When PIK interest accrues, which balance sheet changes occur?

When PIK interest accrues, which balance sheet changes occur?

• A. Debt increases and Retained Earnings decrease
• B. Cash increases and Debt decreases
• C. Inventory increases and Accounts Payable increases
• D. Cash decreases and Equity increases

Answer: (A)

PIK interest accrues means interest is paid in kind by adding to the principal, not in cash. When interest accrues, you record an interest expense, which reduces net income. That lower net income reduces retained earnings, a component of equity. At the same time, because the interest is capitalized rather than paid in cash, the outstanding debt increases. Cash isn’t affected since no cash outflow occurs with accrual, and other accounts like inventory or accounts payable aren’t involved in this transaction. So the balance sheet shows debt increasing and equity (via retained earnings) decreasing.

PIK interest accrues means interest is paid in kind by adding to the principal, not in cash. When interest accrues, you record an interest expense, which reduces net income. That lower net income reduces retained earnings, a component of equity. At the same time, because the interest is capitalized rather than paid in cash, the outstanding debt increases. Cash isn’t affected since no cash outflow occurs with accrual, and other accounts like inventory or accounts payable aren’t involved in this transaction. So the balance sheet shows debt increasing and equity (via retained earnings) decreasing.