When a company borrows money from a bank, which of the following accounts are affected?

• A. Cash (Asset) and Notes Payable (Liability)
• B. Accounts Receivable (Asset) and Common Stock (Equity)
• C. Inventory (Asset) and Retained Earnings (Equity)
• D. Prepaid Expenses (Asset) and Accounts Payable (Liability)

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the transaction. When a company borrows money from a bank, it receives cash (an asset) and incurs a liability in the form of notes payable, which represents the obligation to repay the borrowed amount.
2. Step 2: Identify the accounts involved. The accounts affected are 'Cash' (an asset account) and 'Notes Payable' (a liability account). This is because borrowing money increases the company's cash balance and simultaneously creates a liability.
3. Step 3: Analyze the other options provided. For example, 'Accounts Receivable' and 'Common Stock' are not affected because borrowing money does not involve selling equity or receiving payments from customers. Similarly, 'Inventory' and 'Retained Earnings' are unrelated to borrowing transactions, as inventory pertains to goods and retained earnings reflect accumulated profits. Lastly, 'Prepaid Expenses' and 'Accounts Payable' are also irrelevant, as prepaid expenses involve advance payments and accounts payable relate to obligations for goods or services already received.
4. Step 4: Apply the accounting equation. The accounting equation is Assets = Liabilities + Equity. Borrowing money increases assets (cash) and liabilities (notes payable), keeping the equation balanced.
5. Step 5: Conclude that the correct accounts affected are 'Cash' (Asset) and 'Notes Payable' (Liability), as these directly reflect the borrowing transaction.