International Financial Reporting Standards(IFRS) dictate the companies the standards for preparing the financial statements. According to the standards and regulations, companies must disclose their financial statements. Preparation of statements is mandatory according to the standards. The financial statements should be fair, transparent, and comparable around the world.
Compliance with accounting standards is necessary. Financial reporting encompasses the disclosure of the financial results of a business to the stakeholders of an organization. Preparation of financial statements is also part of the financial reporting.
The company’s financial statements give useful insights to the investors and creditors about the company’s health. There are five types of financial statements that give an inside glimpse of a company’s financial health: Income Statement, Balance Sheet, Statement Of Cash Flow, Statement For Change In Equity, and Notes to The Financial Statements.
This article will discuss the balance sheet, its importance, different accounts in the balance sheet, and the balance sheet.
A balance sheet can be formally defined as,
A company’s financial statement, which reports the assets, liabilities, and shareholder’s equity at a specific point of time, mostly the end of a year, is called a balance sheet. A balance sheet is also known as the statement of financial position.
Have you heard about the accounting equation?
The formula of the accounting equation is actually the format of the balance sheet.
The accounting equation states:
Assets= Liabilities + Shareholder’s Equity.
Types Of Balance Sheets
A balance sheet can be categorized into different types based on reporting and format. Let’s discuss each of these.
Types Of Balance Sheet According To Format
According to the formating pattern, a balance sheet has four types.
Classified Balance Sheet
The classified balance sheet presents the information about the assets, equity, and liabilities in a detailed form. Each category is sub-divided into sub-categories. In other words, each and every item of a company’s assets, liabilities, and equity are disclosed in the classified balance sheet. Most commonly, big businesses use classified balance sheets because it gives more information about a company’s financial health.
Common Size Balance Sheet
A common-size balance sheet is more than a classified balance sheet. Besides the information disclosed in a standard balance sheet, there is an additional column on the equity and assets side of the common size balance sheet. It gives additional information on each item as a percentage of total assets and each item of liability as a percentage of total liabilities. This information is fruitful for understanding the change in trends of different items.
Comparative Balance Sheet
When a company wants to present data of multiple financial periods, the comparative balance sheet is used. It represents side-by-side data of assets, liabilities, and equity for a given period. For instance, a company’s 5 years financial position statement will be quoted in a comparative format.
Vertical Balance Sheet
The vertical balance sheet is a single-column format where assets are reported first. Liability line items follow the assets and then comes the shareholder’s equity. The vertical balance sheet is usually constructed in the decreasing order of liquidity. It means the asset line items start from most liquid to least liquid. Similarly, liability line items are also reported in a sequence of most liquid to least liquid.
Types Of Balance Sheet According To Reporting
There are two financial reporting standards, IFRS and GAAP. There exist a difference between both standards of reporting. The representation of the balance sheet can also be classified based on each standard.
IFRS(International Financial Reporting Standards) is a financial reporting system adopted in many countries except the USA. It is often referred to as British Reporting. According to IFRS, a balance sheet lists the items in order of increasing liquidity. The non-current assets are listed first and followed by current assets.
GAAP(Generally Accepted Accounting Principles) or GAAP US is a set of standards used for financial reporting and followed in America. Under the GAAP, a balance sheet lists the item in order of decreasing liquid. The items are listed from most liquid to least liquid items in each category.
Balance Sheet Accounts
What are different accounts that are disclosed in a balance sheet?
The main segregations of a balance sheet are:
- Shareholder Equity
Each of three is further sub-divided into categories and items based on different accounts in a business. Let’s discuss each.
Assets are the possessions of a company. On the asset side of a balance sheet, all the current and non-current assets are recorded to increase or decrease liquidity. In general, IFRS is followed. Therefore, we will quote most examples under IFRS reporting. The asset side starts with current assets and goes to non-current assets.
The current assets are short-term assets of a company or business. These assets can be easily converted into cash. Following are the most common short-term assets that are listed on the company’s balance sheet.
Cash And Cash Equivalents
A company’s cash in hand, cash at a bank, and short-term deposit certificates are the most liquid asset. These can be traded as hard currency. Therefore, the first balance reported on a balance sheet is cash and cash equivalents.
Marketable securities are short-term investments of a company in debts or equity securities. These can be bought or sold at any time in the open market.
A company makes sales on cash and on credit. The credit sales are converted into customers accounts that are accounts receivable. It refers to the amount external customers have to pay to the company. A part of the account receivables is treated as a provision for bad debts.
Stock And Inventory
Stock and inventories are goods at hand for sale. Inventories are usually reported at the amount which is the lowest between actual cost and market price.
Some expenses are paid in advance. For instance, annual charges for an ad or annual insurance premiums are written off as they’re realized. Until the realization of accounts, they’re treated as a current asset.
Non-current assets are the long-term assets of a company, and they are less liquid or non-liquid.
Fixed Assets(Tangible Assets)
The long-term physical assets in possession of a company are called fixed assets. Fixed assets include building, plant, land, machinery, office equipment, furniture, etc.
The non-physical long-term assets are called intangible assets. These assets include goodwill, patent, copyrights, trademark, etc.
It also includes any intellectual property. Intangible assets are non-physical but valuable.
Liabilities are the outstanding obligations of a business. Like assets, liabilities are also sub-classified into current and non-current liabilities. Let’s discuss each of these.
The short-term liabilities of a business organization are called current liabilities. The current liabilities are those items that are due in less than 12 months. Following are some examples of current liabilities.
Current Portion Of Long-Term Debt
In a long-term loan, a company is supposed to pay annual interest and a portion of principal. The amount of principal due within one year is called as current portion of long-term debt (CPLTD).
Bank Indebtedness/ Line Of Credit
Bank indebtedness refers to any amount that you are liable to pay to your bank. The common example of bank indebtedness can be bank overdraft, line of credit, collection charges of bank, etc.
Outstanding interest is the interest payable by the company on the loan it has taken.
Unpaid and due wages or salaries of employees come under outstanding expenses.
Under many business contracts, the customers pay in advance for a whole year. Until the services are provided, the amount remained a liability for the seller of services.
Dividend Due And Payable
Any unpaid and due dividend to the stockholders of the company is a current liability.
In a business, credit sales and credit purchases both exist. Account payable corresponds to the outstanding balances that a business owes to other companies or sellers.
Non-current liabilities are long-term liabilities that are due within 2-10 years. These liabilities can be sub-classified as:
Long Term Loan
A long-term loan corresponds to the long-term bank loan or bonds issued. It is the net amount of interest and principal payable.
Pension Fund Payable
A company maintains a pension fund for the retirement benefits of its employees. The pension fund is also recorded in long-term liabilities.
Deferred Tax Liability
Deferred tax liability is the amount of tax that is due but not payable within the next 12 years.
Shareholder’s equity can be defined as the money of the shareholders they’ve invested in the business. The term‘ net assets’ is also used for shareholder’s equity. Shareholder’s equity is the net balance of assets after paying all the liabilities.
Share capital is the total authorized capital or part of authorized capital that the company has raised through the issuance of shares. It refers to the product of the total number of outstanding shares and the face value of each share.
Every year, the company invests its earnings into the business or write-offs the outstanding liabilities. After reinvestment, the remaining amount is distributed among the shareholders as a dividend. Retained earnings are the portion of earnings that are not distributed to shareholders and kept for reinvestment.
A balance sheet is the snapshot of the company’s financial position at the end of each financial year. It is one of the most extensively used financial statements used by management, customers, creditors, and shareholders.
A balance sheet helps in the financial analysis because most of the financial ratios are calculated based on the balance sheet. These financial ratios are used in the financial analysis of any company’s financial position.