The balance sheet is an extended representation of the standard accounting equation. It represents the financial position of the entity at any point in time. That is why; it is also called Statement of Financial Position. The accounting equation is written as:
Assets = Equity + Liabilities
Following the equation in mind, the balance sheet is prepared where the sum of all items of equity and liabilities must equate to the sum of all assets of the entity.
It is one of the most important statements used by investors and accountants. It is used in conjunction with income statements to calculate various types of financial ratios to analyze the performance of an entity over the years using trend analysis. The balance sheet of competitors can also be used to conduct the entity’s own performance analysis with competitors.
Header
The header of the statement of financial position starts with the name of the entity along with the period of the statement as follows:
ABC Company
Balance Sheet
As of 31st December 2015
Components of Balance Sheet
Shareholder’s Equity
- Common stock
- Preferred stock
- Retained earnings
Liabilities
- Long term loans
- Long term portion of finance lease
- Notes Payable
- Accounts Payable
- Accrued Expenses
Assets
Non-current assets
- Property, Plant & Equipments
- Vehicles
- Computers
- Furniture & Fixture
Current Assets
- Cash
- Bank
- Prepaid Expenses
Format
Balance sheet can be prepared into formats. One is T account and the other is report format.
Specimen Balance Sheet
ABC Company
Blance Sheet
As on 31st Dec, 2015
| Assets | Liabilities & Equity | ||
| Current Assets: | Liabilities: | ||
| Cash in hand | 20,000 | Notes Payable | 10,000 |
| Cash at bank | 25,000 | Accounts Payable | 12,000 |
| Accounts Receivable | 5,000 | Accrued Expenses | 5,000 |
| Prepaid insurance | 4,000 | Unearned Income | 9,000 |
| Prepaid Office Rent | 5,000 | Interest Payable | 2,000 |
| Total Current Assets | 49,000 | Total Liabilities | 38,000 |
| Non-current assets | Common Stock | 44,000 | |
| Machinery | 50,000 | Retained Earnings | 12,000 |
| Accumulated Depreciation | (5,000) | ||
| Net non-current assets | 45,000 | ||
| Total Assets | 94,000 | Total Equity & Liabilities | 94,000 |
Example
ABC is a top classed construction company. It has undertaken various successful construction projects in the past and is one of the most trusted names in the industry. Now just that, it also expanded itself in international markets, especially in the MENA region. As a result, it has to incur heavy costs on account of investment to ease out the expansion phase. Following is the trail balance available for its recent financial year ended 31st Dec 2016:
| Account | Debit $ | Credit $ |
| Paid up capital | 30,000 | |
| Vehicle | 10,000 | |
| Plant & Machinery | 20,000 | |
| Accounts payables | 10,000 | |
| Sales | 20,000 | |
| Cost of goods sold | 16,000 | |
| Accounts receivable | 4,000 | |
| Operating expenses | 5,000 | |
| Admin & selling expenses | 5,000 | |
| Total | 60,000 | 60,000 |
Required:
Prepare a balance sheet from the trial balance given above for the period ended 31st December 2016.
Solution
From the trial balance given above, we can make the balance sheet as follows:
| Equity | $ | Assets | $ |
| Paid up capital | 30,000 | Vehicle | 10,000 |
| Accumulated profit/ (loss) | (6,000) | Plant & Machinery | 20,000 |
| Liabilities | Accounts receivable | 4,000 | |
| Accounts payables | 10,000 | ||
| 34,000 | 34,000 |
From the information presented in the balance sheet above, it is quite clear that ABC is incurring losses of $ 6,000. In order to improve its profitability, ABC has to increase its sales revenue, reduce expenses and improve recoveries from its debtors. This is to ensure a very low portion of receivables turns into bad debts.
One of the reasons ABC is incurring losses might be that ABC is expanding its operations in the MENA region. So, it would be incurring heavy investment over assets as well. So, that could be the reason for losses in the initial periods. A comprehensive analysis of financial statements with background information could help the management accountant in driving the right reasons.