Corporate Financial Accounting Vs Other Disciplines – Numbing the nuances 1

It is very common for students, both executives and non-executives, to get bogged down with the many nuances in the world of professional accounting. I would try to use this medium to help you understand some of these. Let’s start with the accounting equation which you would all agree is a jargon that must be accepted; Assets = Liabilities + Equity. I am sure your next question would be why?

Let’s use a series of examples to illustrate some of it. Eugene had just finished a programme at the Lagos Business School and got inspired to set up a dairy shop with five million naira from his father. Eugene registers a company on the Corporate Affairs Commission (CAC) portal seamlessly, thanks to the ease of doing business drive by the government of the day. The company’s name is EBEC Ltd which has now opened an account with Trumpbank in Surulere. Eugene deposits the five million naira given to him by his father into this account.

The accounting equation in the above example illustrates that the five million in the bank belongs to Ebec Ltd, which would be an asset while the shares registered with the CAC become equity; hence Asset (5,000,000) = Liability (0) + Equity (5,000,000). This is essentially the company’s beginning and serves as the base of every other thing to follow.

Ebec Ltd then decides to purchase a piece of equipment which would be used for processing the milk supplied by herdsmen in his locality. The machine would cost twenty-five million naira and Ebec Ltd has only five million in the bank hence it has to borrow twenty million from Clara, his sister. This means that the equipment would become an asset to Ebec Ltd, its five million would leave his bank, and he would now owe twenty million. Hence we have;

Asset (25,000,000 {the equipment}) = Liability (20,000,000 {Clara} + Equity (5,000,000); our accounting equation is still intact.

Moving on to the core of the business operation, Ebec ltd has installed the equipment and processed milk for sale. He sold five thousand gallons of dairy-processed milk for twenty-eight million. He also bought raw milk and other production materials for seventeen million in January. This implies that there were sales and cost of production for the business in January. Where does this fit into our accounting equation? To answer this, we would need to expand our equation further;

Assets =Liabilities + Owners’ Contributed capital + Revenue – Expenses

This expanded equation helps us understand that a business owner or entrepreneur only increases its value as long as it makes a profit and which is borne from excess revenue over expenses. In other words, for Ebec Ltd to grow the money his father gave him, he must continually report profits. From the above example, we would have;

Asset (33,000,000) which is made up of (25,000,000 {the equipment} +11,000,000 {excess cash from revenue over expenses}) = Liability (20,000,000 {Clara} + Equity (5,000,000) + Revenue (28,000,000) – Expenses (17,000,000).

At this stage, Ebec Ltd has assets totalling 36,000,000 and liabilities and equity totalling the same. This is just a snippet into understanding what forms the base of accounting for anyone confused as to why the assets must equal the total of its liabilities and equity.

We will dive deeper in our next edition. Thank you.