When cash is received from a customer in payment for an account receivable, how are the elements of the accounting equation affected?
A) Decrease assets (cash) and increase assets (accounts receivable)
B) Increase assets (cash) and decrease assets (accounts receivable)
C) Increase assets and increase liabilities
D) Increase assets and increase equity
E) None of the above
The correct answer and explanation is :
The correct answer is B) Increase assets (cash) and decrease assets (accounts receivable).
Explanation:
When cash is received from a customer in payment for an account receivable, it affects the accounting equation, which is structured as:
Assets = Liabilities + Equity
- Assets are the resources owned by the business (e.g., cash, accounts receivable).
- Liabilities are the obligations the business owes to others (e.g., loans, accounts payable).
- Equity represents the owner’s claims to the business’s assets (e.g., stockholders’ equity, retained earnings).
The key point here is that the transaction involves two assets: cash and accounts receivable. Here’s the breakdown:
- Increase in Cash: When the company receives cash from a customer, the business’s cash balance increases. This is an increase in the asset section of the equation.
- Decrease in Accounts Receivable: The amount of cash received reduces the company’s accounts receivable because the customer has paid what they owed. Therefore, accounts receivable (which is also an asset) decreases.
Thus, the transaction impacts the asset side of the accounting equation by increasing cash and decreasing accounts receivable. Importantly, the total value of assets does not change, because cash and accounts receivable are just two different forms of assets.
This transaction does not affect liabilities or equity, as no new debts are incurred nor any income earned directly in this step. The reduction in accounts receivable (an asset) is offset by the increase in cash (another asset), keeping the balance of assets the same.
This is why the correct answer is B. The equation stays balanced: Total Assets before and after the payment are the same, and the elements of Liabilities and Equity are unaffected.