Lesson-9 Balance Sheet Learning Objectives • • • • To understand the meaning of balance sheet To know the method of preparing a balance

sheet To know the difference between profit and loss account and balance sheet To know the relationship between profit and loss account and balance sheet

Balance Sheet The American Institute of Certified Public Accountants defines balance sheet as “a tabular statement of summary of balances (debits and credits) carried forward after an actual and constructive closing of books of account and kept according to the principles of accounting.” The purpose of balance sheet is to show the resources that the company has, i.e. its assets, and from where those resources come from, i.e. its liabilities and investments by owners and outsiders. The balance sheet is one of the important statements depicting the financial strength of the company. On one hand, it shows the properties which were utilized and on the other, the sources of those properties. The balance sheet shows all the assets owned by the company and all the liabilities and claims it owes to owners and outsiders. The balance sheet is prepared on a particular date. The right hand side shows properties and assets. Usually, there is no particular sequence for showing various assets and liabilities. The Companies Act, 1956 has prescribed a particular form for showing assets and liabilities in the balance sheet for companies registered under this act. These companies are also required to give figures for the previous year along with the current year’s figures. Form and Contents of Balance Sheet There is no specific way to prepare balance sheet in the case of proprietary concerns and partnership firms. The balance sheet is generally divided into parts, i.e. assets, liabilities and capital. It is usually prepared in the horizontal form. The assets are shown on the right hand side and capital and liabilities on the left hand side. The order of assets and liabilities is either on liquidity basis or on permanency basis. When balance sheet is prepared on liquidity basis, large liquid assets like cash in hand, cast at bank, investments etc. are shown first and small liquid assets later. On liabilities side, the liabilities to be paid in the short period are shown first, long-term liabilities next and capital in the last. The liquidity form is suitable for banking and other financial companies. When balance sheet prepared on permanency basis, on assets side, fixed assets are shown first and liquid assets later. On liabilities side, the capital is shown first, long-term liabilities next, and short-term and current liabilities in the last. The Companies Act has adopted permanency form for preparing balance sheet. The act has prescribed a form for the preparation of balance sheet. This form is set out in Part I of Schedule VI or as near thereto as circumstances admit. Section 211 (i) states that

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every balance sheet of a company shall give a true and fair view of the state of affairs of the company as at the end of the financial year and shall, subject to the provisions of the sections, be in the form set out in Part I of Schedule VI, or as near thereto as circumstances admit or in such other form as may be approved by the Central Government either generally or in particular case; and in preparing the balance sheet due regard shall be had, as far as may be to be general instructions for preparation of balance sheet under the heading “Notes” at the end of that part. Schedules The details of various items are shown separately in schedules. It incorporates all the information required under Part I A of Schedule VI. The schedules, accounting policies and other explanatory notes will form part of the balance sheet. A number of schedules are prepared to supplement the information supplied in the balance sheet. The schedules of investments, fixed assets, debtors etc. are prepared to give details about these transactions. A banking company may prepare a detailed schedule of advances so as to supplement the balance sheet information. All these schedules are used as part of financial statements. Explanation of Balance Sheet Items 1. Share Capital Share capital is the first item on the liabilities side of a balance sheet. Authorized and issued capital is shown giving the number of shares and their amount. The number of shares for which public has applied (subscribed capital) are mentioned along with the type of capital, i.e. preference share capital and equity share capital. If the capital is issued for other than cash, the amount of such capital is mentioned. The fact of issue of bonus share is also mentioned. Any unpaid calls are deducted from the called up capital. If forfeited shares are reissued, this amount is added to the paid-up capital. 2. Reserves and Surplus Under this heading, all those reserves which have been created out of undistributed profits are shown. Reserves are classified as capital reserves and revenue reserves. Capital reserves are the reserves which are not free for distribution as profits whereas revenue reserves are created out of appropriations of profits. Following items are included here: • • • • • • • Capital reserves Capital redemption reserve Share premium account Other reserves Surplus, i.e. profit and loss account Proposed additions to reserves Sinking fund

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The additions and deductions since last balance sheet will be shown under each head. The word “fund” in relation to any reserve should be used only where such reserve is specifically represented by earmarked investments. 3. Secured Loans All those loans against which securities are given are shown under this category. Debentures are shown under this heading. Loans and advances from bank, subsidiary companies etc. should be shown separately and the nature of securities should also be mentioned. 4. Unsecured Loans These are the loans and advances against which the company has not given any security. The items included here are deposits, loans and advances from subsidiary companies and loans and advances from other sources. Short-term loans from banks and other sources are also shown in this category. Short-term loans include those which are due for not more than one year on the balance sheet. Loans from directors, managers etc. should be shown separately under different sub-headings. This is done to show regard to them. 5. Current Liabilities and Provisions These are divided into current liabilities and provisions. In this category, following items are included: (a) Current liabilities include the following: • • • • • • • Acceptances Sundry creditors Subsidiary companies Advance payments and unexpired discounts Unclaimed dividends Other liabilities, if any Interest accrued but not paid on loans

(b) Following items are included under provisions: • • • • • • Provision for taxation Proposed dividends Provision for contingencies Provision for provident fund scheme Provision for insurance, pension and similar staff benefits schemes Other provisions

Assets Side The assets are given under the following heads: 1. Fixed Assets

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Fixed assets are those which are purchased for use over a long period. These assets are meant to increase production capacity of the business. They are not acquired for sale but are used for a considerable period of time. The balance sheet is prepared to show the financial position of the concern. These assets should be shown in such a way that balance sheet depicts true financial position of the business. Fixed assets are shown distinctly from each other, e.g., goodwill, land building, leaseholds, plant and machinery, furniture, railways sidings, patents, live stock, vehicles etc. These assets are shown at their original cost. Any additions and deductions during the year are shown separately. The amount of depreciation upto the previous year and during the current year is separately deducted from the assets. 2. Investments Investments are shown by giving their nature and mode of valuation. Investments under various sub-heads such as investments in government or trust securities, in shares, debentures and bonds, and in immovable properties are given separately in the inner column of the balance sheet. 3. Current Assets According to Alexander Wall, “Current assets are such assets as in the ordinary and natural course of business move onward through the various processes of production, distribution and payment of goods, until they become cash or its equivalent by which debts may be readily and immediately paid.” Current assets are either cash in hand and at bank or shortly convertible into cash. The assets like debtors and bills receivables are one step away from cash. The stocks-in-trade is considered to be two steps away from sales, which when made the collections will be undertaken. The commonly used method of valuation, i.e. cost price, is not strictly used while valuing stock. The stock is used either at cost or market price, whichever is low. This is done to avoid anticipating profits during inflationary conditions and taking into account losses if there is a fall in prices of stock. The debtors are shown after making a provision for bad and doubtful debts. The debtors, if more than six months old, are given separately. The amounts owned by directors etc., if included in debtors, are also separately mentioned. 4. Miscellaneous Expenditure Deferred expenditure is shown under this heading. Miscellaneous expenditure are the expenses which are not debited fully to the profit and loss account of the year in which they have been incurred. These expenses are spread over a number of years and unwritten balance is shown in the balance sheet. The items under this heading are preliminary expenses, discount allowed on issue of shares or debentures, interest paid out of capital during construction etc. Balance Sheet of ….(name of the company) as on ….(date on which balance sheet is prepared)

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Liabilities Share Capital Authorized-Shares of Rs.…each Issued-Preference shares of Rs…each Equity shares of Rs…each Less calls unpaid Reserves and Surplus Capital Reserve Capital Redemption Reserve Share Premium Other reserves Profit and Loss Account Secured Loans Debentures Loan and advances from banks Loans and advances from subsidiary Other loans and advances Unsecured loans Fixed deposits Short term loans and advances Other loans and advances Current Liabilities and Provisions

Rs.

Assets Fixed Assets Goodwill Land Building Households Railway Sidings Plant and Machinery Furniture Patents and Trade Marks Livestock Vehicles Investments Government or trust Securities Shares, Debentures, Bonds A. Current Assets Loans and Advances Interest accrued Stores and Spare parts Loose tools Stock in Trade Work in progress Sundry debtors Cash and Bank Balances B. Loans and Advances Advances and loans to subsidiary Bills receivables Advance Payments Miscellaneous Expenditure Preliminary Expenses Discount on issue of Shares and Debentures Other Deferred Expenses Profit and Loss Account (Debit Balance)

Rs.

A. Current Liabilities Acceptances Sundry Creditors Outstanding Expenses B. Provisions Provision for Taxation Proposed Dividends For Contingencies For Provident Funds Scheme For Insurance, Pension and other benefits

Distinction between Profit and Loss Account and Balance Sheet 1. Profit and Loss Account Profit and loss account is an 1. account. Balance Sheet Balance sheet is a statement of assets and liabilities.

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2. 3. 4.

Profit and loss account shows the 2. profit or losses during the accounting period. It is prepared for the accounting 3. period which has ended. Accounts appearing in profit and 4. loss account are completely closed.

The balance sheet shows the financial position of the business. It is prepared as on the last date of the accounting period. Accounts appearing in the balance sheet carry forward balance which become the opening balances for the next period.

Relationship of Profit and Loss Account with Balance Sheet Profit and loss account provides the vital link between the balance sheet at the beginning of a period and the balance sheet at the end of that period. Profit and loss account deals with the costs incurred during the current period for the purpose of earning the related revenue. The impact of this is disclosed by the balance sheet. The balance sheet exhibits expenditure which is either outstanding or paid in advance, i.e. the unexpired benefits. It also serves as a means of carrying forward unexpired acquisition costs of assets. The amount of net profit or loss reported by the profit and loss account is carried forward in the balance sheet showing their impact on various other terms disclosed in the balance sheet. Profit and loss account explains the changes in the owner’s capital or equity between the opening and closing balance sheet of the accounting period. Thus, balance sheet shows the transactions remaining for execution as a result of the revenue transactions of the profit and loss account. The preparation of profit and loss account precedes the working of the balance sheet and the balance sheet cannot be prepared without the preparation of the profit and loss account. The profit and loss account can be prepared without the balance sheet. However, absence of balance sheet will fail to disclose the impact of the revenue terms on the balance sheet which is the final resulting financial position of the business. The balance of accounts given in the trial balance is obtained after the completion of double effect of the transactions mentioned in the ledger. Hence, • • • Nominal account balances are transferred to and appear in either trading account or profit and loss account Balance of other accounts is carried forward and appears in the balance sheet The same balance, from within the trial balance, cannot, therefore, appear both in the trading or profit and loss account and in the balance sheet

Summary 1. The profit and loss account and the balance sheet are together known as final accounts. These are the final steps in the accounting process. 2. The profit and loss account is prepared to show the financial results of an enterprise.

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3. Balance sheet shows the position of assets and liabilities of a business entity as on a particular date.

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