Balance Sheet

What is a Balance Sheet

To understand this subject,please think of the literal meaning of the words ‘balance’ and ‘sheet’. Balance, this means that the balance sheet must be balance. There are two parts to it and each part must total to the same figure. Put another way, the sum of the debit balances must equal the sum of the credit balances. All the figures come from the extended trial balance. The balance sheet sound like the trial balance but income and expenditure accounts are not included. The balance sheet balances because one figure, being the different between the income and expenditure accounts (which is of course the profit or less) is transferred to the balance sheet.

Sheet taken literally this means a sheet of paper on which the figures are listed.

The balance sheet is a logical listing of the three types of accounts as below:

  • Assets accounts  (with the debit balances)
  • Liability accounts  (with the credit balances)
  • Capital accounts  (with the credit balances)

Balance Sheet Format

Basic structure of balance sheet

Basic structure of balance sheet

Profit and Loss Accounts’s Positions

The net profit or net loss at the bottom of the profit and loss account is added to the capital accounts. The result is that the balance sheet balances, which is essential.

The profit and loss account covers a stated period of time. if trading is continuing, the profit or loss would be different if the period were to be one day longer or shorter. The balance sheet is not like that and it does not cover a period of time. it is a listing of the balances on just one fixed date which is stated, usually the last day of the trading period.

The Concept of Ownership

Asset and liability accounts are relatively easy to understand, but the capital accounts may cause difficulties. Sometimes there may be just one account called the capital account. In other cases there may be several accounts.

Example of ownership accounts in a company:

  • Share capital accounts
  • Share premium accounts
  • Revenue reserves

The capital accounts represent the net worth of the business. This is the present book value of the owners’ investment in the business, which is not the same thing as the value of their original investment. The owners are a different entity to the business itself. A registered company has a legal existence and personality separate from shareholders who own it. This is not the case in a business owned by a sole trader.

If a company is wound up, and if the assets and liabilities are worth book value and if the costs of winding up are ignored, the owners will be paid out exactly the value of the capital accounts.This is easy to understand in the case of a listed public company. for example, If you own shares in HSBC bank, you are not the same as the bank.You are gust one of a very large numbers of its owners. the capital accounts in the books of HSBC bank represent the money owing to you and the other shareholders. It is the value of the combined investment made by all the shareholders.