Solved: Which of the following is an example of increasing…

Question:

Which of the following is an example of increasing both current liability and use assets?

A. Paying off car loan and investing money in retirement fund

B. Paying down mortgage and putting money in savings

C. Selling a motorcycle to pay off a debt

D. Trading in an old car for a newer car and financing the balance

Answer:

D. Trading in an old car for a newer car and financing the balance

Increasing liabilities

When you trade in your old car and get a new one, you have two options for paying the balance. If you decide to finance the balance from your pocket, you do not have any financial obligation to anyone. However, you become liable to pay the lender when you finance the balance from external funds.

Financing a car balance with borrowed money after a trade-in implies you have increased your liabilities. You will remain to pay the lender who assisted you in paying the remaining balance of your car fully. This liability will keep reducing with time as you honor your responsibility to repay whenever they fall due.

Increasing assets

The value of the old car traded in is not equivalent to the value of the new car acquired. The value of the new car you get is higher than that of the old car you have disposed of. The net of what you have disposed to what you have brought in is a positive figure. The positive value is interpreted as increased current assets in your balance sheet.

This explains why option D is the correct scenario where you will increase both assets and liabilities in your balance sheet.

Options A, B and C are not correct because they are either decreasing assets while increasing liability or vise-versa.

In option C, it is decreasing both assets and liabilities and hence is not the correct scenario described in our case. When you sell a motorcycle, you have reduced your assets. When you pay your debt from sales proceeds of the motorcycle you have reduced your liabilities as well.

With option B, you reduce your mortgage liability when you pay it and increase your assets in form of more savings. Since this option is only increasing assets, it is not our wanted example.

In option A, you are reducing your liabilities since you’re paying off your financial obligation towards a car loan. Besides, you are investing a proportion of your disposable income into a retirement fund, increasing your assets. This option is decreasing liabilities hence an unwanted example.