A balance sheet, also called a statement of financial position, reports the assets, liabilities and owner’s equity of the business at a given date. This represents the cumulative results of all the transactions the business has engaged in from the start. Since it is basically historical in nature by its reporting of a series of recorded transactions, it thus provides a glimpse of the financial conditions of the company.
The balance sheet is an expansion of the standard accounting equation: Assets = Liabilities + Owner’s Equity. Through the nature of the equation, one can see how balances from liabilities and owner’s equity are related to the assets as a whole. The financing of the assets can then be described as either created through owner’s personal money (equity) or through borrowed sources (liabilities).
For financial accounting purposes, assets include those costs that have not been applied to revenues in the past and are considered to afford economic utility in the production of revenues in the future. They can be classified as current or non-current assets. Current assets used to refer only to cash and assets that will be realized in cash in one year. However, modifications were made so as to embrace items that are involved in the normal operating cycle of the company. Generally, cash is converted into inventories, inventories into receivables and receivables ultimately into cash again. Hence, current assets now include cash, inventories, accounts receivables and prepaid expenses. Prepaid expenses represent the substitutes for expenditures that will be used within the year. Noncurrent assets include investments, land, buildings and equipment, intangible assets and other long-term assets.
Liabilities measure the economic obligations of the company to the creditors. These include items making claim against the current assets such as accounts payable for goods and services purchased. Moreover, it can also include contingent liabilities, long-term debts, deferred revenues and deferred income taxes. The method for liability settlements vary and it may call for cash payment or settlements through delivery of goods or services.
Owner’s equity measures the interest of the owner in the total resources of the company. This is essentially a claim on the assets after the creditors have been paid in full. Owner’s equity is the difference in assets and liabilities and speaks for the net worth or capital of the company. The reporting of owner’s equity varies depending on the type of business. Businesses can be described as a sole proprietorship, partnership or corporation.
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