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Examples of Trading and Profit and Loss Account and Balance Sheet:Learning Objectives:

1. Prepare trading and profit and loss account and balance sheet.

Example 1:From the following balances extracted from the books of X & Co., prepare a trading and profit and loss account and balance sheet on 31st December, 1991.

$ $Stock on 1st January 11,000 Returns outwards 500Bills receivables 4,500 Trade expenses 200Purchases 39,000 Office fixtures 1,000Wages 2,800 Cash in hand 500Insurance 700 Cash at bank 4,750Sundry debtors 30,000 Tent and taxes 1,100Carriage inwards 800 Carriage outwards 1,450Commission (Dr.) 800 Sales 60,000Interest on capital 700 Bills payable 3,000Stationary 450 Creditors 19,650Returns inwards 1,300 Capital 17,900

The stock on 21st December, 1991 was valued at $25,000.

Solution:

X & Co.Trading and Profit and Loss Account

For the year ended 31st December, 1991

To Opening stock 11,000 |By Sales 60,000 To Purchases 39,000 | Less returns

i/w 1,300 Less returns o/w 500 | 58,700 38,500 |By Closing

stock 25,000To Carriage inwards 800 | To Wages 2,800 | To Gross profit c/d 30,600 | | 83,700 | 83,700 | To Stationary 450 |By Gross profit

b/d 30,600

To Rent and rates 1,100 | To Carriage outwards 1,450 | To Insurance 700 | To Trade expenses 200 | To Commission 800 | To Interest on capital 700 | To Net profit transferred to capital a/c

25,200 |

|

| 30,600 | 30,600 |

X & Co.Balance Sheet

As at 31st December, 1991

Liabilities $ | Assets $Creditors 19,650 |Cash in hand 500Bills payable 3,000 |Cash at bank 4,750Capital 17,900 |Sundry debtors 30,000Add Net profit 25,200 |Bill receivable 4,500 43,100 |Stock 25,000 |Office equipment 1,000 | 65,750 | 65,750 |

Example 2:The following trial balance was taken from the books of Habib-ur-Rehman on December 31, 19 ....

Cash 13,000Sundry debtors 10,000 Bill receivable 8,500 Opening stock 45,000 Building 50,000 Furniture and fittings 10,000 Investment (Temporary) 5,000 Plant and Machinery 15,500 Bills payable 9,000Sundry creditors 20,000Habib's capital 78,200Habib's drawings 1,000

Sales 100,000Sales discount 400 Purchases 30,000 Freight in 1,000 Purchase discount 500Sales salary expenses 5,000 Advertising expenses 4,000 Miscellaneous sales expenses 500 Office salary expenses 8,000 Misc. general expenses 1,000 Interest income 1,000Interest expenses 800 2,08,700 2,08,700

Closing stock on December 31, 19 ... was $10,000

Required: Prepare income statement/trading and profit and loss account and balance sheet from the above trial balance in report form.

Solution:

Habib-ur-RehmanIncome Statement/Profit and Loss Account

For the year ended December 31, 19.....

Gross sales 100,000 Less: Sales discount 400 Net Sales 99,600

Cost of Goods Sold :

Opening stock 45,000 Purchases 30,000 Add: Freight in 1,000 31,000 Less purchase discount 500 Net purchases 30,500 Cost of goods available fort sale 75,500 Less closing stock 10,000 Cost of goods sold 65,500

Gross profit 34,100

Operating Expenses: Selling Expenses: Sales salary expenses 5,000 Advertising expenses 4,000 Misc. selling expenses 500 9,500 General Expense: Office salaries expenses 8,000 Misc. general expenses 1,000 9,000 Total operating expenses 18,500 Net profit from operations 15,600

Other Expenses and Incomes: Interest income 1,000 Interest expenses 800 Net increase 200 Net income 15,800

Habib-ur-RehmanBalance Sheet

As at December 31, 19.....

ASSETS Current Assets: Cash 13,000 Sundry debtors 10,000 Bills receivable 8,500 Stock on Dec. 31, 19 .. 10,000 Investment 5,000 Total Current Assets 46,500 Fixed Assets: Buildings 50,000 Plant and Machinery 15,500 Furniture and fittings 10,000 Total Fixed Assets 75,500 Total Assets 122,000

LIABILITIES: Current Liabilities: Sundry creditors 20,000 Bills payable 9,000 Total Current Liabilities 29,000 Fixed Liabilities: Habib's capital 78,200 Net income for the year 15,800 94,000 Less: Drawings 1,000 93,000 Total Liabilities and Capital 122,000

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Preparing Profit and Loss Account From Trial Balance

Preparation of Profit and Loss Account

Profit and loss account or income statement is prepared from the trial balance.

To keep things as simple as possible initially a very simple version of profit and loss account is shown and the more complex issues and more elegant formatting of the report are not covered in this article.

We start with the following trial balance

Trial Balance of Narayana Rao & Co, on 31.12.2007

Account Debit

Rs.

Credit

Rs.

Purchases 100,000

Wages 6,000

Rent 2,400

Travelling expenses 4,800

Interest 1,200

Returns inward 4,000

Bank 10,000

Cash 34,000

Machinery 14,000

Furniture 1,000

Loan 45,800

Miscellaneous expenses

200

Returns outward 3,000

Salaries 12,000

Insurance 800

Discount 900

Sales 99,900

Sundry creditors 50,000

Capital 110,000

Drawings 15,000

Advertisements 2,400

Buildings 10,000

Sundry debtors 80,000

Stock (1-1-2007) 10,000

308,700

308,700

Profit and Loss Account

Dr. Cr.Particulars Rs. particulars Rs.To Purchases 100,000By Sales 99,900

Stock (1-1-2007) 10,000Returns outward 3,000

Wages 6,000Stock (31-12-2007) 50,000

Rent 2,400

Travelling expenses 4,800

Interest 1,200

Returns inward 4,000

Salaries 12,000

Insurance 800

Discount 900

Miscellaneous expenses

200

Advertisements 2,400

Net Profit 8,200

152,900 152,900

Procedure of Preparing Profit and Loss Account From Trial Balance

From trial balance all amounts nominal accounts (accounts related to revenues and expenses) are shown in the debit and credit sides of the profit and loss account. This account is similar to the other accounts in the ledger. All credit amounts in the trial balance are shown in the credit side of the P&L account and all debit amounts are shown on the debit side. When totals of these two sides are compared, if credit side is more than the debit side, the firm has made a profit. In the example the credit side is more than the debit side by Rs. 8,200. This amount is shown at the end in the debit side as net profit. Then

similar to the ledger accounts, the total of both sides are shown at the both sides in the same line at the same level.

If you notice an additional entry which was not there in the trial balance was included in the credit side of P&L account. This item is stock on 31-12-2007. The closing stocks in the store, shop floor and finished goods store are ascertained and are valued by accountants. This figure is to be included in the profit and loss account to determine the profit made in a period.

After the profit and loss account is prepared, balance sheet of the firm, that shows its assets and liabilities as on the day can be prepared. All real accounts with debit balances are assets. All personal accounts with credit balances are liabilities. All personal accounts with debits balances are assets. All customers' account balances are summed up and the total amount is shown as sundry debtors in the balance sheet. All suppliers' account balances are summed and the total amount is shown as sundry creditors in the balance sheet.

Liabilities Rs. Assets Rs.

Sundry creditors

50,000 Buildings 10,000

Loan 45,800 Machinery 14,000

Capital 110,000

Furniture 1,000

Net Profit 8,200 Sundry debtors

80,000

Balance Sheet as on 31.12.2007

Drawings 15,000

Stock (31-12-2007)

50,000

Bank 10,000

Cash 34,000

214,000

214,000

As mentioned at the beginning many complex adjustments that are done to prepare profit and loss account and balance sheet as well as certain formatting conventions are ignored to provide a simple treatment in this article. The objective of the article is to show the basic logic of determining profit and then preparing a balance sheet.

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How to Prepare a Trading Account?

FOLLOW

How to prepare a Trading Account? Let us now consider the individual items recorded in the Trading

Account. (i) Opening Stock : This means the closing stock of the previous year. In the first year of

business there will be no opening stock. In a trading concern the opening stock consists of finished goods

only. But in a manufacturing concern, it comprises raw materials, work in progress, and finished goods.

Opening stock is the first item on the debit side of the Trading account.

How to prepare a Trading Account?

Let us now consider the individual items recorded in the Trading Account.

(i) Opening Stock : This means the closing stock of the previous year. In the first year of business there

will be no opening stock. In a trading concern the opening stock consists of finished goods only. But in a

manufacturing concern, it comprises raw materials, work in progress, and finished goods. Opening stock

is the first item on the debit side of the Trading account.

(ii) Purchases and Purchase Return: Purchases include cash and credit purchase of goods. Purchases

are recorded on the debit side of the Trading Account after deducting the Returns outward or Purchase

return. Care should be taken to ensure that purchases do not include the amount of goods taken or

purchased by the proprietor for his own use, the cost of goods received on consignment, goods in transit,

goods purchased on hire purchase basis, goods distributed as free samples. ,

(iii) Direct Expenses: These include manufacturing wages, carriage inward, power and fuel, factory

lighting and heating, factory rent and rates, factory insurance, freight, octroi, customs duty on imported

materials, royalty on production, etc. These expenses are recorded on the debit side of the Trading

Account.

(iv) Sales and Sales Return: Sales include both cash and credit sales. Sales return or Return outward is

deducted from total sales and net sales are credited to the Trading Account. Care should be taken to

ensure that sales do not include sale of any fixed assets, goods sent on consignment and goods sold on

approval.

(v) Closing Stock: It means the goods which remain unsold at the end of the accounting year. Closing

stock is valued on the principle of cost or market price whichever is lower. It is exposed on the credit side

of the Trading Account. Closing stock is also shown, as an asset in the Balance Sheet.

While preparing the Trading Account, adjustment entries are made for expenses outstanding and

expenses paid in advance, if any. For example, a part of the direct wages or factory rent may be

outstanding. Similarly, factory insurance might have been paid in advance for some months of the next

year. Expenses outstanding are added to while expenses paid in advance are deducted from the

expenses shown on the debit side of the Trading Account.

Note : Carriage outwards, packing charges for goods sold, export duty, cash discount on sales pill appear

in Profit and Loss Account, because these are all selling expenses

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Prepare Trading and Profit and Loss Account and Balance Sheet

>> OCTOBER 14, 2010

In corporate accounting, you have to learn final accounts of company in which you have to prepare trading and profit and loss account and balance sheet. These statements are advance than final accounts of individual. You have to spend your brain to understand its adjustments. I am taking one of following question and tell you how to solve it. This question came in my

http://www.blogger.com/rearrange?blogID=2410664366776677676&widgetType=HTML&widgetId=HTML10&action=editWidget&sectionId=main

M.Com.'s higher Accounts.

Problem

The alfa manufacturing company ltd. was registered with a nominal capital of Rs. 60,00,000 in equity shares of Rs. 10 each. The following is the list of balances extracted from its books on 31st March , 2009.

Calls in arrears Rs 75,000

Premises Rs. 30,00,000

Plant and machinery Rs. 33,00,000

Interim Dividend paid on Ist Nov. , 2009 Rs. 3,92,500

Stock, 1st April, 1988 Rs. 7,50,000

Fixtures Rs. 72,000

Sundry Debtors Rs. 8,70,000

Goodwill Rs. 2,50,000

Cash in hand Rs. 7,500

Cash at Bank Rs. 3,99,000

Purchases Rs. 18,50,000

Preliminary Expenses Rs. 50,000

Wages Rs. 8,48,650

General Expenses Rs. 68,350

Freight and Carriage Rs. 1,31,150

Salaries Rs. 1,45,000

Directors' Fees Rs. 57,250

Bad Debts Rs. 21,100

Debenture Interest Paid Rs. 1,80,000

Share Capital Rs. 40,00,000

12% Debentures Rs. 30,00,000

Profit and loss account ( credit balance) Rs. 2,62,500

Bill Payable Rs. 3,70,000

Sundry Creditors Rs. 4,00,000

Sales Rs. 41,50,000

General Reserve Rs. 2,50,000

Bad Debts provision 1st April 2009 Rs. 35,000

Prepare trading and profit and loss account and balance sheet in proper form after making the following adjustments

i) Depreciation plant and machinery by 15%

ii) Write off Rs. 5,000 from preliminary expenses

iii) Provide for half year's debenture interest due.

iv) Leave bad and doubtful debts provision at 5% on sundry debtors.

v) Provide for income tax @ 50%

vi) Stock on 31st march, 2010 was Rs. 9,50,000

Solution

Ist Step : Write Small sign in list of balances relating to adjustment

In first step of solving this problem, you have to read the question and write small sign in list of balances relating to adjustment. With this, you can treat correctly.

2st Step : Make Working Notes for Adjustments

Working Notes :-

1. ) Depreciation on plant and machinery by 15%

33,00,000 X 15% = 4,95,000

2. Rs. 5,000 written off preliminary expenses will show in the debit side of profit and loss account. And rest Rs. 45,000 will show in the asset side in balance sheet.

3.) Show half year debenture interest due as outstanding interest in the debit side of profit and loss account.

4) Provision for Doubtful Debts Account

Credit Side :

Bad debts provision 1st April, 1988 Rs. 35,000

Transfer to Profit and loss account (Balancing figure) Rs 29,600

--------------------------------------------------------------------Total = Rs. 64,600--------------------------------------------------------------------

Debit Side

Bad Debts Rs. 21,100

New bad debts provision 5%

8,70,000 X 5% = Rs. 43,500

-------------------------------------------------------------------Total Rs. 64,600-------------------------------------------------------------------

Now, balancing figure of Rs. 29600 will go to debit side of profit and loss account and new provision of Rs. 43500 will deduct from sundry debtors in balance sheet.

5) Provide for Income Tax @ 50%

Calculate net profit before charging income tax in profit and loss account and then calculate its 50% and it will be shown as provision for income tax in the debit side of profit and loss account and also it will be shown in the liability side in balance sheet.

6) Closing stock of Rs. 9,50,000 will go to the credit side of trading account. We will also show it in asset side in balance sheet.

7) Interim dividend paid will go to the debit side of profit and loss appropriation account. 15% dividend distribution tax and surcharge of 3% is paid by companies before distribution. It means it will also be debited in profit and loss appropriation account. In balance sheet, dividend distribution tax and surcharge will be shown in the liability side in balance sheet.

8.) Call in arrears will deduct from equity share capital in liability side of balance sheet.

After this, you have to make trading, profit and loss account, profit and loss appropriation account and balance sheet.

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How to prepare balance sheet

Prepare balance sheet from trial balance in five easy steps. Format and elements of classified balance sheet.

1. Reasons companies prepare balance sheet

A balance sheet is a picture of a company's financial position as of a point in time. A balance sheet can be prepared as of any date, but it's usually prepared as of month, quarter or year-end.

A balance sheet is a very valuable statement that provides information about financial health of a company. Things like cash, accounts receivable, accounts payable, net worth, etc. can be determined by looking at a balance sheet.

There are multiple good reasons to prepare a balance sheet. First, you (as a business owner or a business manager) will want to know where your company stands in terms of financial health at a point in time. Second, anybody interested in your company will want to see your balance sheet. Such interested parties may include the following:

Banks: Financial institutions want to know if your company will be able to repay a loan when you apply for one.

Investors: At some point one source of capital (your savings in the business) may not be sufficient to maintain a rapid growth. You may want to find investors who would like to invest in your company. Before inventors give you their money, though, they might want to see a balance sheet (and other financial statements) to ensure their investments won't go south in the future.

Authorities: Some authorities might like to see a balance sheet of your business. A good example is the Internal Revenue Service (IRS).

Vendors: Sometimes vendors ask for a balance sheet (and other financial statements) to understand if you will be able to settle your obligations. Note: Where possible, you should also ask for the vendors' financial statements to understand if your vendors will stay in business long enough to provide you with the products you buy from them.

Customers: Similar to vendors, customers may sometimes ask for a balance sheet (and other financial statements) to understand if you will be able to stay in business to provide them with products or services you sell. For instance, from customers' standpoint, changing vendors may be time and resource-consuming; thus, customers want to analyze your balance sheet to make sure you will not go bankrupt in the near future. Note: Where possible, you should also ask for customers' financial statements to see if they will be able to pay for goods or services you provide.

As you can see, there are a lot of parties that will be interested in a balance sheet of your company, so it's a good idea to prepare one regularly.


2. Classifications on balance sheet

All balance sheets are normally classified: that is, different financial elements on a balance sheet are grouped into categories and presented under a common caption. This is a general practice that helps to compare balance sheets of different companies. You can see an example below. For instance, if there are two companies within different industries, they may have different items (components) going into the Current Assets category. However, due to this classification rule, it may sometimes not be as relevant to compare components of current assets. Instead, you may

just compare the total current assets of the two companies, and that may be all you need in your analysis.

Illustration 1: Example of classifications on the balance sheet (horizontal)

Assets Liabilities

Current Assets Current liabilities

Investments Non-current liabilities

Fixed Assets

Intangible Assets Equity

Other Non-current Assets Common Stock

Retained Earnings

The example above shows a balance sheet in a horizontal format: Assets are on the left side, and Liabilities and Equity are on the right side. It is also possible to present a balance sheet in a single column format (vertically) as follows:

Illustration 2: Example of classifications on the balance sheet (vertical)

Assets

Current Assets

Investments

Fixed Assets

Intangible Assets

Other Non-current Assets

Liabilities

Current liabilities

Non-current liabilities

Equity

Common Stock

Retained Earnings

It is a matter of preference, but normally balance sheets are presented vertically as shown in Illustration 2.

Important term to remember, as we discuss balance sheet classifications further, is a balance sheet date. A balance sheet date is the date as of which the balance sheet is prepared. For example, most businesses prepare their balance sheets at least once a year as of December 31. However, the balance sheet date is not the date when a balance sheet is actually prepared and becomes available.

As you may have noticed in Illustration 1, assets are on the left side, and liabilities and equity are on the right side. There is a reason why they are presented liked that. Total assets equal the sum of total liabilities and total equity. This is a fundamental accounting equation that results in this equality:

Assets = Liabilities + Equity

This equation must hold true in any balance sheet, and if it doesn't, then it is due to an error somewhere in the balance sheet. You can use this rule in situations where your assets don't equal your liabilities and equity.

The reason the equation must hold true is because assets are economic resources of a business used to accomplish its main goal, i.e. increase owners' wealth. Liabilities and equity are the sources of such assets. In other words, liabilities and equity show where assets were obtained from. Liabilities are claims of third parties for resources provided to the business (e.g. creditors). Equity is claims of business owners for resources they invested in the business. Equity, therefore, is an indicator of how many assets the owners can claim in the business after all liabilities are settled. The difference between assets and liabilities (i.e. equity) is sometimes called net worth.

Any trial balance account (trial balances are a starting point in preparing a balance sheet – see further) has a balance. An account may have a debit or credit balance. The normal account balance also indicates whether the account is increased or decreased when it's debited or credited. There are rules stating which account has a debit or credit balance. The illustration below shows accepted conventions about such balances:

Illustration 3: Normal balances, increases and decreases for balance sheet accounts

Balance Sheet CategoryIncrease (Normal

Balance)Decrease

Assets Debit Credit

Contra Asset Accounts Credit Debit

Liabilities Credit Debit

Contra Liability Accounts Debit Credit

Equity Credit Debit

For example, an asset account called Cash increases when it's debited and decreases when it's credited. The Cash account normally has a debit balance.

Note that there are "contra" accounts. Such accounts are opposite to their related accounts and thus have a different normal balance. Contra accounts are presented as a reduction to their related accounts on the balance sheet. An example of such accounts is Accumulated Depreciation. This account has a credit balance and is related to the Fixed Assets account. On the balance sheet, Accumulated Depreciation (credit balance) is shown under Fixed Assets (debit balance) and reduces the balance of Fixed Assets creating Net Fixed Assets.

Going back to the accounting equation, note that assets normally have debit balances, and liabilities and equity have credit balances:

Debit Balance Credit Balance Credit Balance

Assets = Liabilities + Equity

Let's review each balance sheet classification in more detail.


2.1. Current assets on classified balance sheet

Current assets are cash and other assets that are expected to be converted to cash or sold or used up usually within one year or the company's operating cycle, whichever is longer, through the normal operations of the business.

An operating cycle, for a manufacturing company, represents time it takes to invest cash by buying raw materials, produce a product, and receive cash back after selling the product. An operating cycle may be more or less than a year depending on the industry.

Current assets are usually listed in the order of liquidity starting with cash and cash equivalents.

Examples of current assets are cash and cash equivalents, marketable securities, accounts receivable, inventories, and prepaid expenses.

Cash and cash equivalents represent coins, currency, checks, money orders, money on deposit and short-term, highly liquid investments that are usually reported with cash on the balance sheet. Normally, highly liquid means that the investments can be converted to cash within 90 day and with a minimal loss in their value due to changes in interest rates.

Marketable securities are short-term (temporary) investments in securities and other interest-generating financial assets. Such investments are usually made to earn interest on excess cash which is currently not used in the business.

Accounts receivable are amounts due from customers on credit sales (i.e. sales when customers agree to pay you later).

Accounts receivable sometimes may have a related contra asset account called Allowance for Doubtful Accounts. Such an account represents the amounts that you believe may not be collectable (e.g. a customer is bankrupt). The net amount (Accounts Receivable – Allowance for Doubtful Accounts) is shown on the balance sheet.

Inventories are raw materials, work-in-process (i.e. started but unfinished products), finished goods (i.e. products ready for sale), and sometimes supplies (e.g. spare parts for your machinery and equipment).

Similar to accounts receivable, the Inventories Account may also have a related contra asset account called Excess and Obsolete Reserve (E&O Reserve). This account represents the cost of inventory that you do not anticipate to sell or use in your production any more due to technical obsolescence, etc. The net amount (Inventories – E&O Reserve) is presented on the balance sheet. Note that not all businesses will have an E&O reserve.

Prepaid assets are prepayments you've made that will benefit future periods.

For example, if you pay an insurance premium for your business, the coverage you obtain is for a year. Thus, the benefits you will be getting from this asset are extended over a year. Normally, prepaid assets shown in the current assets are the ones expected to be used (expected to expire) within a year after the balance sheet date. If a prepaid asset is expected to provide benefits for

longer, then the portion of the prepaid asset related to benefits after one year is shown in the non-current assets (i.e. Other Non-current Assets) on the balance sheet.

2.2. Non-current assets on classified balance sheet

All assets not included into current assets are non-current (long-term) assets. They are presented on the balance sheet after the current assets and may include the following classifications: fixed assets, intangible assets, investments, and other non-current assets. Let's review each classification in greater detail.

Fixed assets may include land, buildings, machinery and equipment, vehicles, and leasehold improvements.

Fixed assets are expected to be utilized by the company (i.e. provide benefits) over a period longer than one year. Note that fixed assets are tangible assets (i.e. have physical substance). Fixed assets, as they provide benefits, use up some of their cost.

The process of allocating this decrease in fixed assets' cost to multiple years is called depreciation.

A contra asset account called Accumulated Depreciation keeps information about how much of the fixed assets' cost has been depreciated. The net amount (Fixed Assets – Accumulated Depreciation) is shown on the balance sheet.

Intangible assets may include patents, goodwill, technology, customer lists, value of non-compete agreements, among others.

Intangible assets are similar to fixed assets except that the major value of intangible assets comes with the rights they bring to the owner and not their physical substance. Similar to fixed assets, some intangible assets lose their value with time as they provide benefits (process is called amortization), and this process is reflected in the Accumulated Amortization account. Note, however, that some intangible assets (e.g. trademarks or goodwill) have indefinite lives, and thus, they are not amortized.

Investments are long-term investments in securities of other companies. Such securities may be debt securities (e.g. bonds, notes receivable) or equity securities (e.g. stock).

Other non-current assets may include other long-term assets not included into the investments, fixed, or intangible assets categories. Such other assets may be portions of prepaid expenses that will start expiring in more than a year after the balance sheet date, the cash surrender value of life insurance on officers, and others.


2.3. Current liabilities on classified balance sheet

Current liabilities are obligations due to be paid or settled within one year or the company's operating cycle, whichever is longer.

Usually current liabilities are settled by using current assets. Therefore, sometimes it is useful to compare current assets and current liabilities to understand if your business will be able to pay your current obligations using your current assets (the difference between the two is called working capital). Current liabilities may include accounts payable, accrued expenses, short-term loans, current portion of long-term debt, and income taxes payable. Let's review current liabilities in greater detail.

Accounts payable are liabilities (obligations) created by buying goods or services on account. In other words, it is your company's promise (and obligation) to pay for purchased goods or service later.

For example, if you purchased merchandise inventory today, and the credit terms state that you need to pay for the inventory next month, then you need to record this obligation as an account payable in your books.

Accrued expenses represent costs incurred but unpaid as of the period end.

Accrued expenses are required under the accrual basis of accounting, which is used for financial reporting purposes. An example of accrued expenses may be a cell phone bill with the billing period running from the 16th of the current month to the 15th of the following month. You will not receive the bill until the middle of the next month; however, you have used the cell phone for 15 days in the current month and, therefore, should recognize cell phone expense for 15 days of the current month by posting an accrued expense.

Short-term loans are notes payable expected to be settled within one year after the balance sheet date.

For example, if your company purchased equipment and issued a note payable to be settled in six months after the balance sheet date, then the amount of the note will be recorded under short-term loans.

Current portion of long-term debt represents the amount of long-term debt that will be paid within one year after the balance sheet date.

For example, some long-term debts (i.e. bank loans) are required to be paid in installments quarterly or semiannually, and then, a balloon payment is made at the maturity date for the remaining balance. The installment payments to be paid within one year after the balance sheet date represent short-term obligations and thus are recorded in the current liabilities under the caption "Current Portion of Long-term Debt" (may be shortened to Current Portion of LT Debt).

Income taxes payable are the amounts of income taxes that your company is obligated to pay to local, state, or federal authorities. These obligations are presented in the current liabilities section because it is usually expected that these balances will be paid within a year after the balance sheet date.

2.4. Non-current liabilities on classified balance sheet

Non-current (long-term) liabilities are other liabilities that are not included into the current liabilities section. Therefore, non-current liabilities are obligations that are not expected to be due (paid) within one year after the balance sheet date. Examples of non-current liabilities are long-term lines of credit and term loans.

A line of credit is an agreement, under which a bank provides your business with loans of money (i.e. up to an approved limit) during a predefined period.

You can take out the amount you need (e.g. via check, ATM, etc.), repay it, and then borrow again. At a point in time you can only have an outstanding balance up to a certain limit. This kind of loans is sometimes called revolving loans. If an outstanding amount is to be repaid within more than a year after the balance sheet date, then the amount is shown under the non-current liabilities on the balance sheet date.

Term loans are loans that are to be paid on a certain date (i.e. maturity date). Again, if the payment date is not within one year after the balance sheet date, then the loan is presented under the non-current liabilities.

As mentioned above, when we talked about current liabilities, any portion of long-term debts (whether it's a line of credit or term loan), which is to be paid within one year after the balance sheet date, must be presented under the current liabilities


2.5. Equity on classified balance sheet

Equity is the owners' claim on assets. Equity, as noted above, is also the difference between assets and liabilities. Equity may include multiple financial elements. The most common equity elements are capital (common stock), current year earnings, and retained earnings. Let's review them in more detail.

Capital (common stock for corporations) represents the amounts contributed by owners to the business. Depending on the legal form of a business, capital can be named differently.

Current year earnings are the net income or loss of the business for the current year. This amount is the difference between all revenues and all expenses on the income statement. Current year earnings are presented on the balance sheet only until they are transferred to retained earnings.

Retained earnings are net income (loss) retained (accumulated) by your company.

For a company with relatively simple operations, retaining earnings are cumulative net incomes (losses) less dividends paid out since the company's origination. Note that when dividends are paid out, they reduce retaining earnings. Also note that retained earnings may be a negative amount in situations when the company is not profitable (i.e. more losses than net incomes).

3. Balance sheet format

A balance sheet is a financial statement that has a certain commonly used format.

First of all, a balance sheet has a header. The header needs to include your company name, the title of the financial statement (i.e. balance sheet), and period(s) presented in the financial statement. Note that some balance sheets are presented for one year, while others are presented for two years in a comparable format (e.g. comparable balance sheets of public companies). An example of the header for a single-year balance sheet is presented below:

Your Company NameBalance Sheet

December 31, 2010

Next, the balance sheet with related captions is presented. Major captions (Assets, Liabilities, Equity) are presented first. Then, the next level captions are shown. The next level captions are the categories (classifications) we reviewed earlier (current assets, investments, etc.). Under each caption, components of the caption are presented. An example of the current assets caption is presented below:

ASSETS

Current AssetsCash

Marketable Securities Accounts Receivable

Inventories

Prepaid Expenses

Note how the components of current assets are intended to the right so it's easier to read the balance sheet.

Finally, let's recall that assets can be shown on the left side while liabilities and equity are shown on the right side (horizontal presentation). Alternatively, assets can be shown first with liabilities and equity presented underneath the assets. If a balance sheet for a single period is shown, it seems to be more readable to show assets on the left and liabilities and equity on the right side. However, if comparable balance sheets (i.e. a balance sheet for two or more periods) are prepared, then it makes more sense to show liabilities and equity under assets.


4. Example of preparing balance sheet

There are several steps in preparing a balance sheet. These steps are not prescribed procedures, so there may be variations based on your company’s needs and situation. Let’s review each step in detail.

4.1. Step 1: Prepare balance sheet template

A balance sheet template is a blank format with header, date, categories, and components of categories. The template can be prepared on paper, or better off, it can be prepared in a spreadsheet software (e.g. MS Excel).

For our illustration, we prepared a balance sheet template in MS Excel and presented it below. The template is in the vertical format due to width limitations on our website:

Illustration 4: Balance sheet template

Your Company NameTrial Balance

December 31, 20X0

ASSETS


December 31, 20X0

Current Assets:

Cash & Cash Equivalents

Marketable Securities

Accounts Receivable

Inventories

Prepaid Expenses

Total Current Assets

Fixed Assets

Intangible Assets

Investments

Other Non-current Assets

TOTAL ASSETS

LIABILITIES

Current Liabilities:

Accounts Payable

Accrued Expenses

Short-term Loans


December 31, 20X0

Current Portion of LT Debt

Income Taxes Payable

Total Current Liabilities

Non-current Liabilities:

Line of Credit

Term Loan

Total Non-current Liabilities

TOTAL LIABILITIES

EQUITY

Capital

Current Year Earnings

Retained Earnings

TOTAL EQUITY

TOTAL LIABILITIES & EQUITY

The spaces highlighted in light green are the ones where we will enter amounts taken from the trial balance.


4.2. Step 2: Obtain trial balance for your company

A trial balance is the collection of all accounts that exist in the company's chart of accounts with balances as of a particular date. Each account has either a debit or credit balance. The total of all debits equals the total of all credits (i.e. double-entry accounting system).

Most businesses, nowadays, use accounting software that is capable of generating a trial balance. Therefore, for your purposes, you can extract such a trial balance from your software. If you don't use such software, then you can prepare a trial balance from your records using, for example, MS Excel.

For our illustration, we obtained the trial balance from our accounting software as shown below:

Illustration 5: A trial balance extracted from accounting software


December 31, 20X0

Account Account Name Debit Credit

1000 Petty Cash $ 500

1010 Chase Checking 42,000

1020 PayPal Checking 23,500

1030 Savings 300,000

1040 Money Market 25,000

1200 Marketable Securities 0

1300 Accounts Receivable 389,000

1350 Allowance for Doubtful Accounts 25,500

1400 Raw Materials 87,000

1410 Work-in-process 12,000

1420 Finished Goods 132,000

1430 Spare Parts 58,000


December 31, 20X0

1500 Prepaid Insurance 5,400

1510 Prepaid Rent 3,000

1600 Land 570,000

1610 Buildings 430,000

1620 Leasehold Improvements 100,000

1630 Office Equipment 44,000

1650 A/D-Buildings 240,000

1660 A/D-Leasehold Improvements 51,000

1670 A/D-Office Equipment 25,000

1700 Patens 170,000

1710 Trademark 60,000

1750 Accum Amort-Parents 90,000

1800 Investments in Debt Securities 0

1810 Investments in Equity Securities 75,000

1900 Cash Surrender Value Life Insr 54,000

2000 Accounts Payable 285,000

2100 Accrued Payroll 205,000

2110 Accrued Property Taxes 42,000

2120 Accrued Vacation 323,000

2200 Short-term Bank Loan 245,000


December 31, 20X0

2300 Current Portion of Line of Credit 100,000

2400 State Income Tax Payable 30,000

2410 Federal Income Tax Payable 60,000

2500 Line of Credit (Revolver) 53,000

2510 Term Loan 250,000

3000 Capital 50,000

3010 Current Year Earnings 159,000

3020 Retained Earnings 346,900

Total $ 2,580,400 $ 2,580,400

Note that the total in the Debit column equals the total in the Credit column.


4.3. Step 3: Group trial balance accounts by classification

There are more trial balance accounts in Illustration 5 than there are balance sheet classifications (groups) in Illustration 4. That is because some classifications (groups) may include multiple trial balance accounts. For example, Cash and Cash Equivalents on the balance sheet template will include the following trial balance accounts since they have the same nature: Petty Cash, Chase Checking, PayPal Checking, Savings, and Money Market. Therefore, the next step is to group all accounts on the trial balance by their respective balance sheet classifications.

Here we have added another column to the trial balance where we entered the balance sheet classification for the accounts. Refer to Illustration 6 below.

4.4. Step 4: Subtotal account balances by classification

The following step is to subtotal the balances in the accounts for each classification. Note that when subtotals are prepared, all asset balances are calculated as Debit – Credit, while all liability and equity balances are calculated as Credit – Debit. For example, the subtotal for the balance sheet classification "Accounts Receivable" is equal to the debit amount in the account 1300, Accounts Receivable, less the credit balance in the account 1350, Allowance for Doubtful Accounts (that is, $389,000 - $25,500 = $363,500). Even though the calculations seem to be complicated, if you use spreadsheet software, it is pretty easy:

Illustration 6: Trial balance with subtotals for balance sheet classifications (groups)


December 31, 20X0

Acct # Account Name Debit CreditBalance SheetClassification

Subtotal

1000 Petty Cash $ 500

Cash & CashEquivalents

391,000

1010 Chase Checking 42,000

1020 PayPal Checking 23,500

1030 Savings 300,000

1040 Money Market 25,000

1200 Marketable Securities 0 MarketableSecurities

0

1300 Accounts Receivable 389,000 Accounts

Receivable363,500

1350 Allowance for Doubtful Accts 25,500

1400 Raw Materials 87,000

Inventories 289,0001410 Work-in-process 12,000

1420 Finished Goods 132,000

1430 Spare Parts 58,000

1500 Prepaid Insurance 5,400 Prepaid 8,400


December 31, 20X0

Expenses1510 Prepaid Rent 3,000

1600 Land 570,000

FixedAsset

828,000

1610 Buildings 430,000

1620 Leasehold Improvements 100,000

1630 Office Equipment 44,000

1650 A/D-Buildings 240,000

1660 A/D-Leasehold Improvements 51,000

1670 A/D-Office Equipment 25,000

1700 Patens 170,000

IntangibleAsset

140,0001710 Trademark 60,000

1750 Accum Amort-Parents 90,000

1800 Investments in Debt Secs 0 Investments 75,000

1810 Investments in Equity Secs 75,000

1900 Cash Surrender Value Life Insr 54,000 Other Non-currentAssets

54,000

2000 Accounts Payable 285,000 AccountsPayable

285,000

2100 Accrued Payroll 205,000

AccruedExpenses

570,0002110 Accrued Property Taxes 42,000

2120 Accrued Vacation 323,000

2200 Short-term Bank Loan 245,000 Short-term Loans 245,000


December 31, 20X0

2300 Current Portion of Line of Credit 100,000 Current Portionof Long-term Debt

100,000

2400 State Income Tax Payable 30,000Income Taxes

Payable90,000

2410 Federal Income Tax Payable 60,000

2500 Line of Credit (Revolver) 53,000 Line of Credit 53,000

2510 Term Loan 250,000 Term Loan 250,000

3000 Capital 50,000 Capital 50,000

3010 Current Year Earnings 159,000 Current YearEarnings

159,000

3020 Retained Earnings 346,900 RetainedEarnings

346,900

Total $ 2,580,400 $ 2,580,400

The final step is to transfer the classification subtotals from the trial balance (Illustration 6) to the balance sheet template (Illustration 4). For example, we transfer the $391,000 subtotal from the trial balance for Cash & Cash Equivalents to the identical line on the balance sheet template. The result will be a completed balance sheet:

sIllustration 7: Completed balance sheet template


December 31, 20X0

ASSETS

Current Assets:

Cash & Cash Equivalents $ 391,000 Marketable Securities 0

Accounts Receivable 363,500 Inventories 289,000

Prepaid Expenses 8,400 Total Current Assets 1,051,900

Fixed Assets 828,000

Intangible Assets 140,000

Investments 75,000

Other Non-current Assets 54,000

TOTAL ASSETS $ 2,148,900

LIABILITIES

Current Liabilities:

Accounts Payable 285,000 Accrued Expenses 570,000

Short-term Loans 245,000 Current Portion of LT Debt 100,000

Income Taxes Payable 90,000 Total Current Liabilities 1,290,000

Non-current Liabilities:

Line of Credit 53,000 Term Loan 250,000

Total Non-current Liabilities 303,000

TOTAL LIABILITIES 1,593,000

EQUITY


December 31, 20X0

Capital 50,000 Current Year Earnings 159,000

Retained Earnings 346,900 TOTAL EQUITY 555,900

TOTAL LIABILITIES & EQUITY $ 2,148,900

A few notes about the completed balance sheet:

The subtotals and totals on the balance sheet (i.e. the $1,051,900 for current assets) were directly determined when all subtotals from the trial balance were transferred to the balance sheet template.

The total assets of $2,148,900 equal the total liabilities and equity of $2,148,900. However, these totals don't match the trial balance totals for debits and credits of $2,580,400 (Illustration 6). The reason these totals don't match is because in the trial balance the totals are calculated for the debit and credit balances separately. In the balance sheet, though, some credit balances are subtracted from debit balances and vice versa (i.e. due to contra asset and contra liability accounts). Therefore, the totals on the trial balance and the balance sheet may not match.

Normally, if a particular balance sheet classification has a zero balance (i.e. Marketable Securities in Illustration 7), the classification line is not shown. We left Marketable Securities in there so it is consistent with the balance sheet template (Illustration 4) we prepared earlier. The line for Marketable Securities can be taken out without any "harm" to the balance sheet.

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