,
1
k
I
HE BALANCE SHEET
FINANCIAL POSITION OF AN INDIVIDUAL
Anna Wnng is a loan officer in a cummu nhty branch of the Royal
Bank of Canada. As part of her dillies, she authorizes loans to individ
uals and to businesses wishing to borrow money.
Re.entlv, a yuung pu rsori named Mai Kotisha visited Anna to apply
br a loan. Mai is a graduate of her local ulleges hortitulture program
and has been working for a landsaper fnr the past ear.
2
CHAPTER
1/THE
BALANCE
SHEET
Mai has the entrepreneurial spirit—that is, she would like to own
and operate a business. Although quite young. Mai [eels that her col
lege training, combined with the practical experience gained over the
past year,, will enable her to suessfully start her uss n landscaping
business.
Mai needs $ 10 000 in order to start the business and is appk ing to
Anna’s bank for a loan. In deciding whether to grant a loan, Anna
examines the financial position of the applkant. This is what she does.
First, she lists the items owned by the applicant:
Items Owned by Mal Kousha
Cash
Government Bonds
Clothing
Furniture
Equipment
Automobile
A creditor is a person or
bosness that has poended
credit or Joaned 1o1ey.
$ 2000
5 000
3 000
10 000
7 000
10 000
$37 000
Next, Anna lists what Mai owes to creditors. Creditors are people or
businesses that extended credit when items were Purchased or who
loaned money used to purchase possessions. These creditors must be
paid before an individual has complete title to his/her possessions.
Debts Owed to Creditors by
Mat Kousha
Credit Card Debt
Bank Loan
$ 200
2 000
Now Anna determines the financial position of the applicant.
Calculation of Financial Position
VIai’s financial position is determined by making the following calcu
lation:
I
rI’
I
By calculating the cost of the items owned by an indi idual and sub
tracting the debts owed, it is possible to determine a persons net
UNIr
NOrth s t
ie
1
tems
jwed and debts ed
iI
•,et
iiferu’Ce een
1/FINANCIAL
PosiTioN.
.3
worth at any given time. The net worth represents the difference
between the total owned and the debts owed. Thus. Anna has deter
mined that Mai Kousha’s net worth is 534 800.
Accounting Terminology
rhe subject accounting is often called tilt’ Ianquaq’ of business. An under
standing of accounting terminology will help you in both your per
sonal Life and in your business career. Starting with the items owned
by Mai, let’s translate Mai’s financial position into the language of
accounting.
ASSETS
Assets are items of iIue
owned by a business or
I abilities are the debts of
a buinecs or person.
Personal equity is
100’S set North,
I
a
per-
In accounting, items of value owned by a business or person are called
assets. The total of Mai’s assets are $37 000. Now let’s look at the
accounting terminology for debts.
LIABILITIES
Debts or amounts owed to others by a business or a person are called
liabilities. Mai’s liabilities total $2 200, The last part of determining the
financial position is the net worth.
PERsoNAL Eauitv
equity is a term which represents a person’s net worth. Mai’s
personal equity or net worth is $34 800. Because there is a substantial
difference between Mai’s assets and liabilities, the bank gave her the
loan. Mai’s very positive net worth indicated to the bank that Mai
would he able to repay the loan.
Personal
Accounting Equation
The financial position of a person or a business can be stated in the
form of an equation called the accounting equation, as follows:
Liabilities
1ijtiitv
*
In Mai’s case, the accounting equation is:
¶ 3’’
UtI)
S2 .0)
+
S
SOil
or
S 37 0(B)
53
(lOt)
This accounting equation is the basis for much of the accounting the
ory you will learn.
Balance Sheet
Mai’s financial position is illustrated in Figure 1 -1 in the form of a bal
ance sheet. This is a financial statement which lists assets, liabilities,
and personal equity (net worth) at a specific date.
I
_____
_____
_____
_
_
_
4
.(APTER
1/THE
BALANCE
SHEET
Mai Kousha
Personal Balance Sheet
September 30, 19-Assets
Cash
Government Bonds
Clothing
Furniture
Equipment
Automobile
$ 2 000
5 000
3 000
10 000
7 000
10 000
Total Assets
$37 000
FGuR€
1 -1
Liabilities
Credit Card Debt
Bank Loan
Total Liabilities
$
200
2 000
2 200
Personal Equity
M. Kousha. Net Worth
34 800
Total Liabilities
and Personal Equity
537 000
Personaf bfance sheet
FINANCIAL POSITION OF A BUSINESS
The financial position of a business is determined in the
same way as
that described for Mai Kousha. In the next few pages, we
will exam
ine the financial position and the balance sheet for a small
business
called Hill’s Sports Club. Hill’s Sports Club will be used
in this text to
demonstrate a variety of accounting procedures. This
business will be
followed from its formation through its first year of operati
on, thereby
presenting an opportunity to examine both accounting
and nonaccounting procedures, problems, and decision makin
g faced by all
business proprietors.
UNIT
I
FINANCIAL
PosIrtoN..5
Background Information
Klt.’ l)uhord nd his family Ipe11vd Hills Slits Club in St.
ati rim,’s, Ontario \lans fattors ere insoRed in ks it’s dt’tisuin ti
eonte an elttrt’pre wur and tipeti his
it listtics.
k’ es atkgriluild and t*atitutiied Interest ti atlilcits, oIl1lHt1eI
ith his lortttal edttatioti, pros tied the U’s pert se Iletessar\ to operate
tiits i’s ie of business. His atliletit hat.kgitinid iltinded pla’s iri tennis
in the Viridsor initior Tennis Team atiti ratqtiet ball for the Windsor
A Team. K’s le apitali,ed ott his Interest ni athietits b’s timtpletitig
it’rees in phsical udutatiun s’sitit a minor in business.
K le felt his unique background and interests, tottihiried with a
apatitv br hard ‘sork and a desire to suueed, qitalilied him to
heuotne a suuu,essful em repreneur. lie du ided to investigate the
ilen t ial in the Niagara Region for openi rig a sports tIn b for men and
wu mien of all ages. Through his ten nis playing, he had beet nite famil
iar with the thtain of Kill’s Sports Clubs which had started in
California and had spread across the United States and Europe butt
which had only begun to enter the Canadian market. Kyle felt the use
of t he Hill’s name and promotional material would assist him in hit ild
ing a clientele for his club, so he applied to become a licensee. A
licensee pays a monthly rate to Hill’s Sports Club International for the
use of Hill’s name in a particular region of the country but operates
the business as his or her own. Because of Kyle’s background, he was
approved as the licensee for the Niagara Region.
As with any business, starting this business required the owner to
take risks in the hope of being successful. Kyle collected all of his
available cash and applied for a loan and mortgage from the bank to
(
—
—
start his club,
Introducing Accounting
The Dubord family had to make many decisions in developing their
sports club into a suc,cessful business. A method of keeping accurate
records was needed to provide information required to make these
d ecisit ins. This fact serves to introduce the subject of acco ii n t ing.
Purpose of Accounting
‘the ptlrpL’sL’ f accLunting is to provide financial information for deci
sion making. To fill this need, a professional accounting firm was
hired to develop art accounting sstetn for Kill’s. Ati Jcoutiting sys—
tein is an organiied method of performing acouinting tasks. Every
attouriting system 111(1st.
• Reord the dav.to.dav aui’s ities of the business
•
Snnitnart,e and report information in financial statements for
maR si’s and det isiorm ritaking.
________
6
.
.CHAPTER
1/THE
BALANCE
SHEET
Business Entity Concept
in this chapter, the study of accounting will begin with a look at the
balance sheet, which is one of the financial statements for Hill’s Sports
Club. It should be pointed out at this time that the financial data for
the business must he kept separate from Kylec personal financial data
in order to prepare accurate financial statements. Each business
should he considered as a separate unit or entity for the purpose of
keeping accounting records. This is known as the business entity 1ncept.
CoMPANY BALANCE SHEET
The financial position of Hill’s Sports Club on opening day is shown in
Figure 1-2 in a balance sheet. Just as with the personal balance sheet
shown for Mai Kousha, the company balance sheet is a formal report
or statement showing the financial position of a business at a certain
date. It lists assets, liabilities, and owner’s equity, which is an account
ing term for the owner’s claim against the assets of the company.
Hill’s Sports Club
Balance Sheet
July 1, l9—
A balance sheet is a
financial statement which
lists the assets, ablities,
nd owner’s equity at a
peciIic date.
Owner’s cquty is the
owrsr’s da:m igainst the
asets of the company.
Assets
Cash
$ 5000
6 000
Receivable
Accounts
500
Office Supplies
25 000
Land
110 000
Building
Training Equipment 94 500
Total Assets
FtGuE 1 -2
$241 000
Liabilities
Accounts Payable
$
Bank Loan
Mortgage Payable
Total Liabilities
4000
65 000
80 000
149 000
Owner’s Equity
92 000
K. Dubord, Capital
Total Liabilities
and Owner’s Equity $241 000
Company biance sh€t
The company’s financial position can also be described in terms of th
accounting equation. as follows:
$211 (00
$241 (}t)
1:J!)i1itie
SI lQ 000
$2 41 Us)
*
±
()Ufl(’! iUttV
S)2
i))
in this equation. the two sides balance. The left side iS24i 000) equal
the right side S241 000).
_____
________
___
UNIT
1/FINANCIAL
POSITION. .1
Notice that the balance sheet also balances. The total of the left side
equals the total of the right side. This is why it is called a balance sheet.
Notice also that accounting terminology is used for all of the items on
the balance sheet. The amount owed by customers for memberships.
$6 000, is called Accounts Receivable. The amount owed as debts to
creditors, $4 000, is Accounts Payable. The loan (mortgage) owed on
the building. $80 000, is MorTga,je Payable.
Balance Sheet Preparation
The opening balance sheet for Hill’s Sports Club will be used as an
example to discuss the correct format and procedures to follow when
preparing a balance sheet. This is known as a formal report since it is
prepared according to a specific set of rules, outlined in the following
steps.
STEP 1: PREPARE STATEMENT HEADING
The three-line heading is centred at the top of the page and is
designed to provide information in this sequence:
Litic 1: Who?
nc 2: Wtiit ?
line 3: When?
—
—
—
HIll’% ‘1))rts tIUL)
R (in cc Sheet
fuly 1. I
—
—
huiiic’, nurne
ti tt’inet It ni me
date of statement
STEP 2: LIsT ASSETS
The assets are listed on the left side of the page. Before the assets are
totalled, the liabilities must be listed and totalled. Then, if required,
the necessary number of blank lines must be inserted before the
owner’s equity section and before the assets’ total so that the final
totals on both sides of the statement will be on the same line.
Subheading
Tat tide
Assets
——
Cash.
Accounts Receivable
Office Supplies
Land
Building
Training Equipment
.Tota1 Assets
Dollar cign, top of column
$
5000
6 000
500
25000
110000
94 500
$241 000
ne tine n&at Iitjen oi column
offa, igrn be.de
c3Iumn :otal
J
auble it
aes ndlate n.ai tot
_____f
8
1/THE
CHAPTER
BALANCE
SHEET
STEP 3: LIsT LIABILITIES
The liabilities are listed and totalled on the right side
bheding
--—————
Lat of ia6dities
—
ubtotai titli
Liabilities
—
$
lAccounts Payable
Bank Loan
I. Mortgage Payable
Total Liabilities
4
65
80
149
of
the page:
Doflar sgn. top of column
000
000
000 _,jSingte me dicates ddrnon
I. of column
000
Subtotal at 9ght ‘ide of
J statement
I.
STEP 4: SHow OWNER’S EQUITY
The owner’s equity section, showing the owner’s investment, is on
the right side of the page after the liabilities section. As explained pre
viously, the final totals of each side must be on the same line. This
allows for a more attractive presentation of the information and
emphasizes the fact that the left side of the balance sheet equals the
right side, that is, A = L + OE.
Subheadmg
Owner’s Equity
—
Owner’s qame
K. Dubord, Capital
utte
ITotal Liabilities
land Owner’s Equity
Total
Dollar sign at fiOIl totaI
of column
92 000
$241 000
_j
J
Sing line to indicate
laddition of column
Di line ndicates final
1 total
FACTS TO REMEMBER
The total assets and the total liabilities and owner’s equity are written
on the same line:
Tt,iI \‘cjs
U)
F:,
!t: i:lJ
Hu:1\
S
t
The appearance of the balance sheet is very important since the state
ment may be viewed by a variety of people inside and outside the
business, Statements such as this create an impression regarding the
business and should be prepared as attractively and accurately as
UNIT
1/FINANCIAL P05ITI0N..9
jussible. In additiini to lilt’ speulicatiolls for balan
ce sheet preparation
gis Cl) Ill the esamples. the follosviiig requirenl
ci.isidered:
ents should he
1. No ahbresiations should be used in the statement.
2. The statement should contain no corrections,
3. rOr tilt’ balance slien, dollar signs should he placed as loilo
ns:
• Beside the first figure in each olunm
• Beside tile final total on both sides of the statemen
t.
Additional Accounting Terminology
Earlier in the chapter. you started to build your
accotlilting socahu
by learning what assets, liabilities, and equity were.
Here Is addi
tional information regarding these terms as
they relate to the balance
lary
sheet for 11111’s Sports Club.
ASSETS
Assets are resources or Items of value owned
by a business. They
include the foliowinw
• Cash: Currency (bills and coins), bank deposits, cheq
ues. money
orders, and credit card receipts
• Accounts Receivablt The total amount due from
debtors (cus
tomers). Debtors are persons of businesses which owe
a business
money as a result of purchasing goods or services
on credit. The
amount Is normally due within 30 days.
• Office Supplies: Items purchased for use wIthin
the business
Office
.
LIABILITIES
Liabilities are the debts of the business. The creditors
who are owed
these amounts are said to have a claim against the asset
s of the busi
ness. This claim by the creditors Is the right to be
paid the amount
owing to them before the owner of the business can
benefit from their
sale. For example. Hill’s Sports Club lists a building
at $110 000 as an
asset. A mortgage Is Induded in the liabilities at $80
000. If the build
ing were sold, the creditor would have to be paid
in full before the
owner could obtain the balance.
Liabilities include items such as:
• Accounts Payablt The total amount owed to
the creditors for the
purchase of goods or services of the business. Thes
e amounts are
normaily due in 30 days.
• Bank Loan: The amount of loans owing to
the bank. These loans
vary in length of time fl—S lean). Some bank loans
are demand
loans and are due whenever payment Is demanded
by the bank.
• Mortgage Payablt The amount borrowed from
financial institu.
tions usually to purchase buildings or land. The
lender has the right
10
1/THE
CHAPTER
BALANCE
SHEET
to obtain control of the property in the event the borrower fails
repay the debt. Since this liability is normally large in amount, th
time to repay is longer than other liabilities for example, 25 years
E quites
are cams
the assets
against
of a company.
EQUITIES
The assets are listed on the left side of the balance sheet. On the rig[
side are the claims against the assets. These claims are called equities.
The liabilities section lists the claims of the creditors. The owner
equity section lists the owner’s claim. The owner’s claim is what th
company is worth to the owner, or the net worth. It is listed on th
balance sheet using the word Capitar beside the owner’s name se
K. Dubord, Capital on page 6). The owner’s equity is the differenc
between the assets and the liabilities (OE = A L).
—
Order of Items on the Balance Sheet
The assets and liabilities on the balance sheet are listed in a particula
order.
ASSETS
Lquidit order is the
order n whtch assets can
be converted into rash
Assets are listed in the order of liquidity. This is the order in whic
they would likely be converted to cash. Using the balance sheet fo
Hill’s Sports Club as an example, the order would he Cash, Account
Receivable, and Office Supplies, since this is the order that these item
could be converted to cash. After assets such as Cash, Account
Receivable, and Office Supplies come assets of a different type—thos
which last a long time and are used for a long period of time to operat
the business. Examples include Land, Building, and Trainin
Equipment. They are listed in order of useful life to the business wit
the longest lasting listed first.
Order of Assets
Reasons
Cash
$ 5 000
Accounts Receivable
6 000
Office Supplies
500
Land
25 000
Building
1 10 000
Training Equipment
94 500
Tie
..
at
‘
ty
Ia’e
Most liquid asset.
Received within 30 days.
Easily converted to cash.
Assets listed in order of length of
useful life in the business. Longest
life listed first and shortest life last.
o
tut biOiCS
ore rtei
acordng
to
she
L I A B I I. I T I E S
date 50ev are due to be
Liahilattes are listed according
paid.
to longest term. This is known as the maturity date rule.
to
payment due date from most recers
UNtT
1/FtNANCIAL
Order of Uabflltles
Accounts Payable
Bank Loan
Mortgage Payable
$ 4 000
65 000
80 000
PosToN..1 I
Reasons
Payable within 30 days.
Payable usually withIn 1—5 years.
Payable within 25 years.
Valuation of Items on the Balance Sheet
All of the items on the balance sheet have a dollar value. There are
accounting rules governing the methods used to assign dollar values.
One of them is the cost principle.
COST PRINCIPLE
Assets are valued according to the cost principle. When assets are
obtained, they are recorded at the actual cost to the business. This fig
ure is never changed even though the owner might think that the
value of the assets has increased.
Users of the Balance Sheet
For a variety of reasons, a number of people and organizations could
be interested in the financial position of a business. The following
chart provides a brief introduction to users of a balance sheet and
indicates reasons for their interest. When you consider the number of
users of this financial information and the importance of the decisions
they are making, it is easy to see why it is essential to employ the
most objective, accurate data available in preparing the balance sheet.
Users
)
Reasons for Interest
Owner
Indicates his or her claim on the assets. Comparing balance sheets at dif
ferent points in time will show whether or not the financial position is
improving.
Creditors
Companies considering extending credit or lending money are inter
ested in liquid assets available to meet payments as well as claims on
assets.
Investors
Investors investigate the financial position of a business as one of the
factors they consider in deciding whether or not to invest in the busi
ness. They want to protect their investment and are interested in much
the same information as are creditors.
Government
Government departments need information for policy decision making.
statistical reports, and taxation.
12
.CHAPTER
1/THE
BALANCE
SHEET
CoMMoN RECORDING PRACTICES
There are several common recording pratties foIIo ed by m
accountants. They are described and illustrated below:
1. When ruled accounting paper is used, dollar signs and decimals
are not required.
2. A single line indicates addition or subtraction.
I Double lines indicate final totals.
R ed jcc3unt rig
Assets
—
jrer
Cash
500
00
Accounts Receivable
1
200
75
Equipment
5
000
00
Total Assets
6
700
75
A ilgie ‘ne
‘diate iddtior
or bract.on
Double hne nd
I_____
final :orals
4. When ruled accounting forms are not used, dollar signs and dcc
mals are used.
5. Dollar signs are placed before the first figure in a column and
beside final column totals when accounting forms are not used.
r
Assets
Cash
Accounts Receivable
Equipment
Total Assets
L
500.00
1 200.75
5 000.00
$6 700.75
$
6. Abbreviations are not used on financial statements unless the
official name of the company contains an abbreviation. For
example, Lumonics Inc. does contain a short form (Inc.) in its
official name and should be written as Lumonics Inc. Goldcorp
Investments Limited should n’t be written in short form since ti
ompan uses Limited, not Ltd., as part of its official name.
7. Accounting records must be neat and legible. They are used by
many people and are kept for a long period of time. They are
UNIv
1/FINANCIAL
PosiTioN. .13
either printed, keyed, or written in ink. Care must be taken to
write numbers and words clearly and legibly.
‘WHAT HAVE I LEARNED IN UNIT 1?
To determine the financial position of a business
To classify items as assets, liabilities, or owner’s equity
To calculate owner’s equity
To prepare a balance sheet
a To use correct recording procedures
If you have learned the material in Unit 1, you are ready to proceed to
Unit 2. To determine if you are ready to proceed. yo teacher may
now want to give you a review sheet and test for Unit I.
•
•
•
CHECK YOUR READING
QuEsTioNs
1. What is meant by ‘finandaI position”?
2. Define asset and give an example of an asset.
3. (a) Define liability and give an example.
(b) Define owner’s equity.
4. What is the accounting equation?
5. What is a balance sheet?
6. Why did Kyle Dubord decide to go into business for himself?
What risks did he take?
7. How is the owner’s equity calculated?
8. In what order are assets listed on the balance sheet?
9. In what order are liabilities listed on the balance sheet?
10. What does a single ruled line on a financial statement indicate?
What do double lines mean?
11. What is the business entity concept?
12. What is the cost principle?
APPLY YOUR KNOWLEDGE
ExERcisEs
1. Sherry Rosenblatt is a student at Templeton Secondary School.
She works part time as a secretary at a local real estate office. The
following is a list of items Sherry has prepared in order to calcu
late her personal financial position on April 30, 19--.
14
CHAPTER
1/THE
SHEET
BALANCE
Cash in Bank
Portable Stereo System
Clothes
Tape Collection
Jewellery
Loan from Father for Stereo
$200
300
850
230
120
200
(a) Determine Sherry’s financial position by calculating her net
worth.
(b) Determine your own net worth.
2. Complete the following equations in your study guide or note
book.
A
L
=
$ 75000
?
110000
50000
80 000
+
$25000
80000
49000
40000
49 000
OE
$50000
45000
?
?
?
3. Classify the following items as assets, liabilities, or owner’s
U ity:
I
I
Cash
Bank Loan
Equipment
Land
Mortgage
Furniture
Owner’s Investment in the Business
4. The balance sheet items for the Tidey Company are listed in ran
dom order below.
a) Prepare lists of the assets, the liabilities, and the owner’s
equity.
(h Complete the accounting equation for the Tidey Company in
your study guide or notebook, following the format shown
be I ( w
Assets S
=
liabilities $
+
Owner’s Equit S
Ur’ur
j
1/FINANCIAL
Cash
Building
Land
Bank Loan
Mortgage
Equipment
S. Tidey, Capital
PosIrIoN..15
$11 500
60 000
35000
9 500
40 000
20 000
77 000
5. Prepare balance sheets using the format in Figure I-I and Figure
1 -2 for the following:
(a) Sherry Rusenhlatt (refer to exeftise I on page I 3)
I h) Tidey Company (ruler to exeftise 4 on page I 4)
6. The balance sheet items for Nakhooda Real Estate are listed
below. Prepare a balance sheet dated September 1 5, 19-- listing
assets and liabilities in correct order.
Cash
Accounts Receivable
Office Equipment
Bank Loan
Accounts Payable
Building
J. Nakhooda, Capital
Land
Mortgage Payable
Supplies
$2500
?
5 000
3 500
2 000
55 000
45 000
25000
40 000
600
7. The assets and liabilities of Susan Baird, a lawyer, on March 31,
I9-- are as follows:
Cash
Due from Clients
Office Supplies
Office Equipment
Bank Loan
Owed to Creditors
)
$11000
28 000
I 700
19 000
7 500
5 000
16
CHAPTER
1/THE
SHEET
BALANCE
(a> Classify each item as an asset or a liability.
b Calculate Baird’s equity.
Prepare a balance sheet.
Ic>
8. Le Bistro is a restaurant owned by \lkhael Kurri. The restau
rant’s assets and liabilities on September 30, 19-- are as follows’
Cash
Food Supplies
Restaurant Supplies
Furniture and Fixtures
Land and Building
Payable to Suppliers
Mortgage Payable
Bank Loan
$ 17000
3 000
4 000
50 000
190 000
12 000
85 000
20 000
(a) Calculate Kurri’s equity.
(h) Prepare a balance sheet.
[
UNIT 2
BusiNEss TRANSACTIONS
The balance sheet for Hill’s Sports Club was prepared on July 1. 19-Events will occur in the business after this date which will change th
value of the balance sheet items. For example, customers will pay tht
remainder owing on their memberships. equipment will be purchase
for the business, and payments will be made to creditors. All of thes
events are examples of transactions.
INTRODUCING TRANSACTIONS
A b.
n .‘n
rjr1ca(on
of ‘‘gs f
A transadi’n is an event occurring during the operation of a busines
which results in a financial change. A business transaction akvay
includes an exchange of things of value.
Trans.ition
oi ii t
h
i
-
‘
‘
\
n
: