Balance Sheet – SS1 Financial Accounting Lesson Note (Second Term)

A Balance Sheet is a statement of the financial position of a business on a certain date, showing its assets, liabilities and capital.

Behavioural objectives

1. Define a Balance Sheet and explain why it is a position statement.
2. List the headings under which assets, liabilities and capital are grouped.
3. Arrange fixed assets and current assets in the correct order.
4. Distinguish between fixed assets and current assets, and between current liabilities and long-term liabilities.
5. State the advantage of the vertical format over the horizontal format.

What is a Balance Sheet?

A Balance Sheet is a statement that lists the assets, liabilities and capital of a business at a particular date.

• Position statement: it shows where the business stands on one day, such as 31 December.
• Well arranged: items are grouped under headings so that the reader can understand them easily.
• Source of the figures: it is a list of the asset, liability and capital balances left in the ledger.

How does the Balance Sheet relate to the final accounts?

The Balance Sheet is not an account, but it is one of the final accounts of a business.

• Not double entry: unlike the Trading and Profit and Loss Account, it is not part of the double entry system.
• Balances left: after the nominal account balances are transferred to the Trading and Profit and Loss Account, only asset and liability balances remain in the ledger.
• A list of balances: the Balance Sheet lists these remaining balances.
• Final accounts: the Trading and Profit and Loss Account and the Balance Sheet together are called the final accounts.

What is the layout of the Balance Sheet?

The Balance Sheet is prepared by listing and grouping assets and liabilities under five headings.

1. Fixed Assets: long-lasting assets kept for use in the business.
2. Current Assets: assets held for a short time or easily turned into cash.
3. Current Liabilities: debts due within one year.
4. Long-term Liabilities: debts not due within one year.
5. Capital: the owner’s claim on the business.

What are the points to note?

• Position statement: a Balance Sheet shows the position of a business at a particular date.
• Not a period statement: a Trading and Profit and Loss Account covers a period, such as one year.
• Transfers at year end: the balances on the Profit and Loss Account and Drawings Account are transferred to the Capital Account by Journal entries.
• Details still shown: the Balance Sheet still shows these details, so the reader can see how the closing capital is arrived at.

In what order are fixed assets listed?

Fixed assets are listed in order of permanence, starting with the one that lasts longest.

1. Land and Buildings
2. Plant and Machinery
3. Furniture and Fittings
4. Equipment/Tools
5. Motor Vehicles

In what order are current assets listed?

Current assets are listed in the reverse order of realisability, which means the hardest to turn into cash comes first.

1. Stock
2. Debtors
3. Bank
4. Cash

• Realisability: the ease with which an asset can be converted to cash.
• Cash last: cash is already in money form, so it is listed last.

What are assets?

Assets are the resources, properties or possessions owned by the business, and what other people or firms owe the business.

• Land and Buildings: a shop or factory owned by the business.
• Motor Vehicles: a delivery van.
• Furniture, Equipment, Machinery and Tools: items used to run the business.
• Stock: goods kept for sale.
• Cash at hand and Cash at Bank: money held by the business.
• Debtors: money owed to the business by customers.

Assets are divided into two groups: fixed assets and current assets.

What are fixed assets?

Fixed assets are long-lasting assets acquired for use rather than for resale.

• Purpose: they help the business to earn revenue.
• Examples: Land and Buildings, Plant, Machinery, Motor Vehicles, Furniture, Fittings, Tools and Equipment.

What are current assets?

Current assets are assets held by the business for a short period.

• Changing form: they are converted from one form to another in the course of business.
• Cash or near cash: they are cash or can be turned into cash fairly easily.
• Examples: Stock (Inventory), Trade Debtors (or Sundry Debtors), Bank and Cash.

What are liabilities?

Liabilities are obligations arising from past transactions, showing what the business owes other people or firms.

• Outsiders’ claims: they are claims by outsiders on the assets of the business.
• Two groups: liabilities are classified as current liabilities and long-term liabilities.

What are current liabilities?

Current liabilities are short-term debts due for settlement within twelve months (one year) of the Balance Sheet date.

• Trade Creditors (or Sundry Creditors): suppliers who are owed money for goods bought on credit.
• Bank Overdraft: money owed to the bank for withdrawing more than the account holds.

What are long-term liabilities?

Long-term liabilities are debts not due for repayment within twelve months (one year) of the Balance Sheet date.

• Long-term loans: money borrowed to be repaid over several years.
• Mortgages: loans secured on land or buildings.
• Debentures: long-term loans to a company.

What is capital?

Capital is the amount the business owes its owner, being the owner’s investment plus profits kept in the business.

• Increases: it increases with the net profit and any extra money the owner puts in.
• Decreases: it decreases with drawings and any net loss.
• Closing capital: opening capital plus net profit minus drawings.

What is the accounting equation?

The accounting equation states that the assets of a business equal its capital plus its liabilities.

• Equation: Assets = Capital + Liabilities.
• Why it balances: the total of the assets side must agree with the total of the capital and liabilities side.

What are the formats of a Balance Sheet?

There are two formats of a Balance Sheet: the horizontal format and the vertical format.

• Horizontal format: assets are on one side and capital and liabilities are on the other, side by side. The Balance Sheet earlier prepared for Ade Molayo used this format.
• Vertical format: all items are listed in one column, one group below the other.

What is the advantage of the vertical format?

The main advantage of the vertical format is that it shows the net current assets, also called the working capital.

• Working capital: current assets minus current liabilities.
• Not shown in horizontal format: a horizontal Balance Sheet does not show this figure directly.

Evaluation

1. Define a Balance Sheet.
2. Explain how a Balance Sheet differs from a Trading and Profit and Loss Account.
3. List the five fixed assets given in the note in order of permanence.
4. Distinguish between current liabilities and long-term liabilities, giving examples of each.
5. State the main advantage of the vertical format of the Balance Sheet.

Assignment

Classify each of the following as a fixed asset, current asset, current liability or long-term liability: Motor Vehicles, Debtors, Mortgage, Trade Creditors, Stock, Bank Overdraft. Then explain what is meant by working capital.