Which of the following best explains how making payments on a car affects the fundamental accounting equation?

• A. Paying for a car reduces assets (cash) and increases liabilities (car loan), keeping the equation balanced.
• B. Car payments increase both assets and owner's equity.
• C. Paying for a car only affects owner's equity and not assets or liabilities.
• D. Making payments on a car reduces liabilities (car loan) and reduces assets (cash), with no effect on owner's equity.

Answer: (D)

Verified step by step guidance

1. Understand the fundamental accounting equation: Assets = Liabilities + Owner's Equity. This equation must always remain balanced.
2. Identify the components involved in the transaction: Making payments on a car involves reducing cash (an asset) and reducing the car loan (a liability).
3. Analyze the impact on assets: When cash is used to make a payment, the cash balance decreases, which reduces the total assets.
4. Analyze the impact on liabilities: The car loan balance decreases as payments are made, which reduces the total liabilities.
5. Confirm there is no effect on owner's equity: Since the transaction only affects assets and liabilities, owner's equity remains unchanged, keeping the accounting equation balanced.