WHAT IS A BALANCE SHEET?
A balance sheet provides a detailed list of the value of assets and liabilities and the owner’s proprietorship. The value of all items in the balance sheet is based on the historical cost principle. That is, the dollar amounts shown are the original values: in the case of assets, the historical cost would be the original purchase price including any costs, such as installation costs, associated with obtaining the asset and establishing it within a business so it is able to contribute to the functioning of the business.
The balance sheet is like a snapshot of the business at a particular point in time. It is the representation of the financial status of a business at a particular moment, therefore rendering it good for only one day in the life of the business. The business will change its financial status from day to day as it continues to engage in transactions; every transaction affects the balance sheet in some way. A balance sheet shows:
• What is owned by a business (assets);
• What is owed by a business (liabilities);
• What a business is worth (equity): the difference between assets and liabilities equals the worth of the business i.e. the owner’s/shareholders’ equity.
Note: Proprietorship (depending on the type of business) is also referred to as owner’s equity, member’s funds, capital, or shareholder’s equity.
What are examples of assets and liabilities?
Assets = cash, cash receivable, investments, equipment, inventory (stock), property (buildings and land).
Liabilities = accounts payable, loans (long term debt), employees entitlements (salaries, long service leave accumulation, superannuation/pension contributions, holiday pay etc.).
What is owner’s equity/shareholders’ equity?
This is the amount of money that is invested into the business - it also includes profits made by the business that have been reinvested rather than withdrawn.
What is a balance sheet made up of?
• The two sides of the sheet must balance out hence the term ‘balance sheet’. A business pays for its assets through loans or by accessing its equity (the amount of money invested in or made by the business).
As stated above - a balance sheet has 3 parts: a) assets b) liabilities and c) owner’s/shareholders’ equity.
• The (value of) assets appear on one side of the balance sheet and the (current amount of) liabilities on the other side.
• The difference between assets and liabilities is the owner’s/shareholders’ equity.
Is there an accounting equation to represent this?
The accounting equations that represent this are:
Assets = Liabilities + Owner’s Equity: A = L + OE
Owner’s Equity = Assets – Liabilities: OE = A - L
The accounting equation used differs according to the balance sheet format used, but the end results should be the same, irrelevant of the style of balance sheet used.
Note: the value of all items in the balance sheet is based on the historical cost principle. That is, the dollar amounts shown are the original values: in the case of assets, the historical cost would be the original purchase price including any costs, such as installation costs, associated with obtaining the asset and establishing it within a business so it is able to contribute to the functioning of the business.
An accounting report prepared at the end of every accounting period is the balance sheet. This report states the financial position of a business at one particular point in time. A Balance Sheet has three main sections:
Assets: these are items of value owned by the business.
Liabilities: these are debts owed by the business to outsiders
Proprietorship: this is the owner’s claim on the assets of the business. It is also referred to as the net worth of the business. It may consist of the capital the owner has contributed to the business plus any profits earned by the business which have not been withdrawn.
What does a balance sheet look like?
Fundamentally the balance sheet includes all the accounts listed in a business’s general ledger (naturally this varies from business to business). And because accounts differ from one company to the next the information represented on the balance sheet also differs.
Balance sheets have several formats (how the information is presented) the two most used are referred to as:
1. Narrative (report) format (where the accounts are represented vertically on the sheet). The equation used for the report format is: OE = A-L
2. T format (where the information is represented in a T shape with the assets on one side and liabilities on the other. The equation used in the T form format is A = L +OE
As long as the business is consistent in the type of format – the format they use is a matter of personal choice.
NOTE: If a balance sheet does not balance then the figures are incorrect.
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