Preparing the Balance Sheet :: Deriving information relating to Position :: Illustration
What indicates the Position of an Organisation
Even in accounting, in trying to ascertain the position of a business entity, this is what we think of.
The position of an organisation is indicated by the value of the assets and liabilities held by the organisation.
Information relating to the Assets and Liabilities
Real AccountsReal accounts are related to tangible aspects. In general we can identify that all asset accounts are real accounts.
Personal AccountsPersonal accounts are related to persons and organisations. These are persons/organisation which owe the organisation or to whom the organisation owes. In effect they are either the creditors (liabilities) or debtors (assets) for the organisation.
Deriving information relating to profits is a requirementIn the process of deriving the information relating to profits made during the accounting period, all the nominal accounts are closed by transfer to the Trading and Profit and Loss a/c. Balance in the Trading and Profit and Loss account represents either profit or loss. Profits belong to ownership. We know that profits increase capital and loss decreases capital. Consider Trading and Profit and Loss account balance to be an equivalent of capital account balance and understand that it is to be treated similar to capital account.
The correct position of the business as at a particular instance cannot be ascertained unless the profits or losses up to that point of time are ascertained.
Thus deriving the information relating to profits is a requirement in deriving the information relating to the position of the organisation. This should explain the reason why the ascertainment of the position generally goes along with the ascertainment of the profits of the business.
After having preparing the Trading and Profit and Loss a/c, we will be left with only real and personal accounts having balances. These accounts represent either assets or liabilities. We can say that all the real and personal accounts together give us the information relating to the position of the organisation.
Where to obtain the information?The values of the assets and liabilities of an organisation are revealed by the balances in the real and personal accounts after ascertaining the profits.
Therefore, if we need the information relating to the assets and liabilities, we just need to collect the ledger account balances from the books of accounts relating to real and personal accounts after having ascertained the profits.
Utility of Trial BalanceThe Trial balance is a statement that gives the ledger account balances as at a particular point of time. Therefore, we can find the balances in the accounts representing assets and liabilities from the trial balance. If we ascertain the profit or loss based on the balances in the nominal accounts in the trial balance, we will be left with the special nominal account, the Trading and Profit and Loss a/c making the information relating to the assets and liabilities complete.
Thus, if there is a Trial Balance containing only real and personal account balances, it amounts to having the information relating to the assets and liabilities as on the date of the trial balance ready hand.
Information relating to position - when needed/obtained?
- It needs this information to aid internal financial and managerial decision making.
- It has to periodically submit the information to statutory authorities for taxation and other regulatory purposes.
- It may have to submit the information relating to its position when it approaches lending institutions for finance.
Theoretically, the information may be derived as and when needed by collecting the ledger account balances relating to the real and personal accounts. The only limitation being that it does not contain the information relating to the special nominal account giving the information relating to current period profit which can be obtained only by conducting the exercise to ascertain profits.
It is conventionally derived at a point which indicates the end of the accounting period (i.e. the period for which the profits are ascertained). Say if the organisation ascertains the profits made for the period from 1st April 20_5 to 31st March 20_6, it would ascertain the position as on 31st March 20_6.
Accounting period - beginning and endingThe ending day for an accounting period would be followed by the beginning day for the subsequent accounting period and as such the information relating to the position of the organisation as on the last day of a particular accounting period would be the information relating to its position as on the first day of the subsequent accounting period. Thus we can say that the information relating to position is derived in relation to the opening and closing days (moments) of the accounting periods.
To be more specific we can say moment instead of day i.e. the last moment of the accounting period and the first moment of the subsequent accounting period. We can also assume that there would be no transactions after the information relating to the position of an organisation has been ascertained on the last day of the accounting period till it is taken into consideration on the first day of the subsequent accounting period.
Computerised AccountingIn computerised accounting, all the tasks other than recording the journal are automatically managed by the program. There is nothing to be done to post the ledger, derive the trial balance if needed, prepare the Trading and Profit and Loss a/c etc. Thus the information relating to the position of the organisation is also readily available as and when needed without making any efforts for deriving it.
Balance Sheet - Statement presenting the information relating to Position
Format of the Balance SheetThe Balance Sheet is a statement and is made in a T format. It has two sides named the Assets side and the Liabilities side put side by side. The Liabilities side is placed to the left and the assets side to the right.
Preparation of the Balance SheetIn its simplest form this statement is nothing but a statement of ledger account balances remaining after ascertainment of the profits of the organisation, arranged in a such a way that all the ledger accounts with a debit balance are on the assets side and all the ledger accounts with a credit balance are on the liabilities side.
Balance sheet is a statement and not a ledger accountBalance sheet like a trial balance is a statement. It is not a ledger account though it looks similar in format to the 'T' format of a ledger.
We may mislead ourselves to the wrong notion that just like all nominal accounts are closed by transfer to the Trading and Profit and Loss a/c, all the real and personal accounts are closed by transfer to the Balance sheet.
Saying 'the real and personal account balances are transferred to the balance sheet' would be wrong. In the first instance the balance sheet is not a ledger account and secondly there is no transfer. We can say that the balances in the real and personal accounts, at the end of the accounting period, are shown in the balance sheet. They are transferred to the subsequent accounting periods.
Illustration - Preparation of Balance Sheet
Trading and Profit & Loss
NoteConsider Trading and Profit and Loss a/c as being an equivalent of the Capital a/c. Treat it similarly.
Preparation of the Balance SheetWe take the figures (after having ascertained the profits) relating to the real and personal accounts in the trial balance to make up the balance sheet.
The rule to be followed
- Accounts with debit balances on the assets side
- Accounts with credit balances on the liabilities side
The Balance Sheet drawn from the above Trial Balance would be:
Trading & Profit/Loss
Is it this simple?Practically, in deriving the information relating to the correct position of the organisation, there are a number of aspects to be taken care of. It is not as simple as collecting the ledger account balances of the real and personal accounts as and when we intend to ascertain the position.
However if we understand the whole idea clearly, we can make the task of preparing the balance sheet seem as simple as this.