chapter 2

Chapter 2 Notes - Balance Sheet
Section 2.1: Financial Position
Perhaps the most important objective of accounting is to determine the financial position of an
individual or business on a particular date.
How do we do this for an individual like you?
1. List all of the things that you own with a dollar value (assets)
2. List all of your debts or monies owed to others (liabilities)
3. Subtract your total liabilities from your total assets. This difference is called your net worth or net
value (equity)
(In other words, 'financial position' is just another term for equity or worth or value.)
The same three steps above can be used to calculate the financial position of a business on a particular
Accounts Receivable (an asset) refers to money owing to us from our debtor customers. A debtor is an
individual or business who owes us money.
Accounts Payable (a liability) refers to money we owe to our creditor suppliers. A creditor is an
individual or business to whom we owe money.
So now we know that total assets minus total liabilities equal owner’s equity for any business. And
because this equation is absolutely essential to an understanding of this course, this calculation is known
as the fundamental accounting equation.
Assets - Liabilities = Owner’s Equity (A - L = OE)
The fundamental accounting equation may also be written as:
Assets = Liabilities + Owner’s Equity (A = L + OE)
Assets, Liabilities and Owner’s Equity can all be found on a financial statement known as a Balance Sheet,
(or Statement of Financial Position under International Financial Reporting Standards (IFRS) which are
now in use in Canada.)
A balance sheet is used to calculate the net worth or net value or equity of an individual or business on a
particular date.
Section 2.2: Balance Sheet
A balance sheet shows the financial position (A = L + OE) of an individual or business on a particular
The financial position of a business refers to the net worth or net value or owner's equity of that
business at a specific point in time.
The formal method of presenting the financial position of a business is by means of a financial statement
known as a balance sheet (or Statement of Financial Position under IFRS).
A business balance sheet lists all of the assets and liabilities of that firm on a particular date. It is
analogous to taking a picture of that business at a given point in time.
Please note that the personal assets and liabilities of the business owner do not belong on the business's
balance sheet (see Business Entity Concept below under GAAP). For example, the owner’s personal
vehicle and personal bank loan should not appear on the balance sheet of the owner’s business.
And please note that for the sake of ease and convenience, we will mostly be looking at the balance
sheets of service-based sole proprietorships during the first few months of this course.
The individual items seen on financial statements such as balance sheets and income statements are
known as accounts.
Accordingly, most businesses have several asset accounts (e.g., Bank Balance, Accounts Receivable,
Equipment) and several liability accounts (e.g., Bank Loan, Accounts Payable). Sole proprietorships will
only have one equity account though, which is the owner’s name followed by the term Capital (e.g., B.
Pitt, Capital). Capital is just another term for equity or worth or value.
Accounts Receivable (Asset) - When customers of our business buy products from us, they often buy
them with the understanding that they will not have to pay for them until a later date, known as
buying/selling 'on credit' or 'on account'. This debt to our business is considered an asset because it
represents money that is owed to our firm. (The assumption is that all debts owing to another business
will eventually be paid.) These debts are included on the balance sheet under an asset account known as
Accounts Receivable. A customer who owes money to our business is known as a debtor.
Accounts Payable (Liability) - When a business purchases goods or services from one of its suppliers, it
often buys them with the understanding that it will not have to pay for them until a later date, once
again known as buying/selling 'on credit' or 'on account'. These purchases represent a debt of the
business that must eventually be paid. As such, they are included in a liability account on the balance
sheet known as Accounts Payable. A supplier (or lender) to whom our business owes money is known as
a creditor.
Individual and Commercial Debtors and Creditors under A/R and A/P - Individual debtor customers
under Accounts Receivable and individual creditor suppliers under Accounts Payable are always listed in
alphabetical order based on their last names, e.g., B. Gold.
For commercial debtors and creditors though, the first name of the company is used to determine
alphabetical order, e.g., Hughes Dry Goods.
Liquidity of Assets
Assets are always listed in order of liquidity on the balance sheet.
Liquidity refers to the relative ease and speed with which assets can be converted into cash.
The most liquid assets come first, while less liquid assets come later.
Of course, Cash on Hand and Bank Balance are already in their most liquid forms, while liquidity in
relation to Accounts Receivable refers to how quickly such debts will be collected in full, which is
typically 30 days or less.
As for non-monetary assets, liquidity means the relative ease and speed with which such assets can be
sold on the open market at or near their fair market value.
That said, non-monetary assets like Equipment and Building will likely never have to be converted into
cash unless the business runs into financial difficulty and is forced to sell off (or liquidate) those longterm assets in order to satisfy the claims of its creditors.
Alternatively, another way of recording assets on the balance sheet is to list them in the order in which
they will be used up or consumed - those likely to be used up most quickly come first while those most
likely to last a long time come later.
Due Date of Liabilities
On the other hand, liabilities are always listed on the balance sheet in the order in which they are due
and payable. The earliest due dates come first while the later due dates follow afterwards. In the
absence of express due dates however, common sense must dictate the order in which liabilities are
listed on the balance sheet.
Summary of Balance Sheet Formatting Rules
When preparing a balance sheet, pay particular attention to the following:
1. Proper accounting paper must be used (i.e., columnar paper)
2. The heading is centered on the top three lines in the following order - who (name of business), what
(name of financial statement) and when (date of preparation)
3. Subheadings (Assets, Liabilities, Owner’s Equity) are underlined
4. Assets are listed in order of liquidity (see above)
5. Liabilities are listed in the order in which they must be paid (due date) unless no due dates are
provided, in which case common sense must prevail (A/P, B/L, M/P)
6. Both individual and commercial debtors and creditors are indented and listed after dashes in
alphabetical order under either Accounts Receivable (debtors) or Accounts Payable (creditors)
7. The sole proprietor’s first initial and last name followed by a comma and “Capital” is always listed
under Owner’s Equity, e.g., B. Goldkind, Capital
8. If a column of figures is to be added or subtracted, place a single line below those numbers and draw
that line from margin to margin
9. Figures for Total Assets and Total Liabilities and Equity are double underlined (from margin to margin)
and must appear in the same row at the bottom of the balance sheet - please note that the single line
above and double line below these two figures must remain "closed" (sandwich rule)
10. Typical hand-prepared balance sheets contain five dollar signs (first asset, first liability, three totals)
11. Abbreviations should never be used unless the name of a business already contains one, e.g., IBM
12. Do not use decimals or commas when recording dollar figures on columnar paper
13. All lines must be drawn with a ruler and all terms must be written neatly
14. Use a pencil when preparing financial statements to allow for easy corrections
15. There must be at least one space between Total Liabilities and the Owner’s Equity section
16. Total liabilities actually appears twice on the right side of the balance sheet - once as Total Liabilities
and once as an element of Total Liabilities and Equity
17. A single dash or double zero in the far right money column indicates zero cents - please be
consistent in your choice of method (although your teacher prefers dashes)
18. All terms should be capitalized on the balance sheet
Related flashcards
Create Flashcards