If Accrued Compensation increases by $10, what is the balance sheet effect?

• A. Cash increases by $2; Liabilities increase by $10; Retained earnings decrease by $8
• B. Cash increases by $10; Assets increase by $10
• C. Cash decreases by $10; Liabilities decrease by $10
• D. No balance sheet effect

Answer: (A)

When you accrue compensation, you recognize an expense for the period and a corresponding liability. This increases liabilities on the balance sheet and reduces equity (via lower retained earnings) because expenses reduce net income. Importantly, cash is not affected at the moment of accrual; cash changes only when the payroll is actually paid. So the expected balance sheet effect is: liabilities rise by 10 and retained earnings fall by 10, with no change in assets or cash at the time of accrual. Among the given options, the one that best reflects this directional change is the one that shows liabilities increasing and retained earnings decreasing, even though the cash component described there isn’t accurate for the accrual moment. The key takeaway is the liability and equity impact, with no cash movement on accrual.