Balance sheet

Balance Sheet of X Ltd. as on 31st March, 2011

Equity and Liabilities

Amount in Rs.

Assets Amount in Rs.

Shareholders’ equity

5,00,000 Fixed assets 4,50,000

Outsiders’ equity/liabilities

3,00,000 Investment 1,50,000

Current assets 2,00,000

8,00,000 8,00,000

Questions

• If owners equity is Rs. 10,000 and total liabilities are Rs. 15,000, what is the value of total assets?

• If the total assets of a business are Rs. 100,000 and the long term liabilities are Rs. 50,000 and current liabilities are Rs. 25,000; what is the amount of owners equity?

Possible changes in Balance Sheet

Possibility Example

An increase in assets followed by an increase in liabilities and vice versa

Purchase of a tractor using a bank loan

A decrease in assets followed by a decrease in liabilities and vice versa

Using the savings deposit in bank to return the loan from a friend

An increase in assets followed by an increase in equity and vice versa

Interest earned on the savings deposit increasing the net worth

A decrease in assets followed by a decrease in equity and vice versa

Theft of some personal possessions leads to decrease in owners equity

An increase in an asset followed by a decrease in another asset and vice versa

Using my savings balance in bank to purchase a computer

An increase in a liability followed by a decrease in another liability and vice versa

Taking a new bank loan to return the loan from a friend

Separate entity concept/Business entity concept

• Business and Businessman/owner/shareholder are two separate entities.

Rationale:• True and fair view of financial position and

profitability of business as distinct from its owners.

More pronounced in company form of business as distinction is accepted from legal point of view.

Separate entity concept/Business entity concept

Accounting impact of the concept:

• Owner has limited liability in case of a company• Consolidated statements.

Example: Saloman vs Saloman & Company Limited

• Saloman had shoes business that he sold to a company Saloman & Company Limited, which he formed. There were 7 members- his wife, daughter and 4 sons who took one share each and Saloman himself took 20,000 shares. The price paid by company to Saloman for purchasing his business was Rs. 30,000; which was paid to him in terms of 20,000 fully paid shares of Rs. 1 each and 10,000 debentures of Rs. 1 each. Owing to strike in shoe business, company was wound up. The assets of the company amounted to Rs. 6,000 only. Debts due to outside unsecured creditors were Rs. 10,000.

Example: Saloman vs Saloman & Company Limited

• The unsecured creditors claimed that Saloman Company Limited, was really the same person as Saloman, he could not owe money to himself and they should be paid their debt out of the assets of the company. Is the claim of unsecured creditors justified???

Money measurement concept• Only transactions and events that can be

expressed in terms of money find place in the books of accounts or accounting records.

Rationale • To provide a uniform unit of measurement

that can be used to present heterogeneous facts about an entity.

• Ease in understanding the affairs of business.

• If business owns Rs. 10,000 of cash, 600 kgs of raw material, 2 trucks, 1000 square yard of building space etc., we cannot add these together to know the amount of resources possessed by the company.

• However, if we express these in single unit of measurement viz. Rs. 10,000 of cash; Rs. 12,000 of raw material, Rs. 1,00,000 of both trucks and Rs. 50,000 of building, all these items can be added together and precise estimate about the total worth/assets of the business can be made.

• Constant monetary value, that is value of money would stay constant though, in reality its real value may change depending upon the rate of inflation/deflation. • However, no account for subsequent

changes in purchasing power of money is given in books of accounts.

• For instance, a machine purchased in the year 2006 for Rs. 2 lacs is shown in books at the same monetary value irrespective of changes in the value of money.

• Exception: Countries with high inflation rates.

• For instance, if annual inflation rate is 100%, the machinery bought for Rs. 10,000 at the beginning of the year would be reported at Rs. 20,000 at the end of the year (10,000*200/100).

• Limitation: Limits the scope of accounting reports. For instance, no place for non-monetary events viz. a team of dedicated and motivated employees, a team of technical experts, good relationship network, advantageous location of business.

Going concern concept• An entity would run its operations for a

indefinite long period of time in future and it neither has intention nor necessity to liquidate the venture in foreseeable future.

• Continuity essential for doing economic transactions with outside world.

Implication: Basis of valuation of resources is influenced more by their future utility to the business entity than by their current market valuation.

Cost concept• Monetary assets are the assets whose

cash value is fixed by a contract, intended for resale. For instance, accounts receivables, cash, bank balance, marketable securities etc

• Non-monetary assets are those assets whose cash value is not fixed by a contract and these are used for future operations of business. For instance, Land, Building, Machinery, Furniture etc.

• Non-monetary assets to be recorded at the cost at which these are originally acquired i.e. historical cost not at the current market value (in line with going concern concept).

• Non-monetary assets are shown at book value =

• Historical Cost - depreciation, thus systematically reducing the value by amount of its usage (depending upon the useful life of an asset)

• Non-monetary assets shown at fair value (the value at which assets can be exchanged or liability can be settled between knowledgeable and independent parties).

• An asset which is developed over a period of time and is not purchased in outright transaction will not be shown in accounting records unless there is a clear evidence that it has been purchased.

• Goodwill = Purchase price – Net assets (total assets – total liabilities).

Dual aspect concept

• Every transaction has two aspect namely, benefit and sacrifice and accountant should record both these effects to know true and fair worth of the company’s resources.

• It is the concept that leads to fundamental accounting equation:

• Assets = Liabilities + Capital • X Limited started business with cash Rs.

50,000.

Balance sheet as on 31st March, 2011

Owner’s equity

Rs. 50,000

Cash Rs. 50,000

Total equities

Rs. 50,000

Total assets

Rs. 50,000

Balance sheet as on 31st March, 2011

• Deposit cash Rs. 10,000 into bank

Owner’s equity

Rs. 50,000 Cash Rs. 40,000

Bank balance

Rs. 10,000

Total equities

Rs. 50,000 Total assets

Rs. 50,000

• Borrowed from Ramesh Rs. 30,000

Owner’s equity

Rs. 50,000 Cash Rs. 70,000

Loan from Ramesh

Rs. 30,000 Bank balance

Rs. 10,000

Total equities

Rs. 80,000 Total assets

Rs. 80,000

Balance sheet as on 31st March, 2011