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Balance sheets
Balance sheet - introduction
The balance sheet is a list of balances arranged according to whether they are assets, capital or liabilities, to depict the financial situation of the business on a specific date. It is often referred to as a 'snapshot' of the firm on a particular date - as if we had entered in the firm and taking photographs of the various components that make up the business. It can only be constructed on one date and not over a period of time as the values for assets and liabilities will change frequently.
The balances that are featured in the balance sheet would be the balances remaining on our trial balance after the trading and profit and loss account for the period has been completed. All the balances remaining have to be assets, capital or liabilities. All other balances would have been closed off when the trading and profit and loss account was completed.
The word 'account' generally indicates if something is part of the double entry system. Therefore, both the trial balance and the balance sheet are not part of the double entry system. No entries are made in the ledger accounts to record the fact that we have drawn up a balance sheet. All we are actually doing is listing the assets, capital and liabilities balances so as to form a balance sheet.
As with the trading and profit and loss account, there are two ways of presenting a balance sheet - horizontal and vertical. The vertical style will be adopted in this course although we will briefly show you what a 'horizontal' balance sheet is.
Balance sheet layout
Assetswill appear under two headings:fixed assetsandcurrent assets.
Fixed assets can be characterised by the following features:
- They are expected to last for at least one year (i.e. long-term)
- They are to be used in the business to help generate income for the firm (e.g. they could be used in production)
- They were not bought specifically for resale - although they may be sold later
- Examples of fixed assets would include land & buildings, machinery, fixtures & fittings.
Current assets can be characterised by the following features:
- They have a short life within the firm (less than one year).
- They can be converted into cash fairly quickly (i.e. they are liquid).
- Their values will change frequently - stock levels fluctuate, banks balances move up and down, and debtors and creditors will alter as personal accounts are settled.
- Current assets are stock, debtors, bank and cash.
The order that current assets appear is in relation to how quickly they can be turned into cash. This means that cash will appear at the bottom of the list because it is the most liquid of all the assets, closely followed by debtors, then stock.
As we know from the accounting equation, and our work on double entry bookkeeping, all transactions are considered in their dual affect on the business. The balance sheet is no exception. As the name suggests, there will be two 'sides' to the balance sheet which must, obviously, balance. A balance sheet which does not balance is an incorrect balance sheet.
Other balance sheet sections
Capital
Here we list the total resources that have been injected into the firm by the owner as at the end of the financial period under analysis. This figure will need to be adjusted for items which increase capital and items which decrease capital.
Net profits would be added to the capital balance, whereas net losses would be deducted.
Drawings are reductions in capital and therefore will always be deducted on the balance sheet.
Liabilities
Liabilities relate to any amounts of money that have been borrowed by the firm. Technically, capital is a special form of liability in that the business is 'borrowing' money and resources from the owner of the business. However capital will always be kept separate from the liabilities of the firm. Liabilities are split into two sections - defined below:
Long-term liabilities
Money owed by the firm which will not be repayable until after one year or more (e.g. bank loans and mortgages).
Current liabilities
This is money owed by the firm which will be repaid during the next year (e.g. creditors and bank overdrafts).
As stated earlier, we need the remainder of the balances from the trial balance which were not used in the construction of the trading and profit and loss account - we will use the previous example of D Balls.
| D Ball - Trial Balance as at 31 December 2003
|
| -
| Dr (£)
| Cr (£)
|
| Sales
| -
| 6000
|
| Purchases
| 4000
| -
|
| Insurance
| 650
| -
|
| Lighting & heating
| 450
| -
|
| General expenses
| 120
| -
|
| Machinery
| 2100
| -
|
| Debtors
| 890
| -
|
| Creditors
| -
| 980
|
| Bank
| 1970
| -
|
| Discounts allowed
| 130
| -
|
| Discounts received
| -
| 110
|
| Cash in hand
| 80
| -
|
| Drawings
| 700
| -
|
| Capital
| -
| 3000
|
| Loan
| -
| 1000
|
| -
| 11090
| 11090
|
Stock in trade as at 31 December 2003 was valued at £300
The lines in bold will be used in the construction of the balance sheet - note that closing stock appears in both the trading and profit and loss account as well as the balance sheet. The balance sheet drawn up on this date will look as follows:
| D Ball - Balance Sheet as at 31 December 2003
|
| -
| £
| £
| £
|
| Fixed assets
| -
| -
| -
|
| Machinery
| -
| -
| 2,100
|
| -
| -
| -
| -
|
| Current assets
| -
| -
| -
|
| Stock
| 300
| -
| -
|
| Debtors
| 890
| -
| -
|
| Bank
| 1970
| -
| -
|
| Cash
| 80
| 3240
| -
|
| Less Current liabilities
| -
| -
| -
|
| Creditors
| -
| (980)
| -
|
| Working capital
| -
| -
| 2260
|
| -
| -
| -
| 4360
|
| Less Long term liabilities
| -
| -
| -
|
| Loan
| -
| -
| 1000
|
| Net assets
| -
| -
| 3360
|
| -
| -
| -
| -
|
| Financed by:
| -
| -
| -
|
| Capital
| -
| -
| 3000
|
| Add Net profit
| -
| -
| 1060
|
| -
| -
| -
| 4060
|
| Less Drawings
| -
| -
| 700
|
| -
| -
| -
| 3360
|
Notice the following features of the balance sheet:
1. The top 'half' of the balance sheet shows the following calculation:
|
| £
|
|
| Fixed assets
|
| +
| Current assets
|
| -
| Current liabilities
|
| -
| Long-term liabilities
|
| =
| Net assets
|
2. Within the top 'half' there is the following calculation:
|
| £
|
|
| Current assets
|
| -
| Current liabilities
|
| =
| Working capital
|
Working capital is a very handy concept used by businesses. Basically it shows us how liquid the firm is - has it got enough 'near' cash items (items that could be converted into cash quickly without losing their value) to pay its short-term debts (current liabilities). If this figure is negative then the firm may have problems in the near future.
3. The term 'Financed by' explains where the resources have come to finance the firm's operations - other than the borrowing that is. The capital figure here is adjusted by profits (or losses) and drawings made, to give us the new capital figure for the new trading period. The adjustments needed in the actual capital account would be as follows:
| 2003
| -
| £
| 2003
| -
| £
|
| 31 Dec
| Drawings
| 700
| 1 Jan
| Balance b/d
| 3,000
|
| 31 Dec
| Balance c/d
| 3,360
| 31 Dec
| Profit & Loss
| 1,060
|
| -
| -
| 4,060
| -
| -
| 4,060
|
| -
| -
| -
| 2004
| -
| -
|
| -
| -
| -
| 1 Jan
| Balance b/d
| 3,360
|
Notice that profits add to the capital because they are credited to the capital accounts. Any net loss would be debited to the capital accounts. Drawings always reduce the capital balance and therefore are always transferred to the capital account at the end of the trading period on the debit side.
4. The section on long-term liabilities is not always present. Actually, if there are no long-term liabilities then this section can be missed out totally. Be careful though, some texts present the long-term liabilities as added on to the bottom half of the balance sheet. This should not matter, adding this section on to the bottom is exactly the same as subtracting the amount form the top 'half' of the balance sheet - just be consistent.
Horizontal balance sheet
The horizontal balance sheet simply lists assets on the left hand side and capital and liabilities are the right hand side. Follow the link below to see how the balance sheet of D Ball would look as a horizontal balance sheet.
Also See
Comments
These notes are aimed at people studying for AQA A Level Accounting Unit 1, but will also be suitable for other courses and exam boards.
Originally submitted by duke_stix on TSR Forums.
