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Balance Sheet Explained

Balance Sheet Explained

A balance sheet may be defined as “a statement prepared with a view to measure the exact financial position of a business on a certain date.

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

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

(a) All real and personal account having debit balances should be shown on the assets side of balance sheet which is on the right-hand side.

(b) All the real and personal account having credit balances should be shown on the liabilities side of balance sheet, which is on the left-hand side. The excess of assets over liabilities represents the capital of the owner. This figure of capital must tally with the closing balance of capital account in the ledger after the net profit or loss has been transferred therein.

It shows that when real and personal accounts are placed on the opposite sides of balance sheet according to the nature of balances, the assets side should be equal to liabilities side.

As stated earlier and personal accounts having debit balances are called assets; actually at trader’s property and possessions as also the debts owing to him (sundry debtors and bills receivable) are assets.

The real and personal accounts having credit balances along with owner’s capital are shown as liabilities. So liabilities are the debts owing by a business to third parties and the owner of the business.

Classification of Assets

Assets have been classified as follows:

(a) Fixed Assets. The assets of a durable nature which 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 as capital assets or fixed capital expenditures or long lived assets. Fixed assets are collectively known as ‘Block’.

(b) Floating or Circulation Asset. Those temporarily held assets which are meant for resale or which frequently undergo change e.g. cash, stock, stores, debtors and bills receivable. Floating assets are again sub-divided into two parts, liquid assets and non-liquid assets. Liquid assets are those which can be readily converted into cash without appreciable loss. Cash in hand and cash at bank are the example of such assets. Other assets which cannot be readily converted into cash, or not without appreciable loss, are called non-liquid assets e.g., stock, stores.

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

The liabilities of a concern can be classified as given below:

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

(b) Current Liabilities. Those liabilities which are to be redeemed in near future usually within a year. Trade creditors, bank loan, bills payable etc., are examples of current liabilities.

(c) Contingent Liabilities. These are not actual liabilities but their becoming actual liability is contingent on the happening of a certain event. In other words, they would become liabilities in the future provided the contemplated event occurs. If it does not occur, no liability is incurred. Since such a liability is not an actual liability, it is not shown in the balance sheet. Usually, it is mentioned in the form of a footnote.

Form of Balance Sheet

A balance sheet has two sides-the left-hand side and the right-hand side. These two sides, however, are not comparable with the debit side and credit side of a ledger account because balance sheet is not an account. Words ‘To’ or ‘By’ are not used in the balance sheet The left-hand side is liabilities side and contains credit balances of all real and personal accounts and on the right-hand side which is “assets” side, are listed the debit balances of real and personal accounts.

Arrangement of Assets and Liabilities in Balance sheet 0

The assets and liabilities should be arranged in balance sheet in some specific order. Arrangement of assets and liabilities in the balance sheet is called ‘Marshalling of assets and liabilities’. There are two systems of arrangement of assets and liabilities in the balance sheet:

(a) Order of Liquidity.

(b) Order of Permanence.

In liquidity order most easily realizable assets are shown first and are followed by assets which are less easily resalable. So, the assets most difficult of realization will be shown last. In case of liabilities, these will be shown in the order in which they are payable the most pressing liability being placed first.

Distinction between Trial Balance and Balance Sheet

1. Trial balance is the ‘means’ of accounting process of which the balance sheet is the ‘end’ because a balance sheet is always prepared from the figures taken out of trial balance.

2. The purpose of preparing a trial balance is to check the arithmetical accuracy of account books; but balance sheet is drafted to reveal the financial position of the business.

3. The two sides of balance sheet are called ‘liabilities’ and ‘assets’ sides respectively but incase of -trial balance the columns are ‘debit’ and ‘credit’ columns.

4. For completing the accounting cycle, the preparation of balance sheet is. necessary; but the preparation of trial balance is not always necessary. –

5. The period after which a balance sheet is prepared, is normally one year but trial balance is prepared very often and it may be monthly, quarterly or half-yearly.

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

7. Generally, trial balance does not contain closing stock but balance sheet does.

8. It is not possible to know the accrued, advance, outstanding and prepaid receipts and expenses from trial balance, but balance sheet discloses such items.

Manufacturing Account

Some concerns like to ascertain the cost of goods manufactured by them during the year distinctly before they prepare the trading account and ascertain the gross profit. This account is called the manufacturing account and is prepared in addition to the trading account. It has the under mentioned characteristics:

(i) Since the purpose of preparation of this account is to ascertain the cost of goods produced during the year, the opening and closing stocks of finished goods are not entered in it ; they will figure in trading account.

(ii) In respect of materials it is the figure of materials consumed which is debited to the account. This figure is obtained by adjusting the purchase of materials for the opening and closing stocks of materials e.g., Opening stock of raw materials Add: purchases of raw materials during the year Less: closing stock of raw materials Cost of materials consumed

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

(iv) All expenses in factory- wages, power and fuel, repairs and maintenance, factory salaries factory rent and rates 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 raised by sale of waste or scrap materials are deducted from raw material purchases.

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

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