Payments to suppliers would have no effect on net income or shareholders’ equity. True False
The correct answer and explanation is:
Correct Answer: True
Explanation (300 words):
Payments to suppliers typically do not affect net income or shareholders’ equity directly, and this statement is True when considered in the context of accrual accounting, which is the standard for financial reporting.
Under accrual accounting, expenses are recorded when incurred, not when cash is paid. For example, if a company purchases inventory or services from a supplier on credit, the expense is recognized when the goods or services are received, not when the payment is made. The transaction increases expenses (such as Cost of Goods Sold or operating expenses) and accounts payable.
When the company later pays the supplier, it is simply settling a liability (Accounts Payable). This payment reduces cash (an asset) and accounts payable (a liability), but does not change net income, because the expense has already been recorded at the time the goods/services were received. Since net income is the driver of changes in shareholders’ equity (through retained earnings), and since the payment doesn’t affect net income, it also does not affect shareholders’ equity.
This principle is especially important in analyzing the cash flow statement. Payments to suppliers appear in the operating activities section, showing how much cash the company used to settle obligations, but it doesn’t impact the income statement (which reports revenues and expenses).
Summary:
- Payment to suppliers reduces cash and accounts payable.
- It does not affect net income (because the expense was already recorded).
- It does not affect shareholders’ equity (which depends on net income).
Therefore, the correct answer is: True — Payments to suppliers do not affect net income or shareholders’ equity.