In Reading 19, Blue Box 4, question 3, can someone explain why the additional periodic expense doesn’t reduce equity?
I understand why the 1% increase in the trend rates increase debt in the numerator and decrease equity in the denominator (since they have to to keep the account equation in balance), but it seems that the additional expense amount would also reduce equity (the denominator) - which, from an accounting equation standpoint, would be offset by a reduction in assets.
Thanks for any insight.
It does. And as you mentioned, debt/equity increases. There is no change in assets, just liability-equity relationship.
Imagine this balance sheet. A=10, E=2, D=8
Now imagine this balance sheet. A=10, E=1, D=9
As you can see, assets did not change but D/E increased immensely as liabilities increased by 1 and equity was reduced by 1.
Thanks for your help.
Actually, as I think through this a little more, I wonder if another aspect to this is that the increased expense is already built into the increased obligation - so doing both (as I suggested initially) would actually result in a double count.
Either way, thanks again for weighing in.