Financial Statement Basics: The Balance Sheet
The Canadian Balance Sheet shows the financial position of an entity which is why this statement is commonly referred to as ‘The Statement of Financial Position.” The first key point to note is that the balance sheet is prepared to show the company’s position at a specified single point in time (Example, as of December 31st, 20xx) whereas other financial statements such as the Income Statement are reported to show the company’s operational performance for a specified length of time such as, “for the year ended December 31st, 20xx.” In this example, the income statement is said to cover an entire year from January 1st – December 31st which is also known as a calendar year-end.
Furthermore, the balance sheet consists of three important elements to consider. It reports the balances of all assets, liabilities and equity accounts for the company. It is critical to understand the fundamental accounting equation in the preparation and presentation of the balance sheet where Assets = Liabilities + Equity.
Assets: contains all resources that the company owns at the balance sheet date. This includes both current and non-current assets that the company utilizes in order to generate future economic benefits. The most common current assets listed on the balance sheet includes cash, accounts receivable and inventory which are resources that are anticipated by management to be converted into cash within a year or the entity’s operating cycle, whichever is longer. Accounts receivable is simply the amount of money owed to the company by its customers which is generated from the sale of goods and services on account. Non-current assets, therefore, contains all resources owned by the company that have a useful life of more than one year. These assets are often referred to as Capital Assets which include equipment, buildings and land. Notice that all assets mentioned thus far whether current or non-current can be classified as Tangible Assets which contain physical substance. However, the balance sheet also presents Intangible Assets which are reported as non-current capital assets as well, since they have a useful life of more than one year but do not have any physical substance such as goodwill and patents. The sum of the current and non-current assets will equate to and be reported on the balance sheet as Total Assets of the company.
Liabilities: represents the claims against the company’s assets that have not been paid at the balance sheet date. Therefore, they are obligations to the company’s creditors. Just like assets, liabilities are subdivided into current and non-current. Accounts Payable is a frequent account that can be seen on the balance sheet and is essentially the direct opposite of the accounts receivable balance. While accounts receivable are amounts owed to the company from a customer sale on account, accounts payable are amounts owed by the company to its creditors arising from purchases on account both of which are either expected to be collected or paid typically within 30 days. Non-current liabilities represent obligations that will not be settled for more than one year or the company’s operating cycle, whichever is longer. Long-term liabilities (non-current) found on the balance sheet include long-term bank loans and notes payable. The creditor’s claims against the assets can be seen by examining the fundamental accounting equation stated above where the entity’s assets equal the creditors’ claim which represents liabilities plus the owner’s claim of the assets representing the company’s equity.
Equity: according to the fundamental accounting equation if we rearrange this to solve for equity, one can conclude that Equity = Assets – Liabilities. Upon closer examination, it can be clearly seen that equity represents the value of a business after liabilities have been reduced from the company’s assets. Often equity is referred to as the residual interest of a company. Also, it is important to note that the creditors’ claims to the assets are always settled first before the owner’s claim can be realized.
Presentation Example for the Statement of Financial Position
ABC Company (COMPANY NAME)
Statement of Financial Position
As at December 31st, 20xx
Accounts Receivable 1,000
Total Current assets $7,000
Total Non-Current assets $82,000
TOTAL ASSETS $89,000
Accounts Payable $3,000
Wages Payable 1,500
Total Current Liabilities $4,500
Lease liability 1,000
TOTAL LIABILITIES $5,500
OWNER’S NAME, Capital 83,5000
TOTAL LIABILITIES AND $89,000
The above illustrated example for the statement of financial position shows various key features. The heading indicates the name of the company, clearly indicates what type of financial statement is shown and what period it is covering. Furthermore, the statement of financial position is visual a representation of the fundamental accounting equation. The left side of the statement represents assets which is also the left side of the equation. The right side of the statement represents liabilities and owner’s equity which in turn captures the right side of the equation. As a result, the statement of financial position is perfectly balanced only when total assets equals total liabilities and owner’s equity.
After examining the above illustrated equity section of the balance sheet and noting the name of the company reporting the statement, it is important to recognize that the form of organization in this example is that of a proprietorship and not a corporation. The difference in the balance sheet reported by a proprietorship and by a corporation lies primarily within the equity section. In a proprietorship, the owner’s capital includes the initial investment in the business, net income (profits) or net loss (losses) and is reduced by any drawings (withdrawals made by the owner for personal use). However, in a corporation, these amounts are split up into two common accounts: Contributed Capital and Retained Earnings. Contributed capital also known as share capital represents the investments made by the shareholders’ of the corporation. Retained Earnings is the cumulative income/loss amounts of the corporation since inception and also includes all dividends paid out to the shareholders. Dividends are similar to drawings in that they both reduce the equity account since they are distribution of equity payments to the shareholders’ or the owner respectively.