Question

Not all events that occur in a business on a daily basis constitute financial transactions that are recorded. Give an example of a business transaction that would not be recorded and explain why it would not need to be recorded.

Answer 1

These are called off-balance sheet items.

Normally, any financial transaction results into an accounting entry if it results in a movement in the entity’s assets, liabilities or equity. But there can be transactions which effectively result in the movement in assets or liabilities and are still not included in the balance sheet.

Let us understand through examples.

#1] Forward purchase agreements (cash and carry trading)

Suppose a company has a lot of inventory available with them, but they are in need of cash. They cannot get the cash unless they first sell their inventory and then receive the money from the customers. But this takes time.

So there is an option available: sell your inventory and promise to buy it back. Notice that two things are happening in this transaction -

1. Selling the inventory right now; and
2. Promising to purchase it back later

As far as accounting is concerned, only the first one is recorded. So you will debit the cash received and credit the inventory sold. But the accounting entries will not show the complete truth, which is that you also need to buy it back some day.

In such kind of transactions, neither an asset nor a liability is recorded, that is - no accounting entry is made. However, a disclosure is required for this.