The Balance Sheet

The Accounting Equation

The accounting equation balances assets to the total of liabilities and equity.

The balance sheet is a snapshot of a company's financial condition at a point in time, traditionally at the end of a period. Two classes of information reveal the company's financial condition: (1) the company's assets and (2) the company's liabilities. An asset is an economic resource of value that a business owns and that is expected to provide future benefits. Assets may be tangible items, such as inventory, or they can be intangible items, such as intellectual property, owned by the company.

A company's debts are its liabilities. A liability is an obligation or amount owed to another individual or entity as a result of a past transaction. The portion of the assets belonging to shareholders is referred to as shareholders' equity. Shareholders' equity, sometimes also referred to as stockholders’ equity, is the value left to owners after debts and obligations have been accounted for, or the business's total assets minus its total liabilities. Accordingly, investors view shareholders' equity as their outstanding claim on the company.

The accounting equation is a company's assets equal to its liabilities plus the shareholders' equity.

{\text{Assets}}={\text{Liabilities}}+{\text{Shareholders' Equity}}

The accounting equation demonstrates that a company's assets are financed by liabilities, shareholders' equity, or a blend of both. In practical terms, the accounting equation demonstrates two things. First, the total assets are the sum of what a company owns. Second, liabilities are contractual obligations to deliver cash or another financial asset to an entity while shareholders’ equity is the difference between total assets and total liabilities. It is also the share capital retained in the company in addition to the retained earnings minus the treasury shares.

Components of the Balance Sheet

The balance sheet gives a snapshot of a company's assets and liabilities at a given point in time; it includes current assets, fixed assets, intangible assets such as goodwill, current and long-term liabilities, and shareholders' equity.

The balance sheet is a snapshot of a company's assets and liabilities at a given point in time. This information is revealed through the accounting equation.

{\text{Assets}}={\text{Liabilities}+\text{Shareholders' Equity}}

The balance sheet begins with asset entries. These entries appear in descending order by liquidity. The company sorts its liquid assets into current assets and its illiquid assets into fixed assets. Current assets include a company's cash, short-term investments, and items of value that can be converted to cash within a year. For example, current assets include cash and cash equivalents, accounts receivable, and inventory.

The next item to appear on a company's balance sheet is its net fixed assets. A fixed asset is a tangible piece of property used in the normal course of business to generate revenue, such as property, plant, or equipment. After recording fixed assets, a company records its intangible assets. Intangible assets include intellectual property and goodwill. Goodwill is the premium paid over the market value of net assets (market value of identifiable assets minus the market value of identifiable liabilities) in an enterprise acquisition. The company totals all of these entries to calculate its total assets.

The company's liabilities, as either current or long term, will appear next on the balance sheet. Current liabilities are the amounts owed by a business to payees that are expected to be paid within one year or during the operating cycle, whichever is longer. For example, current liability entries might include short-term debt, accounts payable, or income taxes payable. Next, the company records its long-term debt and any other unaccounted-for debt. The company totals the liability entries to calculate its total liabilities.

The final item the company includes on the balance sheet is its shareholders' equity. A company calculates its shareholders' equity by subtracting its total liabilities from its total assets. Three categories represent shareholders' equity: preferred stock, common stock, and retained earnings.

The balance sheet provides investors with an overview of Jake's Home Decor Shop's assets, liabilities, and shareholders' equity. The information is revealed through the accounting equation.

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Financial Statements

Contents

The Balance Sheet

The Accounting Equation

Components of the Balance Sheet