Balance Sheet & its

Concepts

Course: Accounting for Managers

Course Coordinator: Dr. Kavita Wadhwa
 Balance Sheet
 Balance sheet is an important financial statement which depicts the financial
position of the business at a particular point of time. It shows the state of assets
and liabilities at a particular point of time.

 It's a stock report.

 One must know and understand the accounting principles/concepts that are
followed while preparing the balance sheet. In total there are eleven such
principles. Five principles are related to balance sheet and six principles are
related to income statement.

 The principles are self-evident for accountants because these principles are so
basic that accountants do not consciously think of these principles, but they
follow/assume. All the accountants across the globe follow with principles. In
USA, FASB has given US GAAP and in India ASB has given Indian GAAP.
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 Balance Sheet Accounting
Principles/Concepts/Assumptions

1. Money measurement Concept

2. Business Entity Concept
3. Going concern Concept
4. Cost Concept
5. Dual aspect Concept

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 Money measurement Concept
 Only those transactions and events are recorded, which can be expressed
in monetary form.
 Money provides a common unit of measurement/ denomination which
facilitates comparison of apples and oranges. Otherwise they cannot
be compared. Through a common unit, heterogeneous items can be
compared, added or subtracted.
 Example: Assets with heterogeneous units.
 Limitations: Important events are not recorded such as death of CEO,
health of employees, labor strike, competitor coming with a new product in
the market. Readers of reports should not expect all the facts in FSs.
 Monetary value of an item is accounted or considered only at the time of
acquisition. Further changes are not recorded even though purchasing
power (PP) of money does not remain same. PP decreases with time.
 New area of Accounting: Inflation Accounting/Accounting for price level
changes. Also, fair value accounting as per IFRS now.
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 Business Entity Concept
 The identity of business is different from that of it's owner.
 Transactions of these two entities (business and businessman) should be kept
separate. Similarly, the transactions of two or three businesses should be kept
separately.
 Business owns the resources, even if the legal owner of the asset is businessman.
 Examples/Implications:
 The capital contributed by owner is treated as liability of the business. Similarly, the
amount withdrawn by owner for personal use is treated as drawings.
 Interest on capital is paid to the owner and interest on drawings is charged from the
owner.
 Loan taken by owner in his/her personal capacity is different from loan taken by
businessman for business purpose.
 Amount spent by owner to meet household expenses is treated as drawings and
amount spent by him to meet the business expenses is treated as business expense.
 Even though business has a separate entity distinct from its owner, but law does
not make any such distinction in case of bankruptcy of business (Sole
proprietorship and partnership but not in case of a company).
 Sometimes this principle creates problems. For example, when owner resides in
the same premises in which he conducts the business. For a company, this
distinction is quite easy to follow.
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 Going concern Concept
 Business will continue to exist for an indefinite period of time.
 Assets and liabilities are shown in the balance sheet at book value under this
assumption. Otherwise, they would be shown at liquidated value.
 Helps to spread the effect of long term transactions over time.
 Measurement of Assets and Liabilities on closing date.
 Examples/Implications: Due to this assumption,
 Business enters into contract with outside parties.
 Assets are classified into current and noncurrent assets and similarly liabilities are
classified into current and noncurrent liabilities.
 We show prepaid expenses as an asset and outstanding expenses as a liability.
 Depreciation is charged on fixed assets.
 Market value of assets is not considered.

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 Cost Concept
Economic resources of the entity are called assets. As per cost concept, Assets
are classified into monetary and non-monetary assets. The question is how to
account for these assets in the balance sheet. Cost principle says that all assets
should be recorded at cost at the time of acquisition.

Non-Monetary Assets Monetary assets

 Those assets whose cash value is not  Those assets whose cash value is fixed by
fixed by a contract. For example, plant a contract irrespective of
and machinery, buildings, macroeconomic factors such as
inflation. Example cash, debtors,
furniture, Inventory. bill receivables, marketable securities,
 The value of these assets is affected by investments, etc.
macroeconomic factors, like  The value of these assets is not affected
inflation. Cash value in rupee terms is by macroeconomic factors, like inflation.
not fixed.
 After acquisition, monetary assets should
 After acquisition, non-monetary assets be recorded at fair value.
should be recorded at original cost.  Fair value is amount at which asset can
be exchanged among two willing parties
in an arm's length transaction.
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 Contd……Cost Concept
 The amount at which non monetary assets are shown does not show the
real worth of the business. Hence, a person analyzing the financial statements
must understand the cost concept as the amount shown in the balance sheet
may not be recoverable for non monetary assets. Hence, instead of value we use
the term book value to denote the worth of non-monetary assets.
 Now, IFRS permits the use of Fair value for non monetary assets as well.

Rationale For cost concept:

 In case of non monetary assets: Showing non-monetary assets at cost meets the
criteria of an accounting principle of relevance, objectivity, and feasibility. We
need to sacrifice some relevance in order to achieve objectivity and
feasibility. How?
 In case of monetary assets: Reporting monetary assets at fair value which captures
future changes also meets the criteria of relevance, objectivity, and feasibility.
How?

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 Dual Aspect Concept

 Each and every transaction in the business affects at least two accounts.
 Due to this concept, asset side of the balance sheet is always equal to
the liability side of balance sheet.
 Assets are the economic resources of the firm and liabilities are the claims
on these resources. These claims are of two types. Insiders’ claim
and outsiders’ claim.
 Therefore, Assets = Liabilities
Assets = Outside Liabilities + Owners equity.

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 Main Items of the Balance Sheet
I Assets
Assets are the economic resources controlled by the organization resulting from
past transaction whose cost can be objectively measured at the time of
acquisition.
 Economic Resources:
Resources are economic when they provide future benefits.
Resources will provide future benefits under three conditions:
(i) They are cash and can be used for cash.
(ii) They are inventory meant for resale and cash received from them.
(iii) They are used in business to generate future cash flows. Example, plant &
machinery, land & building.
 Control: Legal ownership is not necessary. Control refers to present ability to
direct the use of the economic resource and obtain the economic benefits that
flow from it. If the entity enjoys risk and reward of ownership of the resource then
that resource is said to be in the control of the entity and it will show the
resource as an asset in the B/S even if entity is not the legal owner of the asset.
Example asset acquired on hire purchase.
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 Contd…..Assets

 Past Transaction: There should be actual transaction. Mere promise to buy a

resource will not qualify as an asset.
 Cost:
In case of cash purchase: Price paid when the items purchased is the cost.
In case of construction: The total amount spent for construction or
manufacturing the item is the cost.
In case of exchange: Price of another asset (given) if asset is acquired in
exchange of other asset is the cost.
In case of a gift/donation: Market value of the gift is the cost of the asset.

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 Types of Assets
 Classification based on Convertibility:
 Current Assets
 Non-Current / Fixed / Long-Lived Assets

 Classification based on Tangibility / Physical Existence:

 Tangible Assets
 Intangible Assets

 Classification based on Usage:

 Operating Assets
 Non-Operating Assets

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 Current Assets
 An entity shall classify an asset as current when:
(a) it expects to realize the asset, or intends to sell or consume it (convert into
cash), within a period of one year or its normal operating cycle whichever is
longer; or
(b) it holds the asset primarily for the purpose of trading; or
 An entity shall classify all other assets as non‐current.
 Operating Cycle: Time between the acquisition of assets for processing and
their realization in cash or cash equivalents
Cash or Collect
Cash from
Customer

Deliver the Purchase of

product, Send Inventory (RM,
sales invoice Mer)

Store the
Dr. Kavita Wadhwa Convert RM
product in
into FG
warehouse
 Types of Current Assets
 Cash and Cash equivalents (C&CE)1: Cash – Cash at hand and cash in bank (demand
deposits)
CE: Short term (with maturity < 3 Months), highly liquid investments that are readily
convertible to known amounts of cash & which are subject to insignificant risk of changes in
value, Like govt. securities (T‐bills, Bank Term Deposits with original maturity < 3 Months)
 Short Term Investments (or Marketable Securities)2: (Current Investments)
– Investments in govt. bonds or corporate stocks / bonds which the entity plans to hold
for a relatively short period (< 1 year), Temporary use of idle cash
 Notes Receivable (Short-term advances) 3: Written promises to pay by borrowers or others
in the form of Bills of exchange.
 Accounts Receivable or Sundry Debtors or Trade Receivable4 :
– Amounts due from others that generally arise from the sale of goods or services
– Reported after deducting Provision for doubtful debt -> Net Amount realizable
 Bills Receivable5: It is a document that your customer formally agrees to pay at some
future date (the maturity date). This can be discounted from a bank before the maturity.
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 Types of Current Assets

 Inventory : Assets that are

– Held for sale in ordinary course of business (FG),
– In process of production for sale (WIP), or
– To be consumed in production of goods or services to be sold (RM)
Supplies: Papers, envelopes etc.
 Prepaid Expenses: Advance payments for services or goods not yet received like Prepaid
insurance
 Accrued Income – Income earned but not received.
 1,2,3,4,5- Financial assets as per IFRS (new classification of current assets)

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 Non-Current Assets
 Plant, Property and Equipment (PPE):
 Tangible and relatively long-lived. Also known as fixed assets.
 Their use spans beyond one year or the operating cycle and they are used to produce goods
and services that will generate future cash flows.
 If such assets are instead held for resale, they are classified as inventory, even though in a sense
they are long-lived assets.
 These also include natural resources (such as coal mines), bearer plants which are used in the
production or supply of agriculture produce (such as tea bushes, cotton plants, fruit tree, etc).
 Depreciation/Depletion is charged on these assets except land.
 Other Assets:
 Investments: Securities of one company owned by another company in order to control
the other company or in anticipation of earning long-term return from the investment.
 Intangible Assets: Non-physical resourced controlled by the entity. Examples: Goodwill,
Patents, Trademarks, Copyrights, Franchises, etc.
 Goodwill does not appear in the books of accounts unless it is paid for. It appears in books
of accounts if it arises on acquisition of other business where purchase price>fair value of
the net assets.
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 Tangible vs Intangible Assets
Operating vs Non-Operating Assets
 Tangible assets: They have physical existence. They can seen, touched and felt. Examples:
Cash, Inventory, Furniture, Land & Buildings, Plant & Machinery.
 Intangible assets: They do not have physical existence. They cannot be seen, touched
and felt. Examples, Goodwill, Patents, Copyrights, Trademarks, Franchise Agreements, etc.
 Remember: Assets such as bank deposits, accounts receivable, and long-term investments
in bonds and stocks lack physical substance, but are not classified as intangible assets.
These assets are financial instruments and derive their value from the right or claim to
receive cash or cash equivalents in the future.

 Operating Assets: Assets that are required in the daily operation of a business. In other
words, operating assets are used to generate revenue from a company’s core business
activities. Examples: Cash, Inventory, P&M, Copyrights, Patents, etc.
 Non-Operating Assets: Assets that are not required for daily business operations but can still
generate revenue. Examples: Short-term investments, Marketable securities, Vacant land,
Interest income from a fixed deposit, etc.
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 II Liabilities
 Present obligations resulting from past transactions that have to be settled in future
by outflow of assets or providing services.
 Liabilities are of two types: Current and Non-Current/Long-Term Liabilities

 Current Liabilities: An entity shall classify a liability as current when it expects to settle
the liability within one year or its normal operating cycle whichever is longer.

 Non-Current Liabilities: Obligations that a company reasonably expects to pay at

least after one year in the future or beyond the normal operating cycle (typically will
be paid out of noncurrent assets. Primarily in the nature of long term financing.

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 Types of Current Liabilities
• Sundry Creditors or Accounts Payable or Trade Payables: Suppliers (i.e. vendors) claims for
goods or services furnished but not yet paid.
• Bills Payable: The bills of exchange that has been received by a company and not yet
been paid on account of purchase of goods and services on credit.
• Notes Payable or Short-Term Loan/Borrowings/Debt: Formal written note to pay to a lender
such as banks or financial institutions (can be interest bearing); given mainly by supplier of
funds rather than of goods and services.
• Current portion of long term debt: Part of long-term loan that is due within next 12
months/operating cycle.
• Unearned Revenue or Deferred Revenue: Pre‐collections, service not rendered
• Taxes payable: Taxed unpaid; Owed to government for taxes
• Accrued or Outstanding Expense : Expenses due but not paid; Eg., Interest Payable, Wages
Payable
• Dividends Payable : Dividend declared but not paid and they become a legal obligation
• Short term Provisions: Liability of uncertain timing and amount, Requires estimation,
Reported separately‐ Provision for product warranty
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 Types of Non-Current Liabilities

 Long term Borrowings, Notes Payables, Debentures or Bonds payable

 Secured Loan: Loans secured by mortgage of assets, Mortgage Payable
 Unsecured Loan: Loans not secured by assets
 Deferred Tax Liability: Taxes Payable in future arising from Taxable Temporary
difference (Always non‐current in nature)
 Pension Liabilities (for pension benefits payable to employees)

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 III Owners’ Equity
 Owners’ Equity (OE): The owner’s funds invested and earned in the business. EQUITY
is the residual interest (or claims of the owners) in the assets of the entity after
deducting all its liabilities
 Different names of Owners’ Equity are Shareholders’ equity, Stockholders’ equity,
Shareholders’ Funds or Net Assets.
 Owners’ Equity = Paid in Capital or Contributed Capital + Retained Earnings
 Paid in Capital = Common Stock (at par) + Additional Paid in Capital + New Capital (if
any).
 Retained Earnings (RE) : Entity’s accumulated profits of previous years since inception.
RE = Total profits of the entity from its inception to date – Total amount of dividends paid
out to its shareholders over its entire life.
 In case of unincorporated businesses (Sole proprietorship and Partnership), a
different terminology is used for OE and it is generally shown as a single number i.e.
Capital

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 More on Equity: Capital

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 More on Equity: Capital

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Exercise 1: Classification of Financial Statement Items
 Classify the items :
1.Whether it belongs on the Income statement (IS), Balance Sheet (BS)
2.Whether it is a revenue (R), expense (E), asset(A), liability(L) or Owners’ equity (OE)

S. No. Item Appears on the Classified as

1 Cash BS C Asset
2 Equipment BS F Asset
3 Furniture BS F Asset
4 Creditors BS C Liability
5 Salary Expense IS Expense
6 Salary Outstanding BS C Liability
7 Accounts Receivable BS C Asset
8 Bills Payable BS C Liability
9 Retained Earnings BS OE
10 Membership fees earned IS Revenue
11 Long-Term Loan BS LT Liability
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 Basic Accounting Equation

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 Classified Balance Sheet (Formats)
 Presents a snapshot at a point in time
 Total Investing = Total Financing = Creditor Financing + Owner Financing
 To improve understanding, companies group similar assets and liabilities together
 Sequencing : Order of Liquidity (US) vs Order of Permanence (the following order
will be reversed in this case)

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Dr. Kavita Wadhwa
Walmart Consolidated Balance Sheet (Vertical Format)

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FORMAT
OF B/S

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 India – As per Revised Schedule III of Companies Act, 2013
(Assets are followed by Equity and Liabilities)

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Dr. Kavita Wadhwa
 Transactional Analysis
S.No. Transactions Assets = Liabilities + Owners' Equity
Assets = Liabilities + Common Stock RE
1 Mr. A started business with capital of Cash + 10,00,000 Common Stock
10,00,000 + 10,00,000
2 He raised loan of 5,00,000 from Cash + 5,00,000 Loan + 5,00,000
Bank
3 Purchased Plant and Machinery for Cash - 2,00,000
2,00,000 in cash P&M + 2,00,000

4 Purchased goods worth 20,000 in Cash - 20,000

cash Inventory +20,000
5 Purchased goods worth 30,000 on Inventory + 30,000 Creditors + 30,000
credit
6 Inventory costing 15,000 is sold for Cash + 20,000 RE + 5,000
20,000 in cash Inventory - 15,000
7 Inventory costing 10,000 is sold for Inventory - 10,000 RE + 2,000
12,000 on credit Receivables + 12,000
8 Paid 20,000 to the supplier Cash - 20,000 Creditors - 20,000
9 Building rent paid for 4000 Cash - 4,000 RE - 4,000
10 Received 7000 from customer Cash + 7,000
Receivables - 7,000

11 The owner withdraws 5000 cash for Cash - 5,000 Common Stock
his personal use. - 5,000
12 The owner withdraws goods worth Inventory - 5,000 Common Stock
5000 for his personal use. - 5,000
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 Balance Sheet
Assets Amount Liabilities Amount

Cash 1278000 Creditors 10000

Receivables 5,000 Loan 500000

Inventory 20,000 OE

P&M 200000 Common Stock 990000

RE 3000 993000

1503000 1503000
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 THANK YOU

Dr. Kavita Wadhwa