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Trading,pl and balance sheet


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  • 1. Examples of Trading and Profit and LossAccount and Balance Sheet:Learning Objectives: 1. Prepare trading and profit and loss account and balance sheet.Example 1:From the following balances extracted from the books of X & Co., prepare a trading andprofit and loss account and balance sheet on 31st December, 1991. $ $Stock on 1st January 11,000 Returns outwards 500Bills receivables 4,500 Trade expenses 200Purchases 39,000 Office fixtures 1,000Wages 2,800 Cash in hand 500Insurance 700 Cash at bank 4,750Sundry debtors 30,000 Tent and taxes 1,100Carriage inwards 800 Carriage outwards 1,450Commission (Dr.) 800 Sales 60,000Interest on capital 700 Bills payable 3,000Stationary 450 Creditors 19,650Returns inwards 1,300 Capital 17,900The stock on 21st December, 1991 was valued at $25,000.Solution: X & Co. Trading and Profit and Loss Account For the year ended 31st December, 1991To Opening stock 11,000 |By Sales 60,000 LessTo Purchases 39,000 | 1,300 returns i/w Less returns o/w 500 | 58,700 By Closing 38,500 | 25,000 stockTo Carriage inwards 800 |To Wages 2,800 |To Gross profit c/d 30,600 | | 83,700 | 83,700 |To Stationary 450 |By Gross 30,600
  • 2. profit b/dTo Rent and rates 1,100 |To Carriage 1,450 |outwardsTo Insurance 700 |To Trade expenses 200 |To Commission 800 |To Interest on 700 |capitalTo Net profit |transferred to 25,200capital a/c | | 30,600 | 30,600 | X & Co. Balance Sheet As at 31st December, 1991 Liabilities $ | Assets $Creditors 19,650 | Cash in hand 500Bills payable 3,000 | Cash at bank 4,750Capital 17,900 | Sundry debtors 30,000Add Net profit 25,200 | Bill receivable 4,500 43,100 | Stock 25,000 | Office equipment 1,000 | 65,750 | 65,750 |Example 2:The following trial balance was taken from the books of Habib-ur-Rehman on December 31,19 ....Cash 13,000Sundry debtors 10,000Bill receivable 8,500Opening stock 45,000Building 50,000Furniture and fittings 10,000Investment (Temporary) 5,000Plant and Machinery 15,500Bills payable 9,000Sundry creditors 20,000Habibs capital 78,200
  • 3. Habibs drawings 1,000Sales 100,000Sales discount 400Purchases 30,000Freight in 1,000Purchase discount 500Sales salary expenses 5,000Advertising expenses 4,000Miscellaneous sales expenses 500Office salary expenses 8,000Misc. general expenses 1,000Interest income 1,000Interest expenses 800 2,08,700 2,08,700Closing stock on December 31, 19 ... was $10,000Required: Prepare income statement/trading and profit and loss account and balance sheetfrom the above trial balance in report form.Solution: Habib-ur-Rehman Income Statement/Profit and Loss Account For the year ended December 31, 19.....Gross sales 100,000Less: Sales discount 400Net Sales 99,600Cost of Goods Sold:Opening stock 45,000Purchases 30,000Add: Freight in 1,000 31,000Less purchase discount 500Net purchases 30,500Cost of goods available fort sale 75,500Less closing stock 10,000Cost of goods sold 65,500
  • 4. Gross profit 34,100Operating Expenses:Selling Expenses: Sales salary expenses 5,000 Advertising expenses 4,000 Misc. selling expenses 500 9,500General Expense: Office salaries expenses 8,000 Misc. general expenses 1,000 9,000Total operating expenses 18,500Net profit from operations 15,600Other Expenses and Incomes:Interest income 1,000Interest expenses 800Net increase 200Net income 15,800 Habib-ur-Rehman Balance Sheet As at December 31, 19.....ASSETS Current Assets: Cash 13,000 Sundry debtors 10,000 Bills receivable 8,500 Stock on Dec. 31, 19 .. 10,000 Investment 5,000 Total Current Assets 46,500 Fixed Assets: Buildings 50,000 Plant and Machinery 15,500 Furniture and fittings 10,000 Total Fixed Assets 75,500
  • 5. Total Assets 122,000LIABILITIES: Current Liabilities: Sundry creditors 20,000 Bills payable 9,000 Total Current Liabilities 29,000 Fixed Liabilities: Habibs capital 78,200 Net income for the year 15,800 94,000 Less: Drawings 1,000 93,000 Total Liabilities and Capital 122,000………………………………………………………………………………………………………………………………………………………………
  • 6. Preparing Profit and Loss Account From TrialBalancePreparation of Profit and Loss AccountProfit and loss account or income statement is prepared from the trial balance.To keep things as simple as possible initially a very simple version of profit and loss accountis shown and the more complex issues and more elegant formatting of the report are notcovered in this article.We start with the following trial balanceTrial Balance of Narayana Rao & Co, on 31.12.2007Account Debit Credit Rs. Rs.Purchases 100,000Wages 6,000Rent 2,400Travelling expenses 4,800Interest 1,200Returns inward 4,000Bank 10,000Cash 34,000Machinery 14,000Furniture 1,000Loan 45,800Miscellaneous expenses 200
  • 7. Returns outward 3,000Salaries 12,000Insurance 800Discount 900Sales 99,900Sundry creditors 50,000Capital 110,000Drawings 15,000Advertisements 2,400Buildings 10,000Sundry debtors 80,000Stock (1-1-2007) 10,000 308,700 308,700Profit and Loss Account Dr. Cr. Particulars Rs. particulars Rs. To Purchases 100,000By Sales 99,900 Stock (1-1-2007) 10,000Returns outward 3,000 Wages 6,000Stock (31-12-2007) 50,000 Rent 2,400
  • 8. Travelling expenses 4,800Interest 1,200Returns inward 4,000Salaries 12,000Insurance 800Discount 900Miscellaneous 200expensesAdvertisements 2,400Net Profit 8,200 152,900 152,900Procedure of Preparing Profit and Loss Account From Trial BalanceFrom trial balance all amounts nominal accounts (accounts related to revenues andexpenses) are shown in the debit and credit sides of the profit and loss account. Thisaccount is similar to the other accounts in the ledger. All credit amounts in the trial balanceare shown in the credit side of the P&L account and all debit amounts are shown on thedebit side. When totals of these two sides are compared, if credit side is more than the debitside, the firm has made a profit. In the example the credit side is more than the debit side byRs. 8,200. This amount is shown at the end in the debit side as net profit. Then similar tothe ledger accounts, the total of both sides are shown at the both sides in the same line atthe same level.If you notice an additional entry which was not there in the trial balance was included in thecredit side of P&L account. This item is stock on 31-12-2007. The closing stocks in the store,shop floor and finished goods store are ascertained and are valued by accountants. Thisfigure is to be included in the profit and loss account to determine the profit made in aperiod.After the profit and loss account is prepared, balance sheet of the firm, that shows its assetsand liabilities as on the day can be prepared. All real accounts with debit balances are assets.All personal accounts with credit balances are liabilities. All personal accounts with debitsbalances are assets. All customers account balances are summed up and the total amount is
  • 9. shown as sundry debtors in the balance sheet. All suppliers account balances are summedand the total amount is shown as sundry creditors in the balance sheet.Liabilities Rs. Assets Rs.Sundry 50,000 Buildings 10,000creditorsLoan 45,800 Machinery 14,000Capital 110,000 Furniture 1,000Net Profit 8,200 Sundry 80,000 debtors Balance Sheet as on 31.12.2007 Drawings 15,000 Stock (31- 50,000 12-2007) Bank 10,000 Cash 34,000 214,000 214,000As mentioned at the beginning many complex adjustments that are done to prepare profitand loss account and balance sheet as well as certain formatting conventions are ignored toprovide a simple treatment in this article. The objective of the article is to show the basiclogic of determining profit and then preparing a balance sheet.………………………………………………………………………………………………………………………………………………………………….
  • 10. How to Prepare a Trading Account?FOLLOWHow to prepare a Trading Account? Let us now consider the individual items recorded in the TradingAccount. (i) Opening Stock : This means the closing stock of the previous year. In the first year ofbusiness there will be no opening stock. In a trading concern the opening stock consists of finished goodsonly. But in a manufacturing concern, it comprises raw materials, work in progress, and finished goods.Opening stock is the first item on the debit side of the Trading account.How to prepare a Trading Account?Let us now consider the individual items recorded in the Trading Account.(i) Opening Stock : This means the closing stock of the previous year. In the first year of business therewill be no opening stock. In a trading concern the opening stock consists of finished goods only. But in amanufacturing concern, it comprises raw materials, work in progress, and finished goods. Opening stockis the first item on the debit side of the Trading account.(ii) Purchases and Purchase Return: Purchases include cash and credit purchase of goods. Purchasesare recorded on the debit side of the Trading Account after deducting the Returns outward or Purchasereturn. Care should be taken to ensure that purchases do not include the amount of goods taken orpurchased by the proprietor for his own use, the cost of goods received on consignment, goods in transit,goods purchased on hire purchase basis, goods distributed as free samples. ,(iii) Direct Expenses: These include manufacturing wages, carriage inward, power and fuel, factorylighting and heating, factory rent and rates, factory insurance, freight, octroi, customs duty on importedmaterials, royalty on production, etc. These expenses are recorded on the debit side of the TradingAccount.
  • 11. (iv) Sales and Sales Return: Sales include both cash and credit sales. Sales return or Return outward isdeducted from total sales and net sales are credited to the Trading Account. Care should be taken toensure that sales do not include sale of any fixed assets, goods sent on consignment and goods sold onapproval.(v) Closing Stock: It means the goods which remain unsold at the end of the accounting year. Closingstock is valued on the principle of cost or market price whichever is lower. It is exposed on the credit sideof the Trading Account. Closing stock is also shown, as an asset in the Balance Sheet.While preparing the Trading Account, adjustment entries are made for expenses outstanding andexpenses paid in advance, if any. For example, a part of the direct wages or factory rent may beoutstanding. Similarly, factory insurance might have been paid in advance for some months of the nextyear. Expenses outstanding are added to while expenses paid in advance are deducted from theexpenses shown on the debit side of the Trading Account.Note : Carriage outwards, packing charges for goods sold, export duty, cash discount on sales pill appearin Profit and Loss Account, because these are all selling expenses…………………………………………………………………………………………………………………………
  • 12. Prepare Trading and Profit and Loss Account and Balance Sheet>> OCTOBER 14, 2010In corporate accounting, you have to learn final accounts of company in which you have toprepare trading and profit and loss account and balance sheet. These statements are advancethan final accounts of individual. You have to spend your brain to understand its adjustments. Iam taking one of following question and tell you how to solve it. This question came in myM.Com.s higher Accounts.ProblemThe alfa manufacturing company ltd. was registered with a nominal capital of Rs. 60,00,000 inequity shares of Rs. 10 each. The following is the list of balances extracted from its books on31st March , 2009.Calls in arrears Rs 75,000Premises Rs. 30,00,000Plant and machinery Rs. 33,00,000Interim Dividend paid on Ist Nov. , 2009 Rs. 3,92,500Stock, 1st April, 1988 Rs. 7,50,000Fixtures Rs. 72,000Sundry Debtors Rs. 8,70,000Goodwill Rs. 2,50,000
  • 13. Cash in hand Rs. 7,500Cash at Bank Rs. 3,99,000Purchases Rs. 18,50,000Preliminary Expenses Rs. 50,000Wages Rs. 8,48,650General Expenses Rs. 68,350Freight and Carriage Rs. 1,31,150Salaries Rs. 1,45,000Directors Fees Rs. 57,250Bad Debts Rs. 21,100Debenture Interest Paid Rs. 1,80,000Share Capital Rs. 40,00,00012% Debentures Rs. 30,00,000Profit and loss account ( credit balance) Rs. 2,62,500Bill Payable Rs. 3,70,000Sundry Creditors Rs. 4,00,000Sales Rs. 41,50,000
  • 14. General Reserve Rs. 2,50,000Bad Debts provision 1st April 2009 Rs. 35,000Prepare trading and profit and loss account and balance sheet in proper form after making thefollowing adjustmentsi) Depreciation plant and machinery by 15%ii) Write off Rs. 5,000 from preliminary expensesiii) Provide for half years debenture interest due.iv) Leave bad and doubtful debts provision at 5% on sundry debtors.v) Provide for income tax @ 50%vi) Stock on 31st march, 2010 was Rs. 9,50,000SolutionIst Step : Write Small sign in list of balances relating toadjustmentIn first step of solving this problem, you have to read the question and write small sign in list ofbalances relating to adjustment. With this, you can treat correctly.2st Step : Make Working Notes for AdjustmentsWorking Notes :-1. ) Depreciation on plant and machinery by 15%
  • 15. 33,00,000 X 15% = 4,95,0002. Rs. 5,000 written off preliminary expenses will show in the debit side of profit and lossaccount. And rest Rs. 45,000 will show in the asset side in balance sheet.3.) Show half year debenture interest due as outstanding interest in the debit side ofprofit and loss account.4) Provision for Doubtful Debts AccountCredit Side :Bad debts provision 1st April, 1988 Rs. 35,000Transfer to Profit and loss account (Balancing figure) Rs 29,600--------------------------------------------------------------------Total = Rs. 64,600--------------------------------------------------------------------Debit SideBad Debts Rs. 21,100New bad debts provision 5%8,70,000 X 5% = Rs. 43,500-------------------------------------------------------------------Total Rs. 64,600-------------------------------------------------------------------
  • 16. Now, balancing figure of Rs. 29600 will go to debit side of profit and loss account and newprovision of Rs. 43500 will deduct from sundry debtors in balance sheet.5) Provide for Income Tax @ 50%Calculate net profit before charging income tax in profit and loss account and then calculate its50% and it will be shown as provision for income tax in the debit side of profit and loss accountand also it will be shown in the liability side in balance sheet.6) Closing stock of Rs. 9,50,000 will go to the credit side of trading account. We will also show itin asset side in balance sheet.7) Interim dividend paid will go to the debit side of profit and loss appropriation account. 15%dividend distribution tax and surcharge of 3% is paid by companies before distribution. It meansit will also be debited in profit and loss appropriation account. In balance sheet, dividenddistribution tax and surcharge will be shown in the liability side in balance sheet.8.) Call in arrears will deduct from equity share capital in liability side of balance sheet.After this, you have to make trading, profit and loss account, profit and loss appropriationaccount and balance sheet.………………………………………………………………………………………………………………………………………………………………
  • 17. How to prepare balance sheetPrepare balance sheet from trial balance in five easy steps. Format and elements ofclassified balance sheet.1. Reasons companies prepare balance sheetA balance sheet is a picture of a companys financial position as of a point in time. A balancesheet can be prepared as of any date, but its usually prepared as of month, quarter or year-end.A balance sheet is a very valuable statement that provides information about financial health of acompany. Things like cash, accounts receivable, accounts payable, net worth, etc. can bedetermined by looking at a balance sheet.There are multiple good reasons to prepare a balance sheet. First, you (as a business owner or abusiness manager) will want to know where your company stands in terms of financial health ata point in time. Second, anybody interested in your company will want to see your balance sheet.Such interested parties may include the following: Banks: Financial institutions want to know if your company will be able to repay a loan when you apply for one. Investors: At some point one source of capital (your savings in the business) may not be sufficient to maintain a rapid growth. You may want to find investors who would like to invest in your company. Before inventors give you their money, though, they might want to see a balance sheet (and other financial statements) to ensure their investments wont go south in the future. Authorities: Some authorities might like to see a balance sheet of your business. A good example is the Internal Revenue Service (IRS). Vendors: Sometimes vendors ask for a balance sheet (and other financial statements) to understand if you will be able to settle your obligations. Note: Where possible, you should also ask for the vendors financial statements to understand if your vendors will stay in business long enough to provide you with the products you buy from them. Customers: Similar to vendors, customers may sometimes ask for a balance sheet (and other financial statements) to understand if you will be able to stay in business to provide them with products or services you sell. For instance, from customers standpoint, changing vendors may be time and resource-consuming; thus, customers want to analyze your balance sheet to make sure you will not go bankrupt in the near future. Note: Where possible, you should also ask for customers financial statements to see if they will be able to pay for goods or services you provide.As you can see, there are a lot of parties that will be interested in a balance sheet of yourcompany, so its a good idea to prepare one regularly.
  • 18. How to prepare balance sheet2. Classifications on balance sheetAll balance sheets are normally classified: that is, different financial elements on a balance sheetare grouped into categories and presented under a common caption. This is a general practicethat helps to compare balance sheets of different companies. You can see an example below. Forinstance, if there are two companies within different industries, they may have different items(components) going into the Current Assets category. However, due to this classification rule, itmay sometimes not be as relevant to compare components of current assets. Instead, you mayjust compare the total current assets of the two companies, and that may be all you need in youranalysis.Illustration 1: Example of classifications on the balance sheet (horizontal) Assets Liabilities Current Assets Current liabilities Investments Non-current liabilities Fixed Assets Intangible Assets Equity Other Non-current Assets Common Stock Retained EarningsThe example above shows a balance sheet in a horizontal format: Assets are on the left side, andLiabilities and Equity are on the right side. It is also possible to present a balance sheet in asingle column format (vertically) as follows:Illustration 2: Example of classifications on the balance sheet (vertical) Assets Current Assets Investments Fixed Assets
  • 19. Intangible Assets Other Non-current Assets Liabilities Current liabilities Non-current liabilities Equity Common Stock Retained EarningsIt is a matter of preference, but normally balance sheets are presented vertically as shown inIllustration 2.Important term to remember, as we discuss balance sheet classifications further, is a balancesheet date. A balance sheet date is the date as of which the balance sheet is prepared. Forexample, most businesses prepare their balance sheets at least once a year as of December 31.However, the balance sheet date is not the date when a balance sheet is actually prepared andbecomes available.As you may have noticed in Illustration 1, assets are on the left side, and liabilities and equity areon the right side. There is a reason why they are presented liked that. Total assets equal the sumof total liabilities and total equity. This is a fundamental accounting equation that results in thisequality: Assets = Liabilities + EquityThis equation must hold true in any balance sheet, and if it doesnt, then it is due to an errorsomewhere in the balance sheet. You can use this rule in situations where your assets dont equalyour liabilities and equity.The reason the equation must hold true is because assets are economic resources of a businessused to accomplish its main goal, i.e. increase owners wealth. Liabilities and equity are thesources of such assets. In other words, liabilities and equity show where assets were obtained
  • 20. from. Liabilities are claims of third parties for resources provided to the business (e.g. creditors).Equity is claims of business owners for resources they invested in the business. Equity, therefore,is an indicator of how many assets the owners can claim in the business after all liabilities aresettled. The difference between assets and liabilities (i.e. equity) is sometimes called net worth.Any trial balance account (trial balances are a starting point in preparing a balance sheet – seefurther) has a balance. An account may have a debit or credit balance. The normal accountbalance also indicates whether the account is increased or decreased when its debited orcredited. There are rules stating which account has a debit or credit balance. The illustrationbelow shows accepted conventions about such balances:Illustration 3: Normal balances, increases and decreases for balance sheet accounts Increase (Normal Balance Sheet Category Decrease Balance) Assets Debit Credit Contra Asset Accounts Credit Debit Liabilities Credit Debit Contra Liability Accounts Debit Credit Equity Credit DebitFor example, an asset account called Cash increases when its debited and decreases when itscredited. The Cash account normally has a debit balance.Note that there are "contra" accounts. Such accounts are opposite to their related accounts andthus have a different normal balance. Contra accounts are presented as a reduction to their relatedaccounts on the balance sheet. An example of such accounts is Accumulated Depreciation. Thisaccount has a credit balance and is related to the Fixed Assets account. On the balance sheet,Accumulated Depreciation (credit balance) is shown under Fixed Assets (debit balance) andreduces the balance of Fixed Assets creating Net Fixed Assets.Going back to the accounting equation, note that assets normally have debit balances, andliabilities and equity have credit balances: Debit Balance Credit Balance Credit Balance Assets = Liabilities + Equity
  • 21. Lets review each balance sheet classification in more detail.How to prepare balance sheet2.1. Current assets on classified balance sheetCurrent assets are cash and other assets that are expected to be converted to cash or sold or used upusually within one year or the companys operating cycle, whichever is longer, through the normaloperations of the business.An operating cycle, for a manufacturing company, represents time it takes to invest cash by buying rawmaterials, produce a product, and receive cash back after selling the product. An operating cycle may bemore or less than a year depending on the industry.Current assets are usually listed in the order of liquidity starting with cash and cash equivalents.Examples of current assets are cash and cash equivalents, marketable securities, accountsreceivable, inventories, and prepaid expenses.Cash and cash equivalents represent coins, currency, checks, money orders, money on deposit andshort-term, highly liquid investments that are usually reported with cash on the balance sheet. Normally,highly liquid means that the investments can be converted to cash within 90 day and with a minimal lossin their value due to changes in interest rates.Marketable securities are short-term (temporary) investments in securities and other interest-generatingfinancial assets. Such investments are usually made to earn interest on excess cash which is currentlynot used in the business.Accounts receivable are amounts due from customers on credit sales (i.e. sales when customers agreeto pay you later).Accounts receivable sometimes may have a related contra asset account called Allowance forDoubtful Accounts. Such an account represents the amounts that you believe may not becollectable (e.g. a customer is bankrupt). The net amount (Accounts Receivable – Allowance forDoubtful Accounts) is shown on the balance sheet.Inventories are raw materials, work-in-process (i.e. started but unfinished products), finished goods (i.e.products ready for sale), and sometimes supplies (e.g. spare parts for your machinery and equipment).Similar to accounts receivable, the Inventories Account may also have a related contra assetaccount called Excess and Obsolete Reserve (E&O Reserve). This account represents the cost ofinventory that you do not anticipate to sell or use in your production any more due to technical
  • 22. obsolescence, etc. The net amount (Inventories – E&O Reserve) is presented on the balancesheet. Note that not all businesses will have an E&O reserve.Prepaid assets are prepayments youve made that will benefit future periods.For example, if you pay an insurance premium for your business, the coverage you obtain is for ayear. Thus, the benefits you will be getting from this asset are extended over a year. Normally,prepaid assets shown in the current assets are the ones expected to be used (expected to expire)within a year after the balance sheet date. If a prepaid asset is expected to provide benefits forlonger, then the portion of the prepaid asset related to benefits after one year is shown in the non-current assets (i.e. Other Non-current Assets) on the balance sheet.2.2. Non-current assets on classified balance sheetAll assets not included into current assets are non-current (long-term) assets. They are presentedon the balance sheet after the current assets and may include the following classifications: fixedassets, intangible assets, investments, and other non-current assets. Lets review eachclassification in greater detail.Fixed assets may include land, buildings, machinery and equipment, vehicles, and leaseholdimprovements.Fixed assets are expected to be utilized by the company (i.e. provide benefits) over a periodlonger than one year. Note that fixed assets are tangible assets (i.e. have physical substance).Fixed assets, as they provide benefits, use up some of their cost.The process of allocating this decrease in fixed assets cost to multiple years is called depreciation.A contra asset account called Accumulated Depreciation keeps information about how much ofthe fixed assets cost has been depreciated. The net amount (Fixed Assets – AccumulatedDepreciation) is shown on the balance sheet.Intangible assets may include patents, goodwill, technology, customer lists, value of non-competeagreements, among others.Intangible assets are similar to fixed assets except that the major value of intangible assets comeswith the rights they bring to the owner and not their physical substance. Similar to fixed assets,some intangible assets lose their value with time as they provide benefits (process is calledamortization), and this process is reflected in the Accumulated Amortization account. Note,however, that some intangible assets (e.g. trademarks or goodwill) have indefinite lives, andthus, they are not amortized.
  • 23. Investments are long-term investments in securities of other companies. Such securities may be debtsecurities (e.g. bonds, notes receivable) or equity securities (e.g. stock).Other non-current assets may include other long-term assets not included into the investments, fixed, orintangible assets categories. Such other assets may be portions of prepaid expenses that will startexpiring in more than a year after the balance sheet date, the cash surrender value of life insurance onofficers, and others.How to prepare balance sheet2.3. Current liabilities on classified balance sheetCurrent liabilities are obligations due to be paid or settled within one year or the companys operatingcycle, whichever is longer.Usually current liabilities are settled by using current assets. Therefore, sometimes it is useful tocompare current assets and current liabilities to understand if your business will be able to payyour current obligations using your current assets (the difference between the two is calledworking capital). Current liabilities may include accounts payable, accrued expenses, short-termloans, current portion of long-term debt, and income taxes payable. Lets review currentliabilities in greater detail.Accounts payable are liabilities (obligations) created by buying goods or services on account. In otherwords, it is your companys promise (and obligation) to pay for purchased goods or service later.For example, if you purchased merchandise inventory today, and the credit terms state that youneed to pay for the inventory next month, then you need to record this obligation as an accountpayable in your books.Accrued expenses represent costs incurred but unpaid as of the period end.Accrued expenses are required under the accrual basis of accounting, which is used for financialreporting purposes. An example of accrued expenses may be a cell phone bill with the billingperiod running from the 16th of the current month to the 15th of the following month. You willnot receive the bill until the middle of the next month; however, you have used the cell phone for15 days in the current month and, therefore, should recognize cell phone expense for 15 days ofthe current month by posting an accrued expense.Short-term loans are notes payable expected to be settled within one year after the balance sheet date.
  • 24. For example, if your company purchased equipment and issued a note payable to be settled in sixmonths after the balance sheet date, then the amount of the note will be recorded under short-term loans.Current portion of long-term debt represents the amount of long-term debt that will be paid within oneyear after the balance sheet date.For example, some long-term debts (i.e. bank loans) are required to be paid in installmentsquarterly or semiannually, and then, a balloon payment is made at the maturity date for theremaining balance. The installment payments to be paid within one year after the balance sheetdate represent short-term obligations and thus are recorded in the current liabilities under thecaption "Current Portion of Long-term Debt" (may be shortened to Current Portion of LT Debt).Income taxes payable are the amounts of income taxes that your company is obligated to pay to local,state, or federal authorities. These obligations are presented in the current liabilities section because it isusually expected that these balances will be paid within a year after the balance sheet date.2.4. Non-current liabilities on classified balance sheetNon-current (long-term) liabilities are other liabilities that are not included into the currentliabilities section. Therefore, non-current liabilities are obligations that are not expected to bedue (paid) within one year after the balance sheet date. Examples of non-current liabilities arelong-term lines of credit and term loans.A line of credit is an agreement, under which a bank provides your business with loans of money (i.e. upto an approved limit) during a predefined period.You can take out the amount you need (e.g. via check, ATM, etc.), repay it, and then borrowagain. At a point in time you can only have an outstanding balance up to a certain limit. Thiskind of loans is sometimes called revolving loans. If an outstanding amount is to be repaid withinmore than a year after the balance sheet date, then the amount is shown under the non-currentliabilities on the balance sheet date.Term loans are loans that are to be paid on a certain date (i.e. maturity date). Again, if the payment dateis not within one year after the balance sheet date, then the loan is presented under the non-currentliabilities.As mentioned above, when we talked about current liabilities, any portion of long-term debts(whether its a line of credit or term loan), which is to be paid within one year after the balancesheet date, must be presented under the current liabilities
  • 25. How to prepare balance sheet2.5. Equity on classified balance sheetEquity is the owners claim on assets. Equity, as noted above, is also the difference betweenassets and liabilities. Equity may include multiple financial elements. The most common equityelements are capital (common stock), current year earnings, and retained earnings. Lets reviewthem in more detail.Capital (common stock for corporations) represents the amounts contributed by owners to the business.Depending on the legal form of a business, capital can be named differently.Current year earnings are the net income or loss of the business for the current year. This amount is thedifference between all revenues and all expenses on the income statement. Current year earnings arepresented on the balance sheet only until they are transferred to retained earnings.Retained earnings are net income (loss) retained (accumulated) by your company.For a company with relatively simple operations, retaining earnings are cumulative net incomes(losses) less dividends paid out since the companys origination. Note that when dividends arepaid out, they reduce retaining earnings. Also note that retained earnings may be a negativeamount in situations when the company is not profitable (i.e. more losses than net incomes).3. Balance sheet formatA balance sheet is a financial statement that has a certain commonly used format.First of all, a balance sheet has a header. The header needs to include your company name, thetitle of the financial statement (i.e. balance sheet), and period(s) presented in the financialstatement. Note that some balance sheets are presented for one year, while others are presentedfor two years in a comparable format (e.g. comparable balance sheets of public companies). Anexample of the header for a single-year balance sheet is presented below: Your Company Name Balance Sheet December 31, 2010Next, the balance sheet with related captions is presented. Major captions (Assets, Liabilities,Equity) are presented first. Then, the next level captions are shown. The next level captions arethe categories (classifications) we reviewed earlier (current assets, investments, etc.). Under eachcaption, components of the caption are presented. An example of the current assets caption ispresented below:
  • 26. ASSETS Current Assets Cash Marketable Securities Accounts Receivable Inventories Prepaid ExpensesNote how the components of current assets are intended to the right so its easier to read thebalance sheet.Finally, lets recall that assets can be shown on the left side while liabilities and equity are shownon the right side (horizontal presentation). Alternatively, assets can be shown first with liabilitiesand equity presented underneath the assets. If a balance sheet for a single period is shown, itseems to be more readable to show assets on the left and liabilities and equity on the right side.However, if comparable balance sheets (i.e. a balance sheet for two or more periods) areprepared, then it makes more sense to show liabilities and equity under assets.How to prepare balance sheet4. Example of preparing balance sheetThere are several steps in preparing a balance sheet. These steps are not prescribed procedures,so there may be variations based on your company’s needs and situation. Let’s review each stepin detail.4.1. Step 1: Prepare balance sheet templateA balance sheet template is a blank format with header, date, categories, and components ofcategories. The template can be prepared on paper, or better off, it can be prepared in aspreadsheet software (e.g. MS Excel).For our illustration, we prepared a balance sheet template in MS Excel and presented it below.The template is in the vertical format due to width limitations on our website:
  • 27. Illustration 4: Balance sheet template Your Company Name Trial Balance December 31, 20X0 ASSETS Current Assets: Cash & Cash Equivalents Marketable Securities Accounts Receivable Inventories Prepaid Expenses Total Current Assets Fixed Assets Intangible Assets Investments Other Non-current Assets TOTAL ASSETS LIABILITIES Current Liabilities: Accounts Payable
  • 28. Your Company Name Trial Balance December 31, 20X0 Accrued Expenses Short-term Loans Current Portion of LT Debt Income Taxes Payable Total Current Liabilities Non-current Liabilities: Line of Credit Term LoanTotal Non-current Liabilities TOTAL LIABILITIES EQUITY Capital Current Year Earnings Retained Earnings TOTAL EQUITYTOTAL LIABILITIES & EQUITY
  • 29. The spaces highlighted in light green are the ones where we will enter amounts taken from thetrial balance.How to prepare balance sheet4.2. Step 2: Obtain trial balance for your companyA trial balance is the collection of all accounts that exist in the companys chart of accounts withbalances as of a particular date. Each account has either a debit or credit balance. The total of alldebits equals the total of all credits (i.e. double-entry accounting system).Most businesses, nowadays, use accounting software that is capable of generating a trial balance.Therefore, for your purposes, you can extract such a trial balance from your software. If youdont use such software, then you can prepare a trial balance from your records using, forexample, MS Excel.For our illustration, we obtained the trial balance from our accounting software as shown below:Illustration 5: A trial balance extracted from accounting software Your Company Name Trial Balance December 31, 20X0Account Account Name Debit Credit 1000 Petty Cash $ 500 1010 Chase Checking 42,000 1020 PayPal Checking 23,500 1030 Savings 300,000 1040 Money Market 25,000 1200 Marketable Securities 0 1300 Accounts Receivable 389,000 1350 Allowance for Doubtful Accounts 25,500 1400 Raw Materials 87,000
  • 30. Your Company Name Trial Balance December 31, 20X01410 Work-in-process 12,0001420 Finished Goods 132,0001430 Spare Parts 58,0001500 Prepaid Insurance 5,4001510 Prepaid Rent 3,0001600 Land 570,0001610 Buildings 430,0001620 Leasehold Improvements 100,0001630 Office Equipment 44,0001650 A/D-Buildings 240,0001660 A/D-Leasehold Improvements 51,0001670 A/D-Office Equipment 25,0001700 Patens 170,0001710 Trademark 60,0001750 Accum Amort-Parents 90,0001800 Investments in Debt Securities 01810 Investments in Equity Securities 75,0001900 Cash Surrender Value Life Insr 54,0002000 Accounts Payable 285,0002100 Accrued Payroll 205,000
  • 31. Your Company Name Trial Balance December 31, 20X0 2110 Accrued Property Taxes 42,000 2120 Accrued Vacation 323,000 2200 Short-term Bank Loan 245,000 2300 Current Portion of Line of Credit 100,000 2400 State Income Tax Payable 30,000 2410 Federal Income Tax Payable 60,000 2500 Line of Credit (Revolver) 53,000 2510 Term Loan 250,000 3000 Capital 50,000 3010 Current Year Earnings 159,000 3020 Retained Earnings 346,900 Total $ 2,580,400 $ 2,580,400Note that the total in the Debit column equals the total in the Credit column.How to prepare balance sheet4.3. Step 3: Group trial balance accounts by classificationThere are more trial balance accounts in Illustration 5 than there are balance sheet classifications(groups) in Illustration 4. That is because some classifications (groups) may include multipletrial balance accounts. For example, Cash and Cash Equivalents on the balance sheet templatewill include the following trial balance accounts since they have the same nature: Petty Cash,Chase Checking, PayPal Checking, Savings, and Money Market. Therefore, the next step is togroup all accounts on the trial balance by their respective balance sheet classifications.
  • 32. Here we have added another column to the trial balance where we entered the balance sheetclassification for the accounts. Refer to Illustration 6 below.4.4. Step 4: Subtotal account balances by classificationThe following step is to subtotal the balances in the accounts for each classification. Note thatwhen subtotals are prepared, all asset balances are calculated as Debit – Credit, while all liabilityand equity balances are calculated as Credit – Debit. For example, the subtotal for the balancesheet classification "Accounts Receivable" is equal to the debit amount in the account 1300,Accounts Receivable, less the credit balance in the account 1350, Allowance for DoubtfulAccounts (that is, $389,000 - $25,500 = $363,500). Even though the calculations seem to becomplicated, if you use spreadsheet software, it is pretty easy:Illustration 6: Trial balance with subtotals for balance sheet classifications (groups) Your Company Name Trial Balance December 31, 20X0 Balance SheetAcct # Account Name Debit Credit Subtotal Classification 1000 Petty Cash $ 500 1010 Chase Checking 42,000 Cash & Cash 1020 PayPal Checking 23,500 391,000 Equivalents 1030 Savings 300,000 1040 Money Market 25,000 1200 Marketable Securities 0 Marketable 0 Securities 1300 Accounts Receivable 389,000 Accounts 363,500 Receivable 1350 Allowance for Doubtful Accts 25,500 1400 Raw Materials 87,000 1410 Work-in-process 12,000 Inventories 289,000 1420 Finished Goods 132,000
  • 33. Your Company Name Trial Balance December 31, 20X01430 Spare Parts 58,0001500 Prepaid Insurance 5,400 Prepaid 8,400 Expenses1510 Prepaid Rent 3,0001600 Land 570,0001610 Buildings 430,0001620 Leasehold Improvements 100,000 Fixed1630 Office Equipment 44,000 828,000 Asset1650 A/D-Buildings 240,0001660 A/D-Leasehold Improvements 51,0001670 A/D-Office Equipment 25,0001700 Patens 170,000 Intangible1710 Trademark 60,000 140,000 Asset1750 Accum Amort-Parents 90,0001800 Investments in Debt Secs 0 Investments 75,0001810 Investments in Equity Secs 75,0001900 Cash Surrender Value Life Insr 54,000 Other Non-current 54,000 Assets2000 Accounts Payable 285,000 Accounts 285,000 Payable2100 Accrued Payroll 205,000 Accrued 570,000 Expenses2110 Accrued Property Taxes 42,000
  • 34. Your Company Name Trial Balance December 31, 20X0 2120 Accrued Vacation 323,000 2200 Short-term Bank Loan 245,000 Short-term Loans 245,000 2300 Current Portion of Line of Credit 100,000 Current Portion 100,000 of Long-term Debt 2400 State Income Tax Payable 30,000 Income Taxes 90,000 Payable 2410 Federal Income Tax Payable 60,000 2500 Line of Credit (Revolver) 53,000 Line of Credit 53,000 2510 Term Loan 250,000 Term Loan 250,000 3000 Capital 50,000 Capital 50,000 3010 Current Year Earnings 159,000 Current Year 159,000 Earnings 3020 Retained Earnings 346,900 Retained 346,900 Earnings Total $ 2,580,400 $ 2,580,400The final step is to transfer the classification subtotals from the trial balance (Illustration 6) to the balancesheet template (Illustration 4). For example, we transfer the $391,000 subtotal from the trial balance forCash & Cash Equivalents to the identical line on the balance sheet template. The result will be acompleted balance sheet:
  • 35. sIllustration 7: Completed balance sheet template Your Company Name Trial Balance December 31, 20X0 ASSETS Current Assets: Cash & Cash Equivalents $ 391,000 Marketable Securities 0 Accounts Receivable 363,500 Inventories 289,000 Prepaid Expenses 8,400 Total Current Assets 1,051,900 Fixed Assets 828,000 Intangible Assets 140,000 Investments 75,000 Other Non-current Assets 54,000 TOTAL ASSETS $ 2,148,900 LIABILITIES Current Liabilities: Accounts Payable 285,000 Accrued Expenses 570,000 Short-term Loans 245,000 Current Portion of LT Debt 100,000 Income Taxes Payable 90,000 Total Current Liabilities 1,290,000 Non-current Liabilities: Line of Credit 53,000 Term Loan 250,000 Total Non-current Liabilities 303,000 TOTAL LIABILITIES 1,593,000
  • 36. Your Company Name Trial Balance December 31, 20X0 EQUITY Capital 50,000 Current Year Earnings 159,000 Retained Earnings 346,900 TOTAL EQUITY 555,900 TOTAL LIABILITIES & EQUITY $ 2,148,900A few notes about the completed balance sheet: The subtotals and totals on the balance sheet (i.e. the $1,051,900 for current assets) were directly determined when all subtotals from the trial balance were transferred to the balance sheet template. The total assets of $2,148,900 equal the total liabilities and equity of $2,148,900. However, these totals dont match the trial balance totals for debits and credits of $2,580,400 (Illustration 6). The reason these totals dont match is because in the trial balance the totals are calculated for the debit and credit balances separately. In the balance sheet, though, some credit balances are subtracted from debit balances and vice versa (i.e. due to contra asset and contra liability accounts). Therefore, the totals on the trial balance and the balance sheet may not match. Normally, if a particular balance sheet classification has a zero balance (i.e. Marketable Securities in Illustration 7), the classification line is not shown. We left Marketable Securities in there so it is consistent with the balance sheet template (Illustration 4) we prepared earlier. The line for Marketable Securities can be taken out without any "harm" to the balance sheet.