The Balance Sheet

Overview

Following a simple introduction to the Financial Statements, this chapter aims to give an in-
depth presentation of one of the most important FS – the Balance Sheet.

Learning Objectives

At the end of this module, the learner shall be able to:

1. Define what the Balance Sheet is;

2. Identify the purpose of the Balance Sheet;

3. Enumerate the different major elements of the Balance Sheet;

4. Explain each account name reported under the Balance Sheet;

5. Differentiate account form and report form presentations of a Balance Sheet;

6. Identify the accounts normal balances, and

7. Prepare a Balance Sheet from the given account tiles.

Discussion

The Balance Sheet is what is also known as the Statement of Financial Position for it presents a
snap shot of what the company owns and owes and its net worth as of a given time.

PURPOSE OF THE BALANCE SHEET

Talking about the purpose of this FS in focus, let us check on the first elements in the statement.
The heading of the statement comprises of three lines, the first line being the name of the
business entity for the identification of the reporting company while the second line indicates
what the particular statement is it. The third line is the date of the statement. Here, one can
find the difference of this statement to any other FS. It states “as of DATE” or “as of the year
ended, DATE” or simply the date as opposing to other statements which indicate a period of
accounting rendered as “for the period ended, DATE.” Here, we can deduce that the Statement
of Financial Position or the Balance Sheet presents the actual account balances on the specific
time as indicated.

The Balance Sheet is the hub of all other statements because it requires amount as reported by
the other FS. The cash ending balance or the cash net flow indicated in the Statement of Cash
Flows is the amount reported in the cash account balance in the SFP. The Equity account
reported in the SFP is the ending balance of the equity account as presented in the Statement of
Changes in Equity. The Net Income/Loss as reported in the Income Statement is closed to the
Equity account, thus it affects the equity balance whose net amount is reported in the Balance
Sheet.

ELEMENTS OF THE BALANCE SHEET

As presented in the previous discussions, the Balance Sheet follows the accounting equation
format, thus its main elements consist of ASSETS, LIABILITIES and EQUITY. As an equation, it
is presented so as to be understood that the company’s assets are attributed to two claims: claim
of the creditors, liabilities and claim of the owners, equity. Under these main elements are the
different account titles whose values are added to come up with a balanced equation.

ASSETS

Assets are the resources owned and managed by the company and regarded as possessing
value to meet payables or to retain as legacies. Assets are reported in the Balance Sheet and
increase the company’s value or empower its operations. There are many types of assets but
this module will only focus on the following:

Cash

This is the most well-known asset, which sometimes is mistaken to be the measure of the
company’s worth. However, it is just the money owned by the company, that which is readily
available to sustain company’s operation. Cash is brought into the company’s operation by
means of investment from the owners and investors, from the proceeds of cash loans from
creditors, or from revenues from services rendered or goods sold. On the other hand, it is used
to buy assets and to pay for the operating expenses.

Cash can further be classified as Cash on Hand or Cash in Bank. Cash on hand refers to the
money kept and maintained in the company’s owned properties. Cash in Bank refers to the
money deposited to the bank under the company’s name be it a savings or a checking/current
account.

Time deposits are money owned by the company but do not form part of the company’s cash
balance. They are instead considered as investments if their maturity date is longer than 90
days. Restricted deposits within the 90-day period is reported under Cash and Cash
Equivalents. In this case, the account name used in the Balance Sheet reporting is Cash and
Cash Equivalents. However, the breakdown of which is required to be presented in the Notes
to the Financial Statement section or on a particular Schedule accompanying Cash Account.

Receivables

This asset classification represents the company’s claim from those who owe payments to the
company for its rendered services or delivered goods. Accounts Receivables represent the
receivables from customers with a standing credit agreement with the company. Notes
Receivables show the amount due from customers as evidenced by a Promissory Note, a legal
document stating that the borrower promises to pay a certain amount and its interest in the date
specified.

Inventory

Merchandising and Manufacturing companies maintain assets called inventory. This represents
the cost of the unsold merchandise. In case of the Merchandising Business, this account holds
the goods ready for sale. Manufacturing business holds several inventory accounts for they are
accounting for the raw materials and the finished products alike.

Supplies

It is a common mistake to include in the Inventory account those materials used in the day-to-
day operations of the business. Strictly, the Inventory account is only for the goods for sale.
Materials used in the operation are classified under the supplies account. Supplies can further
be classified according to their use, thus there are office supplies, factory supplies, maintenance
supplies, and others.

Prepaid Expenses

In Fundamentals of Accounting, Business and Management 1, the concept of Accrual basis

accounting was discussed. Also following the Matching Principle, the expenses should be
recorded on the accounting period when they were used regardless of when they were paid.
Thus, expenses paid in advance are recorded as Prepaid Expenses, e.g. Prepaid Rent, Prepaid
Insurance.

Property, Plant and Equipment

These are long-term assets that are used in the business operations. Considered as non-current
assets, Property, Plant and Equipment are assets owned by the company and are projected to be
used in the business for more than one year of operations. Examples of assets classified under
this title are the Land, Land Improvements, Building, Building Improvements, Vehicles,
Machineries, Office or Factory Equipment and others.

Property, Plant and Equipment are depreciated. This means that the cost of the equipment
(though reported using the historical cost), is allocated over the useful life span of the asset. It is
rendered using the Accumulated Depreciation Account, which appears just below the asset
account title. Accumulated Depreciation is a contra-asset account, thus has a normal credit
balance.

LIABILITIES

The first claimants of the company’s assets are the creditors, the organization to whom the
company owes an amount that it is obligated to pay in cash, goods or services. There are
several types of liabilities, some of which are presented as follows:
Payables

Payables show the amount of obligation that the company is bound to pay its creditors.
Basically, there are two kinds of payables – the Accounts Payable and the Note Payable.
Accounts payable represents the obligations due to the suppliers of goods or services that the
company used in the business operation. Notes Payable is an obligation evidenced by the
company’s promissory note indicating the amount of the principal and the interest due on the
date as specified.

Accrued Expenses

The opposite of Prepaid Expenses are Accrued Expenses. These are the payables at the end of
the accounting period which remain unpaid because of one reason or another. Examples of the
commonly reported accrued expenses include: Salary Payable, Utilities Payable, Rent Payable,
Subscriptions Payable, Insurance Payable.

Unearned Income

The Accounting principle of Revenue Recognition states that the revenue is recognized only
when services are rendered or goods are delivered regardless on when the payment is made.
There are actual customers who pay for the services and goods in advance. This gives rise to
the Unearned Income account which is a repository of payments from customers made before
the services are rendered or goods are delivered. So instead of recording these advanced
payments as Income, they are logically recorded as the company’s liability.

Long-Term Liability

The amount reported in this section represents the company’s obligations whose maturity dates
are beyond the one-year period and normally comes with an interest. One common example is
Bank Loan, which are the proceeds of the company’s financing activities.

EQUITY

Equity represents the owner’s claim over the assets of the business, thus it is also referred to as
the net worth of the business after paying for the obligations to the creditors.

PRESENTATION FORMAT OF THE BALANCE SHEET

There are two formats of presenting the Balance Sheet - the account form and the report form.
The account form presents the statement following the T-account format where it is presented
with two sides - the asset side on the left and the liabilities and equity side on the right. This
manner of presentation corresponds with the normal balances of these accounts, the assets with
normal debit balances and the liabilities and owner’s equity with normal credit balances. It
follows that they should present total balances that are equal on both sides.
The following table shows the sample Balance Sheet in account form.

NAME OF COMPANY
Statement of Financial Position
Month XX, XXXX

ASSETS LIABILITIES AND EQUITY

Cash PhP XXX Accounts Payable PhP XXX
Accounts Receivables XXX Notes Payable XXX
Notes Receivables XXX Accrued Expenses XXX
Inventory XXX Unearned Income XXX
Supplies XXX Long-term Payables XXX
Prepaid Expenses XXX
Property, Plant and Equipment XXX Owner, Capital XXX

TOTAL ASSETS PhP XXX TOTAL LIABILITIES AND EQUITY PhP XXX
Figure 1
Proforma Balance Sheet – Account Form
The report form of the Balance Sheet lists down all the assets followed by the liabilities and
owner’s equity. Following is the sample Balance Sheet in the report form:

NAME OF COMPANY
Statement of Financial Position
Month XX, XXXX

ASSETS
Cash PhP XXX
Accounts Receivables XXX
Notes Receivables XXX
Inventory XXX
Supplies XXX
Prepaid Expenses XXX
Property, Plant and Equipment XXX

TOTAL ASSETS PhP XXX

LIABILITIES AND EQUITY

Accounts Payable PhP XXX
Notes Payable XXX
Accrued Expenses XXX
Unearned Income XXX
Long-term Payables XXX

Owner, Capital XXX

TOTAL LIABILITIES AND EQUITY PhP XXX

Figure 2
Proforma Balance Sheet – Report Form

NORMAL BALANCES

Recall the Debit – Credit scheme in journalizing and in posting to the ledger. Debit represents
entry to the left side and Credit as the entry to the right. In presenting the Balance Sheet in the
account form, assets are listed on the left and liabilities and equity on the right. One can take it
as the cue to understand the account normal balances. Assets are accounts with normal debit
balances and liabilities and owner’s equity are accounts with normal credit balance.
Why is it important to know the accounts normal balances? To increase and account is to add
to its normal balance side while to decrease the account means a record to the opposite side.
For example, assets have normal debit balances. Thus, to increase the assets, one debits them
and to decrease, one credits the account. Remember, debit does not mean to add and credit to
deduct. It will only be true for the asset accounts. In case of liabilities and equity accounts,
crediting them will increase their balance while debiting them would be deductions to them.

References:

Books
Horngren, Charles T., Harrison, Walter T., Oliver, Suzanne. Accounting. Jurong,
Singapore: Pearson Education South Asia Pte. Ltd., 2009.

Calix, Conrado T., Peralta, Jose F., Valix, Christian Aris M. Financial Accounting, Includes
SMEs 2016 Edition, Volumes 1, 2 and 3. Manila: GIC Enterprises & Co., Inc., 2016.

Hussey, Roger, ed. Oxford Dictionary of Accounting. Manila: GIC Enterprises & Co., Inc.,
2016.

Web References
“Balance Sheet.” Introduction to Accounting,
https://corporatefinanceinstitute.com/resources/knowledge/accounting/balance-sheet/
(accessed September 24, 2020)