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THE BALANCE SHEET

LEARNING OBJECTIVES

At the end of this chapter you should be able to:

• Explain the meaning and purpose of a balance sheet
• Define and explain the five main elements of a balance sheet
• Explain the distinction between current and non current assets
• Explain the distinction between current and non-current liabilities.
• Explain the meaning of equity
• Explain and apply the balance sheet equation
• Understand the various factors, which influence the format of the balance sheet.

INTRODUCTION

In this chapter you start to learn about the information accountants provide to decision
makers in financial statements. Here we concentrate on the problem of the measurement
of wealth and the way in which accounting approaches it. We look in some detail at the
use of the balance sheet as the measurement of wealth, its components parts such as
assets, liabilities and finally the format in which the balance sheet is presented and the
way in which that is influenced by the type of organization, regulations and the needs of
the users.

THE BALANCE SHEET

The balance sheet reports the financial position of a business entity at a specific point in
time financial position is defined as the economic condition of the reporting entity,
having regard to its control over economic resources, financial structure, capacity for
adoptions and solvency.

The heading of the balance sheet indicates the name of the entity, the name of the report
and the data. The total amount on the two sides of the balance sheet is equal. The equality
is why the statement is called a balance sheet. The name also reflects the fact that the
statement reports the balances of the assets, liabilities and equity on a given date.

PURPOSE OF BALANCE SHEET

The purpose of a balance sheet is to communicate information about the financial

position of an enterprise at a particular point in time. It summaries information
contained in the accounting records in a clear and intelligible form. If the items
contained in it are summarized and classified in an appropriate manner it can give
information about the financial strength of the entity and indicate the relative liquidity of
the assets. It also gives information about the liabilities of the entity. The combination of
this information can assist the user to evaluate the financial position of the entity.
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In most enterprises, a balance sheet is prepared at least once a year. The balance sheet
often called the statement of financial position.

BALANCE SHEET ELEMENTS

We need to know what balance sheets contain. This consists of assets, liabilities and
owners equity.

ASSETS

Assets are future economic benefits controlled by the entity as a result of past
transactions or other events. Before an item can be considered as an asset for inclusion in
the balance sheet it must not only meet the definition of an asset, it must also pass certain
recognition criteria.

• Future economic benefits

• Measured by money
• Owened or controlled by the business
Assets exist in the form of economic resources, which may be tangible (having physical
characteristics) or intangible (assets without physical existence).

CATEGORIES OF ASSETS

For accounting purposes assets are normally separated as far as possible into
subcategories. The reasoning behind this is that accounting statements should provide
information that is useful in making economic decisions.
• Current Assets
• Non current assets (long term)

CURRENT ASSETS

Cash or other assets of the organization that would, in the ordinary course of business of
the organization, be consumed or converted into cash within 12 months period.
Examples for current assets:

• Cash
• Account Receivable
• Prepaid Expenses
• Stock (Inventory)
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NON CURRENT ASSETS

Those are long-term assets of the business that gives future benefits more than one-year
period. Non current assets can be divided to 3 major categories.
• Tangible assets
• Intangible assets
• Investments

Example for the tangible assets are – Land, Building Equipment, Motor Vehicle,
Machinery, Furniture.
Example for the intangible assets are – Goodwill, Trademark, Patent, Copy write.

Having looked at what constitutes an asset and at the way in which assets are divided into
the two classes on the balance sheet, we can now turn to the other part of the balance
sheet. – What economic resources are owed to other entities? In accounting terminology,
these are the liabilities.

LIABILITIES

Liabilities are the future sacrifices of economic benefits that the entity is presently
obliged to make to other entities as a result of past transactions or other past events. As is
the case with assets, liabilities are divided into two classes, current and non-current
liabilities.

CURRENT LIABILITIES

Current liabilities are those liabilities that would, in the ordinary course of business of an
entity, be due and payable within 12 months period.

Some examples of current liabilities are: Accounts payable (Creditors), Short Term
Loans, Bank Overdraft, and Accrued Expenses.

NON-CURRENT LIABILITIES

Those are long-term liabilities, which is necessary to repay after more than one-year
period. Examples of non-current liabilities are: Long Term Loans, Mortgage Loans, Nots
Payables.

It can be seen that there is a thread, which is common to both assets and liabilities: both
are concerned with the accounting period (current) and a time span greater than the
accounting period. (Non-current)

The difference between the definitions of assets and liabilities, in general terms, centers
on who controls the economic resources.

OWNER’S EQUITY (EQUITY)

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Equity is the residual interest in the assets of the entity after deduction of its liabilities.
The equity can be seen as the residual interest due to the owners of the entity hence the
often-used term “owner’s equity”.

Equity is name differently; depend on the capital structure of the organization.

Single ownership - Capital, Owner Equity

Partnership - Partner’s Equity
Company - Shareholders Equity

BALANCE SHEET EQUATION

Balance sheet of the entity is a statement of assets, liabilities and equity at a particular
point in time, because the business is an artificial entity, by definition all the benefits
arising from its assets, belong to someone else.

This is summed up in the balance sheet equitation.

Economic Resources = Equity

The equation describes the balance sheet in its simplest form, it must always hold true.
This can expanded as:

Assets = Liabilities + Owners equity

USING THE BALANCE SHEET EQUATION TO PROVIDE USEFUL

INFORMATION

To clearly understand the information in the statements, you need to see how an
accounting system captures relevant data from the transactions, classifies and saves its
and then organizes it on the financial statements.

The beginning point for accounting systems is the definition of owner’s equity as the
difference can be stated as the following equation for a single proprietorship.

Assets – Liabilities = Owners Equity

Like any equation, this one can be modified by rearranging the terms. The following
modified form of the equation is called the balance sheet equation:

Assets = Liabilities + Owners Equity

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FORMAT OF THE BALANCE SHEET

ASSETS

Non current assets

Land & building (net) xxxx
Machinery & equipment xxxx
Furniture & fittings xxxx
Motor vehicle xxxx
Total non current assets xxxx

Current Assets
Stocks xxxx
Prepaid expenses xxxx
Debtor’s xxxx
Bank xxxx
Cash in hand xxxx

Total current assets xxxx

TOTAL ASSETS xxxx

LIABILITIES

Non-current liabilities
Mortgage Notes xxxx
Long-term loan xxxx
Total Non current liabilities xxxx

Current Liabilities
Creditors xxxx
Bank overdraft xxxx
Accrued expenses xxxx
Short-term loan xxxx
Total current liabilities xxxx

TOTAL LIABILITIES (xxxx)

NET ASSETS xxx

OWNERS EQUITY (SINGLE)

Beginning capital xxxx
Add: Net profit xxx
xxxx
Less; Withdrawals (xxx)
ENDING CAPITAL xxx
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Partnership
Capital Accounts
A xxx
B xxx
C xxx xxxx
Current Accounts
A xxx
B (xx)
C xxx xxxx
TOTAL PARTNERS EQUITY xxxx

Company
Share capital
Ordinary shares xxxx
Preference shares xxxx xxx
Reserves xxx
Retained profit xxx
TOTAL SHAREHOLDERS EQUITY xxx

INFLUENCES ON BALANCES SHEET FORMAT

• Asset values
• Type of business
• Regulations
• Uses of Accounts

SUMMARY

In this chapter we have seen that a balance sheet is an attempt to show the financial
position at one point in time. We also introduced the idea that a business is viewed for
accounting purposes as a separate entity from its owners. From this starting point we
have gone on to define assets, liabilities, and owners equity and to look at the balance
sheet equation. Before moving on to the next chapter you should ensure that you have
understood what is contained in this chapter by working through the review questions and
problems given below.

REVIEW QUESTIONS
1. What information is presented in a balance sheet?
2. Define (a) assets (b) liabilities (c) equity?
3. What events of activities change owner’s equity?
4. What are the essential elements of a useful definition of an asset?
5. Explain in your own words the difference between non-current assets and
current assets and why it is important to classify assets into subgroups.
6. Explain in your own words the difference between liabilities and owners
equity.
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PROBLEMS

1. Prepare a balance sheet from the following information and comment on the
position of the business as shown by that balance sheet.
Rs
Stock of goods held for resole 13,000
Freehold land & Building 164,000
Mortgage on land & Building 158,000
Cash 1,000
Fixtures and fittings 15,200
Office furniture 4,600
Bank overdraft 20,000
Delivery Van 140,000
Owners Equity ?

2. Gardian Company has the following trial balance as at 31 December 2007.

Account Title Debit Credit

Cash 16,000
Accounts Receivable 4,500
Prepaid Insurance 2,500
Supplies 3,000
Equipment 41,500
Accounts payable 5,500
Unearned Revenue 1,500
Notes payable 28,000
Laz Gardian, Capital 24,000
Laz Gardian, Drawing 2,500
Revenue 16,000
Salaries expense 3,700
Utilities expense 400
Marketing expense 900
Total 75,000 75,000

Prepare a balance sheet as at 31 December 2007.