Final IBA Lecture 5

8/3/2019 Final IBA Lecture 5

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Learning Objective A

Examine the different elements of

balance sheet

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1. What is Balance Sheet?

Snapshot of the financial position

At a particular moment in time.

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Balance Sheet Equation

Capital + Liabilities = Assets. (1)

Capital + long-term liabilities + current liabilities =

Fixed assets + Current assets .. (2)

Fixed assets + [current assetscurrent liabilities]

long-term liabilities = Capital .. (3)

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Balance Sheet as at 30th June 2008

Fixed assets (FA) XCurrent assets (CA) X

Less:current liabilities (X)

Net current assets XLess: Long-term liabilities (X)

Net assets X

Capital (at the beginning of theyear)

X

Profits/(losses) X/(X)

Capital (at the end of the year) X 6


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Progress Check 1

Long-term bank loans raised 200,000. The

effect of this transaction on the Balance

Sheet equation will be:

a. Increase in capital and asset

b. Decrease in asset and liability

c. Increase in asset and liabilityd. Decrease in liability, capital and asset

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2. What are the different elements of

balance sheet?

Capital + Liabilities = Assets

Three elements in it:

Assets

Liabilities and

Capital/equity/ownership interests.

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Assets

Assets are the valuable resources which provide future benefits

acquired at a measurable cost and

owned and controlled by the organisation.

Assets may be classified as:

fixed assets and

current assets.

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Fixed assets Fixed assets are:

Long-term in nature

Useful for more than one year.

Examples include, land, building, plant and equipment.

These are tangible fixed assets.

Another type of fixed assets: Intangibles.

have no physical substance.

For example, goodwill, trademark, copyright etc.

Accounting Treatment: B/S: at acquisition cost (including installation and other costs) less

accumulated depreciation.

P& L: annual depreciation is shown as an expense.

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Depreciation

All assets depreciate due to:

wear and tear,

obsolescence,

reduction in value etc.

and have a finite useful life.

Depreciation is a process of allocating the costof an asset over its useful life.

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Depreciation Accounting

Example, Building cost 100,000;

Useful life 50 years.

Annual depreciation

100,000/50=2,000.

Profit and Loss StatementDepreciation expense 2,000

Balance Sheet

Building 100,000Less: Accumulated Depreciation 2,000

Book value or written down value 98,000

=======

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Current Assets

Convertible to cash within one a year orso.

Examples: stock, debtors, cash etc.

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Liabilities

Obligations to the outsiders.

It may be classified as:

current liabilities and

long-term liabilities.

Current liabilities are payable within a year or so.

Examples: Trade creditors and bank overdraft.

Long-term liabilities are payable over a long period of time.

For example, 5 years loan taken from a bank.

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Provision

An amount provided for particular future

expenses or losses.

Provisions for depreciation (accumulated

depreciation)

Provisions for bad debts

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Capital

It refers to the resources provided by the

owners to the business.

Why do we show it on the capital and liability

side of the Balance Sheet?

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Progress Check 2

Which of the following is an asset item?

a. Goodwill

b. Stunning Chief Executive

c. Bank Overdraft

d. Outstanding wages.

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Learning Objective B

Preparation of Balance Sheet

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EXAMPLE 1: VERTICAL FORMAT

Prepare a balance sheet from the

following information of Skylight

Limited at 30th September, 2003:

Capital 1,200,000

Profit and Loss 285,000

Goodwill 150,000

Land and Buildings 500,000

Plant 375,000

Motor vehicles 50,000

Stock 225,000

Bank 510,000Debtors 415,000

Creditors 410,000

Loans 330,000

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Sk li ht Li it d


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Skylight Limited

Balance Sheet as at 30th September, 2003.

Fixed assets

Goodwill 150,000

Land and Buildings 500,000

Plant 375,000Motor vehicles 50,000

_____

1,075,000

Current assetsStock 225,000

Debtors 415,000

Bank 510,000

_____

1,150,000Less: Current liabilities

Creditors 410,000

_____ 740,000

Less: Long-term liabilitiesLoan (330,000)

_____

1,485,,000====

Ownership interestCapital 1,200,000

Profit and Loss 285,000

--------------

1,485,000

=========

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EXAMPLE 2: CHANGES IN BALANCE SHEETSarah started a new business on 1 June. During the firstmonth of her business the following transactions tookplace:

a Sarah opened a bank account in the name of herbusiness and transferred 50,000 of her ownmoney to it.

b She borrowed 35,000 from the Commercial LoanCompany and paid the money into the businessbank account.

c She paid 40,000 for a small business unit

(premises).d She paid 3,000 for a second-hand delivery van.e She bought goods for resale for 10,000, paying

immediately, and further goods for 20,000, oncredit.

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f She sold goods, which had cost 15,000, for25,000. 5,000 of this was cash sales and theremaining 20,000 was credit sales.

g She paid staff wages for June totalling 500.h She paid 100 for petrol for the van.i She received 4,000 from trade debtors.

j She paid 200 to the Commercial LoanCompany as interest on the loan for themonth.

Required:Open a balance sheet for Sarahs business and show each ofthese transactions on it as a series of pluses and minuses toreach the position of the business as at the end of June.Ignore depreciation of the fixed assets. (Atrill & McLaney)


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Journal Entry

a. Bank Dr. 50,000

Capital Cr. 50,000

b. Bank Dr. 35,000

Loan Cr. 35,000

c. Business Unit Dr. 40,000

Bank Cr. 40,000

d. Delivery Van Dr. 3,000

Bank Cr. 3,000


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Continuation of Journal Entries 2

e. (a) Inventory Dr. 10,000

Bank Cr. 10,000

(b) Inventory Dr. 20,000

Accounts Payable Cr. 20,000

f. (a) Bank Dr. 5,000

Accounts Receivable Dr. 20,000

Sales Cr. 25,000

(b) Cost of the Goods Sold Dr. 15,000

Inventory Cr. 15,000


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Continuation of Journal Entries 3

g. Wage Dr. 500Bank Cr. 500

h. Petrol Dr. 100

Bank Cr. 100

i. Bank Dr. 4,000

Accounts Receivable Cr. 4,000

j. Interest Dr. 200

Bank Cr. 200


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Bank Account

Debit Pound Credit Pound

Capital Account 50,000 Business unit

Account

40,000

Loan Account 35,000 Delivery Van

Account

3,000

Sales Account 5,000 Inventory Account 10,000

Accounts

Receivable Account

4,000 Wage Account 500

Petrol Account 100

Interest Account 200

Balance C/D 40,200

Balance B/D 94,000 Balance B/D 94,000


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Delivery Van Account


Bank Account 3,000 Balance C/D 3,0003,000 3,000

Balance B/D 3,000


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Petrol Account


Bank Account 100 Balance C/D 100

100 100Balance B/D 100


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Interest Account


Bank Account 200 Balance C/D 200

200 200

Balance B/D 200


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Loan Account


Bank Account 35,000 Balance C/D 35,000

35,000 35,000

Balance B/D 35,000


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Capital Account


Balance C/D 50,000 Bank Account 50,000

50,000 50,000

Balance B/D 50,000


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Business Unit Account


Bank Account 40,000 Balance C/D 40,000

40,000 40,000

Balance B/D 40,000


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Inventory Account


Bank Account 10,000 Cost of the Goods

sold account

15,000

Accounts payable

Account

20,000 Balance C/D 15,000

30,000 30,000

Balance B/D 15,000


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Sales Account


Balance C/D 25,000 Bank Account 5,000

Accounts

Receivable Account

20,000

25,000 25,000Balance B/D 25,000


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Accounts Receivable Account


Sales Account 20,000 Bank Account 4,000

Balance C/D 16,000

20,000 20,000

Balance B/D 16,000


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Account Payable Account


Balance C/D 20,000 Inventory Account 20,000

20,000 20,000

Balance B/D 20,000


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Cost of Goods sold account


Inventory Account 15,000 Balance C/D 15,000

15,000 15,000

Balance B/D 15,000


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Trial Balance


Bank Account 40,200 Capital Account 50,000Inventory Account 15,000 Accounts Payable

Account

20,000

Petrol Account 100 Loan Account 35,000

Delivery Van

Account

3,000 Sales Account 25,000

Interest Account 200

Accounts

Receivable Account

16,000

Business Unit

Account

40,000

Cost of The Goods

sold Account

15,000

Wage Account 500

1,30,000 1,30,000


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Profit & Loss Account

Sales 25,000

COGS -15,000

Gross profit 10,000

Operating Expenses:Petrol -100

Wages -500

Operating Profit 9,400

Interest -200

Net Profit 9,200


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Balance Sheet

Assets Pound Capital & Liabilities Pound

Non-Current Assets: Capital 50,000.00

Delivery Van 3,000.00 (+)Net Profit 9,200.00 59,200.00

Business Unit 40,000.00

Current Assets: Current Liabilities:Closing stock (inventory) 15,000.00 Accounts Payable 20,000.00

Accounts Receivable 16,000.00 Non-current Liabilities:

Bank 40,200.00 Loan 35,000.00

1,14,200.00 1,14,200.00


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Sarahs Balance Sheet a

Assets

Cash at bank 50,000

Capital and Liabilities

Owners capital 50,000

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Sarahs Balance Sheet b

Assets

Cash at bank [50,000+35,000] 85,000

Capital and Liabilities

Owners capital 50,000

Loan 35,000

85,000

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Balance sheet as at the end of June


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Balance sheet as at the end of JuneAssets Claims

Bank account

(+50,000a +35,000b 40,000c

3,000d

10,000e +5,000f

500g

100h +4,000i200j) 40,200

Capital

(+50,000a 15,000f +5,000f

+20,000f

500g

100h

200j) 59,200

Business unit

(+40,000c) 40,000

Long-term creditor Commercial

Loan Company

(+35,000b) 35,000-

Motor van

(+3,000d) 3,000

Trade creditors

(+20,000e) 20,000

Stock-in-trade

(+10,000e +20,000e

15,000f) 15,000Trade debtors

(+20,000f4,000i) 16,000

114,200 114,200

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Learning Objective C

Interpretation of Balance SheetInformation

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B/S Interpretations

B/S limitations:

The value of assets may not reflect current value.

Subjective valuation rules

May exclude important assets.

However, B/S provides useful insights to the financial health of abusiness:

Liquidity: ability to pay short term liabilities.

Asset Mix: appropriate mix of fixed and current assets.

Financial Structure: appropriate mix of owned and borrowed capitals.

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Current Ratio

Indicator of short-term liquidity

Current Asset/Current Liability

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Skylight Limited

Current Ratio (CA/CL)

1,150,000/410,000 = 2.8

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Home Task

Activity

Try to assess the financial health of Skylight Limited on the

basis of balance information provided.

Home Task

Review self-assessment question 2.1, P.47 of your text

book.

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Final IBA Lecture 5

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