Balance sheet in the accounting system: transactions and accounting

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We will deal with the double entry accounting method and discuss the issue of debit and credit. We will show their meaning for accounting. Shall we start?

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The accounting information system needs a way to record the events that occur in an entity. It is important to note

that not all events are recorded by accounting, but only those that affect the financial position. For example, the

payment of a debt, the purchase of a machine, and the revenue obtained from providing a service are examples of events that

are recorded.

But a discussion with a potential client, the approval of a plan to hire new employees, or the possibility of obtaining a new loan are not events recorded by accounting, because they have not yet affected the financial position.

To show how events affect an entity’s accounting, let us consider seven events of the company Fácil S/A, presented and analyzed below.

Example 1

Cash Investment by Shareholders. On the first day of the month, some people decided to create a company that was named Fácil. To do this, it gathered R$ 80 thousand in resources for its capital in cash. From this moment on, the new company has cash resources (called Cash in accounting), indicating an increase in assets. At the same time, this amount was invested in the company by the shareholders, constituting its Share Capital. Thus, the increase in the Cash asset was followed by an increase in Share Capital, which is part of Equity. The effect of the event on the basic equation is:

\[ \text{Liabilities + Equity} = \text{Assets} \]

\[ \text{Share Capital} = \text{Cash} \]

\[ 80000 = 80000 \]

Example 2

Obtaining a Loan. Shortly after the company was created, a long-term loan was requested and obtained from a bank. These resources will be used in the future for the company’s investments. On the one hand, the event will increase the Cash asset, with an increase of R$ 40 thousand. On the other hand, the company now has a liability of the same amount. The effect on the basic equation is as follows:

\[ \text{Liabilities + Equity} = \text{Assets} \]

\[ \text{Share Capital + Loan} = \text{Cash} \]

\[ 40000 + 80000 = 120000 \]

Example 3

Purchase of Land. The company used the resources available in Cash to buy a plot of land where it intends to build its headquarters in the future. The purchase price was R$ 60 thousand. This is a situation in which there was an increase in the company’s asset, Land, and at the same time a reduction in another asset, Cash, in the same amount. As a result, the accounting equation remains valid, as shown below:

\[ \text{Share Capital + Loan} = \text{Cash + Land} \]

\[ 40000 + 80000 = 60000 + 60000 \]

Example 4

Provision of Service. The company provided a service to third parties and received R$ 18 thousand. This provision of service corresponds to revenue for the company. During a fiscal year, a company may obtain revenues, which, when matched against expenses, will determine the existence of profit or loss. This result will remain part of equity until it is distributed to the shareholder in the form of a dividend. For this reason, on the one hand, we can say that the revenue generated affects the basic equation on the right-hand side. But the

receipt increases Cash, maintaining equality in the accounting equation, as shown below:

\[ \text{Share Capital + Loan + Profit} = \text{Cash + Land} \]

\[ 40000 + 80000 + 18000 = 78000 + 60000 \]

Example 5

Payment of Property Rent. The company made a payment of R$ 7 thousand related to the rent of a property. Note that this rent was used in the process of obtaining revenue and is therefore an expense of the company. The expense reduces the company’s result and, consequently, equity. At the same time that this event reduced the right-hand side of the equation, there was also a decrease in Cash, on the left-hand side. Thus, equality was maintained, as can be seen below:

\[ \text{Share Capital + Loan + Profit} = \text{Cash + Land} \]

\[ 40000 + 80000 + 11000 = 71000 + 60000 \]

Example 6

Purchase of Office Supplies. The company purchased R$ 4 thousand of office supplies on credit. This means that, on the one hand, a new asset, Supplies, comes into existence, and a liability to third parties also arises. This debt to the supplier of the supplies must be settled in the near future, representing an increase in liabilities. Thus, the equation maintains equality, as can be seen below:

\[ \text{Share Capital + Loan + Profit + suppliers} = \text{Cash + Land + supplies} \]

\[ 40000 + 80000 + 11000 + 4000 = 71000 + 60000 + 4000 \]

Example 7

At the end of the month, the company paid salaries in the amount of R$ 5 thousand. This corresponds to an expense and will reduce the company’s result. As a result, the value of Equity will also decrease. At the same time, the payment will decrease the resources available in Cash, maintaining equality in the accounting equation:

\[ \text{Share Capital + Loan + Profit + suppliers} = \text{Cash + Land + supplies} \]

\[ 40000 + 80000 + 6000 + 4000 = 66000 + 60000 + 4000 \]

The Final Balance Sheet

Now we can see the Balance Sheet:

ClassItemAmount
Current AssetsCash66,000
Supplies4,000
Total70,000
Non-current AssetsLand60,000
Total60,000
Total AssetsTotal130,000
Current LiabilitiesSuppliers4,000
Total4,000
Non-current LiabilitiesLoans40,000
Total40,000
EquityShare Capital80,000
Profit Reserves6,000
Total86,000
Liabilities + EquityTotal130,000

We can clearly see that on the Assets side, the highlights are the share of resources in Cash (R$ 66 thousand, or 51% of assets) and Land. While on the liabilities side, the highlight is equity, which represents 66% of the total amount.

Adjustments

Adjusting entries are important because they ensure that revenue recognition and expense matching are guaranteed. These entries are made in accounting at the end of the accounting period.

With the adjustments, the financial statements will show the company’s actual situation. The adjustments are necessary for several reasons. In some cases, they are made because it is very costly to make entries at the moment they occur. This is the case with recording salary expenses, which, according to matching, should be done daily, but for practical reasons the entry is made as an adjustment. In other situations, expenses are associated over the course of time. This is the case with the use of buildings and insurance contracts. There are four basic types of adjustments, which we will study below. They are:

X prepaid expenses;

X deferred revenue;

X accrued expenses; and

X accrued revenue.

In all these cases, there is a time difference between cash movement and recognition or matching. This means that there will be at least two entries: one that affects cash and one that affects income.

Prepaid Expenses

Prepaid expenses (or deferred expenses) are those in which payment occurs before the expense appears in the Income Statement. The most common examples of prepaid expenses are rent, insurance, inventories, and depreciation.

In all cases, the cash movement occurs first: payment to third parties. The offsetting entry for the credit to Cash will be a debit entry in an asset account. Later, the asset account will be credited, with a debit to an Income Statement account.

Prepaid Rent

Consider the example of a company that entered into a rental contract with an advance payment of R$3,000.00 for three months of rent. At the moment the payment is made, the company acquires the right to use the rented property for the coming months.

In this case, R$3,000.00 leaves CASH and R$3,000.00 enters “Prepaid Rent.”

At this moment, the entry does not affect the company’s income; it only changes the asset side of the accounting equation. Since the rent advance referred to a payment for three months, after the first month has elapsed, 1/3 of the Prepaid Rent asset ceases to exist.

For each month, there will be an outflow of R$1,000.00 from “Prepaid Rent” and an inflow of R$1,000.00 into “Rent Expense.”

Insurance

Consider the situation of an insurance contract. Signing and paying for a policy create a right, in the event of a claim, to benefit from the insurance coverage. When a company signs a contract, an asset comes into existence. This asset will be recognized in income in proportion to the period of time.

Suppose an automobile insurance contract is signed for an amount of R$1,200.00. At the time of signing, the following entry will be made:

In this case, R$1,200.00 leaves CASH and R$1,200.00 enters “Prepaid Insurance.”

For each month, there will be an outflow of R$100.00 from “Prepaid Insurance” and an inflow of R$100.00 into “Insurance Expense.”

Consumable Supplies

When an entity acquires inventory, it has an asset that will be used in the future. At the end of each month, we can perform a physical check to determine how much of the inventory was used and make the adjusting entries.

Suppose a company bought, in a given month, a total of twenty printer cartridges for R$50.00 each. The entry at this moment is as follows:

In this case, R$1,000.00 leaves CASH and R$1,000.00 enters “Consumable Supplies.”

At the end of the month, we can check how many cartridges were used. It is enough to physically count the cartridges existing in inventory. Consider that the count revealed the existence of 15 cartridges. This means that 5 cartridges were used. Thus, it is necessary to make the entry for the use of these cartridges, “writing down the inventory”:

In this case, R$100.00 leaves “Consumable Supplies” and R$100.00 enters “Supplies Expense.”

Loans

Similar to what happens above, loans enter by crediting CASH and debiting the appropriate item (Deferred Revenue or Loan) and then, month by month, are removed from their respective item.

Conclusions About Adjustments

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Exercises

1) (Getúlio Vargas Foundation - FGV - 2023) On 12/31/X0, a business entity had R$100,000 receivable from its customers within up to five months. Default was estimated at 4%. Select the option that indicates the presentation of the fact in the business entity’s financial statements.

A) R$96,000 in current assets and R$4,000 in current liabilities, in the balance sheet.

B) R$100,000 in current assets and R$4,000 in current liabilities, in the balance sheet.

C) R$96,000 in current assets, in the balance sheet, and disclosure of R$4,000 in the notes.

D) R$100,000 in current assets, in the balance sheet, and disclosure of R$4,000 in the notes.

E) R$96,000 in current assets and R$4,000 in a contra account of current assets, in the balance sheet.

2) (Getúlio Vargas Foundation - FGV - 2023) A business entity began construction work to expand its office. The work is estimated to last two years, beginning on 01/02/X0 and ending on 12/31/X1. For the work, R$40,000 in construction materials were acquired. Select the option that indicates the accounting treatment of the construction materials in the business entity’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) (Getúlio Vargas Foundation - FGV - 2023) On 12/31/X0, Company X presented 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, Company Y purchased a 100% interest in Company X for R$95,000. On that date, the fair value of the land was R$60,000, of the brand, R$20,000, and of the loans payable, R$9,000, since the interest rate was lower than the market interest rate. Select the option that indicates the goodwill recorded by Company Y related to the acquisition of the interest in Company X.

A) R$19,000.

B) R$21,000.

C) R$24,000.

D) R$29,000.

E) R$31,000.

4) (Getúlio Vargas Foundation - FGV - 2023) Regarding the balance sheet, analyze the following items:

I. When analyzing a balance sheet, the financial manager should have three concerns in mind: liquidity, debt versus equity, and value versus cost.

II. Current assets have the greatest liquidity and include cash and assets that will be converted into cash within one year from the balance sheet date.

III. The book value of shareholders’ equity decreases when the retained earnings reserve is added.

The correct statements are

A) I, II and III.

B) I and II, only.

C) I and III, only.

D) II and III, only.

E) I, only.

5) (Getúlio Vargas Foundation - FGV - 2023) A business entity had an 80% interest in Company X. On 12/30/X0, the business entity presented the following balance sheet:

Current Assets30,000Equity78,000
Cash30,000
Non-current Assets48,000
Investments
Investments (Company X)48,000
Total Assets78,000Total Equity78,000

In year X0, Company X earned a profit of R$10,000 and distributed total dividends of R$2,000. Select the option that indicates the balance of the “Investments” account on the business entity’s balance sheet on 12/31/X0, after the profit is determined and the dividends are recognized by Company X.

A) R$54,000.

B) R$54,400.

C) R$56,000.

D) R$57,600.

E) R$60,000.

6) (Getúlio Vargas Foundation - FGV - 2023) An educational institution acquired, on 01/01/X0, a building to rent to third parties for R$500,000. The useful life of the building was estimated at 50 years. After initial recognition, the educational institution chose to measure the building using the fair value method, with the increase recognized annually in the Income Statement. On that date, it was R$600,000. On 12/31/X1, the institution decided that it would use the building in its business, beginning to account for it as property, plant and equipment. On that date, the fair value of the building was R$700,000. Select the option that indicates the carrying amount of the building on the educational 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.

Solution

1) C

2) D

3) A

4) B

5) B

6) E

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