Balance Sheet

contd. from Accounting Basics

1.3 Balance Sheet 

Mr. Das now started explaining about balance sheet. It is a one kind of financial statement that reports company's assets, liabilities, and stockholders' (or owner's) equity at a specific point in time. It is a snapshot of a company's financial position at a given moment. For example, if a balance sheet is dated March 31, 2009 the figures shown on the balance sheet are the balances in the respective accounts after all transactions of March 31, 2009 have been recorded.

1.3.1 Assets 

Assets are the resources that a company owns. So in your case all motorcycles, cash in the bank, all supplies (raw material) in hand, and equipment are assets. These assets can be reported in accounts called vehicles, cash, supplies, and equipment. Accounts Receivable is also one asset as it records earning or sale made but not paid.
A. Prepaid 
You have to learn about obvious asset,—the unexpired portion of prepaid expenses. Suppose for instance, TOD pays Rs. 15000 on July 1, for an insurance premium on its motorcycles (insurance premium is being paid bi-annually). This is Rs. 2500 for a month. From July 1 till July 31 Rs. 2500 worth of insurance is used or “expires”. This expired amount will be reported as Insurance Expense on July's income statement. The remaining Rs. 12500 “unexpired insurance” premium would be reported in asset account on balance sheet called Prepaid Insurance. Some examples of prepaid include supplies. The portion that gets used up in the current accounting period is listed as an expense on the income statement; and unexpired is listed as an asset on the balance sheet. You might have observed a strong link between income statement and balance sheet which we shall see in later chapters.

B. Cost Principle and Conservatism 
Mr., Das emphasized that company’s assets, should be recorded at original cost and be carried at original cost even when market value of item has increased. This is due to another basic accounting principle known as the cost principle. Accountants may not increase the value but they may decrease the value based on one more concept- Conservatism. For example, if you are preparing balance-sheet for September 30, 2009 and you wish to report value of boxes (used to carry Food Items) as one of the asset which were bought at $1 on July 2009. If price of box has been cut by 50% and current purchase price is 50 cents. Since replacement cost of the inventory (50 cents) is less than original price ($1), principle of conservatism dictates that this inventory asset should be reported at lower amount on balance sheet. In nutshell, by cost principle assets can not be reported at more than cost and by conservatism assets should be reported at less than their cost.

C. Depreciation
All assets such as equipment, vehicles, and buildings are routinely depreciated. This is as per matching principle. For the sake of definition, depreciation is allocation of cost of the asset to “depreciation expenses” in the income statement over its useful life. Generally depreciation is used for assets whose life is limited—for example equipment wears out, vehicles become old and costly to maintain, buildings age, and some assets like IT equipment become obsolete.
Just for the sake of understanding, suppose you have 5 motorcycles, each purchased for Rs. 50,000 with useful life of 5 years (Total=250000). The accountant allocate one-fifth of 250000 to depreciation expenses or match 250000/5 with each year’s revenue for 5 years. Every year the carrying amount or book value will be reduced by Rs. 50000. Book value (or carrying amount) is cost of motorcycles minus total depreciation since acquisition of motorcycles.
This means that after one year the balance sheet will show book value of motorcycles as Rs. 200000, after two years Rs. 150000 and so on till it becomes zero at the end of five years.
Assets are not shown on the balance sheet at their fair market value. Assets such as buildings, equipment, also called as long-term assets are reported at their cost minus the depreciation which shown in the income statement as Depreciation Expense. Thus value of asset on the balance-sheet might have gone up in the market but it is consistently reduced on balance-sheet as accountant has moved some of its cost to depreciation expenses in income statement. It is also possible that some asset (e.g. furniture) might have fair market value much smaller than book value reported on balance sheet. The Land is not depreciated hence it appears at its original cost. Current asset (short term assets) values are close to their market values, since they tend to "turn over" in short periods of time.

1.3.2 Liability 

The balance sheet also shows liabilities as on date of reporting. Liabilities are obligations of the company to others viz. loan from lenders (loan payable), the interest on the loan (Interest Payable), the amount payable to other stores for items purchased on credit (Accounts Payable), and the salaries to be paid (Wages Payable). Occasionally company also receive money in advance before actually earning it. For example some corporate customer may pay you in lump sum on July 1 for Food Items (say Rs. 10,000) to be delivered for next two months. Your company TOD has received cash Rs. 10,000 but it will turn into revenue only when TOD earn it by delivering Food Items. On July 1, cash asset has increased by Rs. 10,000 but TOD also has liability of same amount as it has to fulfill its obligation else return the money.
On July 1, liability account has “unearned revenue”. When TOD deliver Food Items worth Rs. 5000 each for next two months, each month Rs. 5000 is moved from ‘unearned account” to “service revenues”.

1.3.3 Stockholder’s Equity 

This is another section in the balance sheet provided company is a corporation. It is also called Owner’s equity if company is sole proprietorship. The Stockholders' Equity is the difference between the asset and liability. It is "book value" of the corporation. It comprise of common stock, preferred stock, retained earnings, and current year’s net income.
Whenever a company issue shares, common stock increases. With the increase in profit retained earning increases and exactly opposite happens when company incurs net loss. This implies increase in revenue increases stockholder’s equity and expenses case decrease in equity. Now you realized relationship between income statement and balance sheet.