B. Assets +$250,000; Liabilities +$250,000

C. Assets -$250,000; Liabilities +$250,000

D. Liabilities +$250,000; Equity +$250,000

Answer: B

Explanation:

When a company acquires a building through a mortgage, it receives a long-term asset that will be used in business operations. The building account increases by $250,000, increasing total assets. Because the company agrees to repay the mortgage over time, liabilities also increase by $250,000. No revenue is earned and no owner contribution occurs, so equity remains unchanged. This transaction illustrates how companies finance major asset purchases through long-term debt.

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Question 37

At the end of the month, a company accrues employee wages of $3,500 that have not yet been paid. What is the effect on the accounting equation?

A. Assets -$3,500; Equity -$3,500

B. Liabilities +$3,500; Equity -$3,500

C. Assets +$3,500; Liabilities +$3,500

D. Assets +$3,500; Equity +$3,500

Answer: B

Explanation:

Employees have already earned the wages, so the company must recognize wage expense even though payment has not yet been made. Wage expense reduces net income and therefore decreases owner’s equity. At the same time, wages payable is recorded as a liability because the company owes employees the unpaid amount. This adjusting entry follows the accrual basis of accounting by recognizing expenses in the period they are incurred.

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Question 38

The company pays $3,500 cash for wages that were previously accrued. What is the effect on the accounting equation?

A. Assets -$3,500; Liabilities -$3,500

B. Assets -$3,500; Equity -$3,500

C. Liabilities -$3,500; Equity +$3,500

D. Assets +$3,500; Liabilities -$3,500

Answer: A

Explanation:

The wage expense was recognized when the wages were accrued. Therefore, when payment is made later, no additional expense is recorded. Cash decreases by $3,500, reducing assets, while wages payable decreases by the same amount because the obligation has been settled. Owner’s equity remains unchanged because the expense was already recognized in a prior period. The transaction simply eliminates the liability.

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Question 39

A corporation receives $80,000 cash from issuing additional shares of stock. What is the effect on the accounting equation?

A. Assets +$80,000; Equity +$80,000

B. Assets +$80,000; Liabilities +$80,000

C. Assets -$80,000; Equity +$80,000

D. Liabilities +$80,000; Equity +$80,000

Answer: A

Explanation:

Issuing stock allows a company to raise capital from investors. Cash increases by $80,000, increasing assets. In return, shareholders receive ownership interests in the company, causing shareholders’ equity to increase by the same amount. No liability is created because the company is not required to repay shareholders. This transaction is a common example of equity financing used to fund business growth.

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Question 40

A company purchases a trademark for $15,000 cash. What is the effect on the accounting equation?

A. Assets +$15,000; Equity +$15,000

B. Assets -$15,000; Equity -$15,000

C. One asset increases $15,000 and another asset decreases $15,000

D. Liabilities +$15,000; Assets +$15,000

Answer: C

Explanation:

A trademark is an intangible asset that provides future economic benefits through brand recognition and legal protection. When the trademark is purchased, the trademark asset increases by $15,000 while cash decreases by the same amount. Since both accounts are assets, total assets remain unchanged. No liability or equity account is affected because the transaction only exchanges one asset for another.

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Question 41

A consulting firm earns $6,000 in cash for services provided to clients. What is the effect on the accounting equation?

A. Assets +$6,000; Equity +$6,000

B. Assets +$6,000; Liabilities +$6,000

C. Assets -$6,000; Equity +$6,000

D. Liabilities +$6,000; Equity +$6,000

Answer: A

Explanation:

The company receives cash immediately after providing services. Cash increases by $6,000, increasing assets. Since the services have been performed, the amount received is recognized as revenue, which increases owner’s equity through retained earnings. No liability exists because the company has already fulfilled its obligation. This transaction demonstrates the direct relationship between earned revenue and increases in equity.

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Question 42

A company pays $2,200 cash for property taxes. What is the effect on the accounting equation?

A. Assets -$2,200; Equity -$2,200

B. Assets -$2,200; Liabilities -$2,200

C. Assets +$2,200; Equity -$2,200

D. Liabilities +$2,200; Equity -$2,200

Answer: A

Explanation:

Property taxes are operating expenses that reduce the company’s profitability. When the taxes are paid, cash decreases by $2,200, reducing assets. The tax expense decreases net income, which ultimately reduces owner’s equity. Because the taxes are paid immediately, no liability remains. This transaction illustrates how expenses simultaneously reduce assets and equity.

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Question 43

A company completes services that were previously recorded as unearned revenue worth $4,500. What is the effect on the accounting equation?

A. Assets +$4,500; Equity +$4,500

B. Assets -$4,500; Liabilities -$4,500

C. Assets +$4,500; Liabilities -$4,500

D. Liabilities -$4,500; Equity +$4,500

Answer: D

Explanation:

When the company originally received payment, it recorded a liability because the services had not yet been performed. Once the services are completed, the liability is no longer needed and unearned revenue decreases. At the same time, service revenue is recognized, increasing owner’s equity. No cash is received at this stage because payment occurred earlier. This transaction converts a liability into earned revenue.

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Question 44

A company purchases inventory costing $20,000 by paying $8,000 cash and the remaining balance on account. What is the effect on the accounting equation?

A. Assets +$12,000; Liabilities +$12,000

B. Assets +$20,000; Equity +$20,000

C. Assets -$8,000; Liabilities +$20,000

D. Assets +$8,000; Equity +$12,000

Answer: A

Explanation:

Inventory increases by the full purchase price of $20,000. Cash decreases by $8,000, creating a net increase in assets of $12,000. The unpaid portion of $12,000 is recorded as accounts payable, increasing liabilities by the same amount. Owner’s equity is unaffected because no revenue or expense has occurred. The transaction demonstrates a combination of cash and credit financing in a single purchase.

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Question 45

A customer pays $7,000 in advance for services to be performed in the future. What is the effect on the accounting equation?

A. Assets +$7,000; Equity +$7,000

B. Assets +$7,000; Liabilities +$7,000

C. Assets -$7,000; Liabilities +$7,000

D. Liabilities +$7,000; Equity -$7,000

Answer: B

Explanation:

The company receives cash before earning the revenue. Cash increases assets by $7,000. However, because the service has not yet been performed, the amount is recorded as unearned revenue, which is a liability. Owner’s equity does not increase until the company fulfills its obligation. This treatment follows the revenue recognition principle and ensures revenue is recognized in the proper accounting period.

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Question 46

A company records bad debt expense of $800 related to uncollectible accounts receivable. What is the effect on the accounting equation?

A. Assets -$800; Equity -$800

B. Assets +$800; Equity -$800

C. Liabilities +$800; Equity -$800

D. Assets -$800; Liabilities -$800

Answer: A

Explanation:

Bad debt expense recognizes that a portion of accounts receivable may never be collected. The allowance for doubtful accounts reduces the net realizable value of receivables, effectively decreasing assets. At the same time, bad debt expense reduces net income and therefore decreases owner’s equity. No cash changes hands during this adjustment. The entry ensures receivables are reported at a realistic collectible amount.

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Question 47

A company purchases office supplies for $600 cash and uses them immediately. What is the effect on the accounting equation?

A. Assets -$600; Equity -$600

B. Assets +$600; Equity +$600

C. Assets -$600; Liabilities -$600

D. Assets +$600; Liabilities +$600

Answer: A

Explanation:

Because the supplies are used immediately, they are recorded directly as an expense rather than as a supplies asset. Cash decreases by $600, reducing assets. The supplies expense decreases net income and therefore reduces owner’s equity. Since the supplies do not provide future benefits, no asset remains after the transaction. The accounting equation stays balanced through equal decreases in assets and equity.

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Question 48

The owner contributes a vehicle valued at $22,000 to the business. What is the effect on the accounting equation?

A. Assets +$22,000; Equity +$22,000

B. Assets +$22,000; Liabilities +$22,000

C. Assets -$22,000; Equity +$22,000

D. Liabilities +$22,000; Equity +$22,000

Answer: A

Explanation:

The vehicle becomes a business asset and is recorded at its fair value of $22,000. Because the owner contributed the asset rather than lending it to the company, owner’s equity increases by the same amount. No liability is created because there is no repayment obligation. The transaction reflects an additional investment by the owner and increases both assets and equity equally.

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Question 49

A company converts $10,000 of accounts payable into a note payable. What is the effect on the accounting equation?

A. Assets -$10,000; Liabilities -$10,000

B. Assets +$10,000; Liabilities +$10,000

C. Equity +$10,000; Liabilities -$10,000

D. One liability decreases $10,000 and another liability increases $10,000

Answer: D

Explanation:

The company replaces one type of liability with another. Accounts payable decreases by $10,000 because the supplier balance is removed. At the same time, notes payable increases by $10,000 because a formal debt agreement is created. Total liabilities remain unchanged, and there is no impact on assets or owner’s equity. This transaction only changes the classification of liabilities within the balance sheet.

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Question 50

A company receives $9,000 cash from customers for services that were previously performed on account. What is the effect on the accounting equation?

A. Assets +$9,000; Equity +$9,000

B. Assets -$9,000; Equity -$9,000

C. Cash increases $9,000 and Accounts Receivable decreases $9,000

D. Liabilities decrease $9,000 and Equity increases $9,000

Answer: C

Explanation:

The revenue was recognized earlier when the services were performed, creating accounts receivable. When the customer later pays the balance, cash increases by $9,000 while accounts receivable decreases by the same amount. Total assets remain unchanged because one asset is exchanged for another. No additional revenue is recorded, so owner’s equity does not change. This transaction illustrates the collection phase of the revenue cycle under accrual accounting.

Featured Snippet Opportunity

What Is the Effect of Transactions on the Accounting Equation?

Every transaction affects at least two accounts while keeping the accounting equation balanced:

Assets = Liabilities + Owner’s Equity

Common effects include:

Transaction Type	Effect
Owner Investment	Assets ↑, Equity ↑
Borrowing Money	Assets ↑, Liabilities ↑
Paying Expenses	Assets ↓, Equity ↓
Earning Revenue	Assets ↑, Equity ↑
Paying Liabilities	Assets ↓, Liabilities ↓
Collecting Receivables	One Asset ↑, Another Asset ↓
Purchasing Assets for Cash	One Asset ↑, Another Asset ↓
Customer Advances	Assets ↑, Liabilities ↑

FAQ

What is the accounting equation?

The accounting equation is:

Assets = Liabilities + Owner’s Equity

It forms the basis of double-entry accounting.

Why is the accounting equation important?

It ensures every transaction remains balanced and accurately reflects the company’s financial position.

How do revenues affect the accounting equation?

Revenues increase owner’s equity because they increase retained earnings.

How do expenses affect the accounting equation?

Expenses decrease owner’s equity because they reduce net income.

Question 21

Question: A company performs services for a client and receives $1,800 cash immediately. How does this transaction impact the accounting equation?

• A) One Asset increases, while another Asset decreases

• B) Assets increase and Liabilities increase

• C) Assets increase and Equity increases

• D) Liabilities increase and Equity increases

Correct Answer: C

Explanation: When a business provides services and collects cash on the spot, it experiences an immediate influx of economic resources. The asset account Cash increases by $1,800. Simultaneously, because the service has been fully performed, the business has officially earned revenue. Service Revenue directly increases net income, which flows into Retained Earnings, thereby increasing total Equity by $1,800. This structural dual effect keeps both sides of the accounting equation ($Assets = Liabilities + Equity$) perfectly balanced and expanding.

Question 22

Question: A firm signs a contract to hire a new chief financial officer (CFO) for an annual salary of $120,000, starting next month. What is the immediate effect on the accounting equation?

• A) Liabilities increase and Equity decreases

• B) Assets decrease and Liabilities increase

• C) Assets increase and Equity increases

• D) There is no immediate effect on the accounting equation

Correct Answer: D

Explanation: In financial accounting, an exchange of promises or a mere signing of an employment contract is not considered a recordable economic transaction. No assets have been exchanged, no liabilities have been incurred, and no services have been performed yet. An accounting transaction only occurs when economic reality shifts—such as when the employee actually works and earns their salary. Therefore, this event has absolutely zero impact on assets, liabilities, or equity at the time of signing.

Question 23

Question: A business collects a $400 cash deposit from a customer for goods that will be delivered in a future period. How does this affect the equation?

• A) Assets increase and Equity increases

• B) Assets increase and Liabilities increase

• C) One Asset increases and another Asset decreases

• D) Liabilities decrease and Equity increases

Correct Answer: B

Explanation: Receiving cash creates an immediate positive economic impact, so the asset account Cash increases by $400. However, because the goods have not yet been delivered to the customer, the revenue is not earned. Instead, the business owes a future delivery performance obligation, which creates a liability called Unearned Revenue. This transaction represents an expansion of both sides of the equation, where an increase in assets is perfectly mirrored by an increase in liabilities.

Question 24

Question: A company receives its monthly telephone bill for $150, which will be paid within 30 days. What is the effect on the components of the accounting equation?

• A) Liabilities increase and Equity decreases

• B) Assets decrease and Liabilities increase

• C) Assets decrease and Equity decreases

• D) Liabilities decrease and Equity increases

Correct Answer: A

Explanation: The telephone service was consumed during the current month to support the company’s daily operations, meaning it must be recognized immediately as an expense (Telephone Expense). Expenses reduce net income, which directly lowers total Equity. Since the bill has not been paid yet, the company records a short-term obligation to pay later, which increases the liability account Accounts Payable. The net result on the right side of the equation is zero, matching the completely unaffected asset side.

Question 25

Question: A business pays $2,000 cash to purchase a multi-year patent for a new technology. How is the fundamental accounting equation affected?

• A) Assets increase and Liabilities increase

• B) Assets decrease and Equity decreases

• C) One Asset increases and another Asset decreases

• D) Liabilities decrease and Equity increases

Correct Answer: C

Explanation: A patent is an intangible asset that provides long-term future economic value to a company. Purchasing a patent with cash is a classic example of an asset-for-asset exchange. The company’s liquid resources drop, causing the asset account Cash to decrease by $2,000. Simultaneously, its long-term resource base expands, causing the asset account Patents to increase by $2,000. Because the transaction takes place entirely within the asset section, total assets remain completely unchanged, leaving liabilities and equity unaffected.

Question 26

Question: A company returns $300 worth of defective office supplies that were previously purchased on credit and not yet paid for. How does this return affect the equation?

• A) Assets decrease and Liabilities decrease

• B) Assets decrease and Equity decreases

• C) Liabilities decrease and Equity increases

• D) One Asset increases and another Asset decreases

Correct Answer: A

Explanation: Returning defective inventory or supplies reduces the economic resources physically held by the firm, so the asset account Office Supplies decreases by $300. Because the supplies were originally bought on credit and remained unpaid, the company no longer owes the vendor for those specific items. Therefore, the liability account Accounts Payable is reduced by $300. This dual decrease keeps the accounting equation balanced, as both total assets and total liabilities contract by the exact same amount.

Question 27

Question: An owner decides to withdraw $5,000 from their personal savings account and deposit it into the business bank account as a permanent investment. What is the impact?

• A) One Asset increases and another Asset decreases

• B) Assets increase and Equity increases

• C) Assets increase and Liabilities increase

• D) Liabilities decrease and Equity increases

Correct Answer: B

Explanation: This transaction introduces fresh capital into the business entity from an external personal source. The business bank account receives a cash influx, meaning the asset account Cash increases by $5,000. At the same time, the owner’s total equity stake and financial claim against the business entity’s resources expand. This is recorded as an increase in Owner’s Capital (Equity). Both sides of the basic accounting equation increase simultaneously, maintaining a perfect mathematical balance.

Question 28

Question: A firm pays $900 cash for an advertisement that will run in a local newspaper tomorrow morning. How does this affect the accounting equation?

• A) Assets decrease and Liabilities increase

• B) One Asset increases and another Asset decreases

• C) Assets decrease and Equity decreases

• D) Liabilities decrease and Equity increases

Correct Answer: C

Explanation: Advertising is an operational promotion cost whose economic benefit is typically considered fully consumed or expired in the period it occurs. Therefore, it is classified directly as an Advertising Expense. Expenses reduce a company’s profitability, which ultimately drives down total Owner’s Equity. Because the business paid for this promotion using its liquid funds, the asset account Cash drops by $900. This parallel reduction on both sides ensures the basic accounting framework remains stable.

Question 29

Question: A company buys a delivery truck by paying $5,000 cash down and securing a bank loan for the remaining $20,000. What is the total increase in Liabilities?

• A) $25,000

• B) $5,000

• C) $20,000

• D) $15,000

Correct Answer: C

Explanation: Liabilities represent the debts or obligations a business owes to external creditors. In this transaction, the bank loan is the only financing mechanism that creates a new formal debt obligation. This obligation is recorded in the liability account Notes Payable for the borrowed amount of $20,000. The cash down payment affects assets, and the truck acquisition affects assets, but the actual expansion of the liability section on the right side of the equation is strictly capped at $20,000.

Question 30

Question: A business collects $1,200 from a customer on account. What is the specific net effect on total Assets?

• A) Total Assets increase by $1,200

• B) Total Assets decrease by $1,200

• C) Total Assets remain completely unchanged

• D) Total Assets increase by $2,400

Correct Answer: C

Explanation: Collecting money from a customer who was previously billed is an asset conversion event. The business experiences an increase in the asset account Cash by $1,200 because liquid funds were received. Concurrently, the asset account Accounts Receivable must be decreased by $1,200 because the customer’s outstanding credit obligation has been fulfilled. Since one asset increases and another asset decreases by the identical dollar value, the net change to total assets is exactly zero, leaving the equation balanced.

Question 31

Question: A company pays $1,000 cash for a new computer that is expected to be used in office operations for three years. How is this recorded initially?

• A) As an immediate decrease in Assets and decrease in Equity

• B) As an increase in one Asset and a decrease in another Asset

• C) As an increase in Assets and an increase in Liabilities

• D) As an increase in Liabilities and a decrease in Equity

Correct Answer: B

Explanation: A computer provides operational utility over multiple future accounting periods, meaning it fits the definition of a long-term capital asset rather than an immediate expense. When purchased with cash, the asset account Cash drops by $1,000. In exchange, the asset account Equipment increases by $1,000. This is a purely internal reallocation of asset resources. Total assets stay completely flat on day one, and equity remains untouched until depreciation expense is recognized in later periods.

Question 32

Question: A customer sues a company for $50,000 alleging a minor service breach, but legal counsel states the lawsuit is highly frivolous and unlikely to succeed. How does this impact the equation today?

• A) Liabilities increase and Equity decreases

• B) Assets decrease and Liabilities increase

• C) There is no immediate impact on the accounting equation components

• D) Assets decrease and Equity decreases

Correct Answer: C

Explanation: Under accounting standards, a lawsuit or contingent liability is only recognized on the balance sheet if the loss is both probable and reasonably estimable. Because legal counsel has determined that this specific lawsuit is frivolous and highly unlikely to succeed, it fails to meet the criteria of a true present obligation. No economic resources have left the firm, and no actual liability has been incurred. Therefore, it has no immediate impact on the basic accounting equation components.

Question 33

Question: A business owner takes home an office desk worth $600 from the company warehouse for their permanent personal use. What is the effect on the equation?

• A) Assets decrease and Liabilities increase

• B) Assets decrease and Equity decreases

• C) One Asset increases and another Asset decreases

• D) Liabilities increase and Equity decreases

Correct Answer: B

Explanation: When an owner removes non-cash physical business assets for personal non-corporate purposes, it is classified as an owner withdrawal or drawing. This action causes a direct reduction in the company’s asset base, specifically decreasing the Equipment or Office Supplies asset account by $600. It also reduces the owner’s equity stake or claims against corporate resources, which decreases total Equity via the Owner’s Drawings account. This structural contract keeps the basic accounting equation balanced.

Question 34

Question: A firm pays $400 cash to a local mechanic for an oil change and routine maintenance on its delivery van. What is the correct classification?

• A) An increase in an Asset and a decrease in another Asset

• B) A decrease in an Asset and a decrease in a Liability

• C) A decrease in an Asset and a decrease in Equity

• D) An increase in a Liability and a decrease in Equity

Correct Answer: C

Explanation: Routine maintenance tasks like oil changes do not extend the useful life of a vehicle or upgrade its basic operational capacity; they merely keep it running in its normal current state. Consequently, this expenditure must be treated as an immediate operational expense (Maintenance or Repair Expense). Recording an expense lowers net profits, which directly decreases total Owner’s Equity. Paying cash reduces the asset account Cash, meaning both sides of the accounting equation decrease by $400.

Question 35

Question: A corporation borrows $30,000 by signing a 5-year note payable. It immediately uses the entire amount to purchase a piece of specialized machinery. What is the net impact on Liabilities?

• A) Liabilities remain unchanged

• B) Liabilities increase by $30,000

• C) Liabilities decrease by $30,000

• D) Liabilities increase and Equity decreases

Correct Answer: B

Explanation: Securing a bank loan by signing a note creates a formal, long-term financial obligation to an outside creditor. This event causes the liability account Notes Payable to increase by $30,000 on the right side of the accounting equation. Although the borrowed money was immediately converted into a machinery asset, that subsequent asset exchange does not cancel out or diminish the debt owed to the bank. Thus, total liabilities experience a net expansion of exactly $30,000.

Question 36

Question: A company recognizes that $100 of interest has accrued on its bank savings account but has not yet been deposited by the bank. How does this affect the equation?

• A) Assets increase and Equity increases

• B) Assets increase and Liabilities increase

• C) Liabilities increase and Equity decreases

• D) One Asset increases and another Asset decreases

Correct Answer: A

Explanation: Under accrual accounting principles, income must be recognized when it is fully earned, regardless of physical cash receipt. Since the interest has accrued, the company has earned Interest Revenue, which directly increases net income and total Equity by $100. Because the money is owed to the business but not yet received, it records a legal financial claim called Interest Receivable, which is an asset. Thus, Assets increase and Equity increases, keeping the equation perfectly balanced.

Question 37

Question: A business pays $1,500 cash to settle an outstanding account payable owed to a supplier. What is the effect on Owner’s Equity?

• A) Equity increases by $1,500

• B) Equity decreases by $1,500

• C) Equity remains completely unchanged

• D) Equity decreases and Liabilities increase

Correct Answer: C

Explanation: Paying off an existing trade liability is a balance sheet transactional event that involves assets and liabilities only. Cash (an asset) decreases by $1,500 because money is paid out. Accounts Payable (a liability) decreases by $1,500 because the debt is settled. Because this transaction does not represent a revenue-generating activity or an operational expense, it has absolutely zero impact on the income statement or net income. Consequently, total Owner’s Equity remains completely unchanged.

Question 38

Question: A company sells services on account to a client for $2,500. Which statement accurately describes the immediate transactional changes?

• A) Cash increases and Service Revenue increases

• B) Accounts Receivable increases and Service Revenue increases

• C) Accounts Payable increases and Service Revenue increases

• D) Accounts Receivable increases and Unearned Revenue increases

Correct Answer: B

Explanation: Selling services “on account” means the company has fulfilled its performance duties but has granted the customer credit to pay later. Therefore, the company records a contractual right to collect cash, which increases the asset account Accounts Receivable. Because the service has been successfully completed, revenue is fully earned, which increases Service Revenue and expands total Equity. Cash is not altered during this phase; its movement will be captured later when the client settles the bill.

Question 39

Question: A business purchases $800 of warehouse equipment. It pays $200 cash and promises to pay the remaining $600 next month. How does this affect Liabilities?

• A) Liabilities increase by $800

• B) Liabilities increase by $200

• C) Liabilities increase by $600

• D) Liabilities remain completely unchanged

Correct Answer: C

Explanation: The company’s obligation to pay the remaining balance next month represents a short-term credit debt. This transaction increases the liability account Accounts Payable by exactly $600. The asset side matches this shift: Equipment increases by $800, while Cash decreases by $200, creating a net asset increase of $600 ($800 – $200). Thus, the net asset expansion of $600 perfectly mirrors the liability expansion of $600, preserving the mathematical integrity of the accounting equation.

Question 40

Question: A company experiences a minor fire in the breakroom resulting in $1,200 of uninsured damages to office furniture. How does this loss affect the equation?

• A) Liabilities increase and Equity decreases

• B) Assets decrease and Liabilities increase

• C) Assets decrease and Equity decreases

• D) One Asset increases and another Asset decreases

Correct Answer: C

Explanation: An uninsured accident or fire loss represents an involuntary reduction in economic resources without any corresponding future benefit or replacement revenue. Therefore, the company must write down the value of its asset base, causing the asset account Equipment or Furniture to decrease by $1,200. This drop is recorded as a Casualty Loss on the income statement, which lowers net profits and directly reduces total Equity. Both sides decrease simultaneously by $1,200.

Question 41

Question: A firm pays $2,000 cash for a comprehensive 6-month advertising campaign that will begin running next month. What is the immediate effect?

• A) Assets decrease and Equity decreases

• B) One Asset increases and another Asset decreases

• C) Assets increase and Liabilities increase

• D) Liabilities increase and Equity decreases

Correct Answer: B

Explanation: Because the advertising campaign has not started and will provide promotional value over the next six months, the expenditure represents an unexpired economic benefit. It cannot be expensed immediately. Instead, it is recorded as an asset called Prepaid Advertising (or Prepaid Expenses). Paying cash causes the asset account Cash to drop by $2,000, while Prepaid Advertising increases by $2,000. This internal asset shift leaves total assets, liabilities, and equity completely flat on day one.

Question 42

Question: A business owner transfers ownership of a personal computer worth $1,000 into the business to be used permanently by the company secretary. How does this impact the equation?

• A) One Asset increases and another Asset decreases

• B) Assets increase and Liabilities increase

• C) Assets increase and Equity increases

• D) Liabilities decrease and Equity increases

Correct Answer: C

Explanation: When an owner introduces non-cash personal assets into their firm, it is treated as a capital contribution, similar to a cash investment. The business entity gains a new physical resource, which increases the asset account Equipment (or Computer Hardware) by $1,000. Simultaneously, the owner’s total capital claim against the business increases, which boosts total Equity via the Owner’s Capital account. This dual expansion on both sides ensures the basic accounting equation remains perfectly balanced.

Question 43

Question: A company receives a $600 cash payment from a client for services that were performed and recorded on credit last month. How does this affect Equity today?

• A) Equity increases by $600

• B) Equity decreases by $600

• C) Equity remains completely unchanged

• D) Equity increases and Liabilities decrease

Correct Answer: C

Explanation: Under accrual accounting rules, the revenue for these services was already earned, recorded, and added to Equity during the previous month when the work took place. Today’s transaction is simply a collection event where the asset account Cash increases by $600, and the asset account Accounts Receivable decreases by $600. Because it is a simple asset-for-asset exchange, no new income is generated today, meaning total Equity remains completely unchanged.

Question 44

Question: A business receives its monthly water and electricity bill for $250, which it pays immediately using a corporate debit card. What is the impact?

• A) One Asset increases and another Asset decreases

• B) Assets decrease and Liabilities increase

• C) Assets decrease and Equity decreases

• D) Liabilities decrease and Equity increases

Correct Answer: C

Explanation: Utility bills represent immediate operating costs that expire in the current period to maintain daily business activities. Because the bill was paid immediately using corporate cash funds, the asset account Cash drops by $250. On the other side of the equation, the cost is recorded as a Utility Expense, which reduces net income and directly lowers total Equity by $250. This equal reduction on both sides preserves the integrity of the basic equation.

Question 45

Question: A company pays $5,000 cash to reduce the principal balance of an outstanding long-term bank note payable. How does this affect the accounting equation components?

• A) Assets decrease and Liabilities decrease

• B) Assets decrease and Equity decreases

• C) Liabilities decrease and Equity increases

• D) One Asset increases and another Asset decreases

Correct Answer: A

Explanation: Paying down the principal of a loan is an act of fulfilling a past credit obligation. Disbursing funds causes the asset account Cash to drop by $5,000, which lowers total corporate Assets. Concurrently, the outstanding debt owed to the bank is reduced, causing the liability account Notes Payable to decrease by $5,000. This uniform contraction on both sides of the accounting equation ($Assets = Liabilities + Equity$) keeps the framework perfectly balanced without impacting equity.

Question 46

Question: A business buys $300 of office cleaning supplies on account. What is the fundamental impact on the right side of the accounting equation?

• A) Total Equity decreases by $300

• B) Total Liabilities increase by $300

• C) Total Liabilities decrease by $300

• D) Total Equity increases by $300

Correct Answer: B

Explanation: Purchasing supplies “on account” means the company takes immediate possession of the goods but establishes a promise to pay the supplier at a later date. This creates a short-term trade debt, causing the liability account Accounts Payable to increase by $300 on the right side of the equation. On the left side, the asset account Office Supplies increases by $300. The question asks specifically about the right side, which experiences a clear liability expansion.

Question 47

Question: A corporation declares a $2,000 dividend to shareholders but does not pay it immediately, promising to distribute cash next month. What is the immediate effect?

• A) Assets decrease and Equity decreases

• B) Liabilities increase and Equity decreases

• C) Liabilities increase and Assets increase

• D) Equity remains unchanged until cash is paid

Correct Answer: B

Explanation: The formal declaration of a dividend by a corporation’s board of directors creates a legal binding obligation to pay its shareholders. This event establishes a liability, causing the account Dividends Payable to increase by $2,000. Simultaneously, because corporate earnings are being formally earmarked for distribution, Retained Earnings (Equity) decreases by $2,000. The right side of the equation experiences a simultaneous liability increase and equity decrease, leaving total assets completely unchanged.

Question 48

Question: A company performs legal consulting services worth $4,000. The client pays $1,000 in cash immediately and promises to pay the remaining $3,000 next month. How does this affect Assets?

• A) Total Assets increase by $1,000

• B) Total Assets increase by $3,000

• C) Total Assets increase by $4,000

• D) Total Assets remain completely unchanged

Correct Answer: C

Explanation: This multi-account transaction causes two distinct asset accounts to grow. The company receives immediate funds, increasing the asset account Cash by $1,000. It also gains a credit claim for the balance, increasing the asset account Accounts Receivable by $3,000. Together, these adjustments create a total net increase in Assets of $4,000. To maintain balance, Service Revenue is recorded for the full $4,000, which increases total Equity on the right side by the same amount.

Question 49

Question: A business pays a $100 cash fee to the local government to renew its annual operating license. How is this transaction reflected in the accounting equation?

• A) Assets decrease and Liabilities increase

• B) One Asset increases and another Asset decreases

• C) Assets decrease and Equity decreases

• D) Liabilities decrease and Equity increases

Correct Answer: C

Explanation: Annual licensing fees are routine compliance costs that expire within the current period and do not create a long-term capital resource. Therefore, the fee must be classified as a License Expense or Operating Expense. This expense lowers net earnings, which reduces total Owner’s Equity by $100. Because the business settled this fee using cash, the asset account Cash decreases by $100. This equal drop on both sides preserves the balance of the equation.

Question 50

Question: A company determines that $500 of prepaid rent recorded as an asset at the beginning of the year has now officially expired. What adjustment is required?

• A) Liabilities increase and Equity decreases

• B) Assets decrease and Equity decreases

• C) Assets decrease and Liabilities decrease

• D) One Asset increases and another Asset decreases

Correct Answer: B

Explanation: As time passes, prepaid assets systematically expire and transform into operating expenses. Since $500 of the prepaid rent has been consumed, the company must reduce its asset base by decreasing the asset account Prepaid Rent by $500. Concurrently, it must recognize the cost on the income statement as Rent Expense, which reduces net income and lowers total Owner’s Equity by $500. This vital internal adjustment ensures both the balance sheet and income statement are completely accurate.

 

Accounting Equation Transactions Quiz: 50 Multiple Choice Questions

Introduction

Welcome to our comprehensive Accounting Equation Transactions Quiz! This carefully curated set of 50 multiple-choice questions will test your understanding of how business transactions affect the fundamental accounting equation:Assets = Liabilities + Owner’s Equity. Each question is designed to challenge your knowledge of debit and credit rules, transaction analysis, and the dual-entry system. Whether you’re a student preparing for exams or a professional refreshing your skills, this quiz provides detailed explanations to reinforce your learning.

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Questions 1-10: Basic Transaction Effects

Question 1
A company purchases equipment for $10,000 cash. What is the effect on the accounting equation?

A) Assets increase by $10,000, Liabilities increase by $10,000
B) Assets increase by $10,000, Owner’s Equity increases by $10,000
C) Assets increase and decrease by $10,000 (no net change)
D) Assets decrease by $10,000, Liabilities decrease by $10,000

Answer: C
Explanation: When equipment is purchased for cash, one asset (Equipment) increases by $10,000 while another asset (Cash) decreases by $10,000. This is an exchange of one asset for another, resulting in no net change to total assets. The accounting equation remains balanced because total assets stay the same, and neither liabilities nor owner’s equity are affected. This transaction demonstrates that not every business event changes total assets.

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Question 2
A business borrows $50,000 from a bank by signing a note payable. What is the effect?

A) Assets increase by $50,000, Owner’s Equity increases by $50,000
B) Assets increase by $50,000, Liabilities increase by $50,000
C) Assets decrease by $50,000, Liabilities decrease by $50,000
D) Assets increase by $50,000, Owner’s Equity decreases by $50,000

Answer: B
Explanation: When a company borrows money, it receives cash (an asset increase) and creates an obligation to repay the bank (a liability increase). The accounting equation remains in balance because both sides increase by the same amount ($50,000). This transaction affects the asset and liability categories only, with no immediate impact on owner’s equity. The note payable represents a legal obligation that must be repaid according to the terms agreed upon.

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Question 3
An owner invests $20,000 cash into their business. How does this affect the accounting equation?

A) Assets increase by $20,000, Liabilities increase by $20,000
B) Assets decrease by $20,000, Owner’s Equity decreases by $20,000
C) Assets increase by $20,000, Owner’s Equity increases by $20,000
D) Assets increase by $20,000, Liabilities decrease by $20,000

Answer: C
Explanation: When an owner invests personal funds into the business, the company receives cash (asset increase) and the owner’s claim on the business increases (owner’s equity increase). This transaction is recorded by debiting Cash and crediting Owner’s Capital. The accounting equation remains balanced because both sides increase equally. Owner investments increase the business’s net worth and provide resources for operations without creating debt obligations.

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Question 4
A company provides services worth $5,000 to a customer on credit (accounts receivable). What is the effect?

A) Assets increase by $5,000, Owner’s Equity increases by $5,000
B) Assets decrease by $5,000, Owner’s Equity decreases by $5,000
C) Assets increase by $5,000, Liabilities increase by $5,000
D) Assets decrease by $5,000, Liabilities decrease by $5,000

Answer: A
Explanation: Performing services on credit creates an account receivable (asset increase) and generates revenue (owner’s equity increase). Revenue increases owner’s equity because it contributes to net income. The accounting equation remains balanced as assets and owner’s equity both increase by $5,000. This transaction represents the revenue recognition principle – revenue is recorded when earned, regardless of when cash is received. The company now has a right to collect payment from the customer.

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Question 5
A company pays $3,000 for rent expense. What is the effect on the accounting equation?

A) Assets increase by $3,000, Owner’s Equity increases by $3,000
B) Assets decrease by $3,000, Owner’s Equity decreases by $3,000
C) Assets decrease by $3,000, Liabilities decrease by $3,000
D) Assets increase by $3,000, Liabilities decrease by $3,000

Answer: B
Explanation: Paying rent expense reduces cash (asset decrease) and increases expenses, which decrease owner’s equity. Expenses are recorded with debits and reduce retained earnings (part of owner’s equity). The accounting equation remains balanced because both sides decrease equally. Rent is an operating expense that is necessary for business operations but does not provide future economic benefit. This transaction illustrates how expenses consume assets and reduce the owner’s claim on the business.

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Question 6
A company purchases inventory for $8,000 on account (credit). What is the effect?

A) Assets increase by $8,000, Owner’s Equity increases by $8,000
B) Assets decrease by $8,000, Liabilities decrease by $8,000
C) Assets increase by $8,000, Liabilities increase by $8,000
D) Assets increase by $8,000, Owner’s Equity decreases by $8,000

Answer: C
Explanation: Purchasing inventory on account increases inventory (an asset) and creates accounts payable (a liability). Both sides of the accounting equation increase by $8,000. The company now owes money to its supplier. This transaction is recorded with a debit to Inventory and a credit to Accounts Payable. The purchase on credit provides the company with goods while allowing deferred payment, which is a common business practice that helps manage cash flow.

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Question 7
A company receives $1,500 from a customer who previously purchased goods on credit. What is the effect?

A) Assets increase by $1,500, Owner’s Equity increases by $1,500
B) Assets increase and decrease by $1,500 (no net change)
C) Assets decrease by $1,500, Liabilities decrease by $1,500
D) Assets increase by $1,500, Liabilities increase by $1,500

Answer: B
Explanation: Collecting cash from a customer on account converts one asset (Accounts Receivable) into another asset (Cash). Total assets remain unchanged because cash increases while accounts receivable decreases by the same amount. The accounting equation remains balanced with no change to liabilities or owner’s equity. This transaction does not affect the income statement because revenue was already recorded when the sale was made. It simply represents the conversion of a receivable into cash.

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Question 8
A company pays $2,000 on its accounts payable. What is the effect?

A) Assets increase by $2,000, Liabilities increase by $2,000
B) Assets decrease by $2,000, Liabilities decrease by $2,000
C) Assets decrease by $2,000, Owner’s Equity decreases by $2,000
D) Assets increase by $2,000, Owner’s Equity increases by $2,000

Answer: B
Explanation: Paying accounts payable reduces cash (asset decrease) and reduces the liability (accounts payable decrease). Both sides of the accounting equation decrease by $2,000. This transaction represents the settlement of an existing obligation. The company is fulfilling its promise to pay creditors. The accounting equation remains in balance because the reduction in assets is matched by an equal reduction in liabilities, with no effect on owner’s equity.

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Question 9
The owner withdraws $1,000 cash from the business for personal use. What is the effect?

A) Assets increase by $1,000, Owner’s Equity increases by $1,000
B) Assets decrease by $1,000, Owner’s Equity decreases by $1,000
C) Assets decrease by $1,000, Liabilities decrease by $1,000
D) Assets increase by $1,000, Liabilities decrease by $1,000

Answer: B
Explanation: Owner withdrawals (drawings) reduce cash (asset decrease) and reduce owner’s equity because the owner is taking assets out of the business. Drawings are not expenses but rather distributions of profits to the owner. The accounting equation remains balanced as both sides decrease equally. Withdrawals decrease the owner’s claim on business assets and are recorded by debiting Owner’s Drawing account (which reduces capital) and crediting Cash.

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Question 10
A company pays $500 for advertising expense. What is the effect?

A) Assets increase by $500, Owner’s Equity increases by $500
B) Assets decrease by $500, Owner’s Equity decreases by $500
C) Assets decrease by $500, Liabilities decrease by $500
D) Assets increase by $500, Liabilities increase by $500

Answer: B
Explanation: Paying for advertising reduces cash (asset decrease) and creates an expense, which reduces owner’s equity. Advertising is a cost of generating revenue and is recorded as an expense. The accounting equation remains balanced as both sides decrease equally. Expenses are temporary accounts that ultimately reduce retained earnings (owner’s equity). This transaction demonstrates how operating costs consume assets and reduce the net worth of the business.

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Questions 11-20: Revenue and Expense Recognition

Question 11
A company earns $12,000 in service revenue, receiving $4,000 cash and $8,000 on credit. What is the effect?

A) Assets increase by $12,000, Owner’s Equity increases by $12,000
B) Assets increase by $4,000, Owner’s Equity increases by $12,000
C) Assets increase by $12,000, Owner’s Equity increases by $4,000
D) Assets decrease by $12,000, Liabilities decrease by $12,000

Answer: A
Explanation: The company receives $4,000 cash and $8,000 in accounts receivable, totaling $12,000 in assets. Revenue of $12,000 increases owner’s equity. The accounting equation remains balanced with both sides increasing by $12,000. The full amount of revenue is recognized when earned, regardless of whether cash was received or not. This transaction demonstrates the matching principle and the fact that revenue can be earned through both cash and credit sales. Total assets increase by the full value of services provided.

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Question 12
A company pays $6,000 for a 12-month insurance policy in advance. What is the immediate effect?

A) Assets increase by $6,000, Owner’s Equity increases by $6,000
B) Assets decrease by $6,000, Owner’s Equity decreases by $6,000
C) Assets increase and decrease by $6,000 (no net change)
D) Assets decrease by $6,000, Liabilities decrease by $6,000

Answer: C
Explanation: Prepaying for insurance converts cash (asset) into prepaid insurance (asset). Total assets remain unchanged because one asset (Cash) decreases while another asset (Prepaid Insurance) increases by the same amount. The accounting equation remains balanced with no effect on liabilities or owner’s equity at the time of payment. The expense will be recognized gradually over the coverage period. Prepaid insurance is considered an asset because it represents future economic benefit (insurance coverage) that the company will receive.

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Question 13
A company records $2,000 of depreciation expense on equipment. What is the effect?

A) Assets decrease by $2,000, Owner’s Equity decreases by $2,000
B) Assets decrease by $2,000, Liabilities decrease by $2,000
C) Assets increase by $2,000, Owner’s Equity increases by $2,000
D) Assets increase by $2,000, Liabilities increase by $2,000

Answer: A
Explanation: Depreciation expense reduces the book value of equipment (asset decrease) and increases expenses, which decrease owner’s equity. Depreciation is a non-cash expense that allocates the cost of a long-term asset over its useful life. The accounting equation remains balanced as both sides decrease by $2,000. Depreciation reflects the wear and tear on equipment and is crucial for matching expenses with the revenue they help generate. Accumulated depreciation is a contra-asset account that reduces net fixed assets.

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Question 14
A company receives $10,000 in advance from a customer for services to be provided next month. What is the effect?

A) Assets increase by $10,000, Owner’s Equity increases by $10,000
B) Assets increase by $10,000, Liabilities increase by $10,000
C) Assets decrease by $10,000, Liabilities decrease by $10,000
D) Assets increase by $10,000, Owner’s Equity decreases by $10,000

Answer: B
Explanation: Receiving cash in advance creates an asset (Cash) and a liability (Unearned Revenue). The company has an obligation to provide services in the future. The accounting equation remains balanced as both sides increase by $10,000. Unearned revenue is a liability because the company owes services to the customer. Revenue will be recognized only when the services are actually performed, following the revenue recognition principle. This transaction illustrates the difference between cash received and revenue earned.

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Question 15
A company performs services for $7,000 that were previously paid for in advance (unearned revenue). What is the effect?

A) Assets increase by $7,000, Owner’s Equity increases by $7,000
B) Assets decrease by $7,000, Owner’s Equity decreases by $7,000
C) Assets decrease by $7,000, Liabilities decrease by $7,000
D) Assets decrease by $7,000, Liabilities increase by $7,000

Answer: C
Explanation: Recognizing previously unearned revenue reduces the liability (Unearned Revenue) by $7,000 and increases owner’s equity (Revenue) by $7,000. Assets are not affected at this point because the cash was received earlier. The accounting equation remains balanced because a liability decreases while owner’s equity increases by the same amount. This transaction converts a liability into revenue, reflecting that the company has now earned the money it previously received in advance. The obligation to the customer has been fulfilled.

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Question 16
A company pays $4,000 for employee salaries for the current month. What is the effect?

A) Assets increase by $4,000, Owner’s Equity increases by $4,000
B) Assets decrease by $4,000, Owner’s Equity decreases by $4,000
C) Assets decrease by $4,000, Liabilities decrease by $4,000
D) Assets increase by $4,000, Liabilities increase by $4,000

Answer: B
Explanation: Paying salaries reduces cash (asset decrease) and creates an expense, which reduces owner’s equity. Salaries expense is a cost of labor that is necessary for business operations. The accounting equation remains balanced as both sides decrease by $4,000. Salaries are typically a significant operating expense and must be recorded in the period when employees performed the work. This transaction demonstrates the matching principle, where expenses are matched with the revenue they helped generate during the same accounting period.

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Question 17
A company receives a $3,000 utility bill that will be paid next month. What is the effect?

A) Assets increase by $3,000, Liabilities increase by $3,000
B) Assets decrease by $3,000, Liabilities decrease by $3,000
C) Liabilities increase by $3,000, Owner’s Equity decreases by $3,000
D) Liabilities decrease by $3,000, Owner’s Equity increases by $3,000

Answer: C
Explanation: Receiving a utility bill creates a liability (Accounts Payable or Utilities Payable) of $3,000 and records an expense, which decreases owner’s equity by $3,000. Assets are not affected because no cash has been paid yet. The accounting equation remains balanced as liabilities increase and owner’s equity decreases by the same amount. This transaction illustrates the accrual basis of accounting, where expenses are recognized when incurred, not when paid. The company has an obligation to pay for utilities that have already been consumed.

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Question 18
A company collects $1,800 in interest revenue from a bank account. What is the effect?

A) Assets increase by $1,800, Owner’s Equity increases by $1,800
B) Assets decrease by $1,800, Owner’s Equity decreases by $1,800
C) Assets increase by $1,800, Liabilities increase by $1,800
D) Assets decrease by $1,800, Liabilities decrease by $1,800

Answer: A
Explanation: Collecting interest revenue increases cash (asset increase) and increases revenue, which increases owner’s equity. The accounting equation remains balanced as both sides increase by $1,800. Interest revenue is income earned from investments and is part of other income on the income statement. This transaction demonstrates that revenue can come from non-operating sources as well. The company’s cash balance increases, and the earning process for this interest is complete since it has been collected.

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Question 19
A company writes off $500 of accounts receivable as uncollectible. What is the effect?

A) Assets decrease by $500, Owner’s Equity decreases by $500
B) Assets increase by $500, Owner’s Equity increases by $500
C) Assets decrease by $500, Liabilities decrease by $500
D) Assets increase by $500, Liabilities increase by $500

Answer: A
Explanation: Writing off uncollectible accounts reduces accounts receivable (asset decrease) and records bad debt expense, which decreases owner’s equity. The accounting equation remains balanced as both sides decrease by $500. This transaction recognizes that some credit sales will not be collected. Bad debt expense is an operating expense that estimates the cost of extending credit to customers. Writing off an account removes it from the books after it is determined to be uncollectible, though this may have been partially anticipated through an allowance method.

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Question 20
A company pays $2,500 for office supplies that were previously purchased on account. What is the effect?

A) Assets decrease by $2,500, Liabilities decrease by $2,500
B) Assets increase by $2,500, Liabilities increase by $2,500
C) Assets decrease by $2,500, Owner’s Equity decreases by $2,500
D) Assets increase by $2,500, Owner’s Equity increases by $2,500

Answer: A
Explanation: Paying for office supplies on account reduces cash (asset decrease) and reduces accounts payable (liability decrease). Both sides of the accounting equation decrease by $2,500. The accounting equation remains in balance because the payment settles a previously recorded obligation. This transaction does not affect owner’s equity because it represents the payment of a liability, not an expense. The expense was already recognized when the supplies were purchased or used, depending on the accounting method used.

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Questions 21-30: Asset and Liability Transactions

Question 21
A company purchases a building for $200,000, paying $50,000 cash and signing a mortgage for $150,000. What is the effect?

A) Assets increase by $150,000, Liabilities increase by $150,000
B) Assets increase by $200,000, Liabilities increase by $200,000
C) Assets increase by $200,000, Liabilities increase by $150,000, and Assets decrease by $50,000
D) Assets increase by $200,000, Liabilities increase by $150,000, Owner’s Equity increases by $50,000

Answer: C
Explanation: The building (asset) increases by $200,000, cash (asset) decreases by $50,000, and a mortgage (liability) increases by $150,000. The net effect on total assets is an increase of $150,000 ($200,000 – $50,000), while liabilities increase by $150,000. The accounting equation remains balanced. This transaction represents a combination of cash payment and financing. The portion financed through the mortgage creates a long-term liability that will be repaid over time with interest.

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Question 22
A company issues $100,000 of common stock for cash. What is the effect?

A) Assets increase by $100,000, Liabilities increase by $100,000
B) Assets increase by $100,000, Owner’s Equity increases by $100,000
C) Assets decrease by $100,000, Owner’s Equity decreases by $100,000
D) Assets increase by $100,000, Liabilities decrease by $100,000

Answer: B
Explanation: Issuing common stock for cash increases cash (asset increase) and increases contributed capital (owner’s equity increase). The accounting equation remains balanced as both sides increase by $100,000. Stock issuance represents owners’ investment in the business and creates permanent capital. Unlike borrowing, issuing stock does not create a repayment obligation. Shareholders receive ownership rights in exchange for their investment, and their claim is represented in the common stock and additional paid-in capital accounts.

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Question 23
A company repays $30,000 of its bank loan. What is the effect?

A) Assets increase by $30,000, Liabilities increase by $30,000
B) Assets decrease by $30,000, Liabilities decrease by $30,000
C) Assets decrease by $30,000, Owner’s Equity decreases by $30,000
D) Assets increase by $30,000, Owner’s Equity increases by $30,000

Answer: B
Explanation: Repaying a bank loan reduces cash (asset decrease) and reduces the loan liability (liability decrease). Both sides of the accounting equation decrease by $30,000. The accounting equation remains balanced because the reduction in assets equals the reduction in liabilities. Loan repayments do not affect owner’s equity because they represent the settlement of a liability, not an expense. The transaction reduces the company’s debt obligation and its cash balance simultaneously, improving the debt-to-equity ratio.

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Question 24
A company sells equipment with a book value of $15,000 for $12,000 cash. What is the effect?

A) Assets decrease by $15,000, Owner’s Equity decreases by $3,000
B) Assets increase by $12,000, Assets decrease by $15,000, Owner’s Equity decreases by $3,000
C) Assets increase by $12,000, Owner’s Equity increases by $12,000
D) Assets decrease by $15,000, Liabilities decrease by $15,000

Answer: B
Explanation: Cash increases by $12,000 (asset increase), equipment decreases by $15,000 (asset decrease), and a loss of $3,000 is recognized (owner’s equity decrease). Net assets decrease by $3,000 ($12,000 – $15,000), and owner’s equity decreases by $3,000. The accounting equation remains balanced. This transaction illustrates that selling an asset below its book value creates a loss, which reduces owner’s equity. Losses are the opposite of gains and decrease net income.

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Question 25
A company receives a $5,000 grant from the government for business expansion. What is the effect?

A) Assets increase by $5,000, Owner’s Equity increases by $5,000
B) Assets increase by $5,000, Liabilities increase by $5,000
C) Assets decrease by $5,000, Owner’s Equity decreases by $5,000
D) Assets increase by $5,000, Owner’s Equity decreases by $5,000

Answer: A
Explanation: Receiving a government grant increases cash (asset increase) and typically increases owner’s equity (often as a gain or income). The accounting equation remains balanced as both sides increase by $5,000. Government grants are usually treated as income or as a reduction in the cost of assets, depending on the nature of the grant. If the grant is unrestricted, it is recognized as revenue. If restricted, it may be recorded as deferred revenue (liability) until conditions are met. This increases the business’s resources without creating a repayment obligation.

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Question 26
A company declares and pays a $4,000 cash dividend to shareholders. What is the effect?

A) Assets decrease by $4,000, Liabilities decrease by $4,000
B) Assets decrease by $4,000, Owner’s Equity decreases by $4,000
C) Assets increase by $4,000, Owner’s Equity increases by $4,000
D) Assets decrease by $4,000, Liabilities increase by $4,000

Answer: B
Explanation: Paying a cash dividend reduces cash (asset decrease) and reduces retained earnings (owner’s equity decrease). The accounting equation remains balanced as both sides decrease by $4,000. Dividends are distributions of profits to shareholders and are not expenses. They represent a return on investment to owners and reduce the company’s retained earnings. Declaring and paying dividends requires a formal decision by the board of directors and is subject to legal restrictions based on the company’s financial position.

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Question 27
A company invests $25,000 in another company’s bonds. What is the effect?

A) Assets increase by $25,000, Owner’s Equity increases by $25,000
B) Assets increase and decrease by $25,000 (no net change)
C) Assets decrease by $25,000, Owner’s Equity decreases by $25,000
D) Assets increase by $25,000, Liabilities increase by $25,000

Answer: B
Explanation: Investing in bonds converts cash (asset) into an investment (asset). Total assets remain unchanged because one asset (Cash) decreases while another asset (Investments) increases by $25,000. The accounting equation remains balanced with no effect on liabilities or owner’s equity. This transaction represents a change in the composition of assets. The company is using its cash to acquire an investment that may generate interest income in the future. Investments are recorded at cost and may be classified as current or long-term depending on the company’s intentions.

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Question 28
A company pays $8,000 for legal fees related to a lawsuit. What is the effect?

A) Assets increase by $8,000, Owner’s Equity increases by $8,000
B) Assets decrease by $8,000, Owner’s Equity decreases by $8,000
C) Assets decrease by $8,000, Liabilities decrease by $8,000
D) Assets increase by $8,000, Liabilities increase by $8,000

Answer: B
Explanation: Paying legal fees reduces cash (asset decrease) and creates an expense, which decreases owner’s equity. The accounting equation remains balanced as both sides decrease by $8,000. Legal fees are operating expenses that are incurred in the normal course of business. They represent the cost of legal services consumed during the period. Even if the lawsuit relates to a prior period, the expense is recognized when incurred. This transaction demonstrates how professional services consume company resources and reduce net income.

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Question 29
A company receives $15,000 from the sale of treasury stock. What is the effect?

A) Assets increase by $15,000, Owner’s Equity increases by $15,000
B) Assets increase by $15,000, Liabilities increase by $15,000
C) Assets decrease by $15,000, Owner’s Equity decreases by $15,000
D) Assets increase by $15,000, Liabilities decrease by $15,000

Answer: A
Explanation: Selling treasury stock increases cash (asset increase) and increases owner’s equity (specifically, paid-in capital or additional paid-in capital). The accounting equation remains balanced as both sides increase by $15,000. Treasury stock represents shares that were previously issued and then repurchased by the company. Selling them again is not revenue but rather a reissuance of previously owned shares. The sale of treasury stock increases total stockholders’ equity and assets without creating a liability.

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Question 30
A company records a $7,000 liability for income taxes owed. What is the effect?

A) Assets increase by $7,000, Liabilities increase by $7,000
B) Liabilities increase by $7,000, Owner’s Equity decreases by $7,000
C) Assets decrease by $7,000, Liabilities decrease by $7,000
D) Liabilities decrease by $7,000, Owner’s Equity increases by $7,000

Answer: B
Explanation: Recording income tax owed creates a tax payable liability (liability increase) and records tax expense, which decreases owner’s equity by $7,000. Assets are not affected because no cash has been paid yet. The accounting equation remains balanced as liabilities increase and owner’s equity decreases by the same amount. This transaction illustrates accrual accounting, where tax expense is recognized in the period when income was earned, not when the tax is paid. The company has an obligation to pay taxes to the government.

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Questions 31-40: Mixed Transactions

Question 31
A company purchases equipment for $45,000 by paying $15,000 cash and signing a $30,000 note payable. What is the effect?

A) Assets increase by $45,000, Liabilities increase by $30,000, Assets decrease by $15,000
B) Assets increase by $30,000, Liabilities increase by $30,000
C) Assets increase by $45,000, Liabilities increase by $30,000
D) Assets increase by $45,000, Owner’s Equity increases by $30,000

Answer: A
Explanation: Equipment (asset) increases by $45,000, cash (asset) decreases by $15,000, and notes payable (liability) increases by $30,000. Net assets increase by $30,000 ($45,000 – $15,000), matching the increase in liabilities. The accounting equation remains balanced. This transaction combines a cash payment and financing arrangement to acquire a long-term asset. The $30,000 note payable represents a legal obligation that must be repaid over time, typically with interest. The company is acquiring productive capacity while maintaining some cash liquidity.

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Question 32
A company issues $60,000 of bonds payable at face value. What is the effect?

A) Assets increase by $60,000, Owner’s Equity increases by $60,000
B) Assets increase by $60,000, Liabilities increase by $60,000
C) Assets decrease by $60,000, Liabilities decrease by $60,000
D) Assets increase by $60,000, Owner’s Equity decreases by $60,000

Answer: B
Explanation: Issuing bonds payable increases cash (asset increase) and creates a liability (Bonds Payable) of $60,000. The accounting equation remains balanced as both sides increase by $60,000. Bond issuance is a form of long-term borrowing where the company promises to pay interest periodically and repay the principal at maturity. Unlike stock issuance, bond issuance creates a liability that must be repaid. Bondholders are creditors of the company, not owners. The company receives cash now but has a fixed obligation to repay at future dates.

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Question 33
A company pays $6,500 for insurance expense, of which $4,000 relates to the current year and $2,500 relates to next year. What is the effect?

A) Assets decrease by $6,500, Owner’s Equity decreases by $4,000, Liabilities decrease by $2,500
B) Assets decrease by $6,500, Owner’s Equity decreases by $4,000, Assets increase by $2,500
C) Assets decrease by $6,500, Owner’s Equity decreases by $6,500
D) Assets decrease by $4,000, Owner’s Equity decreases by $4,000

Answer: B
Explanation: Cash decreases by $6,500 (asset decrease), insurance expense of $4,000 decreases owner’s equity, and prepaid insurance of $2,500 increases assets. Net assets decrease by $4,000 ($6,500 – $2,500), matching the decrease in owner’s equity. The accounting equation remains balanced. This transaction demonstrates proper allocation of insurance costs: the current year portion is expensed immediately, while the future portion is recorded as a prepaid asset to be expensed in the future when the coverage period occurs.

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Question 34
A company sells merchandise with a cost of $18,000 for $25,000 cash. What is the effect?

A) Assets increase by $25,000, Owner’s Equity increases by $7,000
B) Assets increase by $7,000, Owner’s Equity increases by $7,000
C) Assets increase by $25,000, Assets decrease by $18,000, Owner’s Equity increases by $7,000
D) Assets increase by $18,000, Owner’s Equity increases by $25,000

Answer: C
Explanation: Cash increases by $25,000 (asset increase), inventory decreases by $18,000 (asset decrease), and owner’s equity increases by $7,000 (the gross profit). Net assets increase by $7,000 ($25,000 – $18,000), matching the increase in owner’s equity. The accounting equation remains balanced. This transaction shows both the revenue and expense aspects of a sale. Revenue of $25,000 increases owner’s equity, while the cost of goods sold of $18,000 decreases it, resulting in a net increase of $7,000.

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Question 35
A company collects $9,000 from a customer and records it as unearned revenue because services haven’t been performed yet. What is the effect?

A) Assets increase by $9,000, Liabilities increase by $9,000
B) Assets increase by $9,000, Owner’s Equity increases by $9,000
C) Assets decrease by $9,000, Liabilities decrease by $9,000
D) Assets increase by $9,000, Liabilities decrease by $9,000

Answer: A
Explanation: Receiving cash in advance increases cash (asset increase) and creates unearned revenue (liability increase). The accounting equation remains balanced as both sides increase by $9,000. Unearned revenue is a liability because the company has an obligation to provide services in the future. This transaction follows the cash basis for receipt but the accrual basis for revenue recognition. The company has collected cash but cannot recognize revenue until the service is performed. This is common for subscriptions, memberships, and advance payments.

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Question 36
A company pays $11,000 for rent, of which $8,000 is for the current month and $3,000 is a security deposit. What is the effect?

A) Assets decrease by $11,000, Owner’s Equity decreases by $8,000, Assets increase by $3,000
B) Assets decrease by $11,000, Owner’s Equity decreases by $11,000
C) Assets decrease by $8,000, Owner’s Equity decreases by $8,000
D) Assets decrease by $11,000, Owner’s Equity decreases by $3,000

Answer: A
Explanation: Cash decreases by $11,000 (asset decrease), rent expense of $8,000 decreases owner’s equity, and security deposit of $3,000 increases an asset (Security Deposit). Net assets decrease by $8,000 ($11,000 – $3,000), matching the decrease in owner’s equity. The accounting equation remains balanced. This transaction shows how different portions of a payment are treated differently: the security deposit is an asset that will be returned, while the rent expense represents cost of using the space during the current period.

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Question 37
A company records accrued salaries of $5,000 that have been earned but not paid. What is the effect?

A) Assets increase by $5,000, Liabilities increase by $5,000
B) Liabilities increase by $5,000, Owner’s Equity decreases by $5,000
C) Assets decrease by $5,000, Liabilities decrease by $5,000
D) Liabilities decrease by $5,000, Owner’s Equity increases by $5,000

Answer: B
Explanation: Recording accrued salaries creates a salary payable liability (liability increase) and records salary expense, which decreases owner’s equity. Assets are not affected because no cash has been paid. The accounting equation remains balanced as liabilities increase and owner’s equity decreases by the same amount. This is an accrual accounting adjustment to recognize expenses in the period when employees performed the work, even though payment will occur in the next period. The company has an obligation to pay employees for services already rendered.

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Question 38
A company purchases $16,000 of merchandise inventory, paying $6,000 cash and promising to pay the remainder within 30 days. What is the effect?

A) Assets increase by $16,000, Assets decrease by $6,000, Liabilities increase by $10,000
B) Assets increase by $10,000, Liabilities increase by $10,000
C) Assets increase by $16,000, Liabilities increase by $10,000
D) Assets decrease by $6,000, Liabilities increase by $10,000

Answer: A
Explanation: Inventory increases by $16,000 (asset increase), cash decreases by $6,000 (asset decrease), and accounts payable increases by $10,000 (liability increase). Net assets increase by $10,000 ($16,000 – $6,000), matching the increase in liabilities. The accounting equation remains balanced. This transaction demonstrates a partial cash purchase combined with credit. The company acquires inventory while preserving some cash by using trade credit. The $10,000 payable is a short-term obligation that must be paid within the credit terms offered by the supplier.

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Question 39
A company receives $3,200 in interest from its investments. What is the effect?

A) Assets increase by $3,200, Owner’s Equity increases by $3,200
B) Assets decrease by $3,200, Owner’s Equity decreases by $3,200
C) Assets increase by $3,200, Liabilities increase by $3,200
D) Assets decrease by $3,200, Liabilities decrease by $3,200

Answer: A
Explanation: Receiving interest increases cash (asset increase) and creates interest revenue, which increases owner’s equity. The accounting equation remains balanced as both sides increase by $3,200. Interest revenue is income earned from investments and is part of other income on the income statement. This transaction shows that businesses can earn income from sources other than their primary operations. The earning process is complete because the cash has been received. This increases both the company’s cash balance and its net income.

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Question 40
A company issues $20,000 of common stock in exchange for equipment. What is the effect?

A) Assets increase by $20,000, Owner’s Equity increases by $20,000
B) Assets increase by $20,000, Liabilities increase by $20,000
C) Assets decrease by $20,000, Owner’s Equity decreases by $20,000
D) Assets increase by $20,000, Liabilities decrease by $20,000

Answer: A
Explanation: Issuing common stock in exchange for equipment increases equipment (asset increase) and increases contributed capital (owner’s equity increase). The accounting equation remains balanced as both sides increase by $20,000. This is a non-cash transaction that involves exchanging stock for a tangible asset. The equipment is recorded at the fair value of the stock issued or the equipment received, whichever is more clearly determinable. This transaction increases the company’s productive capacity without using cash or creating debt.

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Questions 41-50: Complex Transactions

Question 41
A company records a $12,000 loss on the sale of machinery. The machinery had a book value of $80,000 and was sold for $68,000. What is the effect?

A) Assets decrease by $12,000, Owner’s Equity decreases by $12,000
B) Assets increase by $68,000, Assets decrease by $80,000, Owner’s Equity decreases by $12,000
C) Assets increase by $80,000, Liabilities increase by $80,000
D) Assets decrease by $68,000, Owner’s Equity decreases by $12,000

Answer: B
Explanation: Cash increases by $68,000 (asset increase), machinery decreases by $80,000 (asset decrease), and a loss of $12,000 decreases owner’s equity. Net assets decrease by $12,000 ($68,000 – $80,000), matching the decrease in owner’s equity. The accounting equation remains balanced. The loss represents the difference between the book value and the selling price. This transaction shows that disposing of assets for less than their book value creates a loss that reduces net income. Losses are recorded as expenses on the income statement.

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Question 42
A company converts $35,000 of bonds payable into common stock. What is the effect?

A) Liabilities decrease by $35,000, Owner’s Equity increases by $35,000
B) Assets increase by $35,000, Owner’s Equity increases by $35,000
C) Liabilities decrease by $35,000, Assets decrease by $35,000
D) Assets increase by $35,000, Liabilities increase by $35,000

Answer: A
Explanation: Converting bonds payable into stock reduces liabilities (Bonds Payable) by $35,000 and increases owner’s equity (Common Stock) by $35,000. Assets are not affected. The accounting equation remains balanced as liabilities decrease and owner’s equity increases by the same amount. This is a financing transaction that changes the capital structure without affecting total assets. Creditors become owners, reducing the company’s debt obligation and increasing stockholders’ equity. This transaction may be done at a pre-arranged conversion rate and can significantly affect the company’s financial leverage.

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Question 43
A company pays $22,000 for a patent. What is the effect?

A) Assets increase by $22,000, Assets decrease by $22,000 (no net change)
B) Assets decrease by $22,000, Owner’s Equity decreases by $22,000
C) Assets increase by $22,000, Liabilities increase by $22,000
D) Assets increase by $22,000, Owner’s Equity increases by $22,000

Answer: A
Explanation: Purchasing a patent for cash converts cash (asset) into an intangible asset (Patent). Total assets remain unchanged because one asset (Cash) decreases while another asset (Patent) increases by $22,000. The accounting equation remains balanced with no effect on liabilities or owner’s equity. Patents are intangible assets that provide legal protection for inventions. The cost of acquiring a patent is capitalized and amortized over its useful life, not expensed immediately. This transaction reflects the exchange of one type of asset for another.

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Question 44
A company receives $14,000 from a customer for services that will be provided over the next 6 months. What is the immediate effect?

A) Assets increase by $14,000, Liabilities increase by $14,000
B) Assets increase by $14,000, Owner’s Equity increases by $14,000
C) Assets decrease by $14,000, Liabilities decrease by $14,000
D) Assets increase by $14,000, Owner’s Equity decreases by $14,000

Answer: A
Explanation: Receiving cash in advance increases cash (asset increase) and creates unearned revenue (liability increase) of $14,000. The accounting equation remains balanced as both sides increase by $14,000. The company has collected cash but has not yet earned the revenue. The $14,000 is recorded as a liability because the company owes services to the customer. This transaction follows the revenue recognition principle, which states that revenue is recognized when earned, not necessarily when cash is received. The liability will be reduced as services are provided over the 6-month period.

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Question 45
A company sells merchandise costing $28,000 for $40,000 on credit. What is the effect?

A) Assets increase by $40,000, Owner’s Equity increases by $12,000, Assets decrease by $28,000
B) Assets increase by $12,000, Owner’s Equity increases by $12,000
C) Assets increase by $40,000, Liabilities increase by $40,000
D) Assets increase by $28,000, Owner’s Equity increases by $40,000

Answer: A
Explanation: Accounts receivable increases by $40,000 (asset increase), inventory decreases by $28,000 (asset decrease), and owner’s equity increases by $12,000 (gross profit). Net assets increase by $12,000 ($40,000 – $28,000), matching the increase in owner’s equity. The accounting equation remains balanced. This transaction shows the complete sales cycle on credit: revenue of $40,000 increases owner’s equity, and the cost of goods sold of $28,000 decreases it. The net effect is an increase in owner’s equity of $12,000 representing the gross profit.

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Question 46
A company purchases land for $100,000 by paying $20,000 cash and giving a $80,000 mortgage. What is the effect?

A) Assets increase by $100,000, Liabilities increase by $80,000, Assets decrease by $20,000
B) Assets increase by $80,000, Liabilities increase by $80,000
C) Assets increase by $100,000, Liabilities increase by $80,000
D) Assets decrease by $20,000, Liabilities increase by $80,000

Answer: A
Explanation: Land (asset) increases by $100,000, cash (asset) decreases by $20,000, and mortgage payable (liability) increases by $80,000. Net assets increase by $80,000 ($100,000 – $20,000), matching the increase in liabilities. The accounting equation remains balanced. This transaction represents a significant asset acquisition with a combination of down payment and long-term financing. The mortgage is a secured loan where the land serves as collateral. The company acquires a productive resource while maintaining some cash for other purposes.

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Question 47
A company records $7,500 of depreciation on a building. What is the effect?

A) Assets decrease by $7,500, Owner’s Equity decreases by $7,500
B) Assets decrease by $7,500, Liabilities decrease by $7,500
C) Assets increase by $7,500, Owner’s Equity increases by $7,500
D) Assets increase by $7,500, Liabilities increase by $7,500

Answer: A
Explanation: Depreciation expense reduces the book value of the building (asset decrease) and increases expenses, which decrease owner’s equity. The accounting equation remains balanced as both sides decrease by $7,500. Depreciation is a systematic allocation of a long-term asset’s cost over its useful life. It reflects the wear and tear on the building and the fact that the asset’s service potential is being consumed. Depreciation is a non-cash expense that affects both the balance sheet and the income statement. Accumulated depreciation is a contra-asset account that reduces the carrying amount of the building.

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Question 48
A company declares a 5% stock dividend on its 100,000 outstanding shares ($10 par value). What is the effect?

A) Assets increase by $50,000, Owner’s Equity increases by $50,000
B) Owner’s Equity decreases by $50,000, Owner’s Equity increases by $50,000 (no net change)
C) Liabilities increase by $50,000, Owner’s Equity decreases by $50,000
D) Assets decrease by $50,000, Owner’s Equity decreases by $50,000

Answer: B
Explanation: A stock dividend transfers $50,000 from retained earnings to paid-in capital. Owner’s equity total remains unchanged because one component decreases while another increases by the same amount. Assets and liabilities are not affected. The accounting equation remains balanced with no net change. Stock dividends distribute additional shares to existing shareholders and do not change total stockholders’ equity. They reduce retained earnings and increase contributed capital, reflecting a capitalization of earnings. This transaction does not affect the company’s resources or obligations.

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Question 49
A company sells an old delivery truck for $10,000 cash. The truck had a book value of $8,000. What is the effect?

A) Assets increase by $10,000, Assets decrease by $8,000, Owner’s Equity increases by $2,000
B) Assets increase by $2,000, Owner’s Equity increases by $2,000
C) Assets decrease by $8,000, Owner’s Equity increases by $10,000
D) Assets increase by $10,000, Owner’s Equity increases by $10,000

Answer: A
Explanation: Cash increases by $10,000 (asset increase), truck decreases by $8,000 (asset decrease), and a gain of $2,000 increases owner’s equity. Net assets increase by $2,000 ($10,000 – $8,000), matching the increase in owner’s equity. The accounting equation remains balanced. The gain represents the excess of the selling price over the book value of the asset. Gains are increases in owner’s equity from peripheral or incidental transactions, not from normal operations. This transaction shows how selling an asset for more than its book value increases the company’s wealth.

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Question 50
A company pays $18,000 for a 2-year insurance policy. What is the effect on the accounting equation over time?

A) Initially, assets increase and decrease by $18,000 (no net change); each month, assets decrease and owner’s equity decreases
B) Initially, assets decrease by $18,000, owner’s equity decreases by $18,000
C) Initially, assets increase by $18,000, liabilities increase by $18,000
D) Initially, assets decrease by $18,000, liabilities decrease by $18,000

Answer: A
Explanation: Initially, cash decreases by $18,000 and prepaid insurance increases by $18,000 (no net asset change). Each month, $750 ($18,000 ÷ 24 months) of prepaid insurance expires, reducing assets and creating insurance expense, which decreases owner’s equity. The accounting equation remains balanced throughout. This transaction illustrates the matching principle and the concept of prepaid expenses. The cost of the insurance policy is allocated over the coverage period. The insurance expense is recognized in the same period as the benefits received, not all at once when paid.

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Final Score Summary

After completing all 50 questions, you should have a comprehensive understanding of how various transactions affect the accounting equation. Remember the fundamental rule:Assets = Liabilities + Owner’s Equity. Every transaction affects at least two accounts and keeps the equation in balance. The dual-entry system ensures that debits equal credits, maintaining this equilibrium.