Balance Sheet
The Balance Sheet (sometimes called a Statement of Financial Position) summarises the business’s assets, liabilities and the net worth of the business. Unlike the P&L the Balance Sheet shows the financial condition of the business at a particular point in time (usually the last day of the business’s financial year).
The Balance Sheet is a statement of what the business owns and what the business owes.
It is called a Balance Sheet because it must balance. The business will have assets which it pays for either by borrowing money (liabilities) or funds contributed by the owner (equity). The value of the assets must equal the funds used to buy the assets.
As we saw at Level 1 there is the accounting equation:
ASSETS equals LIABILITIES plus CAPITAL Depending on which format of Balance Sheet is used, this can be translated into
ASSETS minus LIABILITIES equals CAPITAL
As we have seen, the balance sheet shows the balance on the accounts which are not revenue accounts and have not been used for the P&L. A typical Balance Sheet is shown
NOTE
In practice, accruals accounts and prepayments accounts are implied rather than drawn up. It is common for expense accounts to show simply a balance c/d and a balance b/d. The accrual or prepayment is implied and will be shown in the balance sheet.
Dr Insurance Account Cr
Date Details £ Date Details £
1stJuly Bank 2700.00 31st Mar Balance c/d 1350.00 1st Jan Bank 2700.00 31stMar Profit & Loss a/c 4050.00
5400.00 5400.00
1st Apr Balance b/d 1350.00
However, it is recommended that you follow the basic principle before attempting to skip drawing up an accruals or a prepayments account.
Balance Sheet A Buhari
As at 31st December 2013
£ £ £
Cost Accumulated NBV Depreciation
Fixed Assets
Freehold premises 80,000 0 80,000 Plant and Machinery 50,000 10,000 40,000
Vehicles 40,000 20,000 20,000
170,000 30,000 140,000 Current Assets
Stock 19,287
Debtors 29,500
Less: Provision for doubtful debts 1,475
28,025
Prepayments 1,350
Cash at Bank 6,150
Cash in hand 250
55,062 Current Liabilities
Trade creditors 22,125
Accruals 500
22,625
Net Current Assets (Working Capital) 32,437 Total Assets less Current Liabilities 172,437 Long term liabilities
Bank loan 10,000
Net Assets 162,437
Capital as at 1stJanuary 2013 157,273 Net Profit for the year 30,164
47,437
Less: Drawings 25,000
Capital at 31stDecember 2013 162,437
You will notice that there are three columns. As with the P&L, there is not a lot of significance to the columns other than it makes it easier to read. In general the right hand column shows the totals, the middle column shows how the totals are made up, and the left hand column shows how the subtotals are made up. The exception is the fixed asset section, where the cost less the accumulated depreciation equals the NBV.
Let us look at the entries in detail.
Fixed Assets
Fixed assets are also known as non-current assets. A fixed asset is a property of the business that the business uses in the production of its income. The property is not expected to be consumed or converted to cash any sooner than one year’s time.
Examples of common types of fixed assets include buildings, land, furniture and fixtures, machines and vehicles. Fixed assets are not items for resale but for production, supply, rental or administrative purposes. Assets that are held for resale must be accounted for as stock (inventory) rather than fixed asset. So, for example, if a company is in the business of selling cars, it must not account for cars held for resale as fixed assets but instead as stock. However, any vehicles other than those held for the purpose of resale may be classified as fixed assets such as delivery vans and company cars.
We saw in Chapter 9 how fixed assets may be depreciated. The original cost of the asset is reduced by the accumulated (or provision for) depreciation to arrive at the Net Book Value (NBV). The NBV is the figure which is included in the Balance Sheet figures.
Current Assets
Current assets are assets which are reasonably expected to be converted into cash within one year. They are usually listed in reverse order of their liquidity. Liquidity is the ease with which you can convert into cash. Depending on the nature of the stock, this will usually be the first item. Stock must be sold before it can become cash. If it is sold on credit, it could be some time before its conversion to cash. Trade debtors will be the next item since cash should be forthcoming from them within weeks. The most liquid item is cash itself.
You may have noticed a provision for doubtful debts. Many businesses will put aside an amount of money for credit customers who cannot or will not pay. We will look at this in more detail at Level 3.
Current Liabilities
Current liabilities are liabilities which become due within one year. Again they will be listed in reverse order of liquidity. Apart from trade creditors and accruals, a bank overdraft would be shown here (rather than in the current assets) as well as any VAT due
to be paid to HMRC. Any bank loans which are due to be paid off within the year will be transferred here from the Long Term liabilities.
Net current assets
Net current assets are also known as Working Capital. It is calculated as the current assets less the current liabilities. It shows the amounts of cash the business has to work with over the next 12 months. One would hope that the current assets are more than the current liabilities (i.e. a positive working capital). If the business has a negative working capital it will have problems paying its debts when they become due.
Total assets less current liabilities
This shows the value of the business apart from the long term liabilities (see below). The long term liabilities will not become due until at least 12 months so it is useful to see the probable value of the business for (at least) the next 12 months.
Long term liabilities
These are items which are due to be repaid after more than 12 months. Items will include bank loans and loans from other sources. Such loans will be transferred to the current liabilities when their term becomes less than 12 months.
Capital
Capital is the amount which has been invested by the owners of the business. It shows the net worth of the business.
Any profit is added to the capital annually and any drawings are deducted. Remember that the owners of a company do not receive wages – they receive drawings.
Extended Trial Balance (ETB)
(This will not be assessed in the ICB exam, but it is a most useful aid in drawing up a P&L and a Balance Sheet)
Some businesses will use an Extended Trial Balance in order to facilitate the drawing up of the P&L and the Balance Sheet. It is basically a Trial Balance with categories extending to the right. These categories are ‘adjustments’, ‘Profit & Loss’ and ‘Balance Sheet’. Each category has a column for debits and credits. (See p189).
Suppose we have a Trial balance as shown on the next page:-
We now have to transfer these balances to the Extended Trial Balance (see next page) Trial Balance
31 December 2013
Dr Cr
£ £
Name of account
Sales 162,700
Sales Returns 1,300
Purchases 80,000
Purchase Returns 1,150
Sales Ledger Control 10,000
Purchases Ledger Control 1,000
Heat & Light 900
Rent and rates 10,000
Office Stationery 650
Office Wages 40,000
Office Equipment 12,500
Office equipment accumulated depreciation 2,500
Vehicle 16,000
Vehicle accumulated depreciation 4,000 Stock (at 1stJan 2012) 7,000
Cash (till float) 200
Bank 7,500
VAT 9,600
Bank Loan 5,000
Capital 4,850
Drawings 4,750 ______
190,800 190,800
Account Balance Adjustments Profit & Loss Balance Sheet Dr
£
Cr
£
Dr
£
Cr
£
Dr
£
Cr
£
Dr
£
Cr
£ Sales 162700
Sales Returns 1300 Purchases 80000 Purchase
Returns 1150 Sales Ledger
Control 10000 Purchase Ledger
Control 1000 Heat & Light 900 Rent and Rates 10000 Office
Stationery 650 Office Wages 40000 Office
Equipment 12500 Acc Depn
(Office Equip) 2500 Vehicle 16000 Acc Depn
(Vehicle) 4000 Opening Stock 7000
Cash 200
Bank 7500
VAT 9600
Bank Loan 5000 Capital 4850 Drawings 4750
TOTAL 190800 190800
Before we draw up a balance sheet and a P&L we find the following adjustments:-
1. A customer has gone into liquidation and the amount owing of £1000 must be written off. (Ignore VAT).
2. Depreciation has not yet been accounted for. Equipment is depreciated at 20% per year using the straight line method and vehicles are depreciated at 25% per year using the reducing balance method.
3. Wages for £4500 are still owing.
4. A payment for rent of £4000 has been paid covering the period October 1st to 31st March.
5. Stock has been counted on 31st December 2013 and it amounts to £10,000.
We now need to show these adjustments in the adjustment columns of the ETB.
Remember that each adjustment will need a double entry.
The adjustment for item 1 will be
Debit Bad Debts £1000 Credit Sales Ledger control £1000 We don’t have a bad debts account so we will need to create one.
The adjustment for item 2 will need to be calculated. The equipment is depreciated at 20% per year using the straight line method. 20% of £12500 is £2500.
The vehicle is depreciated at 25% per year using the reducing balance method. 25% of the original cost less the accumulated depreciation. 25% of (£16000 - £4000) is £3000.
Therefore the adjustment will be
Debit Depreciation £5500
Credit Accumulate depreciation Office Equipment £2500 Credit Accumulate depreciation Vehicle £3000 We don’t have a depreciation account so we will need to create one.
The adjustment for item 3 is an accrual.
Debit Wages £4500
Credit Accruals £4500
The adjustment for item 4 is a prepayment. Only half the amount is a prepayment (3 months within the period and 3 months for the next period.
Debit Prepayments £2000 Credit Rent and Rates £2000
Note the treatment of the closing stock (item 5). There will be a new account for the closing stock and we should both debit and credit this account. We will see why when we come to extending the figures.
Debit Closing Stock £10000 Credit Closing Stock £10000
We need to put these adjustments into the ETB. We must total the figures to ensure the debits match the credits.
Once the adjustments have been completed we must put the new totals into the P&L columns and the Balance Sheet columns. We must look at each account and ‘extend’ it by the adjustment. We must add debits to debits and credits to credits. We must subtract credits from debits and debits from credits.
This is where care must be taken to ‘extend’ the figures to the right columns (P&L or Balance Sheet). Note the treatment of both the opening and closing stock. The opening stock is debited to the P&L and the closing stock is credited to the P&L. This is the adjustment required in the calculation of the Cost of Sales. The closing stock is also debited in the Balance Sheet.
Once the figures have been ‘extended’ we will find that the debits and credits do not balance on the P&L or the Balance Sheet. However, the amount it doesn’t balance by will be the same for the P&L as for the Balance Sheet. This missing figure will be the profit figure. Looking at the Balance Sheet, if the ‘missing’ figure is a credit a profit will have been made; if the ‘missing figure is a debit a loss will have been made.
The completed ETB is shown on the next page. Look at each entry and ensure you would be able to do this for yourself. Particularly make sure you know which accounts are P&L accounts and which are Balance Sheet accounts.
Account Balance Adjustments Profit & Loss Balance Sheet Dr
£
Cr
£
Dr
£
Cr
£
Dr
£
Cr
£
Dr
£
Cr
£ Sales 162700 162700
Sales Returns 1300 1300
Purchases 80000 80000
Purchase Returns 1150 1150
Sales Ledger Control 10000 1000 9000
Purchase Ledger Control 1000 1000
Heat & Light 900 900
Rent and Rates 10000 2000 8000 Office Stationery 650 650
Office Wages 40000 4500 44500 Office Equipment 12500 12500
Acc Depn (Office Equip) 2500 2500 5000
Vehicle 16000 16000
Acc Depn (Vehicle) 4000 3000 7000
Opening Stock 7000 7000
Cash 200 200
Bank 7500 7500
VAT 9600 9600
Bank Loan 5000 5000
Capital 4850 4850
Drawings 4750 4750
Bad Debts 1000 1000 Depreciation 5500 5500 Accruals 4500 4500
Prepayment 2000 2000
Closing Stock 10000 10000 10000 10000 Profit 25000 25000 TOTAL 190800 190800 23000 23000 173850 173850 61950 61950
Once we have completed the ETB we can draw up the P&L and Balance Sheet Trading and Profit and Loss Account
For the Year Ended 31st December 2013
£ £
Sales 162,700
Less Sales Returns 1,300
Net Sales 161,400
Cost of Sales
Opening stock 7,000
Purchases 80,000
Less Purchase Returns 1,150 Less Closing Stock 10,000
75,850
Gross Profit 85,550
Expenses:
Heat & Light 900
Rent & Rates 8,000
Office Stationery 650
Office Wages 44,500
Bad Debts 1,000
Depreciation 5,500
60,550
Net Profit 25,000
Balance Sheet
As at 31st December 2013
£ £ £
Cost Accumulated NBV Depreciation
Fixed Assets
Office Equipment 12,500 5,000 7,500
Vehicles 16,000 7,000 9,000
28,500 12,000 16,500 Current Assets
Stock (as at 31st December 2013) 10,000 Debtors (Sales Ledger Control) 9,000
Prepayments 2,000
Cash at Bank 7,500
Cash in hand 200
28,700 Current Liabilities
VAT 9,600
Trade creditors (Purchase Ledger Control) 1,000
Accruals 4,500
15,100
Net Current Assets (Working Capital) 13,600 Total Assets less current liabilities 30,100 Long term liabilities
Bank loan 5,000
Net Assets 25,100
Capital as at 1st January 2013 4,850 Net Profit for the year 25,000
29,850
Less: Drawings 4,750
Capital at 31st December 2013 25,100
Chapter Summary
• All the accounts from a Trial Balance are brought together into two financial statements; the Profit & Loss account and the Balance Sheet.
• The Profit & Loss account shows all the revenue accounts. It takes the net sales and deducts production costs to show a Gross Profit. Expenses are then deducted from the Gross Profit to show a Net Profit (or loss).
• The Balance Sheet shows what a business owns and what it owes. As the name suggests, the Balance Sheet must balance.
• Adjustments are made to accounts so that what is recorded is the amount due in the period rather than what is actually paid. These adjustments are called accruals and prepayments
• An Extended Trial Balance may be used as a tool to help prepare the P&L and the Balance Sheet.
EXAM TIP
You must use all the accounts in the TB in either the P&L or the Balance Sheet. If possible it is a good idea to mark off each account from the TB as it is used in the Financial Statements.
