A balance sheet can be defined as “a statement prepared for the purpose of measuring the exact financial condition of a company on a given date.
“It is prepared from the trial balance after all the nominal account balances are transferred to the operating and profit and loss account and the corresponding accounts are closed in the general ledger. The balances now remaining on the balance sheet Test accounts are personal or real accounts, in others that is, they represent assets or liabilities existing on the account closing date.
All these assets and liabilities are shown on the balance sheet in accordance with certain principles such as:
(a) All real and personal accounts that have debit balances must be shown on the asset side of the balance sheet on the right hand side.
(b) All real and personal accounts that have credit balances should be shown on the liability side of the balance sheet, which is on the left side. The excess of assets over liabilities represents the owner’s capital. This capital figure should match the closing balance of the capital account on the general ledger after the net profit or loss has been transferred to the general ledger.
It shows that when real and personal accounts are placed on opposite sides of the balance sheet according to the nature of the balances, the asset side must be equal to the liability side.
As stated above, personal accounts that have debit balances are called assets; in reality, in the property and possessions of the merchant, since also the debts with him (various debtors and receivables) are assets.
Real and personal accounts that have credit balances along with the owner’s equity are shown as liabilities. Therefore, liabilities are the debts that a company has with third parties and with the owner of the company.
Assets have been classified as follows:
(a) Fixed assets. Assets of a durable nature that are used in business and that are acquired and intended to be kept permanently in order to carry on the business, such as land, buildings, machinery and furniture, etc. They are also sometimes called capital assets or fixed capital expenditures or long-lived assets. Fixed assets are collectively known as “Block”.
(b) Floating or outstanding assets. Those temporarily held assets that are intended for resale or that frequently undergo changes, for example, cash, stocks, stores, debtors, and invoices receivable. Floating assets are again subdivided into two parts, liquid assets and illiquid assets. Liquid assets are those that can be easily converted into cash without appreciable losses. Cash on hand and cash in the bank are examples of such assets. Other assets that cannot be easily converted into cash, or that do not have an appreciable loss, are called illiquid assets, eg stocks, stores.
(c) Fictitious assets. Those assets that are not represented by anything concrete or tangible. Preliminary expenses, the debit balance of the profit and loss account are examples of such assets. These are also called “nominal” or “imaginary” assets.
Classification of liabilities
The liabilities of a company can be classified as follows:
(a) Fixed liabilities. Those liabilities that must be amortized after a long period of time. This includes long-term loans.
(b) Current liabilities. Those liabilities that will be repaid in the near future, usually within a year. Trade creditors, bank loans, bills payable, etc., are examples of current liabilities.
(c) Contingent liabilities. These are not actual liabilities, but whether they become actual liabilities depends on a certain event occurring. In other words, they would become liabilities in the future whenever the contemplated event occurs. If it does not occur, no liability is incurred. Since this liability is not a real liability, it is not shown on the balance sheet. It is usually mentioned in the form of a footnote.
A balance has two sides: the left side and the right side. However, these two sides are not comparable to the debit side and the credit side of a ledger account because the balance is not an account. The words ‘To’ or ‘By’ are not used on the balance sheet. The left side is the liability side and contains the credit balances of all real and personal accounts and the right side, which is the “assets” side, lists the debit balances of real and personal accounts.
Disposition of assets and liabilities on the balance sheet 0
Assets and liabilities should be arranged on the balance sheet in some specific order. The disposition of assets and liabilities on the balance sheet is called “Classification of assets and liabilities”. There are two systems for ordering assets and liabilities on the balance sheet:
(a) Liquidity Order.
(b) Order of permanence.
In order of liquidity, assets that are most easily tradable are listed first and are followed by assets that are least easy to resell. Then the most difficult assets to perform will be displayed last. In the case of liabilities, these will be shown in the order in which they are payable, placing the most urgent liability first.
Distinction between Trial Balance and Balance Sheet
1. The trial balance is the “middle” of the accounting process of which the balance sheet is the “bottom line” because a balance sheet is always prepared from the figures extracted from the trial balance.
2. The purpose of preparing a trial balance is to verify the arithmetic accuracy of the accounting books; But the balance sheet is written to reveal the financial condition of the business.
3. The two sides of the balance sheet are called ‘liability’ and ‘asset’ sides respectively, but in case of judgment balance, the columns are ‘debit’ and ‘credit’ columns.
4. To complete the accounting cycle, the balance sheet is drawn up. necessary; But trial balance preparation is not always necessary. –
5. The period after which a balance is prepared is normally one year, but the trial balance is prepared very frequently and can be monthly, quarterly, or semi-annually.
6. The trial balance contains the three types of accounts, viz. real and nominal personal, but the balance sheet contains only personal and real accounts. ~
7. Generally, the trial balance does not contain closing stocks, but the balance sheet does.
8. It is not possible to know the income and expenses increased, advanced, pending and paid in advance of the trial balance, but the balance sheet reveals these elements.
Some concerns like to clearly determine the cost of the goods manufactured by them during the year before preparing the trade account and determining the gross profit. This account is called the manufacturing account and is prepared in addition to the trade account. It has the features mentioned below:
(i) Given that the purpose of preparing this account is to know the cost of the goods produced during the year, the opening and closing stocks of the finished products are not recorded therein; will appear in the trading account.
(ii) Regarding materials, it is the amount of materials consumed that is charged to the account. This figure is obtained by adjusting the purchase of materials for the opening and closing stocks of materials, for example, initial stocks of raw materials Add: purchases of raw materials during the year Less: closing stocks of raw materials Cost of materials consumed
(iii) In the manufacturing company, there will always be some unfinished products or work in progress. The work-in-process cost at the end of the year is credited to this account, shown on the balance sheet, and charged to next year’s manufacturing account as the beginning balance.
(iv) All expenses for factory wages, energy and fuel, repairs and maintenance, factory wages, factory rent, and fees are charged to this account. The depreciation of the machinery is also debited to this account and not to the profit and loss account as is normally done.
(v) The amounts collected from the sale of waste or scrap materials are deducted from the purchases of raw materials.
(vi) Now the difference is that two sides of this account will be the cost of goods manufactured during the year. This cost will be credited to the manufacturing account and debited from the trading account.
The trading account will now include only the beginning and ending stock of finished goods, the cost of manufactured goods transferred from the manufacturing account, and sales of finished goods. The gross profit will be transferred to the profit and loss account. The profit and loss account and balance sheet will be prepared as already explained.