A balance sheet lists in one section all the assets of the business as
of the last day as of the accounting period and in another section all
claims against these assets. Claims against assets include creditors'
claims, or liabilities, and owner's claims, or investment (also called
equity or net worth).
Cash. This asset includes cash balances in the bank, cash on hand
(including change and petty-cash funds), funds held in trust, sinking
funds, and funds in time deposits. Not all the cash will necessarily be
available for payment of liabilities. Change funds, for example, must be
retained in order to have the change necessary for doing business.
Marketable securities. Included in this classification are such
items as Treasury bills and perhaps stocks and bonds. These assets are
most commonly shown on the balance sheet at their cost to the business or
at their market value.
Accounts receivable. An entry that is identified merely as
"accounts receivable" or has the designation "trade" after it refers to
accounts receivable from customers only. Notes or accounts receivable from
officers, employees, or owners of the business are considered non-trade
receivables and should be entered as a separate item.
Allowance for bad debts. This is an account that is deducted from
the accounts-receivable account to give a more accurate valuation to
accounts receivable. Suppose the business has accounts receivable of
$100,000 and experience indicates that 5 percent of this amount will
be un-collectible. There is no way of knowing which specific accounts
will not be collected, but it can be estimated that $5,000 will eventually
be un-collectible. To reflect this fact on the balance sheet, accounts
receivable are shown at $100,000. An allowance for bad debts of $5,000 is
also entered and deducted from the accounts receivable, leaving a net of
$95,000 as the estimated collectible accounts receivable.
Notes receivable. This account includes the face amount of all
notes that have been given the company and that are still un-matured, even
those that have been discounted at the bank.
Notes receivable discounted. This is a contingent (possible)
liability account. If a note receivable has been discounted at the bank,
the company has had to guaranty its payment. Thus, until the maker of the
note pays the bank, the company has a possible note payable.
The amount of the notes receivable discounted is entered on the balance
sheet under the notes receivable entry and subtracted from the notes
receivable total. An alternative method is not to include it in the notes
receivable total but to show it in a footnote.
Notes and accounts receivable from officers, employees, and owners.
This amount will include amounts due the business from persons connected
with the business in some way. Advances for employee uniforms or cash
loans may have been made, for instance.
Inventories. Inventories are the major asset in some kinds of
businesses, particularly those in the merchandising field. Methods of
valuing inventories are similar in manufacturing and non-manufacturing
companies, but the mechanics of computing the values differ. Therefore,
valuation methods are discussed separately.
Purchased inventories. If the business buys merchandise or raw
materials which it merely holds for a time and then sells with little or
no alteration, the inventory is valued either at cost or at the
replacement price if the latter is below cost. If the replacement price is
higher than cost, the inventory should be valued at cost.
It is generally agreed that if the cost of transportation of the goods
to the company is a significant item, the inventory account should include
this cost. In fact, all costs involved in preparing the goods for sale
could justifiably be included. Such costs might include, for example,
certain costs of dividing and repackaging.
Once it has been decided what costs are to be included in the inventory
account, there are at least four major methods of valuing the inventory:
1. If a business specifically identifies items in costing inventory, it
must be able to tell what was paid for each item. This method is practical
for items with a high unit price, such as new automobiles or major
appliances. As the unit price falls, however, and the number of items in
the inventory increases, this method of valuation becomes less practical.
2. First in, first out, or FIFO, is another method of costing
inventory. It assumes that the first units purchased are the first units
sold, that those still in inventory are the last ones purchased. Thus, the
inventory is valued at the cost price of the last items purchased by the
3. Last in, first out, or LIFO, assumes the opposite - that the last
goods purchased are the first ones sold. The inventory is thus valued at
the cost of the first inventory items to be available for selling. The
inventory valuation under LIFO does not necessarily correspond very
closely to current replacement costs.
4. The average cost method is merely an average of FIFO and LIFO. It
aims to find a middle ground between the two extremes.
If prices of the goods purchased have been rising, the FIFO valuation
will come closest to current market prices - the use of LIFO will tend to
value the inventory at less than current market prices. The choice of
inventory valuation will affect the reported cost of goods sold on the
income statement and also the reported net income.
Manufactured inventories. If the company manufactures goods from
purchased raw materials, the inventory costing or valuation method is
somewhat different. Any raw materials on hand are valued by one of the
methods described for purchased inventories. Valuation of work in process
and finished goods inventories involves three elements:
1. Cost of the raw materials used. This can be computed very exactly.
2. Cost of the direct labor used in converting the raw material into
its present state of completion. This, too, normally lends itself to
fairly exact measurement.
3. Factory overhead, or indirect cost. These are the costs of such
items as insurance, indirect materials, indirect labor, taxes, and so on.
They must be allocated to the units produced on some reasonable basis.
Total indirect costs do not vary with the amount of goods produced, or
at least not proportionately. This means that if the plant is not operated
at its maximum capacity, the indirect costs per unit of production will be
more than would be the case if the plant were operated at a higher level
of production. Therefore, idle time or idle capacity in a plant may cause
the inventory value of manufactured goods to be unrealistically high.
Prepaid and deferred items. Prepaid expenses are prepayments for
goods or services that will be consumed in the near future prepaid rent,
prepaid insurance premiums, office supplies, and so on. Deferred charges
are prepayments that will benefit the company over a period of years, such
as the cost of moving to a new location.
Property, plant, and equipment. This classification includes all
the fixed assets of the business-land, buildings, equipment, and other
tangible items that will last more than a year and will be used in the
normal operation of the business. These items, under generally accepted
accounting principles, should be recorded at their original cost to the
Occasionally, a buyer may find that the seller has raised the valuation
of these assets by appraisal write-ups. If this has accrued, the buyer
must satisfy himself that the value of the assets has in fact increased by
the amount of the appraisal write-up.
Accumulated depreciation and depletion. This account shows the
amount of depreciation, or loss of usefulness, that has been charged
against the property, plant, and equipment while they have been held by
the business. On the balance sheet, the amount in each depreciation
account is deducted from the corresponding property, plant or equipment
total. This leaves the net book value, or un-recovered original cost. A
depreciation account is merely a technique for distributing the cost of a
fixed asset over its estimated useful life. It is quite possible for
assets that are fully depreciated on the books to be still serviceable,
and for assets not fully depreciated to be no longer serviceable.
There are a number of methods of figuring depreciation. Four of the
most common are the straight-line method, the declining-balance method,
the sum-of-the-years-digits method, and the units-of-production method.
The first three methods record depreciation on the basis of time. The
straight-line method records the depreciation uniformly over the years of
the asset's estimated service life. It is by far the most commonly used
because of its simplicity. The declining-balance and sum-of-the
years-digits methods record larger amounts of depreciation in the early
years. With these two methods, increased maintenance expenses in later
years are offset somewhat by the reduced charges for depreciation. Also,
there are some income-tax advantages.
The units-of-production method is based on the estimated productive
capacity of the asset rather than time. It is useful where the amount of
usage varies considerably from time to time.
All four methods will record the same total depreciation over the life
of the asset. There may be a substantial difference in the amount recorded
in any one year, however.
Intangibles. This classification includes such items as patents,
trademarks, and goodwill. The value recorded is their cost to the
business. The amount entered for a patent, for example, will be either the
cost of purchasing the patent right or the cost of developing the patent.
Goodwill will not appear on the balance sheet unless the business
purchased the goodwill and has decided to leave it on the books.
Accounts payable to trade. The amounts recorded in this account are the
amounts owed to regular trade creditors (except notes payable) for
merchandise and other items needed in operating the business.
Notes payable. This item includes all amounts owed by the business
for which a formal note payable has been given if the note is due in 12
months or less from the balance-sheet date.
Accrued taxes payable. This account will show the amounts owed to
various taxing authorities. It will include taxes that have been collected
or withheld but not yet forwarded to the authorities. The account may also
include accruals for items such as property taxes, franchise taxes, and
use taxes the business owes but has not yet been paid. The amount shown on
the balance sheet should be the amount that the business is legally liable
Wages and salaries payable. This account will show all wages and
salaries of employees earned but not paid as of the balance-sheet date.
Any unclaimed wages due former employees will also be included in this
There are some rather rigid legal requirements about the handling of
taxes collected from the employees as opposed to ordinary business
Income taxes payable. This account may not appear on the balance
sheet if the business is operated as a single proprietorship or
partnership. It should be shown for a corporation. The amount may be only
an estimate but will usually be quite accurate.
Unearned income. Some types of businesses receive fairly large
amounts of prepaid or unearned income. The publisher of a newspaper or
periodical, for instance, is paid for subscriptions before the
publications are delivered. If a business rents property to others, the
rent will be received in advance. The amount of such income that has been
received but not earned at the balance-sheet date is recorded here. There
may or may not be a legal requirement that the unearned amounts be
returned if the company fails to deliver the services or products.
Long-term liabilities. For a liability to be considered long term,
its maturity date should be more than 12 months from the balance-sheet
date. If unearned income is prepayment for services covering more than a
year from the balance-sheet date, a proportionate amount of it should be
included here instead of under unearned income.
Owner's equity. Two elements enter into owner's equity: the initial
investment of the owner or owners, and retained profit or loss. The
computation of owner's equity is based on the recorded value of the assets
and liabilities of the business - it is merely the difference between the
total assets and the total liabilities. If the assets are recorded at less
than their true value, the owner's equity will be understated. If the
assets are recorded at an inflated value, the owner's equity will be
If the business is a corporation, the original investments of the
owners will be kept in separate contributed capital accounts. The net
results of operations will be summarized in one or more retained earnings
accounts. All these accounts together make up the owners' investment in
If the business is a single proprietorship or a partnership, each owner
will have a capital account that summarizes his investments, his share of
net income or losses, and withdrawals he has made.