MidTerm1 Question

Consider the purchase of a small $400,000 appartment building that your firm intends to use as a rental unit. The building was purchased with a mix of $100,000 in cash and a 20 year loan for the balance

How could this purchase appear on the balance sheet?
(a) An increase in total assets of $400,000, an increase in owner equity of $100,000
and an increase in other liabilities of $300,000.
(b) A decrease in current assets of $100,000 and a increase in fixed assets of
$400,000.
(c) An increase in fixed assets of $400,000, a decrease in current assets of $100,000
and an increase in other liabilities of $300,000.
(d) None of the above.

ANSWER:

The correct answer is (c) because it is a new fixed asset, $400,000 would appear under "Fixed Assets". You would have a decrease of $100,000 in "Current Assets" because that is the amount you paid in cash for the apartment. Then the remaining $300,000 would appear as an increase in liabilities because that is the amount you took out the loan for.
if (a) was correct, the car would show up as $400,000 in total assets. The $100,000 of owner equity means that there was $100,000 invested in the company by shareholders. The $300,000 increase in "Other Liabilities" would be the car loan.
if (b) was correct, the decrease of $100,000 in "Current Assets" would be spending $100,000 of free cash (probably a down-payment on the car). Then the increase in fixed assets would be the car. Answer (b) does not include the loan of $300,000.

Unless otherwise stated, the content of this page is licensed under Creative Commons Attribution-ShareAlike 3.0 License