Financial accounting and reporting
Financial accounting and reporting

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Financial accounting and reporting

4.3 The balance sheet

At the end of an accounting period, all assets and liabilities are listed from individual accounts on to the trial balance and then added up together, with like items grouped together. There are two ways of showing assets and liabilities on a balance sheet – using either a horizontal format or a vertical format . A horizontal format lists all the assets on the left-hand side and all the liabilities on the right. As a result of the manner in which transactions are recorded using double-entry bookkeeping, the total of assets always equals the total of liabilities. This is why a statement of financial position is commonly called a ‘balance sheet’, that is, both sides (or halves) add up to the same amount. A vertical format often shows capital in the ‘bottom’ half, and in the ‘top’ half shows assets with liabilities deducted from them (current liabilities, for example, are deducted from current assets to show net current assets or liabilities). This is often referred to as the net assets approach . It is also possible to show all assets in the top half and all liability (or credit) balances in the bottom half (which is now possible under the international accounting approach ) Any entity could, in theory, produce a balance sheet in either format, as it is just a matter of presentation. The vertical balance sheet (i.e., using the net assets approach) is common in the UK, but different countries have different rules. It would not, for example, be permitted in France, although other countries with specific regulations may require it for certain types of entities. Examples of a horizontal and vertical balance sheet are shown in Figures 4 and 5 below – again for Mr Schmidt, the hypothetical sole trader whose income statement you looked at previously, in Figure 3.

Mr Schmidt – Balance sheet as at 31 March 2010

££
Non-current assetsCapital
Fixtures and fittings18,000Cash introduced25,000
Retained earnings11,000
Current assetsNet profit for the year9,400
Inventory12,000
Trade receivables5,800Current liabilities
Cash at bank and in hand2,300Trade payables8,200
DrawingsTotal 15,500
Total 53,600Total 53,600

Figure 4 Example of a horizontal balance sheet

Mr Schmidt – Balance sheet as at 31 March 2010

££
Non-current assets
Fixtures and fittings18,000
Current assets
Inventory12,000
Trade receivables5,800
Cash at bank and in handTotal 2,300
20,100
Current liabilities
Trade payablesTotal (8,200)
Net current assetsTotal 11,900
Net assetsTotal 29,900
Capital
Cash introduced25,000
Retained earningsTotal 11,000
36,000
Add: Net profit for the yearTotal 9,400
45,400
Less: DrawingsTotal (15,500)
Total 29,900

Figure 5 Example of a vertical balance sheet, following the net assets approach

Again, do not worry if there are things here that you do not understand, such as drawings or why these are included in the horizontal balance sheet with assets, as these will be explained later (though drawings are simply a withdrawal of capital by the owner(s)). You will see in the above balance sheets that both show the profit of £9,400, as per the income statement in Figure 3, included with the capital elements.

Activity 5

Classify the following items as income, a cost/expense, an asset or a liability:

 

a machine for manufacturing widgets

a. 

income


b. 

cost/expense


c. 

asset


d. 

liability


The correct answer is c.

Discussion

This is a tangible non-current asset – used for carrying out business and likely to be kept for a long time.

 

air conditioning used in a factory

a. 

income


b. 

cost/expense


c. 

asset


d. 

liability


The correct answer is b.

Discussion

This is a cost/expense – a utility needed to keep machinery and employees at an appropriate temperature while they work. If the actual air conditioning plant itself is implied by the words ‘air conditioning’ (rather than what the plant actually does) then this would be a tangible non-current asset, likely to be used and kept for a long time.

 

sales of 1,000 widgets for cash to Mr Mohammad, a customer

a. 

income


b. 

cost/expense


c. 

asset


d. 

liability


The correct answer is a.

Discussion

This is a sale to a customer, generating sales revenue (income).

 

£3,000 borrowed from the bank

a. 

income


b. 

cost/expense


c. 

asset


d. 

liability


The correct answer is d.

Discussion

This is a loan, which will have to be paid back. It is a liability, and whether it is classified as current or long-term will depend on the date of repayment.

 

a heap of metal on the yard, to be used for manufacturing widgets

a. 

income


b. 

cost/expense


c. 

asset


d. 

liability


The correct answer is c.

Discussion

This is raw material to be used in manufacturing so is inventory. Hence, it is a current asset.

 

£4,000 owed to Pyron Ltd for the metal on the yard

a. 

income


b. 

cost/expense


c. 

asset


d. 

liability


The correct answer is d.

Discussion

This is money owed for material to be used in the business, so it represents a trade payable, and would be a current liability.

 

a Toyota Lexus car, used by an employee, but owned by his/her employer, Yen Ltd

a. 

income


b. 

cost/expense


c. 

asset


d. 

liability


The correct answer is c.

Discussion

This is a non-current asset. This is because it is used in the business for transporting the employees (it may be what is called a ‘pool’ car, that is, it is available to a variety of employees). It is important to note that the car is owned by the employee’s company, not the employee. Therefore, the car would be one of the company’s non-current assets.

 

£10,000 of personal savings used by someone starting up a business

a. 

income


b. 

cost/expense


c. 

asset


d. 

liability


The correct answer is d.

Discussion

This is money introduced to do business – therefore, it is capital which may be regarded as a particular type of liability, in that it will eventually be repayable to the owner.

B291_1

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