Balance Sheet

What is Balance Sheet?

The balance sheet is an accounting statement that summarizes the various assets, liabilities and
equities held by a company on a specific date.  The equities are usually considered as part of
the liabilities.  The balance sheet is always drawn up at the close of business day, but is most
relevant on the last day of the company's accounting period (the balance sheet date).  

Balance sheet is an important document not only for bank managers who sanction loan but is
equally important to others who give credits and invest in equity etc. All creditors and investors
all need to familiarize themselves with the assets, liabilities, and equity of a company. The
balance sheet is the best place to find all information at one place. The reason as to why
balance sheet is so called is that it is statement where Assets = Liabilities + Equity

Major Heads of Balance Sheet:

Liabilities:- Assets :-
1. Share Capital 1. Fixed Assets
2. Reserve and Surplus 2. Investments
3. Secured Loans 3. Current Assets, Loans of Advances
4. Unsecured Loans 4. Miscellaneous Expenses
5. Current Liabilities and Provisions 5. Profit and Loss Account (Debit balance)

Assets which are likely to be collectible in the short term (usually within 12 months) are
considered a "current" asset, while anything owed by the company in the same time frame is
considered as a current liability.

VARIOUS TYPES OF CAPITALS (OWNED FUNDS) AND RESERVE DEFINED :

(a) Share Capital : It is important to understand the difference between the following types of
share capitals :-

(i) Authorised Capital : This is the maximum amount of capital that can be raised by the
company. However, it is not compulsory for the company to raise the full authorised capital.

(ii) Issued Capital : This is the amount of capital which company intends to raise at a given point
of time. This amount is usually mentioned in the Memorandum of Association of a company.

(iii) Subscribed Capital: This is the capital which has actually been subscribed.

(iv) Paid Up capital: This is the amount of capital that has been called and received against the
subscribed capital.
For the purpose of Balance Sheet, paid up capital is of utmost importance

(b) Reserves : - There are various types of reserves, some of important types of reserves are :-

(i) Share Premium Reserve : Whenever a company issues shares on premium, the amount
collected by the company above the face value of the share is called "premium". The amount
collected as "premium" is known as share premium reserve. On such share premium reserve no
dividend is payable.

(ii) Revaluation Reserves : Sometimes a company re-values (i.e. revises) its assets. This re-
valuation is done to make the asset show the true market value of the asset. Thus asset is
shown at a higher value than the previous book value and the corresponding increase is created
on liability side by increasing reserves under "revaluation reserves".

(iii) Depreciation Reserve : Usually when a depreciation is made in asset, the value of the asset
is credited with the depreciation amount and equal amount is debited to profit and loss
account. However, sometimes companies companies debit the depreciation amount to profit
and loss account, but instead of crediting the same to asset account, they credit the amount to
Depreciation Reserve Account. Such an entry is called deprecaition reserve. Therefore, while
calculating the networth of a company, it should be excluded from the owned funds by setting
it off against the value of the fixed assets.

(iv) General Reserves : This kind of reserves consists of the profits which have not been actually
distributed among the shareholders. This acts as a cushion for the company for any future loss.

VARIOUS TYPES OF ASSETS DEFINED :

Assets: Items that the business owns and on which a value can be placed.
 

Intangible assets:  These are 'non-monetary' but 'identifiable' assets that have no physical
substance.   Current accounting guidelines mean they almost always relate to goodwill, though
may include patents, licenses, trademarks and so on.

Tangible assets:  These are 'long-lived' physical items held for the purpose of earning revenue.  
Typically these assets  include land, property, plant, machinery, fixtures, fittings and motor
vehicles.

Fixed asset investments:  These are long-term investments, including 'ownership interests' held
in other companies.  For joint ventures and associates, the company's share of the entity's
assets is shown. Other long-term 'minority' investments held can be shown at historical cost or
current valuation, though the accounting notes must declare These are asset, the benefit of
which is usually available to the entity over several accounting periods. Example of fixed assets
include, land, building, Plant & Machinery. Furniture & Fittings, Vehicles, etc.

In case of fixed assets, usually a part of its life is 'being utilised in a particular accounting year,
and thus a certain portion of its cost (depending upon the total expected economic life of the
asset), is appropriated in the shape of "depreciation" in each accounting year The value of fixed
assets at original cost is called "Gross Fixed Assets" and the value of the asset arrived after
deducting depreciation is called "Net Fixed Assets".

Current assets:  Cash in the bank and 'temporary' assets that the company expects to turn into
cash.   Stocks (at the lower of either cost or net realisable value), any goods held for resale, raw
materials to be used in manufacture and work in progress.are examples of such assets.

Accounts Receivable: When credit sale is made, but no bill of exchange/promissory note duly
accepted/signed is held, the amount of such credit sale is known as "Accounts Receivable".

Inventory: Stock of raw material, stock-in-process (also called as semi-finished goods), finished
goods and consumable stores are known as inventory. Usually one of the following two
methods is used for valuation of inventory:-

(a) FIFO = FIRST - IN FIRST OUT: In this method, it is assumed that inventory first purchased is
first consumed/sold out and hence the valuation is done as per purchase price of those items
purchased earlier.

(b) LIFO = LAST IN FIRST OUT: In this method, the valuation of item sold first is done as per
purchase price of the last one, assuming that the items purchased in the last are consumed /
sold.

Investments: A firm may invest its surplus fund in Government Securities or debt instruments or
equities of the corporate sector.

VARIOUS TYPES OF LIABILITIES DEFINED :

Liabilities:  All claims of outsiders against the entity are called liability. It represents all the
things of value, which one owes to others.

Current liabilities:   The liabilities which are to be met out of the current assets within one year
or within one operating cycle (whichever is longer). It includes acceptances, sundry creditors,
advance payments, unclaimed dividends, expenses accrued.

Thus, in nutshell, we can say liabilities the company expects to meet within twelve months of
the balance sheet date are called current liabilities.
Long Term or Term Liabilities : These are the liabilities which-are usually for more than one year
and include all the liabilities other than current liabilities and provisions (see below).

Secured Loans: It represents loans and advances from banks/subsidiaries/others raised by a

company, after creation of charge on its assets. It includes 'Debentures'.

Unsecured Loans: These are loans and advances (including short term) from Banks/
Subsidiaries/others obtained without creating any charge on the assets of the Firm. It includes
fixed deposits received from public.

Acceptances: These are bills of exchange accepted by the firms and generally known as," Bills
Payable". In case of promissory notes it is referred to as "Notes Payable".

Accounts Payable: These represents the debts of the creditors for purchase which is not
evidenced by any formal acceptance as defined above. These are. also referred to as "Sundry
Creditors".

Accrued Liabilities: These represent the obligations accrued but not paid and shall be paid in the
next accounting period.

Provisions: When a liability cannot be precisely determined, it is estimated and provided for.
Examples are provisions for dividends/taxation/PF/contingencies/Debts etc.

Some other Terms relating to analysis of Balance Sheet defined :

Net Sales: Whenever goods are supplied to the customers, these are recorded as sales in the
company's account books. The sum total of such sales during a period is referred as 'gross
sales'. However, some of goods thus supplied may be subsequently returned by the customers
due to various reasons, e.g. the goods may not be strictly as per specification demanded by the
customer, or these got damaged during transit etc. Such returns and allowances are separately
accounted for and at the time of preparation of P&L Statement, the value of such goods are set
off against gross sales. This is known as 'net sales' or "Sales".

Cash Discount / Sales Discount / Trade Discounts: Some companies, with a view to" boost early"
realisation of receivables, allow some discount, e.g. an entity may specify that if their bills are
paid within 15 days, 5% discount will be allowed. This is called "Cash Discount" or "Sales
Discount". Some companies agree to sell the goods at a price lower than the normal price
provided the customer agrees to buy the goods in bulk. Such a discount is known as trade
"discount" and is generally not shown in the P&L A/C separately, rather taken into account in
the value of Sales.

Other Income: Income obtained from the Business operations of an entity is called Operating
Income and Income arising out of an activity which is not the business activity of the firm, are
referred as 'non-operating income' or 'other Income'. For example, on sale of fixed assets an
entity may be able to realise more than the book value of such an asset. This is
called other income.

Manufacturing Expenses: The expenses which are directly incurred on the production /
manufacturing process (such as freight, factory rent, electric charges at the factory site, wages
of labour in the factory etc.) are called manufacturing expenses. These are direct input costs
incurred towards the product manufacturing.

Cost of goods sold: It refers to the direct input costs of goods sold, and comprises of cost of the
raw material and manufacturing expenses. It can be calculated as follows: Opening Stock +
Purchases + Manufacturing Expenses - Closing Stock

Gross Profit: It is the difference between sales and cost of goods sold. This represents the
margin of profit at the point of production of goods.

Operating Expenses: All the expenses which are not directly incurred on production, but are
necessary to run the business, are grouped as "operating expenses". It covers all expenses
relating to selling & distribution as well as general administration expenses (including personnel
expenses) and indirect costs, such as depreciation.

Depreciation: In case of fixed assets, usually a part of its life is 'being utilised in a particular accounting year, and
thus a certain portion of its cost (depending upon the total expected economic life of the asset), is appropriated in
the shape of "depreciation" in each accounting year The value of fixed assets at original cost is called "Gross Fixed
Assets" and the value of the asset arrived after deducting depreciation is called "Net Fixed Assets". The two
methods mostly used for calculating this expense are known as (a) Straight Line Method and (b)
Written down value method or diminishing value method.

In the straight line method, the depreciation is arrived at by dividing the original cost of a fixed
asset by its expected economic life. On the other hand, in case of the "written down value"
method, the expiration is calculated every year at a pre-determined rate on the amount of the
depreciated value (i.e. original cost - earlier depreciation charged) at the end of the previous
year.

Amorstisation: Depreciation and amortisation are almost identical. However, the expiration of
the cost of intangible assets is referred as' 'amortisation, whereas that of a fixed tangible asset
is called 'Depreciation'.

What is a contingent liability? Where is it shown in the Balance Sheet?

Contingent liability is a liability which may arise as a liability in future on the happening of some
event.  This is not an actual liability at present and therefore does not occur in the main body of
the balance Sheet.
Contingent Liability  is shown as a footnote to the balance sheet.  Some of the examples of
Contingent liability are:-

              a) Claims against a company not acknowledged as debt.

              b) Arrears of fixed cumulative dividend on cumulative preference shares.
              c) Uncalled liability on account of partly paid shares in the investment portfolio
 

Current Assets
Current Liabilities • Cash in Hand
• Creditors • Cash at Bank
• Bills Payable • Marketable securities
• Bank Overdraft • Bills Receivable
• Outstanding expenses • Stock and Trade
• Income Tax payable • Accrued Income
• Advances from customers • Prepaid Expenses
• Advances to Others
Non-Current Assets
Non-Current Liabilities
• Building
• Equity Share Capital
• Land
• Preference Share Capital
• Plant and Machinery
• Debentures
• Furniture and Fixtures
• Long Term Loans
• Patent Rights
• Profit & Loss (Cr.)
• Trademarks
• Share Premium Account
• Profit and loss Account (DR)
• Share Forfeited Account
• Discount on Issue of Shares and
• Capital Reserve
Debentures
• Provisions Like Provision for Tax, Dep.
• Preliminary Expenses
• Proposed Dividend
• Other Deferred Expenditure
• Appropriation of Profit E.g. transfer to
• Long-Term Investments
General Reserve, Workman
• Goodwill
Compensation Fund, Debentures Sinking
Fund, Capital Redemption Reserve etc.

 
 AN EXAMPLE TO UNDERSTAND BALANCE SHEET, CASH FLOW ETC.

Based on the following Balance Sheets of ABC company prepare a schedule depicting (a)  changes in Working
Capital and (b)  Funds Flow Statement:-

Balance Sheet

Liabilities 2004 2003 Assets 2004 2003

Rs. Rs. Rs. Rs.
Share Capital 4,50,000 4,00,000 Fixed Assets 7,20,000 6,10,000
Debentures 3,50,000 2,40,000 Investments 1,30,000 50,000
Current Liabilities 1,50,000 1,20,000 Current Assets 3,75,000 2,40,000
General Reserve 2,10,000 2,00,000 Discount on shares 5,000 10,000
PandL Account 70,000              PandL Account                50,000
12,30,000 9,60,000 12,30,000 9,60,000

Additional information available to you is  :

(a) During the year depreciation charged on Fixed Assets was Rs. 60,000/-.
(b) Machinery with a book value of Rs. 40,000/- was sold for Rs. 30,000/-. 
 

Solution :  

Schedule of changes in Working Capital

Particulars 2003 2004 Inc. Dec.

Current Assets A 240000 375000 135000
30000
Current liabilities B 120000 150000

Working Capital A - B 120000 225000

Increase in working capital 105000                       105000
225000 225000 135000 135000

Funds flow Statement for the year ended

 
Particulars Amt. Particulars Amt.
 Funds from operation 205000 Purchase of Investment 80000
Issue of Shares 50000 Purchase of Fixed Assets 210000
Issue of Debentures 110000 Increase in working capital 105000
Sale of machine 30000          
  395000 395000
 

Fixed Assets A/C

 
To balance b/d 610000 By P/L A/C  (Depreciation) 60000
To Cash A/C By cash A/C (Sale) 30000
(bal fig) 210000 By P/L A/C
(Purchases) (Loss on Sale) 10000
             By balance c/d 720000
820000 820000

Adjusted P/L A/C

 
To balance b/d 50000 By funds from operation 205000
To Fixed Assets (Depreciation) 60000  
To Fixed Assets 
(loss on sale) 10000
To tfr to General Reserve 10000
To Discount on share 5000
To balance c/d 70000
205000 205000

TYPES OF FORMATS of BALANCE SHEET UNDER INDIAN COMPANIES ACT :

The Companies Act provides for two formats of Balance Sheet. One is the conventional 'T"
format, wherein assets and liabilities are grouped in descending order of their liquidity. The
other is the vertical format, which was introduced in 1979 on the basis of International
Accounting Standards. So far as non-corporate entities are concerned, IBA, in collaboration with
Institute of Chartered Accountants of India, evolved formats for Financial Statements which
were later on approved by RBI.