If the value of diagnostic equipment falls due to obsolescence, how is the balance sheet adjusted to preserve the accounting identity?

• A. Assets are increased
• B. Liabilities are increased
• C. Equity is reduced
• D. No change

Answer: (C)

When diagnostic equipment becomes obsolete, its value on the balance sheet is written down. That write-down creates an impairment loss that hits the income statement, lowering net income. Lower net income reduces retained earnings, which is part of equity. So the impairment causes assets to drop in value and equity to drop as well, keeping the accounting equation in balance. In this scenario, the impact is seen as a reduction in equity, making that choice the best fit. The other options would not reflect the loss: assets aren’t increased, liabilities aren’t affected by the impairment, and there is, in fact, a change to reflect the loss.