The accounting information system needs a way to record the events that happen in an entity. Not every event is recorded: only those that change the entity's assets, liabilities or equity. Paying off a debt, buying a machine and earning revenue from a service, for example, are all recorded.A conversation with a potential customer, the approval of a plan to hire new staff or the possibility of taking out a loan, on the other hand, are not recorded, because they have not changed the company's financial position yet.Every entry follows the double-entry method: each event has at least one debit and one credit of the same amount, which is why the fundamental accounting equation always holds:\[ \text{Assets} = \text{Liabilities} + \text{Equity} \]To show how events affect this equation, we will follow seven events at a fictitious company, Fácil S/A, during its first month. For simplicity, we ignore taxes.Event 1: the shareholders invest cashOn the first day of the month, a group of people decided to set up a company, Fácil, and pooled R$ 80,000 in cash as its capital. From that moment on the company has cash (in accounting, the Cash account), so its assets have increased. At the same time, the amount invested by the shareholders makes up the Share Capital, which is part of Equity. The increase in the Cash asset was matched by an increase in Share Capital. Entry: debit Cash, credit Share Capital.\[ \text{Cash} = \text{Share Capital} \]\[ 80000 = 80000 \]Event 2: the company takes out a loanRight after it was set up, the company applied for and obtained a long-term bank loan, to be used for future investments. On one side, Cash increases by R$ 40,000; on the other, a liability of the same amount appears. Entry: debit Cash, credit Loans.\[ \text{Cash} = \text{Loan} + \text{Share Capital} \]\[ 120000 = 40000 + 80000 \]Event 3: purchase of landThe company used R$ 60,000 of its cash to buy a plot of land where it plans to build its headquarters. One asset increased (Land) and another decreased (Cash) by the same amount, so the equation still holds. Entry: debit Land, credit Cash.\[ \text{Cash} + \text{Land} = \text{Loan} + \text{Share Capital} \]\[ 60000 + 60000 = 40000 + 80000 \]Event 4: providing a serviceThe company provided a service and received R$ 18,000. This is revenue. Over a fiscal year, revenues matched against expenses determine the profit or loss, and that result is part of Equity until it is allocated (to reserves or to dividends). That is why the revenue increases the right side of the equation, while the cash received increases Cash on the left side. Entry: debit Cash, credit Service Revenue.\[ \text{Cash} + \text{Land} = \text{Loan} + \text{Share Capital} + \text{Profit} \]\[ 78000 + 60000 = 40000 + 80000 + 18000 \]Event 5: paying rentThe company paid R$ 7,000 in rent for a property. The property was used to earn revenue, so the rent is an expense. The expense reduces the result and, with it, Equity; at the same time, Cash goes down. Entry: debit Rent Expense, credit Cash.\[ \text{Cash} + \text{Land} = \text{Loan} + \text{Share Capital} + \text{Profit} \]\[ 71000 + 60000 = 40000 + 80000 + 11000 \]Event 6: buying office supplies on creditThe company bought R$ 4,000 of office supplies to be paid later. A new asset appears (Supplies) and, at the same time, a debt to the supplier, to be settled soon: an increase in liabilities. Entry: debit Supplies, credit Accounts Payable (Suppliers).\[ \text{Cash} + \text{Land} + \text{Supplies} = \text{Loan} + \text{Suppliers} + \text{Share Capital} + \text{Profit} \]\[ 71000 + 60000 + 4000 = 40000 + 4000 + 80000 + 11000 \]Event 7: paying salariesAt the end of the month, the company paid R$ 5,000 in salaries. This is an expense: it reduces the result and therefore Equity, and at the same time it reduces Cash. Entry: debit Salary Expense, credit Cash.\[ \text{Cash} + \text{Land} + \text{Supplies} = \text{Loan} + \text{Suppliers} + \text{Share Capital} + \text{Profit} \]\[ 66000 + 60000 + 4000 = 40000 + 4000 + 80000 + 6000 \]The profit for the month is therefore R$ 18,000 − R$ 7,000 − R$ 5,000 = R$ 6,000.After the seven events, what was Fácil S/A's profit for the month?Answer: R$ 6,000 — revenue of R$ 18,000 minus R$ 7,000 rent and R$ 5,000 salaries. R$ 11,000 is the profit before salaries were paid, and buying supplies on credit is not an expense.The Balance Sheet at the end of the monthWe can now put together the Balance Sheet, using the groups defined by Brazilian Corporate Law (Law 6,404/76, as amended by Laws 11,638/07 and 11,941/09):GroupAccountAmount (R$)Current AssetsCash66,000Office supplies4,000Total70,000Non-current Assets (Property, plant and equipment)Land60,000Total60,000Total AssetsTotal130,000Current LiabilitiesSuppliers4,000Total4,000Non-current LiabilitiesLoans40,000Total40,000EquityShare Capital80,000Profit for the period (to be allocated)6,000Total86,000Liabilities + EquityTotal130,000Two notes on classification. The loan is a Non-current Liability because it falls due after 12 months; the portion due within 12 months of the balance sheet date must be moved to Current Liabilities. And the profit is shown as "Profit for the period (to be allocated)" because this is a mid-year balance sheet: in a Brazilian corporation (S/A), the whole profit must be allocated at year-end (to profit reserves or dividends), since the law only allows an accumulated losses balance on the annual balance sheet.On the asset side, Cash stands out (R$ 66,000, or 51% of total assets), followed by Land (46%). On the funding side, Equity stands out, at 66% of the total (R$ 86,000 out of R$ 130,000).On Fácil S/A's final balance sheet, what percentage of total assets is in Current Assets?Answer: 54% — Current Assets are Cash plus Supplies: R$ 70,000 out of R$ 130,000. The 51% is Cash alone, and 66% is the share of equity.Adjusting entriesAdjusting entries make sure revenues are recognized, and expenses matched against them, in the right period, as the accrual basis requires. They are made at the end of the accounting period.With these adjustments, the financial statements show the company's real situation. They are needed for several reasons. Sometimes it would be too much work to record an event when it happens: salary expense, for example, accrues with every day worked, but for practical reasons it is recorded as an adjustment. In other cases, the expense builds up over time, as with the use of a rented property or an insurance contract. There are four basic types of adjustment:prepaid expenses (paid before they are incurred);unearned revenue (received before it is earned);accrued expenses (incurred before they are paid);accrued revenue (earned before it is received).In all of them there is a time gap between the cash movement and the recognition in the income statement. That is why there will be at least two entries: one that affects cash and another that affects the result.Prepaid expensesPrepaid expenses are paid before the expense appears in the Income Statement. The most common examples are rent and insurance paid in advance. When the payment is made, the credit to Cash is matched by a debit to an asset account (usually a Current Asset). Then, month by month, that asset account is credited and an expense account is debited.The same reasoning, first recording an asset and then moving it to the income statement as it is used up, applies to supplies (which stay in inventory until used) and, more broadly, to the depreciation of property, plant and equipment. These two, however, are not classified as "prepaid expenses" on the balance sheet.Prepaid rentConsider a company that paid R$ 3,000.00 in advance for three months of rent. By paying, it acquires the right to use the property for the coming months.On payment, R$ 3,000.00 leaves Cash and R$ 3,000.00 goes into "Prepaid rent" (debit Prepaid Rent, credit Cash).This entry does not affect the result: it only swaps one asset for another. Since the advance covers three months, at the end of the first month 1/3 of the Prepaid Rent asset no longer exists.Each month, R$ 1,000.00 leaves "Prepaid rent" and R$ 1,000.00 goes into "Rent expense" (debit Rent Expense, credit Prepaid Rent).InsuranceIn an insurance contract, the company pays the premium and, in return, gains the right to be compensated if a covered loss occurs during the policy period. So when it signs the contract, an asset appears, which is moved to the income statement in proportion to the coverage period.Suppose a 12-month car insurance policy with a premium of R$ 1,200.00, paid upfront. On signing, R$ 1,200.00 leaves Cash and R$ 1,200.00 goes into "Prepaid insurance" (debit Prepaid Insurance, credit Cash).Each month, R$ 100.00 (R$ 1,200.00 ÷ 12) leaves "Prepaid insurance" and R$ 100.00 goes into "Insurance expense" (debit Insurance Expense, credit Prepaid Insurance).SuppliesWhen an entity buys supplies, it has an asset that will be used in the future. At the end of each month, a physical count shows how much was used, and the adjustment is then made.Suppose a company bought twenty printer cartridges in a given month at R$ 50.00 each. On purchase, R$ 1,000.00 leaves Cash and R$ 1,000.00 goes into "Supplies".At the end of the month, the count found 15 cartridges in stock, meaning 5 were used. This use must be recorded, "writing it off from inventory": 5 × R$ 50.00 = R$ 250.00. R$ 250.00 leaves "Supplies" and R$ 250.00 goes into "Supplies expense" (debit Supplies Expense, credit Supplies). R$ 750.00 remains in the asset, corresponding to the 15 cartridges still in stock.A company bought 30 cartridges at R$ 40.00 each. At the end of the month, the count found 22 in stock. What is the supplies expense for the month?Answer: R$ 320.00 — 30 − 22 = 8 cartridges were used, and 8 × R$ 40.00 = R$ 320.00. R$ 880.00 is what remains in the asset, for the 22 cartridges still in stock.Unearned revenueThis is the reverse of a prepaid expense: the company receives payment before providing the service or delivering the product. Since it still owes the delivery, the amount received is a liability (for example, "Customer advances"), not revenue.Example: a school receives R$ 6,000.00 in advance for a six-month course. On receipt: debit Cash, credit Customer Advances (liability). For each month of classes given: debit Customer Advances, credit Service Revenue, R$ 1,000.00.Accrued expensesHere the expense has already happened, but payment comes later. Typical examples are a month's salaries paid the following month and interest on loans.Back to Fácil S/A: the R$ 40,000 loan generates interest every month, even if it is only paid at maturity. If the month's interest is R$ 400.00, the adjustment is a debit to Interest Expense and a credit to Interest Payable (liability). Note that receiving the loan itself is neither an adjustment nor revenue: it was recorded in Event 2, with a debit to Cash and a credit to Loans, and the debt only goes down when it is repaid.Accrued revenueFinally, revenue can be earned before it is received: a service provided in December that the customer only pays in January, or interest on an investment that will only be credited on redemption. The adjustment is a debit to a receivable account (asset) and a credit to revenue. When the cash comes in, Cash is debited and the receivable is credited, with no further effect on the result.A school receives R$ 6,000.00 in advance for a six-month course that has not started yet. What is the entry on receipt?Answer: Debit Cash, credit Customer Advances (liability) — the school still owes the classes, so the amount is an obligation. Revenue is recognized month by month, R$ 1,000.00 for each month of classes given; crediting it all to revenue on receipt breaks the accrual basis.Summary of adjustmentsExercises1) (Fundação Getúlio Vargas - FGV - 2023) On 12/31/X0, a business company had R$100,000 receivable from its customers within up to five months. Default was estimated at 4%. Select the option that indicates how this fact is presented in the company's financial statements.A) R$96,000 in current assets and R$4,000 in current liabilities, on the balance sheet.B) R$100,000 in current assets and R$4,000 in current liabilities, on the balance sheet.C) R$96,000 in current assets, on the balance sheet, and disclosure of R$4,000 in a note.D) R$100,000 in current assets, on the balance sheet, and disclosure of R$4,000 in a note.E) R$96,000 in current assets and R$4,000 in a contra account of current assets, on the balance sheet.2) (Fundação Getúlio Vargas - FGV - 2023) A business company started works to expand its office. The works are expected to last two years, starting on 01/02/X0 and ending on 12/31/X1. R$40,000 of building materials were purchased for the works. Select the option that indicates how the building materials are accounted for on the company's balance sheet.A) R$40,000 in current assets.B) R$40,000 in long-term receivables.C) R$40,000 in investments.D) R$40,000 in property, plant and equipment.E) R$20,000 in current assets and R$20,000 in long-term receivables.3) (Fundação Getúlio Vargas - FGV - 2023) On 12/31/X0, Cia X had the following items on its balance sheet: Cash and cash equivalents: R$5,000; Land: R$50,000; Loans payable: R$10,000; Share Capital: R$45,000. In January X1, Cia Y bought 100% of Cia X for R$95,000. On that date, the fair value of the land was R$60,000, that of the brand R$20,000 and that of the loans payable R$9,000, since their interest rate was lower than the market rate. Select the option that indicates the goodwill recognized by Cia Y on the acquisition of Cia X.A) R$19,000.B) R$21,000.C) R$24,000.D) R$29,000.E) R$31,000.4) (Fundação Getúlio Vargas - FGV - 2023) Regarding the balance sheet, consider the following statements:I. When analyzing a balance sheet, the financial manager should keep three concerns in mind: liquidity, debt versus equity, and value versus cost.II. Current assets have the highest liquidity and include cash and the assets that will be converted into cash within one year of the balance sheet date.III. The book value of shareholders' equity decreases when a profit reserve is added.Which statements are correct?A) I, II and III.B) I and II only.C) I and III only.D) II and III only.E) I only.5) (Fundação Getúlio Vargas - FGV - 2023) A business company held an 80% interest in Cia. X. On 12/30/X0, the company had the following balance sheet:Current Assets30,000Equity78,000Cash30,000Non-current Assets48,000InvestmentsInvestments (Cia X)48,000Total Assets78,000Total Equity78,000In year X0, Cia. X earned a profit of R$ 10,000 and distributed dividends totaling R$ 2,000. Select the option that indicates the balance of the "Investments" account on the company's balance sheet on 12/31/X0, after Cia X determined its profit and recognized the dividends.A) R$ 54,000.B) R$ 54,400.C) R$ 56,000.D) R$ 57,600.E) R$ 60,000.6) (Fundação Getúlio Vargas - FGV - 2023) On 01/01/X0, an educational institution bought a building for R$500,000 to rent out to third parties. The building's useful life was estimated at 50 years. After initial recognition, the institution chose to measure the building using the fair value model, with increases recognized annually in the Income Statement. On that date, it was R$600,000. On 12/31/X1, the institution decided to use the building in its own operations, accounting for it as property, plant and equipment from then on. On that date, the building's fair value was R$700,000. Select the option that indicates the carrying amount of the building on the institution's balance sheet on 12/31/X1.A) R$480,000.B) R$500,000.C) R$576,000.D) R$600,000.E) R$700,000.Solution1) E. The expected loss on receivables is not merely disclosed in a note: it is recognized in a contra-asset account (allowance for expected credit losses). The balance sheet shows Receivables of R$ 100,000 less R$ 4,000, that is, R$ 96,000 net in Current Assets. Option E is worded a little loosely (what appears in assets is Receivables of R$ 100,000, and R$ 96,000 is the net amount after the contra account), but it is the only option with the contra-asset account. Option C is wrong because it leaves the loss only in a note.2) D. Materials bought for works to expand the company's own office are property, plant and equipment (construction in progress), not inventory.3) A. Net assets at fair value: 5,000 + 60,000 + 20,000 − 9,000 = 76,000. Goodwill: 95,000 − 76,000 = 19,000.4) B. Statement III is wrong: setting up a profit reserve increases equity.5) B. Equity method: 48,000 + 80% × 10,000 − 80% × 2,000 = 48,000 + 8,000 − 1,600 = 54,400.6) E. When investment property carried at fair value is transferred to property, plant and equipment, its deemed cost is the fair value at the date of change in use (CPC 28, the Brazilian standard equivalent to IAS 40): R$ 700,000.
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