A company decides to use a higher amount of debt in its capital from this year. Which item of its future Profit and Loss Account is most directly raised by this financing decision?
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → Interest expense
Option (1) Depreciation — Incorrect. Depreciation is charged on fixed assets. It rises when the firm buys more assets, which is a capital budgeting decision.
Option (2) Interest expense — Correct. Debt is serviced by paying interest every year. So a higher amount of debt means higher interest expense in future years.
Option (3) Payment of dividends — Incorrect. Dividends are paid to shareholders. It is higher use of equity that may lead to higher payment of dividends.
Option (4) Salaries — Incorrect. Salaries are a cost of running the business. They depend on the staff employed, and the way capital is raised does not change them.
NCERT (2026-27 Edition): “Financial Management … Importance: … (v) All items in the Profit and Loss Account, e.g., Interest, Expense, Depreciation, etc. : Higher amount of debt means higher interest expense in future. Similarly, use of higher equity may entail higher payment of dividends. Similarly, an expansion of business which is a result of capital budgeting decision is likely to affect virtually all items in the profit and loss account of the business. …” |