TOPIC 7: ELEMENTARY BALANCE SHEET

TOPIC 7: ELEMENTARY BALANCE SHEET | B/KEEPING

The balance sheet, also called the statement of financial position, is the third general purpose financial statement prepared during the accounting cycle. It reports a company’s assets, liabilities, and equity at a single moment in time. You can think of it like a snapshot of what the business looked like on that day in time.

Unlike the income statement, the balance sheet does not report activities over a period of time. The balance sheet is essentially a picture a company’s recourses, debts, and ownership on a given day. This is why the balance sheet is sometimes considered less reliable or less telling of a company’s current financial performance than a profit and loss statement. Annual income statements look at performance over the course of 12 months, where as, the statement of financial position only focuses on the financial position of one day.

The balance sheet is basically a report version of the accounting equation also called the balance sheet equation where assets always equation liabilities plus shareholder’s equity.

In this way, the balance sheet shows how the resources controlled by the business (assets) are financed by debt (liabilities) or shareholder investments (equity). Investors and creditors generally look at the statement of financial position for insight as to how efficiently a company can use its resources and how effectively it can finance them.

Balance Sheet Interpretation and Capital of the Busines

Explain the Balance sheet Interpretation and Capital of the business

Format

This
statement can be reported in two different formats: account form and
report form. The account form consists of two columns displaying assets
on the left column of the report and liabilities and equity on the right
column. You can think of this like debits and credits. The debit
accounts are displayed on the left and credit accounts are on the right.

The
report form, on the other hand, only has one column. This form is more
of a traditional report that is issued by companies. Assets are always
present first followed by liabilities and equity.

In
both formats, assets are categorized into current and long-term assets.
Current assets consist of resources that will be used in the current
year, while long-term assets are resources lasting longer than one year.

Liabilities are also separated into current and long-term categories.

Let’s look at each of the balance sheet accounts and how they are reported.

Asset Section

Similar
to the accounting equation, assets are always listed first. The asset
section is organized from current to non-current and broken down into
two or three subcategories. This structure helps investors and creditors
see what assets the company is investing in, being sold, and remain
unchanged. It also helps with financial ratio analysis. Ratios like the
current ratio are used to identify how leveraged a company is based on
its current resources and current obligations.

The
first subcategory lists the current assets in order of their liquidity.
Here’s a list of the most common accounts in the current section:

Current
Cash
Accounts Receivable
Prepaid Expenses
Inventory
Due from Affiliates

The second subcategory lists the long-term assets. This section is slightly different than the current section because many long-term assets are depreciated over time.

Thus, the assets are typically listed with a total accumulated depreciation amount subtracted from them.

Here’s a list of the most common long-term accounts in this section:

Long-term
Equipment
Leasehold Improvements
Buildings
Vehicles
Long-term Notes Receivable

Many
times there will be a third subcategory for investments, intangible
assets, and or property that doesn’t fit into the first two. Here are
some examples of these balance sheet items:

Other
Investments
Goodwill
Trademarks
Mineral Rights

According to the historical cost principle, all assets, with the exception of some intangible assets, are reported on the balance sheet at their purchase price.

In other words, they are listed on the report for the same amount of money the company paid for them. This typically creates a discrepancy between what is listed on the report and the true fair market value of the resources.

For instance, a building that was purchased in 1975 for $20,000 could be worth $1,000,000 today, but it will only be listed for $20,000. This is consistent with the balance
sheet definition that states the report should record actual events
rather than speculative numbers.

Liabilities Section

Liabilities
are also reported in multiple subcategories. There are typically two or
three different liability subcategories in the liabilities section:
current, long-term, and owner debt.

The
current liabilities section is always reported first and includes debt
and other obligations that will become due in the current period. This
usually includes trade debt and short-term loans, but it can also
include the portion of long-term loans that are due in the current
period. The current debts are always listed by due dates starting with
accounts payable. Here’s a list of the most common current liabilities
in order of how they appear:

Current Liabilities
Accounts Payable
Accrued Expenses
Unearned Revenue
Lines of Credit
Current Portion of Long-term Debt

The
second liabilities section lists the obligations that will become due
in more than one year. Often times all of the long-term debt is simply
grouped into one general listing, but it can be listed in detail. Here
are some examples:

Long-term Liabilities
Mortgage Payable
Notes Payable
Loans Payable

A
lot of times owners loan money to their companies instead of taking out
a traditional bank loan. Investors and creditors want to see this type
of debt differentiated from traditional debt that’s owed to third
parties, so a third section is often added for owner’s debt. This simply
lists the amount due to shareholders or officers of the company.

Equity Section

Unlike
the asset and liability sections, the equity section changes depending
on the type of entity. For example, corporations list the common stock,
preferred stock, retained earnings, and treasury stock. Partnerships
list the members’ capital and sole proprietorships list the owner’s
capital.