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Home > Balance Sheets Checklists > Understanding the Balance Sheet

Balance Sheets Checklists

Understanding the Balance Sheet


Checklist Description

This checklist explains what a balance sheet is and how to use it. It is sometimes referred to as a statement of financial position.

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Definition

In financial accounting, the balance sheet is one of four standard financial statements and is a summary of a company’s financial position at a given point in time. The balance sheet normally is broken down into three main elements—assets, liabilities, and net equity—to show what the company owns and owes on that date. It is usual to include intangible assets such as goodwill alongside tangible assets such as property. Typically, a balance sheet is published at the end of the company’s financial year when the accounts have been audited, but it may also be produced at the end of a quarter, half-year, or other specified period.

Of the three elements on the balance sheet, the assets are normally listed first, followed by any liabilities. The difference between the two is the equity, or worth, of the company. The equity may be referred to as net assets, shareholders’ equity, or net worth. The equity will always equal the assets minus the liabilities, or, conversely, the assets must equal the liabilities plus the equity:

Equity = Assets − Liabilities

or

Assets = Liabilities + Equity

The balance sheet is always drawn up so that the assets are presented in one section with the liabilities and equity in the other, and they must match each other, or balance (hence the title “balance sheet”). Double-entry bookkeeping is used to record the value of each line on the balance sheet. Because a corporate balance sheet tends to be lengthy and complex, it is usually published in the company’s annual report, typically with that of the previous year alongside for comparative purposes.

The International Accounting Standards Committee is responsible for drawing up guidelines for corporate balance sheets. Accounts published to this standard are usually marked as IAS compliant. There are also a number of country-specific bodies that draw up accounting guidelines, and, depending on the country where a company is based, such standards may be obligatory.

The assets on a balance sheet typically include the following items: current assets such as inventory, accounts receivable, cash and cash equivalents, and prepaid expenses; long-term assets such as property, plant and equipment; investment property such as real estate held for investment purposes; intangible assets, which includes goodwill, patents and intellectual property; and other financial assets.

The liabilities are usually items such as: accounts payable, provisions for warranties or court decisions, financial liabilities (excluding the two previous items) such as promissory notes and corporate bonds, liabilities and assets for current tax, and deferred tax liabilities and tax assets.

The last element on the balance sheet is the equity, or net worth. Theoretically, the shareholders’ equity actually forms part of a company’s liabilities, as the shares in fact represent monies owed to the shareholders after payment of all other liabilities. In practice, however, the liabilities on the balance sheet exclude the shareholders’ equity. Thus, the equity by definition is equal to the assets minus the liabilities, i.e. the difference between the two.

On the balance sheet equity typically includes: the total number of shares authorized, issued and fully paid, and issued but not fully paid; the par value, i.e. face value, of the shares; a reconciliation of shares outstanding at the beginning and the end of the period covered by the balance sheet; a list of any rights, preferences, or restrictions of the shares; treasury shares, including those held by subsidiary or associated companies; and any shares reserved for issuance under options and contracts.

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Further reading

Book:

  • Williams, Jan R., Susan F. Haka, Mark S. Bettner, and Joseph V. Carcello. Financial and Managerial Accounting: The Basis for Business Decisions. 16th ed. Boston, MA: McGraw-Hill/Irwin, 2011.

Websites:

  • American Institute of Certified Public Accountants (AICPA): www.aicpa.org
  • Financial Accounting Standards Board (FASB; US): www.fasb.org
  • IFRS Foundation and the International Accounting Standards Board (IASB): www.ifrs.org
  • Institute of Chartered Accountants in England and Wales (ICAEW): www.icaew.com

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