Balance Sheet

MANAC I
Session 2
What are the outputs of an
Accounting?

 Financial Statements:

 Balance Sheet

 Profit and Loss Account

Basic Concepts to be known:
1. Money measurement.
2. Entity.
3. Going concern.
4. Cost.
5. Dual aspect.
6. Accounting period.
7. Conservatism.
8. Realization.
9. Matching.
10. Consistency.
11. Materiality
12. Diversity among independent entities
13. Dependability of the data
14. Property Right concept
Basic Concepts Covered in BS:

1. Money measurement.
2. Entity.
3. Going concern.
4. Cost.
5. Dual aspect.

 Related to Balance Sheet

Example

 A business owns Rs.60,000 of cash, 12,000

kilos of raw materials, three tractors, 20,000
square feet of building space, and so on.

 Do not add apples and oranges, it is easy to

add if both of them are expressed in
monetary values.
Concepts …

 Money Measurement
 Representation in a common denominator and
amenable to summarization by addition &
subtraction
Business Entity Concept

 the entity is separate and distinct from

the owners and the entity is liable to the
owner
 Hence, in a limited liability company, the
enterprise is liable to the owner
(shareholder) based on the proportion
of the capital investment (share capital)
made by the latter

 Kutty’s Kab Case

Illustration – Valuation of a Machine
Pradeep, a cotton yarn manufacturer, purchased a
machine paying cash Rs. 70,000. At which value do you
record this transaction?
Historical Cost
Fair Value
Present Value

• Due to its many advantages, historical cost is the

most used in the field of accounting
Cost concept-current assets
 Cash, marketable securities.
 Initially recorded at cost.
 Adjusted to fair value (=market value, if
available).
 Rationale: FV is relevant, objective &
feasible.
 Why is FV relevant & objective for
monetary assets but not for non-monetary
assets?
Example

 A business buys a plot of land in Mumbai

paying Rs.10 million for it, this asset would be
recorded in the accounts of the business at
the amount of Rs.10 million. A year later the
land value had gone up to Rs.50 million, no
change would ordinarily be made in the
accounting records to reflect this fact
Going Concern

 entities have a life of infinite duration,

unless facts are known that indicate
otherwise

 the basis of valuation of resources is

influenced more by their future utility
to the business entity than by their
current market valuation
Dual Aspect Concept

 Balance Sheet Equation

Basic Concepts Covered:
1. Money measurement.
2. Entity.
3. Going concern.
4. Cost.
5. Dual aspect.
6. Accounting period.
7. Conservatism.
8. Realization.
9. Matching.
10. Consistency.
11. Materiality
12. Diversity among independent entities
13. Dependability of the data
14. Property Right concept
What is a Balance Sheet?
 Balance Sheet is concerned with
 Reporting financial position of an entity as of a
particular point in time
 Done by listing all the things of value owned by the
entity as also the claims against these things of value
 Position as represented by the balance sheet is valid
only until another transaction is carried out by the entity
 It is a snapshot of the financial health of an entity

 It is a static statement and change with every economic

transaction
What is a Balance Sheet?
Advantages
 Financial health as whether good or bad
 Financially sound or not

 Allows comparisons with the past financial status

 (Time Series)

 Also comparison between multiple entities (on financial position)

 (Cross section)
Balance Sheet – Conceptual Basis

 I want to purchase a car costing Rs. 500,000. To

do so, I have to borrow. A bank agrees to
finance me if I can invest Rs. 100,000 on my
own
 Two relevant questions:
 What are the things of value you own?

 How much do you owe, and to whom?

Illustration…
Things of value owned by Rs. Amounts owed by Rs.
me me
Savings deposit in bank 50,000 Loan from a friend 50,000

Term deposit in bank 150,000

Other personal possessions 50,000

Total 250,000 Total 50,000

Say, the bank grants me the loan of Rs. 400,000 and I buy the car for Rs.
500,000. After purchase of the car my financial position statement will
change as follows:
Illustration…
Things of value owned Rs. Claims against things Rs.
by me of value
Savings deposit in bank 50,000 Loan from a friend 50,000
Term deposit in bank 50,000 Own claim or net 200,000
worth
Car 500,000 Bank Loan 400,000
Other personal 50,000
possessions
Total 650,000 Total 650,000

As a result of this transaction my worth is

increased from Rs. 250,000 to Rs. 650,000
But, my net worth remains the same. Why?
Learning's from the example …

 Things of value possessed by an entity are referred to as

assets
 Accountants use the term “assets” to describe things of
value measurable in monetary terms
 The amount owed by an entity expressed in monetary
terms, which represents a claim by outsiders against its
assets, is referred to as “liabilities”
 Liabilities are claims of outsiders, against an entity and
are legally enforceable
And …

 Net worth of the owner(s) of the entity = The

value of assets owned by the entity less
liabilities (or outsider’s claims)
 Also known as “owner(s) equity”
 As it represents the claims of owner(s) in case
of an entity
 Hence, financial position statement is
 a summary of the assets, liabilities and net
worth
 as of a particular point in time
Lets compare …
Assets Liabilities &
I II I II
Net Worth
Bank Savings Deposit 50,000 50,000 Loan from a friend 50,000 50,000
Term deposit in bank 150,000 50,000 Own claim / Net worth 200,000 200,000

Car - 500,000 Bank Loan - 400,000

Personal Possessions 50,000 50,000
Total 250,000 650,000 Total 250,000 650,000

Outsiders claim has priority over the owner(s) claim on the assets and
owner(s) equity is always a residual claim
hence
against assets It follows from this that at any point in time, for
all accounting entities owner(s) equity and liabilities will be equal to
assets owned by that entity.
Balance Sheet Equation

 This idea fundamental to accounting could be

expressed as an equality:
 Assets = Liabilities + Owners Equity

 Owner(s) claim is residual:

 Owners Equity = Assets – Liabilities

 The ‘benefit-sacrifice’ aspect

 If assets equal Rs.145,000 and liabilities
equal to Rs. 50,000, then Owner’s Equity
equals _____________
 If assets equal to Rs. 65,000 and Owners’
Equity equals Rs.40,000, then liabilities equal
_____________
Balance Sheet Changes

 Balance sheet represents the position at a

particular point in time
 Any material transaction or exchanges can
change the position
 Let us look at some specific examples of
transactions changing Balance Sheet
Possible changes in Balance Sheet
Possibility Example
An increase in assets followed by an Purchase of a tractor using a bank loan
increase in liabilities and vice versa
A decrease in assets followed by a Using the savings deposit in bank to
decrease in liabilities and vice versa return the loan from a friend
An increase in assets followed by an Interest earned on the savings deposit
increase in equity and vice versa increasing the net worth
A decrease in assets followed by a Theft of some personal possessions
decrease in equity and vice versa leads to decrease in owners equity
An increase in an asset followed by a Using my savings balance in bank to
decrease in another asset and vice versa purchase a computer
An increase in a liability followed by a Taking a new bank loan to return the
decrease in another liability and vice loan from a friend
versa
Other examples

1. Buy a Machinery worth on loan of

Rs.50,00,000
2. I invest into the business of Rs.10,00,000
3. Borrow to buy a Truck of Rs.8,00,000
4. Sold part of the machinery for Rs.5,00,000
5. Borrowed money from a friend to repay
bank loan of Rs.10,00,000
Revenue and Expenses
 The increase in owner(s) equity to match the asset
increase realized from a sale transaction is referred to as
‘revenue’
 The decrease in owner(s) equity to match the decrease in
assets suffered to earn revenue are referred to as
‘expenses’
 Revenues increase owner(s) equity and the expenses
decrease owner(s) equity
 The owner(s) equity increases or deceases to the extent
of profit or loss earned by the entity.
 Owner’s Equity

 Owner(s) equity comprises two parts:

 Owners Equity = Contributed Capital + Retained
Earnings
Take aways…

 The dual aspect principle has particular relevance to

balance sheet
 All the figures are expressed in monetary units, irrespective
of its nature
 All the transactions we reflected were only with respect to
the business entity, (specific entity)
 All the valuations were based on the assumption of a going
concern, and not based on liquidation or break up value
 All the asset valuations were based on historical cost as the
basis of valuation
 List out Assets, Liabilities and Equity either
you or your parents/father has ……….

 THINK………
Questions