After ascertaining the net profit or net loss by preparing the Trading and Profit and Loss Account, the final step in preparing final accounts is the preparation of Balance Sheet.
The purpose of Balance Sheet is to ascertain the financial position of a business i.e., to know what the business owes and what it owns on a certain date.
Hence it shows all assets and liabilities of the business as at the end of the accounting year.
You know that final accounts are prepared from the Trial Balance.
All items of expense and income appearing in 'Trial Balance are transferred to the Trading and Profit and Loss Account.
The remaining items which represent the balances of personal and real accounts are shown in the Balance Sheet.
The accounts showing debit balances represent assets and those showing credit balances represent liabilities.
Assets: The term 'assets' denote the economic resources (property) of the business and includes all current and fixed assets. You know current assets are those assets which are Likely to be realized within a period of one year (or during the normal operating cycle) and includes cash, stock, debtors, bills receivable, short-term investments, etc. The fixed assets, on the other hand, are those assets which are acquired for use in the business over a long period. They may be tangible like machinery and furniture, intangible like goodwill, patents, etc. The assets also include certain expenses and losses which have not been written off in full. Examples of such expenses are: formation expenses, expenses incurred on issue of shares and debentures, unwritten amount of expenditure on advertising, etc. These are shown as the last item under 'Assets' in the Balance Sheet.
Liabilities: The term 'liabilities' denote all claims against the assets of the business whether those of the outsiders (creditors) or those of the owners of the business. The outsider's claims may be sub-divided into (i) current liabilities, and (ii) long-.term.- liabilities. These are shown separately in the Balance Sheet (see figure 7.3). The current liabilities are those obligation which are likely to be met within one year (or during the normal operating cycle). The long-term liabilities refer to item like loans which are not to be paid in the near future. The owner's claim is shown as capital after adjusting it with the amount of net profit and drawings during the year.
