If Assets Increase And Liabilities Decrease What Happens To Equity
Here we are concerned with the Accounting Questions that “if assets (A) increase and liabilities (L) decrease, then what effect will be on Equity (E) or owner's equity or Capital” And "If There is an increase / decrease in liabilities what will happen to assets"?
Practically, it is impossible that assets increase and liabilities decrease at the same time as increase in assets is debited and decrease in liabilities is also debited. According to Dual Aspect Accounting Concept, "For every debit, there must be a credit with an equal amount". However, there are possibilities that total assets are increased and total liabilities are decreased and vice versa. Also, there are possibilities that A increases and L increases with an equal amount at the same time or A decreases and L also decreases with an equal amount. In order to answer these questions, we use Accounting Equation which shows that:
Example: Suppose, the company has assets worth Rs. 50000 on 31st December, 2019. L and E on 31st December, 2019 are Rs. 15000 and Rs. 35000 respectively.
Now, we know that before increase of A and increase of L, the E is Rs. 35000.
Suppose, the net value of asset (cash) increased by Rs. 10000 due to bank loan and the liability (bank loan) is also increased by Rs. 10000, then what will be the E after such changes is shown below:
A after increased is Rs. 60000 and L after decreased is Rs. 25000, now what is E?
By applying Accounting Equation, we get:
60000 = 25000 + E
E = Rs. 35000
So, we can see that E is remained unchanged or there will be no effect on E as there is an equal change in the value of A and L as it is proved by accounting equation.
The examples in which an asset decreases and a liability decreases include cash paid to suppliers, repaying loan, etc.
When A exceeds L, then it is a good sign for the company's business to meet its short-term and long-term obligations. It also increased the E. On the other hand, if the L exceeds A then the company needs more cash and funds to meet its L and as a result, the A and E decreased which is not a good sign for financial health of the company's business.
Question I. If I Buy An Asset Does Liabilities Increase Or Decrease?
It all depends upon whether the asset is acquired by paying cash or by raising funds from outsiders (banks, accounts payable, etc.). If cash is paid then nothing effect on L but the asset increases and decreases at the same out. But if the asset purchased on account, then with the buying of asset, the liability (accounts payable) is also increased.
For Understanding The Relationship Between A, L And E
Question II. If A Company's Assets Remain Constant And Its Liabilities Decrease, What Will Increase?
If a company's assets unchanged during the accounting period and its L decreases then stockholder's equity will increase as proved from Accounting Equation with the help of an example as shown below:
Example: If Total Assets are $80,000$, Liabilities decreased from $30,000 to $20,000. Stockholder's equity before change is $50,000. What be will be the increase in shareholder's equity or Net Worth after change if total assets remained unchanged?
Given:
Total Assets Before Change = $80,000 | Total Liabilities Before Change = $30,000 | Total Equity = $50,000 | Liabilities After Change = $20,000
From accounting equation, we have:
Total Assets Before Change = Total Liabilities Before Change + Equity Before Change
$80,000 = $30,000 + $50,000
Add Change, we have:
$80,000 +0 = $30,000 + (-$10,000) + Equity after change
After the change, we have:
$80,000 = $20,000 + Equity after change
Stockholder's Equity After Change = $80,000 - $20,000 = $60,000
So, if total assets remained the same during the accounting period and total liabilities decreased from $30,000 to $20,000, the stockholder's equity will increase by $10,000 (from $50,000 to $60,000).
Positive assets reduce liabilities and expenses by improving sales, which is an inflow for the business, and increase equity as more assets such as cash can be invested into the business.
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