Chapter 2 Lesson B - Balance Sheet
Introduction of the Host
Mrs.Geetha Dasaraty is a commerce graduate with a Masters in Business
Administration specialising in finance. Her stint with a Coimbatore based company and later with a consulting firm in Chennai has provided her with a decade of experience in project finance and appraisals, accounting and tax laws.
She is a freelance writer and money matters are her forte. She is currently pursuing her final course in Company Secretaryship and is doing a course on Vaishnavism.
She has a passion for literature and Carnatic music. She is also a violinist.
About the Class
12 lessons, one a month. Each lesson is further subdivided into 4 chapters.
Chapter 2 Lesson B - Balance Sheet
In the previous chapter, we dealt with the profit and loss account. In
this chapter, we will deal with a few more aspects of the Profit and Loss
account and then move on to the Balance Sheet.We will deal with the following:
- Depreciation
- Closing Entries
- What is a Balance Sheet?
- Assets
- Liabilities
- Format of Balance Sheet
Depreciation is the decrease in the value of assets due to wear and tear or due to the passage of time. Depreciation is generally charged annually. It is taken to be a percentage of the original cost or the diminishing balance.
Depreciation account is debited to the Profit and Loss account and the asset value is reduced in the Balance Sheet.Generally, depreciation is calculated by the same method every year. In case of any change in the depreciation method, it has to be disclosed.
Losses due to accidents like fire
When stock has been destroyed in fire, the entry is:
Loss by Fire a/c Dr
To Trading a/c
The Trading a/c is credited with the value of the goods destroyed to ascertain the Gross Profit. Where other assets have been destroyed the entry will be:
Loss by Fire a/c Dr
To Asset a/c
Where there is an insurance cover and the loss is recovered, the insurance company is debited and the Loss by Fire a/c is credited.
Where the loss is partially recovered,the insurance company should be debited with what can be recovered and the balance should be debited to the Profit and Loss a/c as irrecoverable.
Where the entire loss is irrecoverable, the entire amount should be debited to the P & L a/c. Where the loss is very heavy it can be spread over four to five years.
Commission payable on Profit
Sometimes as an incentive, a commission on the net profit is paid to the person in charge. The P & L a/c should be debited with the commission and The Manager's or person in charge's personal account should be credited.
Closing Entries
Closing entries are so called, because their effect is to close the books of accounts for the relevant year.
The closing entries for the P & L a/c are:
1. Profit and Loss A/c Dr
To various expenses
(except those already debited to the trading a/c)
2. Incomes and Gains a/c Dr
To Profit & Loss a/c
3. Where there is a net profit, the entry will be:
Profit & Loss a/c Dr
To Capital a/c
4.Where there is a net loss, the entry will be:
Capital a/c Dr
To Profit & Loss a/c
Balance Sheet
The Balance Sheet is a statement, which shows us the exact financial picture of a business concern at a specific point of time. One gets a picture of what assets the firm owns and what are the firm's liabilities. It is prepared to find out the capital or the owners's equity.
The Balance Sheet is a detailed version of the basic accounting equation.
The assets are shown on the right hand side of the Balance Sheet and the liabilities are shown on the left-hand side.
Assets
Any resources, which will result in a future benefit, are known as Assets. Classification of Assets
Assets are classified as Current Assets and Fixed Assets.
Current Assets
Current Assets or Floating Assets are those assets that can be converted into cash as early as possible. Some of the Floating Assets are cash, sundry debtors, stock, etc.
These are also called Circulating Assets.
Fixed Assets
Assets that are not meant for sale but are utilised by the firm are known as Fixed Assets. The utility of the fixed assets is not confined to the accounting period alone.
Assets are used to generate future profits.
Plant and Machinery and buildings, goodwill are fixed assets.
Fixed Assets are further subdivided into tangible or intangible.
Tangible assets can be felt and are buildings, machinery, etc.
Intangible assets cannot be seen, like goodwill.
Fictitious Assets
Assets that are of no value are called 'Fictitious Assets'.
Examples of Fictitious Assets are preliminary expenses.
Long Term Investments
Funds that are idle in a business are invested in marketable debt securities and marketable equities.
Where these securities are for a short period they will appear as Current Assets and where the investments are for a longer period they will appear as fixed assets.
Liabilities
Liabilities are economic obligations of a firm measured according to accounting principles.
Classification of liabilities
Liabilities are classified as short-term liabilities or current liabilities and long term liabilities or non-current liabilities.
Current Liability
These liabilities are paid off within a year and are paid out of current assets or by creating current liabilities. These are paid off on demand.
Trade liabilities, bills payable and other loans are some of the current liabilities.
Long Term Liabilities
All liabilities that are not due for payment within a year are long term liabilities. These do not require Current Assets for paying them off. Public deposits, and other loans from institutions and banks are long term liabilities.
Contingent Liabilities
These liabilities come into existence on the happening of an uncertain event.
These liabilities are shown at the foot of the Balance Sheet and the amounts are not included in the total of the Balance Sheet.
Claims against the firm not acknowledged as debts, arrears of fixed cumulative dividends are a few contingent liabilities.
Functions of a Balance sheet
It gives the financial position of an undertaking on a specified date.
It provides information to the creditors in relation to their debts and the repayment capacity.
It enables investors to get an idea of the profit generation capacity of the enterprise.
It gives an idea of the fund raising capacity of the firm in times of need.
Format of a Balance Sheet
There are two ways of presenting a balance sheet
Horizontal presentation
Under this presentation the balance sheet is divided into two sides, the left-hand side and the right hand side.
The assets are shown on the right hand side and the liabilities are shown on the left-hand side.
Vertical Presentation
Here the Balance Sheet is given in a statement form and is easy to understand by the common man. Today, most establishments use the vertical form of presentation.
The vertical form of presentation is as follows
Z
Company Ltd.
Balance
Sheet as on December31, 2000
Rs.
Fixed Assets:
Land
Building
Machinery
Furniture
Current Assets:
Stock in trade
Sundry debtors
Bills Receivable
Cash at bank
Cash in hand
Less: Current Liabilities:
Sundry Creditors
Bills Payable
Outstanding Expenses
Represented by shareholders funds:
Share Capital
Reserve
Long term liabilities
Total
Questions - Chapter 2 Lesson A
1. State which of the following should be charged to capital and which
to revenue?
a) Rs.1000 paid for erection of new machinery.
b) Rs.50,000 paid on repairs to the new factory.
2. Ascertain the gross profit from the following:
Sales - Rs. 1,50,000
Cost of goods sold - 1,10,000