The Balance Sheet is the last financial statement that is prepared by any organization. This statement helps to ascertain the true financial position of an enterprise at the end of an accounting period. It is a statement that is prepared to ascertain the values of assets and liabilities of a business on a particular date. In other words, a Balance Sheet can be defined as a financial status report of an organization that imparts information related to various assets and liabilities of an organization at the closing of an accounting period. The preparation of the Balance Sheet is compulsory as it is an integral part of financial statements. It is prepared with the help of real and personal accounts balances. It reveals the solvency and liquidity position of a firm on a particular date. An important point to be noted here is that the Balance Sheet is a statement and not an account.
Though similar to an account it also has two sides named Assets and Liabilities, but it is not prepared by following the accounting rule of debit and credit. The assets of a firm are shown on the right-hand side under the head “Assets” and liabilities are shown on the left-hand side under the head “Liabilities” of the Balance Sheet. Liabilities consist of the owner’s / proprietor’s funds and creditors. It should be noted that the sum total of the assets side is always equal to the sum total of its liabilities side. Thus, a Balance Sheet can be defined as a statement depicting a true and fair view of a firm’s financial position at the end of an accounting period.
In the words of Freeman, “A Balance Sheet is an item-wise list of assets, liabilities, and proprietorship of a business at a certain date”. According to Francis R. Stead, “A Balance Sheet is a screen picture of the financial position of a going business at a certain moment”.
Items appearing in the Balance Sheet
Items appearing on the Assets Side of the Balance Sheet
All the assets of a firm and miscellaneous expenditure are recorded on the Assets side of the Balance Sheet. The assets of a firm can be bifurcated as follows:
Fixed Assets: These are the assets that are acquired for a longer period of time, generally for more than one year. These assets are not meant for resale, rather, they are used for the production or rendering of goods and services. Some of the examples of these assets are Machinery, Building, Goodwill, Plant, Furniture, etc. These assets are recorded in the Balance Sheet at cost after deducting depreciation. These assets include both tangible as well as intangible assets.
Tangible Assets are those assets that have physical existence. This implies that these assets can be seen or touched such as Plant, Furniture, Loose Tools, etc. Intangible Assets are those assets that do not have any physical existence. This implies that these assets cannot be seen or touched such as goodwill, patents, trademarks, etc.
Current Assets: These are the assets that are acquired by a firm with the purpose of resale in the business in order to generate revenues. These assets are held for a short period of time. In simple words, current assets can be defined as the assets which are in the form of cash or which can be easily converted into cash within a period of one year during normal business activities. Examples of these assets are debtors, bills receivables, stock, cash in hand, prepaid expenses, etc.
Fictitious Assets: These are the assets that are not convertible into cash. There may be some expenditures or losses that are required to be written-off over some years and the full amount of expenses or losses is not charged from the profits of the accounting year in which they are incurred. The portion of expenditure that is not written-off is shown on the Assets side of the Balance Sheet under the head Miscellaneous Expenditure. For example, Advertisement suspense, debit balance of Profit and Loss Account, etc. These are not actually the assets but are still recorded in the Balance Sheet for writing off them over some years.
Items appearing on the Liabilities Side of the Balance Sheet
The following are the items that appeared on the Liabilities side of the Balance Sheet.
Capital: This is the amount invested by the proprietor in the business to carry out the business activities. Those items which increase the balance of capital such as net profit, fresh capital introduced, and interest on capital is added to the capital. On the other hand, the items that reduce the balance of capital such as net loss, drawings made, interest on drawings, income tax paid, life insurance premium, etc. are deducted from this capital.
Fixed or Non-current Liabilities: These are the long-term liabilities of a business that are to be repaid by the business after a period of one year. For example, long-term loans, loans from banks, mortgages, etc.
Reserves and Provisions: Reserves and provisions are the amounts that are kept aside to meet future uncertainties and losses. For example, general reserve, reserve fund, provision for tax, etc.
Current Liabilities: These are the short-term liabilities of a business that are to be repaid by the business within a period of one year. For example, creditors, bills payable, outstanding expenses, etc.
Contingent Liabilities: These are the liabilities that depend on the happening of some certain event. These are not the actual liabilities but may become the liability in the future on the happening of some specific event. For example, liability in respect of bill discounted is a contingent liability. This is because, if a sole proprietor discounts a bill with the bank and on the actual date of payment, the acceptor fails to pay the amount, then, the sole proprietor will become liable to the bank. These liabilities are neither accounted for nor shown in the Balance Sheet but are shown as a footnote below the Balance Sheet.
Characteristics of a Balance Sheet
The following are the various characteristics of a Balance Sheet.
- It is a statement and not an account hence prepared at a particular date and not for a particular period.
- It follows an equation whereby, Liabilities plus Capital is always equal to the Assets. In case, it doesn’t hold true then it means that errors exist.
- It shows the financial health of the firm by recording the position of its various assets and liabilities. Hence, constitutes an important statement communicating the results of the business to various stakeholders.
- It is prepared only after the Trading, Profit & Loss Account has been prepared. They together constitute the Final Accounts of the business.
- It is the last financial statement prepared by an enterprise.
- It is prepared after preparing the Trading and Profit and Loss Account.
Need for preparing Balance Sheet
A Balance Sheet is a statement that depicts the financial position of a firm on a certain date. The various needs for preparing the Balance Sheet are as follows:
- The first and foremost need of preparing the Balance Sheet is to disclose the true financial position of a business at a particular point in time
- It helps in determining the nature and book value of various assets, such as fixed assets, investments, current assets, etc. at the end of an accounting period.
- It helps in ascertaining the nature and amount of various liabilities such as creditors, long-term liabilities, current liabilities, provisions, etc., which a business owes.
- It discloses important information about capital invested in a business by the proprietor after considering the additional capital invested, drawings made, and profit (or loss) during the accounting period.
- It helps in assessing the solvency and liquidity position of a business.
- It lays down the basis for maintaining books for the next accounting period.
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