Listed below is a sample
balance sheet of a simple corporation. Click on any of the items to get
a brief explanation. Keep in mind that each caption on the balance sheet
is often referred to as an account.
The
first line in the title of the balance sheet is the name of the organization.
If a company is incorporated, the words "Limited" or "Incorporated" or
abbreviations for these such as "Ltd." or "Inc." respectively often follow
the name of the company. The word "Limited" or "Ltd." is more common in
Canada. Go back to top of Balance Sheet.
The second line of the balance sheet simply names the financial statement that follows. In addition to the balance sheet, a set of financial statements will also include:
Cash
represents
that amount of money that is in the bank or kept on the premises of the
business. It usually includes cash equivalent items such as term deposits
and temporary investments that management intends to hold for less than
three months. Go back to Balance Sheet.
Temporary
investments are those that are held for longer than three months but
less than a year. They are often called marketable securities or short-term
investments and can consist of term deposits, stocks and bonds. Go
back to Balance Sheet.
Accounts
receivable represents amounts owed from customers that are due within
the next year. Usually they are due within one or two months. They are
evidenced by an invoice and are often called trade receivables. Go
back to Balance Sheet.
Notes
receivable are similar to accounts receivable except that they are
evidenced by a formal promissory note rather than an invoice and are usually
due after more than 90 days but within one year. Because they are outstanding
for a longer period of time than accounts receivable, they usually bear
interest. Go back to Balance Sheet.
Inventories
consist of goods held for resale. There are two types of companies that
have inventory: manufacturers and wholesalers/retailers. For a manufacturer,
the cost of inventory will include not just the price to purchase it but
also the cost to process it further. These costs will include labour and
overhead. There are entire accounting courses devoted to determining how
much labour and overhead should be allocated to inventory as opposed to
being shown directly as expenses on the income statement. A manufacturer
will typically show three types of inventory: raw material, work in process,
and finished goods. A wholesaler/retailer will simply show one type of
inventory: merchandise. Go back to Balance Sheet.
Supplies
are items used up through the operation of a business. They are not inventory
because they are not held for sale to customers. Go
back to Balance Sheet.
Prepaids
or prepaid expenses are expenditures already made for services expected
to be received within one year. The difference between an expense and a
prepaid expense is that the benefit relating to the latter has not expired.
Go
back to Balance Sheet.
Tangible
capital assets are assets that have physical substance and will be
used over a number of years. Examples include land, buildings, and equipment.
On the balance sheet, these assets are usually listed with land first.
Land is usually the first capital asset listed on the balance sheet because
it is not amortized (this is because its useful life is unlimited). After
this, capital assets are generally listed according to their size. Go
back to Balance Sheet.
Accumulated
amortization was explained in the first part of lesson one. The benefits
of owning a capital asset get reduced through the use of the asset over
its life. The process of this "using up" is called amortization. The accumulated
amortization recorded on an asset since it was purchased is shown as a
reduction from the original cost of the related asset. The cost of an asset
less its accumulated amortization is known as its net book value or carrying
value. The term "depreciation" is the out of date terminology used to describe
amortization. Go back to Balance Sheet.
Long-term
investments are investments such as guaranteed investment certificates,
stocks, bonds etc. that management intends to own for more than one year.
Go
back to Balance Sheet.
Bank
overdrafts, which are essentially a negative cash balance caused by
taking more money out of a bank account than was available. This really
represents a short-term bank loan and many banks provide their customers
with this overdraft facility. Go back to
Balance Sheet.
Demand
bank loans are loans that the bank can demand repayment of within a
very short period of time, usually several days. Consequently, these are
shown as current liabilties. Go back to Balance
Sheet.
Account
payable, which represents amounts owed to suppliers within the next
year. These are usually payable within 30 days and are recorded upon the
receipt of an invoice. These are also known as trade payables. When an
amount is owed to a supplier but the invoice has not yet been received,
the payable must still be recorded. Such a payable may still be shown as
an accounts payable but it is often known as an "accrued" payable. Go
back to Balance Sheet.
Notes
payable are promissory notes that indicate that a liability has to
be settled at least more than 90 days from the issue of the note. Notes
payable can be a current or long term liability depending on when it is
due. They bear interest and have specified payment terms. In the event
of a bankruptcy, the holders of notes payable usually will be paid before
suppliers that are owed accounts payable. Go
back to Balance Sheet.
Wages
or salaries payable represents wages or salaries owed to employees
for work done prior to the end of the period but before their regular pay
day. A person paid a salary is usually not paid for overtime and is paid
a fixed amount each pay period. A person earning a wage is usually paid
a certain amount for each hour of work performed. For example assume you
are an employee of a company whose last pay day was December 24. Your wage
is $10 per hour. Your next pay day is on January 7. Before the end of the
year, you worked 30 hours. The company would record wages payable of $300
on the balance sheet pertaining to the wages incurred and owed to you.
Go
back to Balance Sheet.
Income
taxes payable is the amount the company owes to the government for
taxes on its income. This is not applicable for proprietorships or partnerships,
as the income from these entities is taxed personally in the hands of the
owner. Corporations are separate legal entities and are required to pay
income taxes separately from those paid by the shareholders. Go
back to Balance Sheet.
Employee
taxes and benefits payable consists of amounts withheld from employees'
pay cheques for benefit programs. At a minimum, most companies will deduct
three items from a pay cheque: income taxes, Canada pension plan payments
and employment insurance premiums. For the last two items, the employer
also contributes to the plan. The amounts withheld from the employee's
pay cheque, along with the amounts contributed by the employer must be
remitted to government authorities on a periodic basis. Go
back to Balance Sheet.
Unearned
revenue consists of amounts such as deposits received and advances
from customers. These are also known as deferred revenues. If a
customer pays for something in advance, the company owes the customer the
product or service they have requested. This of course is a liability and
should be recorded as such. This type of liability will eventually be "paid
off" when the service or goods are provided. Go
back to Balance Sheet.
Dividends
payable is a current liability that is applicable only to corporations.
It represents dividends that have been declared but not yet paid by the
company. Recall from the beginning of lesson one that dividends are distributions
of retained earnings. Go back to Balance
Sheet.
GST
payable is a current liability representing the amount of goods and
services taxes collected from customers (net of any GST paid to suppliers).
This net amount must be paid to the Federal government on a periodic basis.
Go
back to Balance Sheet.
Interest
payable is the amount of interest owed on various interest-bearing
liabilities such as bank loans. Interest is incurred through the passage
of time and consequently a liability for interest arises as time passes.
For example, assume that a $100,000 bank loan was taken out on July 1,
2000 bearing interest at 6%. Interest rates, unless specified otherwise,
are always expressed in annual rates. Payment of the loan principal (the
original amount of the loan for $100,000) along with any related interest
is not due to be paid until July 1, 2001. Nevertheless, half of year's
interest is still payable at December 31. Consequently, an amount for 8%
X $50,000 X 6/12 = $2,000 would be recorded as interest payable. Go
back to Balance Sheet.
Current
portion of long-term liabilities represents the principal portion of
any long-term liability that would have to be paid within the next year
or operating cycle, whichever is longer. The most common example of this
is the current portion of a mortgage. For example, if a company owes $60,000
for a mortgage but $5,000 of this amount is to be paid next year, then
that amount would be shown as a current liability while the remaining $55,000
would be shown as a long-term liability. Go
back to Balance Sheet.
Mortgage
payable is a long-term liability consisting of bank loan that has property
as security. Mortgages bear interest and mortgage payments usually pay
off any interest owing to date along with part of the principal (original
amount of the loan). Go back to Balance
Sheet.
Bank
loans other than mortgages are secured with other assets of the company
or not secured at all. They bear interest like mortgages. Go
back to Balance Sheet
Amounts
due to shareholders and owners are often shown as long-term liabilities.
Many businesses raise funds by receiving both equity and loans from the
owners. Corporations, because they have shareholders, are the only entities
that can have shareholder loans. Injecting money into a corporation by
using loans instead of equity provides a tax advantage. When shareholders
wish to receive funds from a company, this can be done without any tax
consequences by having the company repay a shareholder loan. If a shareholder
loan was not made to the company, the only way that funds can be withdrawn
by the shareholder would be through the use of salaries or dividends and
on each of these, the shareholder would have to pay taxes. Go
back to Balance Sheet
Bonds
payable are essentially long-term notes payable with specified payment
and interest terms. They are usually issued only by government bodies and
large corporations that are able to attract this type of financing. A debenture
is one type of bond. Small companies are sometimes able to sell debentures
and raise funds in this manner but to do so they may have to offer a higher
than normal interest rate. These types of bonds are often called "junk"
bonds. Go back to Balance Sheet
Common shares are issued by a corporation to the owners of the business. There are two major types of shares: common and preferred. In more recent years, shares have been named Class A, Class B etc. The company can then assign certain privileges to each class in whatever way it prefers. Nonetheless, one class usually has the characteristics of common shares while others will have characteristics of preferred shares.
The type of equity that is
shown in the balance sheet depends on the legal form of the business. For
unincorporated entities such as proprietorships and partnerships, there
is only one type of equity account and that is the capital account. Each
owner will have a capital account. A capital account is increased when
the owner contributes assets to the business and it is reduced when the
owner takes assets out of the business (this is often called a drawing
or a withdrawal). If a business earns income through its operations, this
will result in an increase in the capital account. If a company has net
losses this will result in a decrease in the capital account.Go
back to Balance Sheet
Retained earnings is another type of equity account. Whereas share capital accounts (common shares or preferred shares) represent the amount of funds origninally invested in the business by the owner, retained earnings represents the cumulative profits or losses of the corporation that have remained in the business. For example if a company earned $10,000 of net income in year 1 and $15,000 of net income in year 2, the retained earnings balance would be $10,000 at the end of year 1 and $25,000 at the end of year 2. If a $15,000 loss was incurred in year 2 instead of $15,000 of net income, the retained earnings at the end of year 2 would be negative $5,000. When retained earnings becomes negative it is renamed "deficit". Please note that a corporation does not use capital accounts - instead share capital accounts and retained earnings are used.
If the shareholders want
some of the profits earned by the corporation to be distributed to them,
this is done through the payment of a dividend, which must be approved
by the board of directors. The board of directors is elected by the shareholders
to oversee the policies and strategic direction of the corporation. Dividends
are considered a distribution of retained earnings and will cause the account
to fall. Go back to Balance Sheet