A balance sheet can be defined as “a statement prepared to measure the exact financial situation of a business on a particular date.
“It is prepared from the trial balance after all balances in nominal accounts have been transferred to the trading and profit and loss account and corresponding accounts in the general ledger are closed. The remaining items that are now left in the trial balance are either personal or real accounts. In other words , they represent either assets or liabilities that exist on the closing date of accounts.
All of these assets and liabilities are shown in the balance sheet under certain principles, such as:
(a) All real and personal accounts with debit amounts must appear on the asset side of the balance sheet on the right hand side.
(b) All the real and personal account that has credit value must appear on the liabilities side of the balance sheet which is on the left. Surplus assets over liabilities represent the owner’s capital. This capital figure must correspond to the closing balance of the capital account in the general ledger after the net profit or loss is transferred therein.
It shows that when real and personal accounts are placed on opposite sides of the balance sheet according to the nature of balances, the asset side must be equal to the liability side.
As mentioned earlier, personal accounts with debit sum are called assets; in fact, on the trader’s property and possessions, since his debts (miscellaneous debtors and receivables) are also assets.
The real and personal accounts with credit value along with the owner’s capital are shown as liabilities. So liabilities are debts that a business owes to a third party and the owner of the business.
Classification of assets
Assets are classified as follows:
(a) Fixed assets. Sustainable assets used in business and acquired and destined to be permanently retained for the purpose of carrying on the business, such as land, building, machinery and furniture, etc. They are also sometimes referred to as capital assets or fixed capital expenditures or long-term assets. Fixed assets are collectively called ‘Block’.
(b) Liquid or circulating assets. The temporarily owned assets that are intended for resale or that often undergo changes, e.g. cash, holdings, stores, debtors and receivables. Liquid assets are again divided into two parts, liquid assets and non-liquid assets. Liquid assets are those that can easily be converted into cash without appreciable loss. Cash in hand and cash in the bank are the example of such assets. Other assets that cannot be easily converted into cash or not without appreciable loss are called non-liquid assets, such as stocks, stores.
(c) Fictitious assets. These assets are not represented by anything concrete or tangible. Preliminary costs, debit balance on income statement are the examples of such assets. These are also called as ‘nominal’ or ‘imaginary’ assets.
Classification of obligations
The obligations of the liabilities can be classified as follows:
(a) Fixed Obligations. The commitments to be redeemed after a long period. This includes long-term loans.
(b) Current liabilities. The commitments to be redeemed in the near future, usually within one year. Business creditors, bank loans, paid bills, etc. are examples of current liabilities.
(c) Contingent liabilities. These are not actual obligations, but their actual responsibilities are contingent upon a particular event happening. In other words, they would become obligations in the future, provided the intended event arises. If it does not, no liability is claimed. As such a liability is not a real liability, it is not shown in the balance sheet. Usually it is mentioned in the form of a footnote.
Kind of balance
A balance has two sides – the left side and the right side. However, these two pages are not comparable to the debit and credit pages of a ledger account because balance is not an account. The words “To” or “Off” are not used in the balance. Left side is the liabilities side and contains credit amounts on all real and personal accounts and on the right side which is “active”, the debit balances are shown on real and personal accounts.
Arranging of assets and liabilities in balance sheet 0
The assets and liabilities must be placed in the balance sheet in a specific order. Arranging assets and liabilities in the balance sheet is called ‘Marshalling of asset and liabilities’. There are two systems for arranging assets and liabilities in the balance sheet:
(a) Liquidity scheme.
(b) Order of permanence.
In liquidity order, the most easily realizable assets are shown first and followed by assets that are less readily resellable. So the assets that are most difficult to realize appear last. In the case of liabilities, these are shown in the order in which they are paid, where the most urgent responsibility is placed first.
The difference between trial balance and balance
1. Trial balance is the ‘means’ of the accounting process where the balance is ‘the end’ because a balance is always prepared based on the figures taken from the trial balance.
2. The purpose of drawing up a trial balance is to check the arithmetic accuracy of the account books; but the balance sheet is prepared to reveal the financial position of the company.
3. The two sides of the balance sheet are called ‘liabilities’ and ‘active’ pages, respectively, but in the case of -trial balance the columns are ‘debit’ and ‘credit’ columns.
4. For carrying out the accounting cycle is preparation of balance sheet. required; but preparation of the trial balance is not always necessary. –
5. The period after which a balance sheet is drawn up is usually one year, but the trial balance is prepared very often and may be monthly, quarterly or semi-annually.
6. Trial Balance contains all three account types, ie. personal real and nominal, but balance only contains personal and real accounts. ~
7. Generally, the sample balance does not include the final stock but the balance.
8. It is not possible to know the accrued, staggered, outstanding and prepaid receipts and expenses from the trial balance, but the balance sheet discloses such items.
Some concerns would like to clearly state the cost of goods manufactured by them during the year before compiling the trading account and finding the gross profit. This account is called the production account and is prepared in addition to the trading account. It has the properties mentioned:
(i) Since the purpose of preparing this item is to ascertain the cost of the goods produced during the year, the opening and closing stocks of finished goods are not recorded; they will be included in the trade accounts.
(ii) In the case of materials, the number of materials consumed is charged to the account. This figure is obtained by adjusting the purchase of materials for opening and closing materials, e.g. Opening of raw materials Add: purchase of raw materials during the year Less: final stock of raw materials Cost of consumed materials
(iii) In the manufacturing process, there will always be unfinished goods or work in progress. The cost of work in progress at year-end is credited to this account, shown in the balance sheet and charged to the production accounts for next year as on the opening balance sheet.
(iv) All expenses for factory wages, power and fuel, repairs and maintenance, factory wages factory house and rates are debited to this account. Depreciation on machines is also written off to this account and not to the income statement, as is usually done.
(v) Amounts raised through the sale of waste or scrap materials are deducted from the purchase of raw materials.
(vi) Now the difference on two sides of this account will be the cost of goods manufactured during the year. These costs are credited to the production account and debited to the trading account.
The trading account will now only include opening and closing finished goods, the cost of goods made as transferred from the production account, and sales of finished goods. Gross profit is transferred to the income statement. The income statement and balance sheet are prepared as already explained.