Unit II Balance Sheet Overview

Back grou nd

As a means of telling interested people about business operations, accounting performs important tasks of recording daily transactions, classifying recorded data, summarizing recorded and classified data and interpreting the summarized facts. In all business enterprises, accounting information is summarized in at least two basic financial reports. One of these financial reports shows what the business is worth in terms of the properties it owns (i.e., the assets), the debts it owes (i.e., the liabilities), and the investment of its owner/s (i.e., the proprietorship). This report is called the balance sheet and this statement informs the users of the financial condition of the business at a given date, usually at the end of an accounting period.

Purp ose

The purpose of Unit II The Balance Sheet - Assets, Liabilities and Owners Equity (Service Business) is to illustrate different forms of balance sheet and how to prepare them. Students will also be introduced in analyzing business transactions using the accounting equation.

In this unit

This unit contains the following topics:

Topics Forms of Balance Sheet Parts of the Balance Sheet Accounting Equation Current Assets Plant, Property and Equipment Current Liabilities Long-Term Liabilities Owners Equity Debit and Credit of Balance Sheet Items Review Questions

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Forms of Balance Sheet

Over view

As provided in the revised SFAS No. 1 based on the International Accounting Standards (IAS), the balance sheet should be prepared following the new accounting concept of materiality and aggregation, i.e., a separate schedule would be attached to the report to explain the amounts with corresponding "notes". It is also required that a separate statement of changes in equity be prepared, and therefore, the owner's equity section of the balance sheet would show only the ending balance of the capital account as shown in the given illustration. The following discussions will provide readers information on how the account and report format of balance sheets may be prepared.

Acco unt For m

In the account form of balance sheet, the assets are listed on the left side of the report and the liabilities and proprietorship on the right side. The example below illustrate the account form:
JOSEPH LABRADOR, COMPANY Balance Sheet December 31, 20XI ASSETS Current Assets Cash & cash equivalents (7) P Marketable Securities Trade & Trade Receivables (8) Prepaid Expenses (9) Total Current Assets Non Current Assets Property, Plant & Equip (10) 20,000 10,000 30,000 29,000 P 89,000 791,000 LIABILITIES AND OWNER'S EQUITY Current Liabilities Trade & Other Payables (11) P 55,000 Current Portion of mortgage Payable 20,000 Total Current Liabilities P 75,000

TOTAL ASSETS

Non Current Liabilities Notes Payable (due in 3 years) P 70,000 Mortgage payable 180,000 Total non current liabilities 250,000 Total liabilities P 325,000 Owner's Equity Labrador, Capital 555,000 TOTAL LIABILITIES P880,000 AND OWNER'S EQUITY P 880,000 ======= ======= Continued on next page

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Forms of Balance Sheet, Continued

Repo rt For m

A balance sheet prepared in report form shows the assets on the top section of the statement and the liabilities and owners equity on the bottom section. The example below illustrate the report form:
JOSEPH LABRADOR, COMPANY Balance Sheet December 31, 20X1 Current Assets Cash & cash equivalents Marketable Securities Trade & Other Receivables Prepaid Expenses Total Current Assets Non Current Assets Property, plant & equipment TOTAL ASSETS LIABILITIES AND OWNER'S EQUITY Current Liabilities Trade & other payables (11) P 55,000 Current portion of mortgage payable 20,000 Total Current Liabilities Non Current Liabilities Notes Payable (due in 3 years) Mortgage Payable Total No Current Liabilities Total Liabilities Owners Equity Joseph, Capital TOTAL LIABILITIES AND OWNER'S EQUITY P 70,000 180,000 250,000 P 325,000 555,000 P 880,000 ======= ASSETS Notes (7) (8) (9)

P 20,000 10,000 30,000 29,000 P 89,000

(10)

791,000 P 880,000 =======

P 75,000

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Forms of Balance Sheet, Continued

Note s

Note 7 - Cash & cash equivalents Cash on Hand Cash in Band Total cash and cash equivalents

P 5,000 15,000 P 20,000 ======

Note 8 Trade & other receivables Accounts Receivable P 20,000 Less: Allowance for Doubtful Accounts 1,200 P 18,800 Notes Receivable 7,500 Interest Receivable 700 Advances to Employees 3,000 Total trade & other receivables P 30,000 ===== Note 9 Prepaid expenses Office Supplies on Hand P 6,000 Prepaid Insurance 20,000 Prepaid Advertising 3,000 Total Prepaid expenses P 29,000 ===== Note 10 Property, plant & equipment Land 300,000 Building 450,000 Less: Accumulated Depreciation 70,000 380,000 Office Equipment 110,000 Less: Accumulated Depreciation 20,000 90,000 Furniture & Fixtures 25,000 Less: Accumulated Depreciation 4,000 21,000 Total Carrying amount 791,000 ===== Note 11 Trade & other payables Accounts Payable 20,000 Notes Payable 18,000 Interest Payable 2,000 Accrued Salaries Expense 5,000 Unearned Rent Income 10,000 Total trade & other payables 55,000 =====

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Parts of the Balance Sheet

Over view

This portion will enumerate the different parts of a balance sheet and their corresponding placement in the financial report being prepared.

State Includes the name of the business, tells the kind of statement it is, and gives the ment date for which the report is prepared Head ing

Asset Items are grouped and each group of items is identified by special captions. , Liabi lity, Prop rieto rship

Capt ions

Classification of each group of items appear against the left margin of the statement.

Acco unt titles

Individual account titles in each classification are indented.

Curr ent Asset s

The individual current assets are usually listed in order of their liquidity, with the most liquid asset, Cash appearing first.

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Plant , Prop erty, Equi pme nt

The plant assets are often listed in order of their expected useful life with the assets with the longest expected useful life, Land appearing first.

Note (#)

The separate schedule attached to the report explaining in detail the aggregated amount presented on the face of the financial statement.
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Parts of the Balance Sheet, Continued

Curr The current liabilities are in theory listed in order of due date, with the debt ent with the earliest due date appearing first. Liabi lities

Capt Each group of items (i.e., total current assets, total plant, property and ions equipment, total current liabilities, etc.) is indented further. Indic ating Total s

Singl e Rule Line

The last figure in each group of items is underlined.

Final The two final totals (i.e., total assets and total liabilities and owners equity) Total appear as the last line in their respective sections and are underlined twice s (double ruled) to indicate a final total.

Peso Sign

Peso signs are used (a) to the left of the first amount of a group of amounts being combined and (b) to the left of each final total.

Peso Amo unt

The peso amount for the detailed items is shown in one column; the total of each classification is extended into the last column on the right-hand side of the statement.

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Accounting Equation
Over view

One important feature of the balance sheet relates to a very simple fact. The balance sheet of any business must show total assets exactly equal in amount to the sum of the liabilities and the capital. This relationship exists regardless of the size of the enterprise or the variety of its assets, liabilities and ownership interest. This identity is called the basic accounting equation. Often it is stated as: ASSETS = LIABILITIES + OWNERS EQUITY Which means, assets equal liabilities plus proprietorship. Other times the equation appears as: ASSET - L IABILITIES = OWNERS EQUITY or ASSET - OWNERS EQUITY = L IABILITIES

Asset s

This includes anything owned or possessed by the business which is capable of being expressed in terms of money or possessing monetary values, and which, consequently, is available for the payment of the debt of the business. In short, assets represent the resources of the business.

Liabi Economic obligations (i.e., debts) payable to an individual or an organization lities outside the business.

Own ers Equi ty

The claim of an owner of a business over the assets of the business after the claims of the creditors have been satisfied.

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Current Assets
Over view

This includes cash and any other assets that are reasonably expected to be converted into cash or consumed during one year or one operating cycle, i.e., whichever is longer.

Cash

Currency, coins and checks that the business has received from customers and other sources that have not yet been deposited in its bank account, as well as the amount the business has on deposit in its bank account, against which checks may be drawn in payment of bills.

Mar keta ble Secu rities

Short-term investment in stocks of other business.

Note s Rece ivabl e

The amount due in the near future from persons or companies on the basis of their formal, written promises to pay cash to the business on the date specified in the promissory note.

Inter est Rece ivabl e

The amount of interest due as of the balance sheet date on notes received from customers.

Acco

The total amount owed to the business by charge account customers.

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unts Rece ivabl e

Adva Cash advance given to an employee to be liquidated in the form of service. nces to empl oyees
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Current Assets, Continued

Merc hand ise inve ntor y

The purchase price of the particular line of goods the business expects to sell to its customers for cash or on a charge account basis. This represents goods on hand as of the balance sheet date.

Accr ued Inco me

Income already earned but not yet collected, such as interest earned on promissory note issued by the customer before the maturity date of the note.

Supp lies on hand

The cost value of such things as wrapping paper and packaging tape and twine, (Store Supplies on Hand), computer ribbons, envelopes, stamps, paper (Office Supplies on Hand) , and other assets of a similar nature that the business will use up in performing its activities.

Prep aid insur ance

That part of the premium cost of all kinds of insurance carried by the business after the balance sheet date. Prepaid insurance is always classified as a current assets even if the amount of the unexpired premiums cover a period longer than one year, the time limit used in defining current assets.

Prep aid rent

Rent paid by the business for facilities to be used after the balance sheet date. For example, on December 1, 20X1, a business paid P30,000 for December, January, and February rent. On a balance sheet dated December 31, 20X1, the amount of Prepaid Rent would be shown as P20,000 the amount paid for the use of the facilities for January and February, 20X2.

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Plant, Property and Equipment

Over view

Assets are classified as plant, property and equipment if they meet the following criteria: (1) they must have physical existence; (2) they must be more or less permanent in nature; (3) they must not be for sale; (4) they must be used in business operations; and (5) they must undergo depreciation (except land). (Pefianco, E., Mercado,R., 1983)

Land The cost of land the business uses to carry on its activities - the lot on which its

factory or office building stands.

Buil ding

The original cost less accumulated depreciation is shown to give the depreciated value of the structures in which the business carries on its operation. This item could be separated into such things as Factory Building, Office Building, Warehouse, and any other type of building the business wishes to show on its statement of financial position.

Equi pme nt

The original cost less accumulated depreciation is shown to give the depreciated value of the equipment used in the operations of the business. The title equipment may also be separated into whatever special assets of this type the business cares to identify. The business may use such titles as Office Equipment for the value of the adding machines, calculators, and typwritters the office employees use, and Delivery Equipment, for the value of the trucks and automobiles the business uses to deliver its merchadise to customers. A manufacturing enterprise would probably show the value of the machines in its factory as Factory Machinery and Equipment.
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Plant, Property and Equipment, Continued

Furn iture and Fixtu res

The original cost less accumulated depreciation is shown to give the depreciated value of furniture and fixtures used in the operation of the business. The title Furniture and fixtures almost explains itself and may also be subdivided. Desks and chairs and counters used by office employees might be listed as Office Furniture and Fixtures. Display cases, chairs used by customers, and merchandise counters in a department store could be entitled Store Furniture and Fixtures.

Accu mula ted Depr eciati on

All property and equipment accounts except land are subject to depreciation. Depreciation is the allocation of the cost of a property account to its period of usefulness in order to recognize a decline in its value because of wear and tear, obsolescence or inadequacy. The total amount of depreciation accumulated over a number of years is called accumulated depreciation.

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Current Liabilities
Over view

Current liabilities are debts or obligations of a business that are expected to be liquidated by the use of assets classified as current or by the creation of another current liability.

Acco unts paya ble

The total amount owed by the business as of balance sheet date for purchases of merchandise, supplies, and services made on a charge account basis and due within one year from the balance sheet date.

Note s Paya ble

The amounts owed by the business on the basis of formal, signed notes such as the thirty-day or six-month notes signed when borrowing from a bank. If merchandise is bought and the creditor requires the business to sign a note for the amount of the purchase, the title Notes Payable is used. If the same business borrowed from a bank, the liability may be shown also as Notes Payable. This is classified as current liability if the note is due within one year.

Inter est Paya ble

The amount of interest owed by the business as of balance sheet date for money borrowed on interest bearing promissory notes issued by the firm. This interest debt builds up each day. The loan is outstanding-the interest accrues-and it is shown as a separate liability apart from the face value of the note, which appears in the Notes Payable account.

Defe rred Inco me

Income already collected but not yet earned. Rental payment received by the lessor from the lessee may be treated as unearned rent income by the former.

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Taxe s Paya ble

The amount of taxes owed by the business as of balance sheet date.

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Long-Term Liabilities
Over view

Long-term liabilities are debts or obligations that will become due and payable after one year from balance sheet date.

Note s Paya ble Long Ter m

Amounts on signed formal notes due after one-year from the date of the balance sheet.

Insta llme nt Cont racts Paya ble

Amounts payable after one year from the balance sheet date on long-term installment notes, such as those signed by the consumers when buying automobiles and household appliances. Installments due within one year from the balance sheet date are listed as current liabilities.

Mort gage Paya ble

A debt due after one year from the balance sheet date that has some of the business property, such as land, buildings, or equipment-pledged as security.

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Owners Equity
Over view

Owners equity or sometimes called capital or proprietorship is the excess of assets over liabilities of a business.

Capi tal

The amount invested in the business by the owner as of the balance sheet date.

With draw al

When the owner withdraws cash or other assets from the business for personal use, its assets and its owners equity both decrease. The amounts taken out of the business appear in a separate account entitled Withdrawals, or Drawing. If withdrawals were recorded directly in the capital account, the amount of owner withdrawals would be merged with owner investments. To separate these two amounts for decision-making, businesses used a separate account for Withdrawals. This account shows a decrease in owners equity.

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Debit and Credit of Balance Sheet Items

Over view

Analyzing business transactions would involve a dual effect in any of the elements of the accounting equation. These dual effects would be analyzed and recorded in terms of debit and credit. This part of the study guide will introduce the readers on the basic understanding of the rules of debit and credit affecting balance sheet items.

Acco unt

The basic summary device of accounting is the account. This is a detailed record of the changes that have occurred in a particular asset, liability or owners equity during a period of time.

TAcco unt

For the purpose of analyzing the balance items into debit and credit, we will be using in our illustrations the T-account. It takes the form of the capital letter T. The vertical line in the letter divides the account into its left and right sides. The account title rests on the horizontal line. For example, the cash account of a business appears in the following Taccount format: CASH

Left side Debit

Right side Credit The left side of the account is called the debit side, and the right side is called the credit side. Often beginners in the study of accounting are confused by the words debit and credit. To become comfortable using them, simply remember debit = left side credit = right side The type of an account determines how increases and decreases in it are recorded. Increases in assets are recorded in the left (the debit) side of the account. Decreases in the assets are recorded in the right (the credit) side of the account. Conversely, increases in liabilities and owners equity are recorded by credits. Decreases are recorded by debits.

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Continued on next page

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Debit and Credit of Balance Sheet Items, Continued

Acco This pattern of recording debits and credits is based on the accounting untin equations: g Equa tion ASSETS = LIABILITIES + OWNERS EQUITY Rules of Debit Credit Debit Credit Debit Credit Debit and for for for for for for Credit Increase Decrease Decrease Increase Decrease Increase

Illust ratio n

The following examples illustrate the accounting equations: Joseph Labrador invested P100,000 cash to begin his accounting business. ASSETS = Cash LIABILITIES + OWNERS EQUITY Labrador, Capital Credit for increase Php 100,000 The business purchased office supplies on account for P5,000. ASSETS = LIABILITIES + OWNERS EQUITY Accounts Payable Credit for increase Php 5,000
Continued on next page

Debit for increase Php 100,000

Office Supplies Debit for increase Php 5,000

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Debit and Credit of Balance Sheet Items, Continued

Illust ratio n, cont .

The following examples illustrate the continuation of the accounting equations:

The business paid one year rental for its office space, P24,000. ASSETS Debit for increase Php 24,000 = LIABILITIES + OWNERS EQUITY Cash Credit for increase Php 24,000 The business paid of the amount owed in buying office supplies. ASSETS Debit for increase Php 2,500 = LIABILITIES + OWNERS EQUITY Cash Credit for increase Php 2,500

Prepaid Rent

Accounts Payable

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Review Questions
Over view

The following questions will encourage the students to review the different topics included in this unit.

Ques tions

The following are the review questions:

1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Define a balance sheet. What is the date line used in the balance sheet? Enumerate and describe briefly the two forms of balance sheet. What determines the classification of a current asset as against a noncurrent asset? What are the criteria in classifying an asset as part of plant, property and equipment? Name at least five accounts that must appropriately be classified under current assets. What is the basic accounting equation? Enumerate and describe the three elements in the accounting equation. Cite transactions that will decrease an asset and increase another asset. How does the use of cash in paying an existing liability affect the accounting equation?

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