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Balance Sheet Explained
A balance sheet can be defined as “a statement prepared to measure the exact financial position of a business at a particular date.
“It is prepared from the trial balance after all the balances of the nominal accounts have been transferred to the trading and profit and loss account and the corresponding ledger accounts have been closed. The balances that now remain in the trial balance are either personal or real accounts. words, they either represent assets or liabilities existing at the date of closing the accounts.
All these assets and liabilities are shown in the balance sheet according to certain principles such as:
(a) All real and personal accounts with debit balances should be shown under assets on the right-hand side of the balance sheet.
(b) All real and personal account having credit balances should be shown on the liabilities 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 correspond to the closing balance of the capital account in the ledger after the net profit or loss has been transferred to it.
This shows that when the real and personal accounts are placed on opposite sides of the balance sheet according to the nature of the balance sheets, the asset side must equal the liability side.
As stated earlier, personal accounts with debit balances are called assets; actually in the merchant’s property and possessions, as well as the obligations to him (various debtors and receivables) are assets.
Real and personal accounts with credit balances along with equity are shown as liabilities. So liabilities are the debts owed by the business to third parties and the business owner.
Assets are classified as follows:
(a) Fixed assets. Assets of a fixed nature that are used in business and are acquired and intended to be retained permanently for the purpose of carrying on the business, such as land, building, machinery and furniture, etc. They are also sometimes called capital assets or fixed assets capital expenditure or fixed assets. Fixed Assets are known as “Block”.
(b) Floating or current asset. Those temporarily held assets that are intended for resale or that change frequently, such as cash, stock, stores, debtors, and receivables. Floating assets are again divided into two parts, liquid assets and illiquid assets. Liquid assets are those that can be easily converted into cash without significant loss. Cash and money in the bank are examples of such assets. Other assets which cannot easily be converted into money or not without significant loss are called illiquid assets eg stocks, stores.
(c) Fictitious Assets. Those assets that are not represented by anything concrete or tangible. Prepaid expenses, the debit balance of the profit and loss account are examples of such assets. These are also called “nominal” or “notional” assets.
Classification of liabilities
The liabilities of the concern can be classified as given below:
(a) Fixed liabilities. Those debts that have to be repaid after a long period of time. This includes long-term loans.
(b) Current Liabilities. These liabilities must be repaid in the near future, usually within one year. Trade creditors, bank loan, accounts payable, etc. are examples of current liabilities.
(c) Contingent liabilities. These are not actual obligations, but their becoming an actual obligation depends on the occurrence of a certain event. In other words, they would become liabilities in the future, provided the planned event occurs. If it doesn’t happen, no responsibility. Since such a liability is not an actual liability, it is not shown on the balance sheet. It is usually mentioned in the form of a footnote.
Form of accounting balance sheet
The balance sheet has two sides – the left side and the right side. However, these two sides are not comparable to the debit and credit sides of an accounting account, since a balance sheet is not an account. The words “To” or “To” are not used in the balance sheet. The left side is the liabilities side and contains credit balances of all real and personal accounts, and the right side, which is the “assets” side, lists debit balances of real and personal accounts.
Arrangement of assets and liabilities on the balance sheet 0
Assets and liabilities must be arranged on the balance sheet in a certain order. The arrangement of assets and liabilities in the balance sheet is called “Sort of Assets and Liabilities”. There are two systems for arranging assets and liabilities on the balance sheet:
(a) Order of Liquidity.
(b) Order of Persistence.
In order of liquidity, the most readily realizable assets are shown first and are followed by assets that are more difficult to resell. Thus, the most difficult-to-realize assets will be displayed last. In the case of liabilities, they will be displayed in the order in which they are due, with the most urgent liabilities being placed first.
Difference Between Trial Balance and Balance Sheet
1. The trial balance is the “means” of the accounting process of which the balance sheet is the “end” because the balance sheet is always prepared from the figures taken from the trial balance.
2. The purpose of preparing a balance sheet is to check the arithmetical accuracy of the accounting books; but the balance sheet is prepared 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 a trial balance, the columns are “debit” and “credit” columns.
4. To complete the accounting cycle, an accounting balance is prepared. necessary; but the preparation of a trial balance is not always necessary. –
5. The period after which a balance sheet is prepared is usually one year, but a trial balance is prepared very often and may be monthly, quarterly or six-monthly.
6. The trial balance contains all the three types of accounts viz. personal real and nominal, but the balance sheet contains only personal and real accounts.~
7. In general, the trial balance does not contain ending inventory, but the balance sheet does.
8. It is not possible to know the accrued, advanced, outstanding and prepaid income and expenses from the trial balance, but the balance sheet discloses such items.
Some concerns like to ascertain clearly the cost of the goods manufactured by them during the year before they prepare the trading account and ascertain the gross profit. This account is called the production account and is prepared in addition to the trading account. It has the following characteristics:
(i) As the purpose of preparing this account is to ascertain the cost of goods manufactured during the year, opening and closing stocks of finished goods are not entered therein; they will appear in the trading account.
(ii) In respect of materials, the amount of materials consumed shall be debited to the account. This figure is obtained by adjusting the material purchase for the opening and ending material stocks, e.g. Beginning Raw Materials Inventory Add: Raw Materials Purchases During the Year Less: Ending Raw Materials Inventory Cost of Materials Consumed
(iii) There will always be unfinished goods or work in progress in a manufacturing concern. Work-in-progress expense at the end of the year is credited to this account shown in the balance sheet and debited to the next year’s production account as the opening balance.
(iv) All factory expenses – wages, power and fuel, repairs and maintenance, factory wages, factory rent and tariffs are debited to this account. Depreciation on machinery is also debited to this account and not to the profit and loss account as is usually done.
(v) Amounts collected from the sale of waste or scrap materials shall be deducted from purchases of raw materials.
(vi) Now the difference is that the two sides of this account will be the cost of goods produced during the year. This cost will be credited to the production account and debited to the trading account.
The trading account will now include only the beginning and ending inventory of finished goods, cost of goods manufactured transferred from the production account, and sales of finished goods. The gross profit will be transferred to the profit and loss account. The income statement and balance sheet will be prepared as already explained.
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