balance sheet explained

A balance sheet can be defined as “a statement prepared for the purpose of measuring the exact financial position of a company at a given date.

“It is prepared from the trial balance after all the balances of the nominal accounts are transferred to the trading and profit and loss account and the corresponding accounts are closed in the general ledger. The balances that now remain in the balance sheet of proof are personal or real accounts, in other words, they represent existing assets or liabilities at the date of closing the accounts.

All these assets and liabilities are shown on the balance sheet according to certain principles such as:

(a) All actual and personal accounts that have debit balances must be shown on the asset side of the balance sheet on the right hand side.

(b) All actual and personal accounts that have credit balances must be shown on the liability side of the balance sheet, which is on the left-hand side. The excess of assets over liabilities represents owner’s equity. This capital figure should match the closing balance of the capital account in the general ledger after net profit or loss has been transferred to the general ledger.

It shows that when the real and personal accounts are placed on opposite sides of the balance sheet based on the nature of the balances, the asset side must equal the liability side.

As noted above, personal accounts that have debit balances are called assets; actually the property and possessions of the merchant, as well as the debts owed to him (sundry debtors and receivables) are assets.

Actual and personal accounts that have credit balances along with owner’s equity are shown as liabilities. So, the liabilities are the debts that a company has with third parties and with the owner of the company.

Asset Classification

The assets have been classified as follows:

(a) Fixed Assets. Assets of a durable nature that are used in the business and are acquired and intended to be kept permanently in order to carry out the business, such as land, buildings, machinery and furniture, etc. They are also sometimes called capital assets or fixed capital expenditures or long-lived assets. Fixed assets are collectively known as a ‘Block’.

(b) Floating or Circulating Assets. Those temporarily held assets that are intended for resale or that undergo frequent changes, for example, cash, inventory, stores, debtors, and receivables. Floating assets are further subdivided into two parts, liquid assets and illiquid assets. Liquid assets are those that can be easily converted to cash without appreciable loss. Cash on hand and cash in the bank are examples of such assets. Other assets that cannot be easily converted to cash, or not without appreciable loss, are called illiquid assets, eg, stocks, stores.

(c) Fictitious assets. Those assets that are not represented by anything concrete or tangible. Preliminary expenses, debit balance of the profit and loss account are examples of such assets. These are also called ‘nominal’ or ‘imaginary’ assets.

Liabilities Classification

The liabilities of a company can be classified as follows:

(a) Fixed Liabilities. Those liabilities that are going to be redeemed after a long period of time. This includes long-term loans.

(b) Current Liabilities. Those liabilities that are to be redeemed in the near future, generally within one year. Trade payables, bank loans, accounts payable, etc., are examples of current liabilities.

(c) Contingent Liabilities. These are not real liabilities, but the fact that they become real liabilities is contingent on the occurrence of a certain event. In other words, they would become liabilities in the future whenever the contemplated event occurs. If it does not occur, no liability is incurred. Since such a liability is not a real liability, it is not shown on the balance sheet. It is usually mentioned in the form of a footnote.

Balance Sheet Form

A balance sheet has two sides: the left side and the right side. These two sides, however, are not comparable to the debit side and credit side of a ledger account because the balance sheet is not an account. The words ‘Until’ or ‘By’ are not used in the balance sheet. The left side is the liability side and contains credit balances for all real and personal accounts and the right side, which is the “assets” side, lists debit balances for real and personal accounts.

Disposal of Assets and Liabilities on Balance 0

Assets and liabilities must be arranged on the balance sheet in some specific order. The arrangement of assets and liabilities on the balance sheet is called ‘Marshalling of assets and liabilities’. There are two systems for disposing of assets and liabilities on the balance sheet:

(a) Liquidity Order.

(b) Stay Order.

In order of liquidity, the most easily salable assets are listed first and are followed by assets that are less easily resalable. Thus, the most difficult assets to realize will be shown last. In the case of liabilities, these will be shown in the order in which they are payable, placing the most pressing liability first.

Distinction between Trial Balance and General Balance

1. The trial balance is the ‘middle’ of the accounting process of which the balance sheet is the ‘end’ because a balance sheet is always prepared from figures drawn from the trial balance.

2. The purpose of preparing a trial balance is to check the mathematical accuracy of the accounting books; But the balance sheet is written to reveal the financial position of the business.

3. The two sides of the balance sheet are called the ‘liability’ and ‘asset’ sides respectively, but in the case of the trial balance, the columns are the ‘debit’ and ‘credit’ columns.

4. To complete the accounting cycle, the preparation of the balance corresponds. necessary; but the preparation of the trial balance is not always necessary. –

5. The period after which a balance sheet is prepared is normally one year, but the trial balance is prepared very frequently and can be monthly, quarterly or semi-annually.

6. Trial balance contains all three types of accounts viz. personal real and nominal, but the balance sheet contains only personal and real accounts.~

7. Typically, the trial balance does not contain closing inventories, but it does contain the balance sheet.

8. Accrued, advanced, pending, and prepaid receipts and expenses cannot be known from the trial balance, but the balance reveals such items.

manufacturing account

Some companies like to clearly determine the cost of goods manufactured by them during the year before preparing the business account and determining gross profit. This account is called the manufacturing account and is prepared in addition to the trading account. It has the following characteristics:

(i) Since the purpose of preparing this account is to determine the cost of goods produced during the year, the initial and final stocks of finished products are not recorded in it; will appear in the trading account.

(ii) Regarding materials, it is the number of materials consumed that is charged to the account. This figure is obtained by adjusting the purchase of materials for beginning and ending stocks of materials, for example, beginning stocks of raw materials. Plus: purchases of raw materials during the year. Less: ending stocks of raw materials. Cost of materials consumed.

(iii) In the manufacturing company there will always be some unfinished products or work in progress. The cost of work in progress at the end of the year is credited to this account, shown on the balance sheet, and charged to the next year’s manufacturing account as the opening balance.

(iv) All expenses for factory wages, power and fuel, repairs and maintenance, factory wages, factory rent and fees are charged to this account. The depreciation of the machinery is also charged to this account and not to the profit and loss account as is usually done.

(v) The amounts collected from the sale of waste or scrap materials are deducted from the purchases of raw materials.

(vi) Now the difference on two sides of this account will be the cost of goods manufactured during the year. This cost will be credited to the manufacturing account and charged to the trading account.

The trade account will now comprise only the opening and closing stock of finished goods, the cost of manufactured goods as carried over from the manufacturing account, and sales of finished goods. The gross profit will be transferred to the profit and loss account. The profit and loss account and the balance sheet will be prepared as already explained.