Australia Need help regarding an accounting equation

[annykinchan]

Hi, I am confused about a scenario:

lets say there is a company with asset of 100K cash, made up of 50K loan and 50K retained earnings of business. A = L + E

Now the business decides to use 50K retained earnings to pay off the $50K loan. so loan become zero and RE becomes zero, so L and E now zero.

But only $50K cash left the company, hence asset still have 50K cash. How does this make sense now... 50K = 0 + 0 ? What did I miss?

Please help

 

[BIG E]

When a loan (debt) is paid off, the Cash (asset) gets reduced, not the retained earnings.
Why would the business "decide" to use retained earnings to pay off a debt?
When the cash from the debt comes into the business account - it's not income, so when it's paid back
it's a reduction of the liability account, not the retained earnings account.

 

[annykinchan]

i am asking because it is said that: retained earnings of a business can be used to distribute dividends, reinvest, or pay off debt... so if the business wants to use retained earnings to pay off debt... how do we show that in the balance sheet?

 

[BIG E]

It is said by WHOM and WHERE did you read that from?
Distribute dividends and reinvest dividends - YES!
Pay off debt?
That's only done when an entity wishes to make the creditor a business owner in lieu of actually paying the debt in cash.
You are misinterpreting that phrase literally.

 

[annykinchan]

thanks for all your answers. If I google online 'what can retained earnings be used for' i would be able to find many links that suggest using retained earnings to pay off debt.

An example would be https://www.myob.com/au/resources/guides/accounting/retained-earnings under 'what should you do with retained earnings? - pay off debt.' may you help clarify?

 

[BIG E]

By reducing debt and not reducing assets, then it's possible to increase Retained Earnings.
But you don't reduce both liabilities and equity simultaneously.
I think you are quite confused. And your link doesn't provide the answer you are looking for.
You are confusing two different concepts by memorizing the accounting formula.

 

[DrStrangeLove]

thanks for all your answers. If I google online 'what can retained earnings be used for' i would be able to find many links that suggest using retained earnings to pay off debt.

An example would be https://www.myob.com/au/resources/guides/accounting/retained-earnings under 'what should you do with retained earnings? - pay off debt.' may you help clarify?

Your source is abusing terminology. That's why it's confusing.

The left-hand side of the balance sheet (assets) describes what resources you have. The right-hand side of the balance sheet explains how you got your resources: you got them from creditors (liabilities) or you got them from owners (equity). Retained earnings are from owners. It's whatever resources the business generated and the owners left invested in the business.

The source you linked to refers to retained earnings as though it's an asset. In the way it's using "retained earnings", it really refers to "assets equal in amount to retained earnings". It's saying that the business can use the assets it has earned and that the owners have left invested to pay down debt (liabilities).