Balance Sheet (Explanation Part 1)

Introduction to Balance Sheet

The balance sheet (also known as the statement of financial position) reports a corporation’s assets, liabilities, and stockholders’ equity as of the final moment of an accounting period. For example, a balance sheet dated December 31 summarizes the balances in the appropriate general ledger accounts after all transactions up to midnight of December 31 have been accounted for.

The balance sheet is one in a set of five financial statements distributed by a U.S. corporation. To get a complete understanding of the corporation’s financial position, one must study all five of the financial statements including the notes to the financial statements.

The structure of the balance sheet reflects the accounting equation: assets = liabilities + stockholders’ (or owner’s) equity. The use of double-entry accounting keeps the balance sheet in balance.

The amounts reported on the balance sheet are summations of the ending balances in the many asset, liability, and stockholders’ equity accounts. The summarized amounts are presented in the following sections of the balance sheet:

• Current assets
• Investments
• Property, plant and equipment
• Intangible assets
• Other assets
• Current liabilities
• Noncurrent liabilities
• Stockholders’ equity

Generally accepted accounting principles (GAAP)

To assist the users of the balance sheet, a U.S. company must prepare its externally distributed financial statements according to common rules known as generally accepted accounting principles (GAAP or US GAAP; pronounced ‘gap’). US GAAP includes basic underlying accounting principles, assumptions, and detailed accounting standards of the Financial Accounting Standards Board (FASB).

Part of US GAAP is to have financial statements prepared by using the accrual method of accounting (as opposed to the cash method). The accrual method means that the balance sheet must report liabilities from the time they are incurred until the time they are paid. It also means the balance sheet will report assets such as accounts receivable and interest receivable when the amounts are earned (as opposed to waiting until the money is received). In short, the accrual method of accounting results in a more complete set of financial statements.

US GAAP will also mean that some of a company’s most valuable things (internally developed brand names, trademarks, patents, creative employees, etc.) will not be included as assets on the company’s balance sheet.

Let’s begin by looking at some balance sheet formats.