Report on the Basics and Importance of Balance Sheets

Observations from App. B.1 and B.2

By Alec Dyer

Accounting using a balance sheet is one of the prime financial tools used by accountants and business owners. Other
documents that hold the same importance include, income statement, statement of stockholders equity and statement
of cash flows. This form is also known as the statement of financial position.
The intent of this report is to give the reader, a better understanding of these forms, assuming that he or she
is at an introductory level. Each balance sheet is a way of displaying the status of a company at the end of a
specified date. Theyre often referred to as a snapshot of the companies current financial state at a given time. So
for example a balance sheet from Luigi Magiano Rectiulazos pizzeria and Sopa emporium on Parmer and Congress,
on July 1st would have all transactions through July 1st recorded.
These forms are invaluable tools. They allow creditors and investors to see what a company owns and owes
to different institutions at the given date on the form. This allows an entity such as a bank to come and evaluate if
theyd like to offer a loan or if the target even qualifies. Again, this form is quite helpful to other entities including,
current investors, potential investors, company management, suppliers, some customers, government agencies, labor
unions and competitors.
To make this form more easy to comprehend this report will be broken down into separate sections. Firstly,
the balance sheet will be explained component by component and and secondly, though not text and not required by
this criteria of this report, a sample balance sheet will be posted to give something to refer to.
Equity

Balance sheets have three main elements to their function: Assets, Liabilities and Owners (Stockholders)

Assets, as the engineering economics class at Lamar University has mentioned many times, is defined as
things that the company owns. Its a resource. This includes an immense amount of items. It includes things like
prepaid adverts, prepaid insurance and other prepaid items. More intuitively it also includes, Cash, Petty Cash,
Temporary Investments, Accounts Receivable, Inventory, Supplies, Prepaid Insurance, Buildings, Equipment,
Goodwill, Land, Bond Issue Costs and many others. Some assets are classified as Contra Assets and incur a credit.
This includes things like Doubtful accounts, accumulated depreciation buildings, accumulated depreciation
equipment and others. All of these items can be classified into three major categories: Current Assets, Investments,
Property, Plant and Equipment, Intangible assets and other assets.
Owners Stockholder Equity along with liabilities can be seen as a source of the companys assets. The
equity is sometimes referred to as the Book Value of a company because it equates to the reported assets minus the
reported liability amounts. Its also often referred to as the a companys residual of assets minus the liabilities.
Liabilities are obligations of the company; they are amounts owed to creditors for a past transaction and
they usually have the word "payable" in their account title. Along with owner's equity, liabilities can be thought of as
a source of the company's assets. They can also be thought of as a claim against a company's assets. For example, a
company's balance sheet reports assets of $100,000 and Accounts Payable of $40,000 and owner's equity of $60,000.
The source of the company's assets are creditors/suppliers for $40,000 and the owners for $60,000. The creditors/
suppliers have a claim against the company's assets and the owner can claim what remains after the Accounts
Payable have been paid.
Liabilities also include amounts received in advance for future services. Since the amount received
(recorded as the asset Cash) has not yet been earned, the company defers the reporting of revenues and instead
reports a liability such as Unearned Revenues or Customer Deposits.
All of these components make up what amounts to a balance sheet for a company or individual.