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Finance for Non-finance Executives
Module 1 -> Unit 1 -> Financial
Statements and Accounting Principles |
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Balance Sheet |
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Let us expand the Example
1.1 further.
The company is
optimistic of business growth. To finance expansion, it
estimates an additional requirement of Rs 10 lakh.
It negotiates a loan for 3 years from
State Financial Corporation at 14% interest rate,
against the mortgage of the building and the machinery
and obtains the cheque on 25th June.
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| Balance
Sheet |
A Balance Sheet can also
be viewed as a statement of Sources, from where
finances have been raised, and Resources, in
which money has been invested.
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Sources (being payable) are
liabilities and Resources (being the ownership
of firm) are
assets.
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| Balance Sheet of Royal
Industries as on June 25, Current Year |
| Liabilities |
Amount (Rs) |
Assets |
Amount (Rs) |
| Capital |
30,00,000 |
Cash |
9,00,000 |
| Profits |
1,00,000 |
Bank Balance* |
12,00,000 |
| Reliable Suppliers
(Creditors)*** |
3,00,000 |
Stock
(Finished Goods) |
2,00,000 |
| 14% Loan |
10,00,000 |
Stock (Raw
Material) |
3,00,000 |
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Building** |
8,00,000 |
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Machinery** |
10,00,000 |
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44,00,000 |
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44,00,000 | |
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Note:
* Is
higher by the sum received from State Financial
Corporation
** Ownership continues with
Royal Industries.
***As the sum is payable,
Reliable Suppliers are creditors. |
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This Balance Sheet is the most
comprehensive we have drawn hitherto. It indicates that
the firm owns assets worth Rs 44 lakh and there are two
sources of financing these assets, namely, owners (Rs 31
lakh) and outsiders (creditors and lenders (Rs 13
lakh)). Another useful way of visualising Balance Sheet
is that it is a statement of Sources, from where
finances have been raised, and Resources, in which money
has been invested. Evidently, Sources (being payable)
are liabilities and Resources (being the ownership of
firm) are assets.
In accounting,
liabilities can be bifurcated into two broad categories:
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Internal liabilities, more
commonly known as Owners' equities = Capital +
Profits
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External liabilities,
consisting of contribution made by creditors and
lenders towards financing assets of a firm.
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Accordingly, there can be more than
one way of presenting the two sides of a Balance Sheet.
The three possible ways are as follows:
- Liabilities = Assets
(1.1)
- Sources = Resources
(1.2)
- Owners' equity* + Liabilities** = Assets
(1.3)
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Note:
* Means
stake/claims of owners in assets.
** Obviously
representing external obligations or external equities.
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Possible Combination of Accounting Transaction
Likewise, a business transaction can assume shape
in any one of the four possible ways:
- Increase in Liability, followed by an
increase in Asset
- Decrease in Liability, followed by a
decrease in Asset.
- Increase in one Liability and decrease in
another Liability.
- Increase in one Asset and decrease in
another Asset.
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Equations 1.1 to 1.3 are more
popularly called as Fundamental Accounting
Equations. Being more informative,
Accounting Equation 1.3 should be
preferred.
Let us continue with the
example of Royal Industries. Assume that the whole stock
of finished goods, costing Rs 2 lakh, has been sold on
45 days credit on 27th June for Rs 2,60,000
to Solvent Buyers & Company. Consequently, profits
will increase by Rs 60,000 (Rs 2,60,000 - Rs 2,00,000) and other changes in
the Balance Sheet (B/S) will appear as follows:
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| Balance Sheet of Royal
Industries as on June 27, Current Year. |
| Liabilities |
Amount (Rs) |
Assets |
Amount (Rs) |
| Capital |
30,00,000 |
Cash |
9,00,000 |
| Profit (Rs 1,00,000
+ Rs 60,000) |
1,60,000 |
Bank
Balance* |
12,00,000 |
| Reliable Suppliers
(Creditors) |
3,00,000 |
Solvent Buyers & Co. (Debtor)* |
2,60,000 |
| 14% Loan |
10,00,000 |
Stock (Raw
Material) |
3,00,000 |
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Building |
8,00,000 |
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Machinery |
10,00,000 |
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44,60,000 |
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44,60,000 | |
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Note:
*As the sum is
receivable, Solvent Buyers & Co. is a debtor. |
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During 28th and
30th June, Royal Industries has incurred and
paid in cash the following expenses: |
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| Salaries |
Rs 30,000 |
| Rent of the shop |
Rs 10,000 |
| Electricity |
Rs 2,000 |
| Stationary |
Rs 2,000 |
| Refreshments |
Rs 3,000 |
| Telephone, postage and courier
charges |
Rs 1,000 |
| Miscellaneous expenses |
Rs 2,000 |
| Total expenses |
Rs
50,000 | |
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According to the Separate Entity
concept, profits are liabilities. By the virtue of the
same concept, expenses are assets of the firm as they
are claims of the company on owners. Expenses are borne
by owners. As a matter of fact, profit figure to be
taken in the Balance Sheet should be net of the expenses
(and, in practice, it is that way only).
Evidently, profit figure shown in the
Balance Sheet is at an inflated value. In accounting, it
is known as gross profit (Selling Price -Cost of Goods Sold). As expenses
reduce gross profit, net profit for Royal Industries
will be (Rs 1,60,000 - Rs
50,000) Rs 1,10,000. |
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| Balance Sheet of Royal
Industries as on June, 30, Current Year |
| Owners' Equity
&Liabilities |
Amount (Rs) |
Assets |
Amount (Rs) |
| Capital |
30,00,000 |
Cash (Rs 9,00,000
- Rs 50,000) |
8,50,000 |
| Net Profit (Rs
1,60,000 - Rs 50,000) |
1,10,000 |
Bank Balance |
12,00,000 |
| Reliable Suppliers
(Creditors) |
3,00,000 |
Solvent Buyers & Co. |
2,60,000 |
| 14% Loan |
10,00,000 |
Stock (Raw
Material) |
3,00,000 |
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Building |
8,00,000 |
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Machinery |
10,00,000 |
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44,10,000 |
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44,10,000 | |
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Thus, assets consist of cash, bank
balance and other similar valuable resources owned by a
business firm such as buildings, machinery or resources
on which it has a legal right to receive from
debtors. |
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