Question

Company B needed additional financing to grow its business, so it took out a loan from the local bank for $100,000 on March 1st. The bank requires that the principal amount of the loan will need to be repaid in two years, with interest due every six months.

How would this transaction impact the accounting equation of Company B on March 1st when it took out the loan?

Answer 1

Business is an economic activity formed and maintained by a community of people with the objective of either earning profit or serving others without profit-motive. For running its show, business firms need funds and so they raise funds either through equity capital or debt capital. Debt capital refers to borrowings from others for a stated interest rate repayable at the end of time period agreed upon between the firm and the lenders. One of the kinds of debt capitals is bank loan whereby firm borrows funds from banks agreeing to repay at specified date by paying interest-alone or installments containing interest and partial principal repayment as per terms of the loan agreed upon. When firm borrows fund through bank loan, cash comes into the business and so cash asset account shall be debited for the amount borrowed. On other side of the accounting equation, liability is being created for the same amount. It means that borrowing fund from a bank relates to capital transaction that would affect assets and liability section of the accounting equation. It doesn't affect income or expense reported under retained earnings section on the accounting equation.