Is it true that if a business creates a liability when it purchases equipment using its own cash
The correct answer and explanation is:
No, it is not true that a business creates a liability when it purchases equipment using its own cash. A liability is created when a business borrows money or incurs an obligation to pay in the future. When a business purchases equipment using its own cash, it does not incur a liability; rather, it exchanges one asset (cash) for another asset (equipment).
Here’s an explanation:
When a business buys equipment, the transaction typically involves two elements. First, the business will use cash, which is classified as a current asset, to pay for the equipment. Second, the business acquires equipment, which is a fixed asset or property, plant, and equipment (PPE). The equipment will be recorded on the balance sheet as an asset, increasing the total value of the business’s assets. At the same time, the cash account decreases by the amount spent on the equipment. Since no external borrowing or obligation to pay in the future is involved, there is no liability created in this case.
Liabilities are obligations a business owes to others, which can include loans, accounts payable, or any other debts. In contrast, using cash to buy an asset like equipment does not result in owing money to a third party. Therefore, it affects the business’s asset side of the balance sheet but does not create a liability.
This distinction is important in accounting. The financial position of a business is assessed by comparing assets, liabilities, and equity. A business’s equity remains unchanged in this scenario because both cash and equipment are assets. Thus, while cash is reduced, the overall financial obligations of the business do not increase when purchasing equipment outright with cash.