How does a Balance Sheet Balance?

Ok, so lets say

I buy a Asset for 500k and use a Loan to fund the 500k

So
____________________
Current Assets = 500k
----------------------------
Current Liability = 500k
----------------------------
Balance = 500k?

My Point is that, wouldnt the Current Liability be more than 500k?

Lets Say the bank charges my with 10% Interest, therefore the Current liablity will be 550k?

Which means the Balance sheet does not Balance? :confused:

Reply 1

GR3YFOXXX

assets = liabilities + equity

500k = 500k

with interest its still;

500k = 500k

The 50k is interest which would be shown on your statement of comprehensive income and not as an asset/liability on the B/S.

Reply 2

roberto111

Sorry but what? i dont get that

Reply 3

GR3YFOXXX

A balance sheet is a list of assets, liabilities and capital/equity. The interest incurred on a loan is an expense and not a liability, therefore it appears on your income statement and not your balance sheet.

Reply 4

DJKL

If the loan has interest due you charge the interest of say 50 as a DR to your profit and loss account. If the only transaction this results in a loss of 50 for the year.If the interest is not actually paid your liability to pay creates a creditor of 50 (CR) interest due. If paid it would have reduced your cash balance if you had one.

Your new balance sheet is then:
Dr Asset 500
Cr Loan ( 500)
Cr InT Due (50)
Net liability (50)

Represented by

Opening equity 0
Loss for year (50)
Net Equity (50)

(you may be more familiar thinking of equity as capital, unsure of terminology you are comfortable using)

The Profit and Loss (income less expenses statement) links the opening balance sheet to the closing balance sheet, the movement in the profit and loss either increases or decreases the equity of the entity, a profit increases equity a loss decreases equity.

This has to be true because all accounting entries have to have both a debit and a credit, these can only post to 5 categories of account, namely:

Assets
Liabilities
Equity
Income
Expense

All nominal accounts fit somewhere within the above category structure.

You can think of it as an equation if you like, being:

Open Assets-closing liabilities+income for year-expenses for year= closing assets-closing liabilities. In effect a profit for the year (I-E) increases the net assets a loss (I-E) reduces the net assets.

Trust this helps

Reply 5

roberto111

Original post by GR3YFOXXX

Thanks for that ! i get it

So, if the interest is not on a balance sheet, doesnt it make it, a bit worthless? as you need the income statement

Reply 6

DJKL

Original post by roberto111

Thanks for that ! i get it

So, if the interest is not on a balance sheet, doesnt it make it, a bit worthless? as you need the income statement

The interest charge is not on the balance sheet however its cost to the business is reflected in either the balance sheet having a creditor for the interest or the bank balance of the business being reduced for the payment of the interest.

The Balance Sheet is a snapshot of the business at a point in time (the balance sheet date) the Income and Expense account is a reflection of the operation of the business over a period of time.

You actually probably really need both statements as they are telling you different things. The worth of the balance sheet is a function of the information you wish to have imparted to you, it gives very limited information on profits (Really only change in retained profits which can be very misleading) but gives some information of the assets and liabilities of the business. The Income and expense account imparts information about the profitability of the business but tells little re its solvency.

The two statements together really give a much fuller picture, the third, and often most important statement, is the cashflow statement.

In reality to really get an understanding of a business you need access to the full Management accounts, including notes. Even quoted company published accounts, with 50 pages of notes, may not give a full picture of what is happening as they do not give a detailed income and expenditure account.

Reply 7

roberto111

Original post by DJKL

Is Profit and Loss accountant the same as a Income Statment?

Reply 8

DJKL

Original post by roberto111

Is Profit and Loss accountant the same as a Income Statment?

Its really the same as an income and expense statement.

A profit and loss account is a summary of all income and expenses of an entity (usually a business) over a period of time (usually a year)

The resultant profit or loss is then added to previous year retained profits to give the carried forward retained profit reflected in the balance sheet.

Have a look at example 2 on the undernoted link, you will see that the profit of £15,800 is shown as part of the balance of the owner in the balance sheet (I think it is a poor example as I would tend to show the capital of the owner as capital not as fixed liabilities) However you will note that the £15,800 profit from the profit and loss account balances the balance sheet.

http://www.accounting4management.com/examples_of_trading_and_profit_and_loss_account_and_balance_sheet.htm

The key is to remember that every transaction has two sides that must be equal, for instance if a business sells an item of stock on credit for £1,000 it:

Dr Debtor £1,000

Cr Sales £1,000

If the debtor then pays the business we have:

Dr Bank £1,000
Cr Debtor £1,000

The DR (debit) and CR (credit) are conventions and indicate, within a general ledger, the sides of a T account we are posting to, Debit to the right, Credit to the left.

All accounts in a general ledger can be classed under one of the folowing heads:

Assets, a DR means an increase in them, a CR means a decrease
Liabilities, a DR means a decrease in them, a CR means an increase
Capital, a DR means a decrease, a CR means an increase
Income, a DR means a decrease, a CR means an increase
Expenses, a DR means an increase, a CR means a decrease

With regard to the General Ledger and the debits and credits, all accounts preparation boils down to the above. The key is getting very comfortable with the ideas so that the debits and credits are second nature and understanding which accounts fit each of the five categories.

Did you get a basic accounts textbook?