Instructor Blog - Credit College - Accounting Essentials

Q: If cost of goods sold in question 7 were to increase to $40,000 and no change is given for inventory, wouldn't that break the accounting equation?

A: Yes. The $40,000 increase in COGS decreases net profit and net worth by $40,000. But total assets do not decrease by $40,000 as they should when inventory is moved from the balance sheet to the income statement. Therefore, the failure to reduce inventory by $40,000 means that total assets remain the same as before, but total liabilities plus net worth decrease by $40,000. The accounting equation is out of balance. Total assets would no longer equal the sum of total liabilities and net worth.

Course overview:  Double Entry Accounting, the Accounting Equation, and Debits and Credits