In this episode of making the Corporate Financial Accounting course (CFA) easy for newbies from other disciplines, I will try to explain the buzzword “balance” which features continuously and how best to get a mastery of it.
The accounting equation discussed in the previous write-up will be repositioned into the elements of financial information; Assets = Liabilities + Owners’ Equity + Revenue – Expenses. Each of these makes up the five elements of financial information or reports. For this write-up, due to its complexities, we would not dive into the technical definitions of these elements as contained in the International Accounting Standards Board (IASB) – Conceptual framework – Chapter 3. However, our objective is to help you understand the dynamics of each element and account for any adjustments thereon.
- Assets – would always have a debit balance;
- Liabilities – would always have a credit balance;
- Owners’ equity – should have a credit balance;
- Revenue – would be seen on the credit side;
- Expenses – would be seen on the debit side;
You would have to take note of the auxiliary verbs used above. Assets, liabilities and Owner’s Equity reside on the Statement of Financial Position (SFP), also called Balance Sheet. At the same time, Revenue and Expenses reside on the Income Statement, also called the Statement of Profit or Loss. The elements that reside on the SFP are cumulative and hence “would always have a balance”, while those on the Income statement are amounts relating to a referenced period. It is, for this reason, I explained the Assets, Liabilities and Owners’ Equity as “would have a balance” while Revenue and Expenses are explained as “would be seen”.
Let’s leave the jargon for a bit and use examples to illustrate. Emilokan enterprises bought a motor vehicle for $120,000 with cash, which it used to run Uber services for three months ending March 2027. Revenue earned from the Uber services in the period amounted to $78,500 but was not paid for, while cash received from customers on the Uber services for the previous period totalled $37,500. Expenses incurred were $47,500 on vehicle maintenance, gasoline and other expenses. Only one-third of this was paid for. We are required to explain the entries that the accountant at Emilokan entries will post for the period ending 31st March 2027.
- Motor Vehicle Purchase for $200,000; the Motor vehicle to the entity will become an asset and would give a debit balance and is funded from another asset, a Cash account, which will be reduced with the amount by crediting it. The Motor vehicle would have a $200,000 debit balance at the end of the entry.
- Revenue earned from Uber services for $97,500; this would be credited to the Revenue account for the period and a debit to Receivables (asset account) as it is still being owed to Emilokan enterprises.
- Receipt from customers from the previous period; this is a settlement of debt previously owed to the company. On receipt of the cash, with Cash being an asset, the account would be debited with $37,500 while the Receivables account would be credited, meaning a reduction.
- Expenses incurred were $47,500 on vehicle maintenance, gasoline and other expenses; the total amount would be debited to the expense account while two-thirds of it will be paid out of the Cash account, a credit and the remaining one-third will be credited to the Payables account, which is a liability.
The above explains how each entry would be captured and has tried to highlight the links with the elements described above. Our next episode will explore the Income Statement and Statement of Financial Position preparation and how it links to the Trial balance.
