Cengage Accounting Exam 1 Practice Test

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Paying creditors on account would result in which effect on the accounting equation?

Cash increases; Liabilities increase

Cash decreases; Liabilities decrease

Paying a creditor on account settles a liability with cash. This decreases the cash asset and decreases the liability (accounts payable) by the same amount, so the accounting equation stays balanced and owner’s equity isn’t affected. This is why the correct description is cash decreasing and liabilities decreasing.

The other options would imply gaining cash, recognizing revenue, or reducing owner’s equity, none of which occur when paying a liability.

Cash decreases; Revenues increase

Cash increases; Owner's equity decreases