FAC1501

LEARNING UNIT 2

THE ACCOUNTING
EQUATION: FINANCIAL
POSITION

Introductory Financial
Accounting
 LEARNING UNIT 2

OVERVIEW
2

Learning outcomes ............................................................................................................................... 10

Key concepts ........................................................................................................................................ 10
Assessment criteria .............................................................................................................................. 11
2.1 Introduction..................................................................................................................................... 11
2.2 Types of business entities .............................................................................................................. 11
2.3 South African forms of business ownership ................................................................................... 12
2.4 Characteristics of a sole trader ....................................................................................................... 12
2.5 The elements of financial statements ............................................................................................. 13
2.6 The double-entry principle .............................................................................................................. 14
2.7 The accounting equation: Financial position .................................................................................. 14
2.8 The statement of financial position ................................................................................................. 23
2.9 Exercises and solutions .................................................................................................................. 30
Self-assessment ................................................................................................................................... 34

LEARNING OUTCOMES

After studying this learning unit, you should be able to:

• list the basic business forms found in South Africa
• explain the characteristics of a sole trader
• understand the accounting equation concerning assets, equity, and liabilities
• explain the effects of financial accounting entries concerning assets, equity, and liabilities on the
accounting equation
• prepare entries in general ledger accounts for assets, equity, and liabilities
• prepare a statement of financial position for a service entity.

KEY CONCEPTS
• Service entity
• Retailing entity
• Manufacturing entity
• Forms of business
• Sole trader
• Double-entry principle
• T-account
• Debit
• Credit
• Accounting equation
• Assets
• Liabilities
• Equity

10
 LEARNING UNIT 2

• Income
• Expenses
• Statement of financial position
• Balancing off accounts
• Trade receivables (debtors)
• Trade payables (creditors)

ASSESSMENT CRITERIA
• The processing of accounting information by different types of business entities
because of the difference in operating activities is explained.
• The form of business ownership according to the capital needs of an entity
is explained.
• The characteristics of a sole trader are explained.
• The elements of the general-purpose financial statements are explained.
• Accounting terminology is explained, and examples of their use are given.
• The principle of debits and credits is explained.
• Business transactions concerning assets, liabilities and equity are explained
with reference to appropriate examples.
• Accounting policy is demonstrated according to the right methods and procedures
when recording in the accounting equation format and in the ledger accounts.
• Assets, liabilities, and equity are defined and classified for recognition in the
statement of financial position.

2.1 INTRODUCTION
In the previous learning unit, you learned that financial accounting is an information system that
communicates financial information to the users of financial accounting information. But who exactly
needs to keep financial accounting records? The answer to this question is simple: everybody who
earns an income!

The average salary earner needs accommodation, food, clothes, and must pay (for example) the
telephone account, school fees and groceries. They would possibly open a clothing account and pay
the school fees in monthly instalments. Salary earners would also have a bank account into which
their salaries are deposited every month. How would they be able to keep track of what has been paid,
what they still owe and how much money they have left without some form of financial accounting
system?

2.2 TYPES OF BUSINESS ENTITIES

The processing of financial accounting information (that is, bookkeeping) will be determined by the
operating activities of an entity and should be adapted to provide the information that is applicable to
the specific operating activities. The operating activities of an entity are those activities from which it
tries to make a profit. The objective of every entity is to earn as large a profit as possible.

Let’s consider the following example:

Mr Bongile Sithole, a qualified electrician, has his own business which he runs from his home. Mr B
Sithole trades as BS Electrical and installs electrical cables and repairs electrical faults. For him to
deliver his services he needs his tools. His clients must supply any cabling or wiring required for the
job, which they buy from the hardware store. The hardware store buys these items from an
engineering company that manufactures them.

11
 LEARNING UNIT 2
• Mr Bongile Sithole therefore runs
— a commercial entity
— which sells
— a service to his clients.

• The hardware store is

— a commercial entity
— which buys and sells
— goods to their customers.

Commercial entities can be retail entities that will sell goods to the public, or wholesalers that only sell
goods to retailer entities.

• The engineering entity is

— a manufacturing entity
— which manufactures and sells
— goods to their customers.

Each of these types of entities will make use of financial accounting records that are suitable to their
own needs. The minimum information that must be available from these financial accounting records
is prescribed by International Financial Reporting Standards (IFRSs).

2.3 SOUTH AFRICAN FORMS OF BUSINESS OWNERSHIP

Mr Bongile Sithole’s entity, the hardware store entity as well as the engineering entity may be conducted
in one of several business forms. To start any business, money is needed. This money is referred
to as capital. Some types of businesses require more capital than others. For example, the
engineering entity would need machines, an electrician would need his toolbox and the hardware
store will need hardware inventory. The amount of capital needed to start and continue business
operations would largely influence the form of the business.

For financial accounting purposes we distinguish between the following forms of business ownership:

• sole traders
• partnerships
• close corporations
• companies

In South Africa two types of companies can be formed, namely a profit company and a non-profit
company.

In this module you will concentrate on the financial accounting records required by different operating
activities (that is sales and services) of a sole trader and we will not venture into any aspects of the
other forms of business ownership.

2.4 CHARACTERISTICS OF A SOLE TRADER

• This entity belongs to one person only. In the case of BS Electrical the entity belongs to Mr
Bongile Sithole.
• It is suitable for smaller types of entities that do not need big amounts of capital to start.

12
 LEARNING UNIT 2
• All decisions regarding the entity are taken by the owner and all the profits and losses accrue to
the owner. Mr Bongile Sithole will take all decisions regarding BS Electrical, and all the profit and
losses will accrue to him as owner.
• Mr Bongile Sithole is the sole owner and disposer of the assets of the business.
• The sole trader is not a legal entity distinct from its owner. Mr Bongile Sithole will conclude any
contracts applicable to his entity in his own name and he will be liable in his personal capacity for
the debts of the entity.
• As the sole trader is not a legal entity, the profits of the entity will be taxed in the hands of the
owner. Mr Bongile Sithole will declare the profits in his personal income tax return, and he will be
taxed on the amount.
• If Mr. Bongile Sithole dies, the entity ceases to exist. If the business activities are taken over by
someone else, a new sole trader entity comes into being.

To be able to do Mr Bongile Sithole’s books it is necessary to look at the accounting equation.

2.5 THE ELEMENTS OF FINANCIAL STATEMENTS

Every entity implements a financial accounting system according to the minimum financial accounting
standards and practices when it draws up financial statements that are used in making economic
decisions. Financial statements will reflect the financial effects of transactions by grouping them into
broad classes according to their economic characteristics, namely assets, equity, liabilities, income,
and expenses. Assets, equity, liabilities, income, and expenses are called the elements of financial
statements.

The elements directly related to the measurement of financial position at a given time in the statement
of financial position are assets, liabilities, and equity.

Assets are all the resources controlled by the entity (whether they are owned by the entity
or not), for example land and buildings, vehicles, furniture, equipment, trading inventory,
trade receivables, bank, and petty cash.

Remember, not all assets controlled by the entity are owned by the entity. If, for example, the entity
bought a vehicle on credit, it does not belong to the entity until the final instalment is paid.

Liabilities are the debts of the entity (all the money owed to third parties), for example
long-term loans, mortgage bonds, bank overdrafts and trade payables.

Equity refers to the amount that the owner invested in the entity and is made up mainly of
capital. It is an indication of the assets that belong to the owner and is referred to as the
owner’s net worth.

Profit or loss is frequently used as a measure of performance. The elements directly related to the
measurement of financial performance for a period in the statement of profit or loss and other
comprehensive income are income and expenses.

Income less expenses = profit for the year

13
 LEARNING UNIT 2

Income is the income earned by the entity through its normal everyday business activities
for the financial accounting period (normally a year), for example sales, rental income,
interest income and credit losses recovered.

Expenses are the running expenses of the entity for the financial accounting period
(normally a year) necessary to earn the income, for example purchases, rental expenses,
telephone expenses, water and electricity, salaries, and wages.

To be able to record transactions correctly it is necessary to have a look at the process of

recording transactions.

2.6 THE DOUBLE-ENTRY PRINCIPLE

Bookkeeping is the part of financial accounting that is concerned with the recording of transactions.
The transactions are recorded in an account.

An account consists of a left-hand side and a right-hand side and is presented in a “T”
format. The left-hand side is referred to as the debit side and the right-hand side is
referred to as the credit side. The name of the “T” account is written across the centre at
the beginning of each account.

This can be illustrated as follows:

Dr (debit side) ……. Account (credit side) Cr

Left-hand side (LHS) Right-hand side (RHS)

For each asset, liability, equity, expense, and income there will be a “T” account in the books of the
entity. All these “T” accounts together are called the general ledger.

The double-entry principle provides a logical method of recording transactions. In using the double-
entry system the monetary (money value) of each transaction must be entered on the debit side of
one ledger account as well as on the credit side of another ledger account. The entry in one ledger
account refers to the corresponding entry in the other ledger account.

As the entries in the two ledger accounts have been entered on opposite sides, the use of the double
entry system allows for cross references. Each transaction is entered in two separate accounts on
opposite sides, and it is therefore possible to check and control the arithmetical and accounting
accuracy of the work. If each transaction is recorded so that the debit and credit entries are equal, the
same sum of all the debits to the account must equal the sum of all the credits. This can be explained
by way of the accounting equation.

2.7 THE ACCOUNTING EQUATION: FINANCIAL POSITION

The logical method of recording transactions by way of the accounting equation is used to process
transaction data. Transactions may:
• affect assets and/or equity and/or liabilities
• generate income or give rise to expenditure

14
 LEARNING UNIT 2
The accounting equation states that:

ASSETS = EQUITY + LIABILITIES

A = E + L

OR

EQUITY = ASSETS – LIABILITIES

E = A – L

The equity equals all the assets in the entity less all the claims against those assets
(liabilities).

The accounting equation is a mathematical equation that should always balance. The financial
position of an entity is indicated by this equation.

For the accounting equation to always balance it requires the involvement of two accounts for each
transaction. The accounting equation is, therefore, based on the double-entry accounting system.

Basic requirements for the accounting equation:

• A minimum of two accounts must be used for each transaction.
• The equation must remain in balance after each transaction. In other words, the debit
side (A) is equal to the credit side (E + L).

Consider the following example of transactions that affect assets and/or equity and/or liabilities:

Before the entity starts to do business, the accounting equation will look like this:

Debit side = Credit side

A = E + L

Possessions the entity = Amounts owed to the + Amounts owed

owns owner of the entity to third parties

What the entity owns = What the entity owes

0 = 0

Note that the recording of transactions is done from the point of view of the business
entity independent from its owner, Mr Bongile Sithole.

15
 LEARNING UNIT 2
Every entity for which separate financial records are kept is a financial accounting entity. It is extremely
important to see the entity as separate from its owner: transactions entered by the entity must be
dealt with from the point of view of the entity whose books are being done.

Transaction 1:
Mr Bongile Sithole, a qualified electrician, started a small service business, BS Electrical on
1 January 20.6. He decided to deposit R40 000 in the entity’s bank account to start the business.

Explanation:
The entity received R40 000 in cash and the money was deposited in a bank account opened in the
name of the entity. It cannot be Mr B Sithole’s bank account. The entity must have its own bank
account. The money (bank account) is an asset because it is a resource controlled by the entity (it can
be used by the entity to do business). The assets increased because it was “0” before this transaction.
The owner deposited the money into the entity’s bank account. Any amount received from the owner
is called capital and this increases equity. The entity now owes Mr B Sithole R40 000. Both the left-
hand side of the equation (A) and the right-hand side of the equation (E + L), now equals R40 000.

The effect of this transaction on the accounting equation can be illustrated as follows:

A = E + L
Bank Capital
R R R
+ 40 000 = + 40 000 + –

NOTE:
The plus sign shows an increase of an element of the accounting equation and a minus shows a
decrease in an element of the accounting equation.

Transaction 2:
On 1 January 20.6 BS Electrical bought a toolbox and tools to be used by Mr B Sithole on credit from
Big Builders for R7 000.

Explanation:
Tools and equipment are resources controlled by the entity (it can be used by the entity to do
business). It is an asset, so the assets increased. The entity owed money to Big Builders, a creditor
(other payable), so the liabilities would increase.

Other payable (creditor) is a person or entity to which the entity, BS Electrical, owes money
when buying non-current assets or incurring an expense on credit. Trade payable (creditor)
is a person or entity to which the entity, BS Electrical, owes money when buying goods or
services on credit. This debt is usually paid back within one year.

16
 LEARNING UNIT 2
The effect of this transaction on the accounting equation can be illustrated as follows:

A = E + L
Bank Tools and Capital Big Builders
equipment (other payable)
R R R R
+ 40 000 + 40 000
+ 7 000 + 7 000
40 000 7 000 = 40 000 + 7 000

Transaction 3:
On 1 January 20.6 BS Electrical bought a ladder from Ladders (Pty) Ltd and paid for it via internet
banking, R1 200.

Explanation:
Money (bank account) is a resource controlled by the entity (it can be used by the entity to do business).
Assets decreased because money was paid by the entity. Tools and equipment, other resources
controlled by the entity (it can be used by the entity to do business), increased, thus assets increased.
Assets increased and decreased with R1 200, leaving us with a nil effect. The left-hand side of the
equation (A) = right-hand side of the equation (E + L) [R47 000 = R40 000 + R7 000].

The effect of this transaction on the accounting equation can be illustrated as follows:

A = E + L
Bank Tools and Capital Big Builders
equipment (other payable)
R R R R
+ 40 000 + 40 000
+ 7 000 + 7 000
- 1 200 + 1 200
38 800 8 200 = 40 000 + 7 000

Transaction 4:
On 1 January 20.6 BS Electrical borrowed R50 000 from Uni Bank at an interest rate of 10% per
annum repayable over 60 months. The R50 000 was transferred to the bank account of the entity.

Explanation:
The money received from Uni Bank increased the bank account. Bank is an asset and therefore the
assets increased with the money received from Uni Bank. The entity however owed Uni Bank
R50 000.

17
 LEARNING UNIT 2
This is an obligation (liability) to pay, and the liabilities increased. The left-hand side of the equation
(A) = the right-hand side of the equation (E + L) [R97 000 = R40 000 + R57 000].

BS Electrical owes Uni Bank, who provided the long-term loan, the money. Uni Bank is a
creditor (financing creditor) of BS Electrical. This long-term debt is usually not paid back
within one year (in this case it will only be paid back over a period of 5 years (60 months)).

The effect of this transaction on the accounting equation can be illustrated as follows:

A = E + L
Bank Tools and Capital Big Builders Uni Bank
equipment (other (long-term
payable) loan)
R R R R R
+ 40 000 + 40 000
+ 7 000 + 7 000
- 1 200 + 1 200
+ 50 000 + 50 000
88 800 8 200 = 40 000 + 7 000 50 000

The following rules can be applied:

Dr (debit side) Asset accounts (credit side) Cr

+ (increase) - (decrease)

Dr (debit side) Liability accounts (credit side) Cr

- (decrease) + (increase)

Dr (debit side) Equity account (credit side) Cr

- (decrease) + (increase)

For you as a learner of financial accounting the reality is that the double-entry rules are not
one of those concepts that you can try to understand – you must learn them!

When analysing a transaction, the following four questions need to be asked:

• Which two accounts are involved in the transaction?
• Do the accounts form part of assets, equity, or liabilities?
• Did the assets, equity or liabilities increase or decrease?
• Which one of the accounts must be debited and which one must be credited?

18
 LEARNING UNIT 2
Let’s consider the transactions of BS Electrical again:

Transaction 1:
Mr Bongile Sithole, a qualified electrician, starts a small service business, BS Electrical, on
1 January 20.6. He decided to deposit R40 000 in the entity’s bank account to start the business.

The effect of this transaction on the accounting equation can be illustrated as follows:

A = E + L
Bank Capital Liabilities
R R R
+ 40 000 = + 40 000 + –

Explanation (detailed explanation of the accounting equation transaction 1):

1. Bank account (an asset) increased; and must therefore be debited.

Dr (debit side) Assets (credit side) Cr

+ (increase) - (decrease)

2. Capital account (equity) increased; and must therefore be credited.

Dr (debit side) Equity (credit side) Cr

- (decrease) + (increase)

The above transaction will be recorded in the ledger accounts as follows:

(a) The debit-side of the bank account:

Dr Bank 1 Cr
Date Details Fol R Date Details Fol R
20.6

Jan 1 Capital (name of 40 000

account to be
credited)

A few things to remember:

• The date of the transaction (date). The transaction took place on 1 January 20.6.
• A description of the other account affected by the transaction to make cross-referencing
easier (details). The account to be debited is bank account and the account to be credited is capital
account.
• Cross-referencing to the folio number of the other account affected (fol). (It will be discussed in
a later learning unit.)

19
 LEARNING UNIT 2
• Recording the amount of the transaction. The amount of the transaction is R40 000. (Bank
account is debited with R40 000, and capital account is credited with R40 000.)

(b) The credit-side of the capital account:

Dr Capital 2 Cr
Date Details Fol R Date Details Fol R
20.6
Jan 1 Bank (name of 40 000
account to be
debited)

Debit side = Credit side = R40 000

Transaction 2:
On 1 January 20.6 BS Electrical bought a toolbox and tools to be used by Mr Bongile Sithole on
credit from Big Builders for R7 000.

The effect of this transaction on the accounting equation can be illustrated as follows:

A = E + L
Bank Tools and Capital Big Builders
equipment (other payable)
R R R R
+ 40 000 + 40 000
+ 7 000 + 7 000
40 000 7 000 = 40 000 + 7 000

Explanation (detailed explanation of the accounting equation transaction 2):

1. Tools and equipment account (an asset) increased and must therefore be debited.

Dr (debit side) Assets (credit side) Cr

+ (increase) - (decrease)

2. Big Builders’ account (a liability) increased and must therefore be credited.

Dr (debit side) Liabilities (credit side) Cr

- (decrease) + (increase)

20
 LEARNING UNIT 2
The above transaction will be recorded in the ledger accounts as follows:

(a) The debit-side of the tools and equipment account:

Dr Tools and equipment 3 Cr
Date Details Fol R Date Details Fol R
20.6

Jan 1 Big Builders (name 7 000

of account to be
credited)

(b) The credit-side of Big Builders’ account:

Dr Big Builders 4 Cr
Date Details Fol R Date Details Fol R
20.6
Jan 1 Tools and equipment 7 000
(name of account
to be debited)

Debit side = Credit side = R7 000

Transaction 3:

On 1 January 20.6 BS Electrical bought a ladder from Ladders (Pty) Ltd and paid for it via internet
banking, R1 200.

The effect of this transaction on the accounting equation can be illustrated as follows:

A = E + L
Tools and Big Builders
Bank Capital
equipment (other payable)
R R R R
+ 40 000 + 40 000
+ 7 000 + 7 000
- 1 200 + 1 200
38 800 8 200 = 40 000 + 7 000

Explanation (detailed explanation of the accounting equation transaction 3):

1. Tools and equipment account (an asset) increased and must therefore be debited.

Dr (debit side) Assets (credit side) Cr

+ (increase) - (decrease)

21
 LEARNING UNIT 2
2. Bank account (an asset) decreased and must therefore be credited.

Dr (debit side) Assets (credit side) Cr

+ (increase) - (decrease)

The above transaction will be recorded in the ledger accounts as follows:

(a) The debit-side of the tools and equipment account:

You will have only one ledger account for each asset, liability, and equity item. Use the same tools
and equipment account as created in transaction 2.
Dr Tools and equipment 3 Cr
Date Details Fol R Date Details Fol R
20.6

Jan 1 Big Builders 7 000

Bank (name of 1 200
account to be
credited)

(b) The credit-side of the bank account:

Use the same bank account created in transaction 1.

Dr Bank 1 Cr
Date Details Fol R Date Details Fol R
20.6 20.6

Jan 1 Capital 40 000 Jan 1 Tools and equipment 1 200

(name of account to
be debited)

Transaction 4:
On 1 January 20.6 BS Electrical borrowed R50 000 from Uni Bank at an interest rate of 10%
per annum repayable over 60 months. The R50 000 was transferred to the bank account of the
entity.

The effect of this transaction on the accounting equation can be illustrated as follows:

A = E + L

Bank Tools and Capital Big Builders Uni Bank

equipment (other (long-term
payable) loan)

R R R R R
+ 40 000 + 40 000
+ 7 000 + 7 000
- 1 200 + 1 200
+ 50 000 + 50 000
88 800 8 200 = 40 000 + 7 000 50 000

22
 LEARNING UNIT 2
Explanation (detailed explanation of the accounting equation transaction 4):

1. Bank account (an asset) increased and must therefore be debited.

Dr (debit side) Assets (credit side) Cr

+ (increase) - (decrease)

2. Long-term loan: Uni Bank account (a liability) increased and must therefore be
credited.

Dr (debit side) Liabilities (credit side) Cr

- (decrease) + (increase)

The above transaction will be recorded in the ledger accounts as follows:

(a) The debit-side of the bank account:

Use the same bank account created in transaction 1 and used in transaction 3.

Dr Bank 1 Cr
Date Details Fol R Date Details Fol R
20.6 20.6

Jan 1 Capital account 40 000 Jan 1 Tools and equipment 1 200

Long-term loan:
Uni Bank (name of 50 000
account to be
credited)

(b) The credit-side of the long-term loan: Uni Bank account:

Dr Long-term Loan: Uni Bank 5 Cr
Date Details Fol R Date Details Fol R
20.6

Jan 1 Bank (name of 50 000

account to be
debited)

The accounting equation is, therefore, based on the double-entry accounting system, and is used
for preparing the statement of financial position at a specific point in time.

2.8 THE STATEMENT OF FINANCIAL POSITION

The statement of financial position reflects the financial position of an entity in terms of the basic
accounting equation on a specific date. It is a statement of balances at a specific date.

23
 LEARNING UNIT 2
The statement of financial position of BS Electrical prepared as at 1 January 20.6 is as follows:

BS ELECTRICAL
STATEMENT OF FINANCIAL POSITION AS AT 1 JANUARY 20.6

ASSETS R EQUITY AND LIABILITIES R

Bank 88 800 Capital 40 000

Tools and equipment 8 200 Other payable 7 000
Long-term loan 50 000
97 000 97 000

At this stage it is necessary to have a look at the ways assets can be used:
• Some assets are used time and time again in the business to earn an income. The tools and
equipment used by Mr Bongile Sithole are examples of such assets. These assets are
classified as non-current assets.
• Some assets have a short life span, and continually change in value in the normal course of
business, for example, money in the bank. These assets are classified as current assets.

24
 LEARNING UNIT 2
Let’s have a look at the difference between non-current assets and current assets.

ASSETS
A present economic resource
controlled by the entity as a result of
past events.
An economic resource is a right that
has the potential to produce economic
benefits.

CURRENT NON-CURRENT

An asset shall be classified as All other assets (thus being assets

current when it satisfies any of the that are not classified as current
following criteria: assets will be classified as non-
current):

• It is expected to be converted into • Non-current assets include

money (realised), or is intended for tangible, intangible and financial
sale or consumption, in the entity’s assets of a long-term nature. (In
normal operating cycle. this module we will only concern
ourselves with tangible non-current
assets.)
• It is held primarily for the purpose • It is not the intention of the entity to
of being traded. sell non-current assets, but to use
these assets over the long-term in
its business operations to earn an
income.

• It is expected to be converted • Non-current assets are those

into money (realised) within assets with a useful life of longer
twelve months of the statement of than one year.
financial position date.

Examples of current assets are: Examples of non-current assets are:

• Trading inventories • Land and buildings

• Consumable stores on hand • Vehicles
• Trade receivables (trade debtors) • Furniture
• Other receivables (other debtors) • Equipment
• Accrued income • Machinery
• Pre-paid expenses
• Bank (positive balance)
• Cash float
• Petty cash

25
 LEARNING UNIT 2
Liabilities can also be non-current or current, depending on when the liability must be settled:
• Some liabilities are payable more than one year after financial year end, that is, they are not
payable within the next financial year. These liabilities are classified as non-current liabilities.
• Liabilities payable within the next financial year are classified as current liabilities.

Let’s have a look at the difference between current and non-current liabilities:

LIABILITIES
A present obligation of the entity to
transfer an economic resource as a
result of past events.

CURRENT NON-CURRENT

A liability shall be classified as All other liabilities (thus being

current when it satisfies any of the liabilities that are not classified as
following criteria: current liabilities will be classified as
non- current):

• It is expected to be settled in the • Are long-term debts and must be

entity’s normal operating cycle settled after one year of the
(usually one year). statement of financial position date.

• It is held primarily for the purpose

of being traded.

• It is due to be settled within twelve

months after the statement of
financial position date.

Examples of current liabilities are: Examples of non-current liabilities are:

• Trade payables (trade creditors) • Long-term loans

• Other payables (other creditors) • Mortgage
• Bank overdrafts • Debentures
• Current portion of long-term
borrowings
• Short-term borrowings
• Accrued expenses
• Income received in advance

26
 LEARNING UNIT 2
According to these principles the correct statement of financial position for BS Electrical is as
follows:

BS ELECTRICAL
STATEMENT OF FINANCIAL POSITION AS AT 1 JANUARY 20.6

ASSETS R EQUITY AND LIABILITIES R

Non-current assets Equity

Tools and equipment 8 200 Capital 40 000
Current assets Non-current liabilities
Bank 88 800 Long-term loan 50 000
Current liabilities
Other payables 7 000

Total assets 97 000 Total equity and liabilities 97 000

The rules that need to be followed when the double-entry accounting is applied can be derived
from the statement of financial position. (The correct vertical format will be discussed later.)
To summarise the ledger accounts in the general ledger:
Dr Bank 1 Cr
Date Details Fol R Date Details Fol R
20.6 20.6
Jan 1 Capital 40 000 Jan 1 Tools and equipment 1 200
Long-term loan:
Uni Bank 50 000

The bank account has transactions on the debit side and the credit side. To determine what the
net result is (i.e., how much money is left in the bank account) the account must be balanced.

An account with entries on both the debit and the credit sides, must be balanced (to
balance is to find the final amount on the account).

To balance the bank account:

• Add the debit side of the bank account and write down the total in pencil: R40 000 +
R50 000 = R90 000.
• Add the credit side of the bank account and write down the total in pencil: R1 200.
• The debit total of the bank account is more than the credit total. To make the two sides
equal the credit side needs an amount of R90 000 - R1 200 = R88 800. This is the balancing
amount and is recorded on the side of the T-account that is the smallest, in this case,
the credit side. It is shown as a balance c/d.
• The account is then totalled (the biggest total in pencil, that is the debit side total of
R90 000) and the balance is b/d on the debit side.
• The bank has a debit balance because the entity has an amount of R88 800 left in the
bank account – which represents an asset of the entity.

27
 LEARNING UNIT 2
Dr Bank 1 Cr
Date Details Fol R Date Details Fol R
20.6 20.6
Jan 1 Capital 40 000 Jan 1 Tools and equipment 1 200
Long-term loan: 31 Balance c/d 88 800
Uni Bank 50 000
90 000 90 000

Feb 1 Balance b/d 88 800

Dr Capital 2 Cr
Date Details Fol R Date Details Fol R

20.6
Jan 1 Bank 40 000

Dr Tools and equipment 3 Cr

Date Details Fol R Date Details Fol R
20.6

Jan 1 Big Builders 7 000

Bank 1 200

8 200

To balance an account with only debit transactions, you only must add the debit side,
that is, R7 000 + R1 200 = R8 200. If there is only one amount in an account, it is left as is.

Dr Big Builders 4 Cr
Date Details Fol R Date Details Fol R

20.6
Jan 1 Tools and equipment 7 000

Dr Long-term loan: Uni Bank 5 Cr

Date Details Fol R Date Details Fol R

20.6

Jan 1 Bank 50 000

28
 LEARNING UNIT 2
According to the balances on the ledger accounts in the general ledger of the assets, liabilities, and
equity, it can be recognised in the statement of financial position as follows:

BS ELECTRICAL
STATEMENT OF FINANCIAL POSITION AS AT 1 JANUARY 20.6
ASSETS Note R
Non-current assets 8 200
Property, plant and equipment (Tools and equipment) 8 200
Current assets 88 800
Cash and cash equivalents (Bank) 88 800

Total assets 97 000

EQUITY AND LIABILITIES
Equity 40 000
Capital 40 000
Non-current liabilities 50 000
Long-term borrowings (Long-term loan: Uni Bank) 50 000
Current liabilities 7 000
Trade and other payables (Big Builders) 7 000

Total equity and liabilities 97 000

The statement of financial position is now shown in its vertical format and this is the correct format
that must be used in future.

29
 LEARNING UNIT 2
2.9 EXERCISES AND SOLUTIONS

EXERCISE 1
3

(a) Define the concept of an accounting entity.

(b) Describe the financial position of an entity in terms of the accounting equation.
(c) Explain the nature of
(i) assets
(ii) equity
(iii) liabilities
(d) Name two sources of financing.
(e) What is meant by the double-entry principle?

SOLUTION: EXCERCISE 1
4

(a) An accounting entity is any entity for which separate financial records are kept.
(b) ASSETS = EQUITY + LIABILITIES
(c) (i) Assets are the possessions of the entity.
(ii) Equity is the interest which the owner has in the business and which the entity therefore
owes to him.
(iii) Liabilities are trade or other payables’ interest or interests of parties other than the
owner(s). Liabilities are therefore the debts of the entity.
(d) The owner and trade payables.
(e) In principle it means that every transaction has a dual effect on the elements of the accounting
equation and that after every transaction the accounting equation must remain in balance.

EXERCISE 2
5

The assets of Maxi Services amount to R30 000 and its liabilities (trade payables) to R5 000.

REQUIRED
6

Calculate the equity.

SOLUTION: EXCERCISE 2
7

Use the accounting equation. The amounts which are given are substituted for the appropriate
symbol and the value of the unknown symbol is calculated.

A = E + L
E = A - L
E = R30 000 - R5 000
E = R25 000

30
 LEARNING UNIT 2

EXERCISE 3
8

T Tom is the owner of Zebra Services which offers a carpet cleaning service. On 30 November 20.6
Zebra Services owns equipment amounting to R100 000. Clients owe R40 000 for services
rendered and Zebra Services owes R20 000 to a supplier for parts purchased. Zebra Services also
has R10 000 in cash in the bank.

REQUIRED
9

Show the accounting equation and determine the equity.

10 SOLUTION: EXCERCISE 3

Step 1: Identify the assets:

Equipment = R100 000
Trade receivables = R40 000
Cash = R10 000
Step 2: Identify the liabilities:
Other payables = R20 000
Substitute these amounts into the equation:
A = E + L
E = A - L
E = R(100 000 + 40 000 + 10 000) - R20 000
E = R150 000 - R20 000
E = R130 000

31
 LEARNING UNIT 2
Zebra Service’s financial position can also be presented in the form of a statement of financial
position as follows:

ZEBRA SERVICES
STATEMENT OF FINANCIAL POSITION AS AT 30 NOVEMBER 20.6

ASSETS R EQUITY AND LIABILITIES R

Equipment 100 000 Equity 130 000
Trade receivables 40 000 Other payables 20 000
Cash in bank 10 000

150 000 150 000

EXERCISE 4
11

Calculate the missing figures using the accounting equation:

R
(a) Bank = 4 000
Vehicles = 5 000
Equipment = 7 000
Equity = ?
(b) Equity = 150 000
Loan = 50 000
Bank = ?
Machinery = 190 000
(c) Bank = 5 000
Trade receivables = 15 000
Buildings = 100 000
Furniture = 40 000
Trade payables = 50 000
Equity = ?
(d) Equity = 60 000
Loan = 10 000
Trade payables = 6 000
Assets = ?

32
 LEARNING UNIT 2

SOLUTION: EXCERCISE 4
12

(a) A = E + L
E = A - L
E = R(4 000 + 5 000 + 7 000) - R0
E = R16 000

(b) A = E + L
R190 000 + Bank = R150 000 + R 50 000
Bank = R200 000 - R190 000
Bank = R10 000

(c) A = E + L
E = A - L
E = R(5 000 + 15 000 + 100 000 + 40 000) - R50 000
E = R160 000 - R50 000
E = R110 000

(d) A = E + L
A = R60 000 + R(10 000 + 6 000)
A = R76 000

33
 FAC1501/1

SELF-ASSESSMENT
13

After you have worked through this learning unit, are you able
123

to:
• classify the different elements of financial statements
correctly? ☺  
• define an asset? ☺  
• define a liability? ☺  
• define income? ☺  
• define expenses? ☺  
• explain the difference between (and give examples of)
non-current assets and current assets? ☺  
• explain the difference between (and give examples of)
non-current liabilities and current liabilities? ☺  
• explain the difference between (and give examples of)
income and expenses? ☺  
• list the rules for debiting and crediting different type of
accounts concerning assets, equity, and liabilities? ☺  
• correctly classify any given account concerning assets,
equity, and liabilities? ☺  
• correctly enter any given transaction concerning assets,
equity, and liabilities into the accounting equation? ☺  
• correctly apply the accounting equation to any given
transaction concerning assets, equity, and liabilities? ☺  
• correctly enter any given transaction concerning assets,
equity, and liabilities in the ledger accounts? ☺  
• prepare a statement of financial position? ☺  

If you have marked all ☺ you may continue to the next learning unit.

If you have marked any  you have to revise that specific section.

If you have marked any  you have to re-study that specific section.

34