WHY DO COMPANIES PREPARE BALANCE SHEET?
Balance sheet is a financial statement which is widely used by accountants for businesses. Balance sheet is also known as the statement of financial position because it helps us to present company’s financial position at the end of a specified period. (fresh books, 2016)
Balance sheets are very important for parties like suppliers, investors, competitors, customers, etc. to know the company’s position, company’s strength and company’s weaknesses. Balance sheets helps to ascertain the amount of capital employed in the business so that we can further calculate different types of ratios. Some important objectives of preparing balance sheets are:
To know the nature of liabilities and actual capital;
It
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than we can assume that the financial position of the company is not sound. This also indicates that there is over trading.
If there is sufficient working capital than we can assume that it has sound financial position and if the business is under trading than there will be increment in liquid assets which shows that the funds are not been utilized and kept ideal.
Discussing some major components of balance sheet
ASSETS
Assets are those things that are owned by an organization which have future economic value that are measurable and expressed in terms of monetary value. Basically assets are those resources which are acquired by a company through various transactions. (accounting coach, 2016)
Some examples of assets are; cash, petty cash, goodwill, prepaid insurance, furniture, etc.
• Contra assets; normally assets are debit balance but contra asset is asset with credit balance.
Some examples are; accumulated depreciation, allowance for doubtful debt, etc.
In classified balance sheet categories of assets are: current assets, investments, fixed assets, intangible assets, etc.
Some
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Conservatism directs accountants to reduce the inventory to lower amount (the replacement cost).
For example: if bhatbhateni’s inventory cost $20000 but in current scenario the cost has dropped to $16000, than the company records $16000 in its balance sheet and records $4000 difference amount as a loss in income statement. (accounting coach, 2016)
• Effects of matching principle;
It states that all expenses must be matched in the same accounting period as the revenues they helped to earn. Matching principle is a combination of accrual accounting and the revenue recognition principle.
For example: if the company’s sales are made through sales representative who earn 10% commission. (The commissions for each calendar month’s sales are paid on 15th day of the following months). If the company’s has $60000 of sales in December, the company will pay commission of $6000 on Jan 15. The matching principle requires to records $6000 commission expenses on the December income statement along with December sales of $60000. (accounting coach, 2016)
Net working capital represents organization’s operating liquidity. In order to compute the net working capital, total current assets are divided from total current liabilities. When there is sufficient excess of current assets over current liabilities, an organization might be considered sufficiently liquid. Another ratio that helps in assessing the operating liquidity of as company is a current ratio. The ratio is calculated by dividing the total current assets over total current liabilities. When the current ratio is high, the organization has enough of current assets to pay for the liabilities. Yet, another mean of calculating the organization’s debt-paying ability is the debt ratio. To calculate the ratio, total liabilities are divided by total assets. The computation gives information on what proportion of organization’s assets is financed by a debt, and what is the entity’s ability to pay for current and long term liabilities. Lower debt ratio is better, because the low liabilities require low debt payments. To be able to lend money, an organization’s current ratio has to fall above a certain level, also the debt ratio cannot rise above a certain threshold. Otherwise, the entity will not be able to lend money or will have to pay high penalties. The following steps can be undertaken by a company to keep the debt ratio within normal
In order for Jim Turin & Sons, Inc to have used this method of accounting it would have had to match the cost of the merchandise with the revenue earned from the sale. Using the matching of revenue and cost the company would have had to have kept an actual inventory and maintained records of the costs associated with said inventory. Since the costs are not immediately deducted under the accrual method they are deferred to the year when the merchandise is
A strong balance sheet gives an investor an idea of how financially stable the company really is. Many professionals consider the top line, or cash, the most important item on a company’s balance sheet. The big three categories on any balance sheet are “assets, liabilities, and shareholder equity.” Evaluating Barnes & Noble’s assets for the time 2014 at $3,537,449, 2013 at $3,732,536 and 2012 at $3,774,699, the company’s performance summarizes that it is remaining stable. These numbers reflect a steady rate over the three year period. Like assets, liabilities are current or noncurrent. Current liabilities are obligations due within a year. Key investors look for companies with fewer liabilities than assets. Analyzing this type of important information, informs a potential investor that if the company owes more money than they are bringing in that this company is in financial trouble. Assessing the liabilities of the balance sheet, for the same time period, it is also consistent with the assets. The cash flow demonstrates a stable performance in the company’s assets and would be determined that the liabilities of this company are also stable. Equity is equal to assets minus liabilities, and it represents how much the company’s shareholders actually have a claim to. Investors customarily observe closely
The balance sheet displays the status of an entity at a specific time. Contrary to the balance sheet, income statements and statements of cash flows cover periods over time. These two forms provide the information on why the balance sheet has changed. To receive the information that contributes to the changes related to a change in retained income, the income statement will provide a detailed summary. To receive an explanation of the events that lead to modifications in cash, received and paid, the statement of cash flows will be utilized to provide that information (Horngren, 2014, p.
Current assets: Cash and cash equivalents Short-term marketable securities Accounts receivable, less allowances of $86 and $99, respectively Inventories Deferred tax assets Vendor non-trade receivables Other current assets Total current assets Long-term marketable securities Property, plant and equipment, net Goodwill Acquired intangible assets, net Other assets Total assets
Under the accrual basis of accounting, expenses are matched with revenues on the income statement when the expenses expire or title has transferred to the buyer, rather than at the time when expenses are paid. The balance sheet is also affected at the time of the expense by a decrease in Cash (if the expense was paid at the time the expense was incurred), an increase in Accounts Payable (if the expense will be paid in the future), or a decrease in Prepaid Expenses (if the expense was paid in
Liquidity: A company’s liquidity depends on the amount of liquid assets it possesses, which are cash or assets that can easily be converted into cash. The cash flow statement shows how much money is coming in and going out of the business therefore it shows how liquid a company is and how flexible it is to cope with emergencies. Working capital is a significant part of the cash flow analysis, it consists of the current assets less the current liabilities and can help assess the liquidity of the business for the upcoming accou...
The Quick Ratio shows that the company’s cash and cash equivalents are the highest t...
It clearly shows the difference between the income and expenses or the net profit (net loss) for the period in question. With the income statement, you can see which of your expenses consumes the greatest portion of your income. If income is greater than expenses, there is a surplus. If income is less than expenses, then there is a deficit. With a surplus, you can decide to save more or invest while if there is a deficit, you should be able to know where to address this.
The balance sheet is used to report the financial position, including amount of assets, liabilities, and stockholders’ equity of an accounting entity at a specific point in time. It includes the name of the entity, title of the statement, specific date of the statement, and units of dollars. The accounting entity should also be precisely defined (Bethel, 2011).
Matching concept is at the heart of accrual basis of accounting. Big Apple Doughnut has sold different types of doughnuts for 30 years in a small town. It purchases a large amount of flour for RM3,000 to bake doughnuts and resells it to a local restaurant for RM10,000. At the end of the period, Big Apple Doughnut should match the RM3,000 cost with the RM10,000 revenue. Moreover, Majority of the company who make sales are against credit term. Example, when the customer receives delivery of goods or services but promises to make the payment within 30 days. In accordance with accrual concept, revenue is recognized when the delivery is made. Now, risk that the customers may not pay the amount due against those sales, which results in the company writing off the account receivable as bad debts expense. The possibility of bad debts exists when the sale is made, so expense should be recognized right at that moment when the sale is made. Recognizing bad debts expense requires considerable
Asset are the resources for running the business work. As a business, if get more assets it means that the business is powerful. Asset also be divided into two categories which is non-current assets and current assets. Non-current assets are long-term use for
The resource of a business that owner own are called assets for example building, machinery etc. In other words we can say the thing that owned by a person a regard to company and having value, commitment and legacies.
In accounting terms, any tangible (physical resources) or intangible (nonphysical resources) that can be possessed or controlled to create positive monetary value is known as Asset. In other words, anything that can be transformed into cash value is termed as asset. This includes:
Financial statements ignore the deviations in price level. These statements are accounting for past rather than accounting for future. Hence they are of little value to management in taking