the first financial statement, that is, a balance sheet which helps in

understanding the financial position of a company.

You will begin the session by understanding the meaning and purpose of the
balance sheet.
You will also learn about the accounting equation, which lays the foundation of
the balance sheet.
Next, you will move on to the asset side of the balance sheet and understand
this with the help of an example of a manufacturing concern.
You will then move on to the equity side of the balance sheet and the liability
side of the balance sheet.
Finally, you will understand the line items in a balance sheet of a services
company.

--- What is a Balance Sheet?---

The basic accounting terms such as assets, liability, equity, revenue and
expenses are interlinked.
The link between these building blocks of financial accounting gives rise to
three fundamental financial statements, which are as follows:

Balance sheet
Profit and loss statement
Cash flow statement

A balance sheet is the first of the three financial statements that you will
learn about.
It gives you a snapshot of the financial position of a company at a particular
point of time.
In fact, if you want to apply for a business loan from a bank, you will need to
submit the balance sheet of your company to the bank.

A balance sheet tells you about the financial position of the company at a
certain point of time.
It shows what an entity owns, how much it owes to others, and the amount that
has been invested in the business by different stakeholders.

the following purposes of preparing a balance sheet:

1.To determine the company’s business position based on economic resources and
obligations.

2.To understand the nature of the liabilities and assets of the business.

3.To determine the liquidity and solvency position of a business.

4.The lenders of a company can gauge its ability to repay the borrowings.

5.Creditors can determine the cash flow position of the organisation.

6.Employees can understand the stability and growth potential of the company.

the following two lenses through which a balance sheet is historically viewed:
Resources and claims view
Sources and users of funds

What information does a balance sheet provide?

A company’s financial position at a particular point in time

A balance sheet is a statement that provides information about the financial

position of a company at a particular point in time.
For instance, a company’s balance sheet would be prepared as on 31/03/2020 and
not from 01/04/2019 to 31/03/2020.
This means the balance sheet would indicate the company’s financial position at
that particular time point and not between over the given period of time.
A balance sheet is a statement that provides information about the financial
position of a company at a particular point in time.
The main purpose of preparing a balance sheet is to provide different
stakeholders with a complete snapshot of the financial position of the
business and determine the nature of liabilities and assets of the business.
The balance sheet classifies assets based on their utility and liabilities based
on the time due for redemption.
It also gives the balance of all the important resources and their sources and,
hence, helps in determining the financial position of the business.

Which of the following statements about the balance sheet is true?

Balance sheet is affected by change in the resources owned by the company.

Resources owned by a company is typically the assets of the company.
One of the three building blocks of a balance sheet is assets.
Hence, any change in the value of the assets of the company will definitely
affect the balance sheet.

The balance sheet gives the users an idea of which of the following?
Financial position of the company and displays what it owns and owes

Resource and Claim

In a company, the equity shareholders contributed ₹1 crore, the lenders
contributed ₹50 lakh, and the assets of the company were jointly
funded with ₹1 crore and ₹50 lakh. In such a case, the lenders can do which of
the following?

Claim against all assets but in proportion to their contribution.

Both equity shareholders and loan capital providers are the sources of the funds
for procurement of the resources (assets).
Thus, their claim will be proportionate to their contribution.

---Accounting Equation---
The accounting equation is a basic principle of accounting and a fundamental
element of the balance sheet.
The fundamental accounting equation, which is also known as the balance sheet
equation,
represents the relationship between the assets, liabilities and owner's equity
of a company.

Accounting Equation => Assets = liabilities + equity

a typical balance sheet consists of ‘Assets’ on one side and ‘Liability and
Equity’ on the other side.
The relationship between these three elements is called the accounting equation,

which is given as below:

Assets=Liability+Equity

The accounting equation is built on the concept of dual aspect.

You also saw how different business transactions are recorded in the books of
accounts and how the accounting equation is always balanced
at the end of every business transaction.

If there is an increase in the value of an asset owing to a business

transaction, then which of the following actions may balance this effect?
Select all appropriate options. (Note: More than one option may be correct.)
Increase in the value of liability
Decrease in another asset
Increase in equity
Mittal Steel is an Indian steel producer. The company has total assets worth
₹600 crore, of which its current assets are valued at ₹50 crore.
Its current liabilities are valued at ₹40 crore and non-current liabilities are
valued at ₹260 crore. What is the value of Mittal Steel’s shareholder’s funds?

The accounting equation states that for any company, Assets = Liability +
Equity.
The total liability can be calculated as the sum of the current and non-current
liabilities, which is ₹40 crore + ₹260 crore,
which equals ₹300 crore. Hence, by entering the values of the assets and the
liability in the accounting equation,
you will get ₹600 crore = ₹300 crore + Shareholder’s funds. Hence, the owner’s
equity of Mittal Steel will be ₹300 crore.

Suppose you are the manager of Xetch Limited. You have joined the company
recently,
and after going through the balance sheet for a particular year, you find the
following details:
Extract from the Balance Sheet as at 31st March: Xetch Limited

Assets Amount (in ₹)

Current assets 1,20,000
Non-current assets ?
Total assets 3,50,000
Liability and equity Amount (in ₹)
Current liability 10,000
Non-current liability ?
Equity 2,00,000
Total liability and equity ?

assets ---- 3,50,0000

current --- 1,20,000
curr-liab -- 10,000
equity --- 2,00,000

The accounting equation states that for any company, Assets = Liability +
Equity.
The value of the total assets is given in the question.
You also know that Current assets + Non-current assets = Total assets. Hence,
on subtracting the value of the current assets from the total assets,
You will get ₹3,50,000 - ₹1,20,000 = ₹2,30,000, which is the value of the
company’s non-current assets.

What is the value of Xetch Limited’s total liability and equity?

1,20,000 + 2,30,000 = 3,30,000

= 20,000
33-21 = 12+20 =
35-21 = 34

The accounting equation states that for any company, Assets = Liability +
Equity. The value of total assets is ₹3,50,000,
as mentioned in the question. Therefore, as per the accounting equation, the
combined value of the total liability and equity is ₹3,50,000.

What is the value of Xetch Limited’s non-current liability?

₹1,40,000
The accounting equation states that for any company, Assets = Liability +
Equity. Using this equation, the combined value of total liability and equity
would be ₹3,50,000.
Therefore, on subtracting the value of the current liability and equity from the
combined value of total liability and equity,
you would get ₹3,50,000 - ₹10,000 - ₹2,00,000 = ₹1,40,000, which is the value of
the company’s non-current liability.

---Balance Sheet: Assets---

All the economic resources that are owned by an organisation are categorised as
its assets.
Depending upon the purpose and usability of assets, they are divided into two
categories: Current and non-current.

Inventories: These are stocks of unsold products held by a company, work-in-

progress or raw materials to be used for manufacturing products.

Current investment: These are short-term investments such as short-term bonds or

government securities maturing within a year.
These short-term investments are made by the company, usually to generate
returns out of idle or surplus cash lying with the company.

Trade receivables: These are funds that a customer owes to the company on
account of buying goods from the company on credit.

Cash, bank and equivalents: These are assets in the form of hard cash or money
in a bank and also includes money market instruments.

These are the most liquid current assets. By liquid, it means that they
can be easily converted into cash.

Other current assets: These are assets other than cash, receivables, inventory
which can be converted into cash within a year.
They hold quite less value and, hence, are not
required to be shown separately but are clubbed together under the heading
‘other current assets’.

--the non-current assets of the balance sheet--

that the non-current assets include the following line items

Property, plant and equipment: These are certain assets that the company uses to
produce goods and services.
These are also known as tangible
assets as they have a physical form, that is, they can be seen and touched.

Capital work-in-progress: These are assets that are still in their development
stage and will become a part of the tangible assets after its completion.

Intangible assets: These are assets that lack a physical form, that is, they
cannot be seen or touched.
For example: Patent, copyright, trademark, computer
software, etc.
Non-current investments: These are long-term investments in another company's
bonds, government securities, mutual funds, etc.
Long-term loans and advances: These are
long-term loans that are leant to the other companies at a fixed rate of
interest.

Other non-current assets: These include capital advances that are made by the
company.

Which of the following are tangible assets? (Note: More than one option may be
correct.)
A vacant plot of land and buildings
Equipment in a factory
Computers used for administrative work in an office

Factors Contributing to Cash and Cash Equivalents

Sale of non-current assets
Non-current assets include assets such as land, buildings and shares of other
companies, which are not expected to get converted into cash within 12 months.
Sale of such assets have the following two effects on the asset side of the
balance sheet:
The amount of non-current assets decreases
The cash and cash equivalent increases
Hence, this could be a possible reason for the increase in the cash and cash
equivalent.

Increase in Current Assets

Zed Motors Limited is a two-wheeler-manufacturing company. An extract from the
company’s balance sheet extract is shown below.
In this table, you will notice a substantial increase in ‘Net receivables’.
Which of the following scenarios could be one of the possible reasons for this
increase?

Extract from the Balance Sheet as at 31 March: Zed Motors Limit

An increase in the percentage of automobiles sold on a credit basis
When goods are sold on credit, the corresponding cash obtained is realised
later.
Hence, the cash becomes a part of accounts receivables.
An increase in Zed Motors Limited’s accounts receivables indicates that
the company has made credit sales.

Cash and cash equivalents include all the amount of money, market instruments
and the very liquid investments that the company has and which could easily be
converted into cash. Since this Rs 5 lakh fund can be very easily liquidated
into cash having value near to the actual amount of cash deposited in the fund,
it is equivalent to cash itself.

Under which of the following will ‘Fixed assets held for sale’ be classified in
the company’s balance sheet?
As per the definition of Current assets, Assets that would get liquidated or
converted into cash in the short term or over the next 12 months are classified
as Current assets. Therefore, Fixed assets that are held for sale will be
classified as Current assets, as the intention of the company is to convert the
fixed assets into cash within the next 12 months.

Non-current assets are assets that are supposed to be used by the company for
generating other assets.
The company does not intend to convert these assets directly into cash/cash
equivalents within 12 months or within one operating cycle. Calculation:

Non-current asset = Land +Plant/Equipment = ₹25,00,000 + ₹10,00,0000 =

₹35,00,000

Companies maintain current assets with the intention to convert them into cash
and cash equivalent within 12 months or one operating cycle.

Calculation:
Current assets = Trade receivables + wages paid in advance + Inventory + Cash at
bank
= ₹4,00,000 + ₹1,00,000 + ₹3,00,000 + ₹65,000
= ₹8,65,000
Hint - Balances given for bank ₹50,000 and Procurement of supplies are opening
balance

The construction of one of its assets is completed and is transferred to

property, plant and equipment.
Once the asset is constructed completely, the balance is transferred to
property, plant and equipment.

---Balance Sheet: Equity---

Usually, you do not start a company to run it for a specific period of time.
You aim to run the company for a long period of time, say, indefinitely.
And in each year of its operation, the company makes some profit or loss.
What happens to the profit made by the company every year, after settling all
its obligations due such as interest and dividend payments?

Well, the residual amount is transferred to the equity portion of the balance
sheet of a company and is used for growth and expansion purposes.

the equity portion of the balance sheet

that equity is basically the owner’s interest in the assets of a firm after
deducting the liability. It consists of two line items, which are as follows:
Equity share capital: This is the amount received from the owners or
investors of a company. It is also known as the ‘contributed capital’.
Other equity: It consists of the following items:
Retained earnings: It is the undistributed or accumulated profits of
the company over the years.
Capital reserve: The reserve is created out of profits that are
earned from the non-operating activities of a company.
It is created to settle capital losses or
finance capital expansion.
For example: Share premium, gain on
revaluation of tangible assets, profit on sale of old equipment, etc.

the equity portion of the balance sheet.

the net profits that are earned by a company belong to the shareholders of the
company.
Hence, the profits must be distributed among them in the form of a dividend.
This is the reason why the undistributed profit is transferred to the equity
portion of the balance sheet in the form of retained earnings.

Accounting Terminology
Big Feast Limited is an Indian FMCG company. An extract from Big Feast Limited’s
balance sheet for the current year is given below.
Extract from the Balance Sheet as on 31st March: Big Feast Limited
Assets Amount (in ₹)

Plant and equipment 10,00,000

Cash 50,000
Patents and copyright 1,00,000
Inventory 2,00,000

Liability and equity Amount (in ₹)

Retained earnings 8,00,000
Equity capital 2,00,000
Short- term debt 2,00,000
Long- term debt 5,00,000

What would be the total current assets for Big Feast Limited at the end of the
year?
Current assets refer to those assets that will be used within the next 12 months
or in one operating cycle.
So, they would include the cash at hand and inventory.
Current assets = ₹50,000 + ₹2,00,000 = ₹2,50,000

The equity portion would include the capital invested by promoters and the
retained earnings of the company. Therefore, Equity = ₹2,00,000 + ₹8,00,000 =
₹10,00,000.

Retained Earnings
For a company, retained earnings represent:
Profits retained by the company after the payment of dividends and after any
transfer to and from reserves
Retained earnings is the amount of net income left for the business after it has
paid out dividends to its shareholders.

Equity and Other Equity

Company’s accumulated profits may have increased by ₹22,50,000.
Equity share capital represents the contribution by the shareholders of the
company and retained earnings includes profits, premium and capital reserves.
The increase in profits shall be included under retained earnings and it shall
have no impact on equity contribution by shareholders.

---Balance Sheet: Liabilities---

current liabilities include the following line items:

Short-term borrowings: These are financial obligations such as short-term bank

loans that are due within a period of 12 months.

Trade payables: These are bills due to creditors on account of credit purchases
made by the company.

Other current liabilities: These are current liabilities that are not assigned
to common liabilities such as short- term borrowings or accounts
payable since it might be too minor to
be reported separately.

Example: Expenses incurred but still unpaid, rent payments received in

advance.
Short-term provisions: These are provisions that are created to meet the short-
term liabilities.

Current tax liabilities (net): When the due date for making tax payment does not
merge with the balance sheet preparation date,
the tax expense for the current
year to be paid by the company is recorded as a current tax liability.

Note: An accurate definition of deferred tax liability is: "A tax that is
assessed or is due for the current period but has not yet been paid." Source:
Investopedia

that the non-current liabilities includes the following line items:

Long-term borrowings: These are long-term loans taken for about 20 to 30 years
in order to purchase assets such as plant and machinery, land and building.

Long-term provisions: A provision refers to an amount of money kept aside in

order to meet the contingent obligations of an enterprise.
Long-term provisions are created to set aside
money for employee benefits such as leave encashment and provident funds.

Deferred tax liabilities: These are those liabilities that are created due to
temporary differences between the reported profit and
the taxable profit of an organisation.
Other non-current liabilities: These are non-current liabilities that are not
assigned to common liabilities since it might be too minor to be reported
separately.

that contingent liabilities refers to a potential or a probable liability that

is actually based on some future event.
If the future event occurs, only then would the organisation be liable to
pay that amount.
It is disclosed in the company reports.

Let’s understand a few line items such as provisions and deferred tax
liabilities

Deferred tax liability :

Deferred tax liability is specifically classified under Non-current liabilities.

It represents an obligation to pay taxes in the future and is not part of the
current period tax liability, and therefore,
it is not part of Current liabilities

Which of the following shall not be included under the heading ‘Non-current
liabilities’ of a balance sheet?
Trade payables-Trade payables are included under Current liabilities and not
Non-current liabilities,
as they are due to be paid within 12 months. As per definition,
Non-current liabilities are any liabilities that are not to be paid within 12
months or urgently.

Which of the following would be disclosed in a company’s annual report as

contingent liability?
An employee has filed a litigation against the company for wrongful dismissal
and there is a 75% chance of the company losing it.
The compensation would amount to ₹5,00,000.
Contingent liability is a potential or probable liability, which is based on
some future event.
Contingent liability is not recorded in the balance sheet but disclosed in the
annual reports of an organisation.

the ‘Long-term debt’

An increase in the land acquisition cost for setting up the company’s new plant
to be funded by borrowings
If the company faces a situation in which the land acquisition cost for setting
up its new plant increases,
then it will try to borrow funds from lenders to meet this high cost. This
borrowing will lead to an increase in the long-term loans of the company.

Find below the extract from the balance sheet of Vertex Ltd:
Current liabilities are the financial obligations, which are due within 12
months or one operating cycle.

Items to be considered under current liability = Bills payable + Bank overdraft

+ Creditors. Substituting the values of each of these, we get

₹4,00,000 = ₹2,20,000 + ₹1,00,000 + creditors.

This gives the value of Creditors = ₹80,000.

We know,
Total liabilities = Non-current liabilities + Current liabilities
As per the previous question, creditors amount is ₹80,000, and using that in the
equation below, we get,

₹20,00,000 = Long-term provisions + ₹10,00,000 + ₹2,20,000 + ₹80,000 + ₹1,00,000

Therefore, long-term provisions = ₹6,00,000

Non-current liabilities are not due within the next 12 months. These are long-
term debts, which are not required to be repaid in the near future.

Here, non-current would include long-term provisions + debentures

= ₹10,00,000 + ₹6,00,000 = ₹16,00,000

urrent liabilities are due within the next 12 months. These are short-term
debts, which are required to be repaid in the near future.

Here, Current would include Short-term loan + Advances from director + Loan from
bank (repayable in 6 months)
= ₹5,00,000 + ₹2,50,000 + ₹1,00,000
= ₹8,50,000

(Hint - Short-term provisions are the amount kept aside by the organisation to
meet short-term liabilities.)

Identify which of the following is not part of short-term provision.

Deferred tax liability
Deferred tax liabilities are the liabilities that are created due to temporary
differences between the reported profit and taxable profit of an organisation.
Hence, it is a separate line item and not part of short-term provisions.

Feedback :
Short-term provisions are the amount kept aside by the organisation to meet
short-term liabilities.

Here,
Short-term provisions would include Provision for employee benefit expenses +
Provision for tax

= ₹3,50,000 + ₹1,50,000
= ₹5,00,000

---Analysing the Balance Sheet---

One can draw several inferences from the balance sheet.
Particular key points
1)Liquidity position it is the ability of an org to meet its short-team
obligations
it is of an org isconsidered to be
strong when it has sufficient cash reserves.
majority of txns taking place on
credit indicates a weak liquidity position

2)Solvency position It shows the source of capital on which an

org depends predominiantly.
if an org is dependent more upon owned
capital, it is considered to be more solvent
if an org is dependent more upon debt
capital than equity capital then it will be considered less solvent.

Reading a balance sheet

---Balance Sheet: Service Company---
Let's take a look at the balance sheet of a service company.
Some line items are slightly different from the balance sheet of the automobile
example that you saw earlier.

An interesting thing you learnt in the video is that goodwill can appear as a
line item in a balance sheet only
when the company pays for acquiring it as part of a business acquisition! If the
goodwill is internally generated,
then it cannot be shown as an asset in the balance sheet.

You also learnt that service companies do not have inventory or work in progress
as a line item.
This is because they do not offer tangible products. Instead, they have a line
item known as ‘unbilled revenue’,
which refers to all the work that is still in progress and not yet completed by
a service company.

Assets
DLF Ltd. is a real estate company with operations all over India.
It has recently purchased several properties for the purpose of selling.
Under which of the following will these be shown in its balance sheet?
Inventories
Buying of properties by a real estate company for the purpose of selling will be
shown under ‘Inventories’,
as they are the commodities that are sold as the part of business operations.
Hence, they are shown under inventories as current assets and not as Non-current
Assets.

Inference/ Accounting Equation

Assume that Amit Limited has purchased a car for delivery purposes, at a total
cost of ₹25,00,000.
The down payment was ₹10,00,000 and the loan amount was ₹15,00,000, which was
due in 120 days.
As a result of this transaction, which of the following happens?
Total assets increased by ₹15,00,000 with a corresponding increase in
liabilities by ₹15,00,000.
Buying a car increases the fixed asset by ₹25,00,000.
However, the down payment shall decrease the cash in hand by ₹10,00,000,
resulting in a net increase of ₹15,00,000. The signing of a loan will increase
the short-term liability by ₹15,00,000.

"Provision for doubtful debts" is deducted from "debtors" to show the actual
trade receivable.
"Advances are given to third parties" and, hence, become an asset for the
company. These are classified under “Financial assets–Loans and advances”
"Long-term debentures" are loans taken by the company and are classified under
“Borrowings”.
"Tax for the current year" needs to be paid within 12 months and is classified
under “other current liabilities”.
"Raw materials" are used to make final goods and, hence, will be classified
under “Inventories”.

subsdaries --- 3rd parties

goodwill
MTR Co. Ltd believes that the company has a good reputation in the market;
hence, its brand must be valued in balance as goodwill for ₹10,00,000.
What would be your advice to the management on this decision.
The company cannot show it as goodwill as it is internally generated and not
from any business acquisition.
Accounting Concept/Terminology
A software company Zedex Ltd has undertaken a contract for developing software
for its client.
The total contract valued at ₹10,00,000. Zedex, as on the date of balance sheet,
has completed developing 30% of the software,
and this has been approved by the client. However, Zedex has not billed the
client for the same. Can Zedex show this as part of revenue?

Unbilled revenue is part of revenue and is also shown as an asset as it is not

received.

‘Unbilled revenue’ refers to all the work that is still in progress and not
completed by a service company.

Under accrual concept, if the revenue is earned, it must be recorded even if not
billed/not received actually.
The corresponding entry for recording revenue shall give rise to an equal amount
under current asset as unbilled revenue.
Sending an invoice moves the transaction from Unbilled Revenue into Accounts
Receivable.

Unbilled Revenue
Given below is an extract from the balance sheet of Addani Limited.
Cash and cash equivalent ₹10 lakh
Machinery ₹20 lakh
Land and building ₹50 lakh
Unbilled revenue ₹5 lakh
Inventory ₹5 lakh
Patent ₹20 lakh

Current assets ₹20 lakh and Non-current assets ₹90 lakh

Current assets are any economic benefits receivable in near future

= Cash and cash equivalent + Unbilled revenue + Inventory
= ₹10 lakh + ₹5 lakh + ₹5 lakh
= ₹20 lakh

Non-current assets shall include tangible and intangible fixed assets

= Machinery + Land/ Building + Patent
= ₹20 lakh+ ₹50 lakh + ₹20 lakh
= ₹90 lakh

Session Summary

In this session, you learnt about the balance sheet in detail. Let’s summarise
the learnings from this session below:

The balance sheet tells you about the financial position of a company at a
certain point of time.

It outlines the accounting equation: Assets=Liability+Equity.

The asset side consists of current and non-current assets.

Current assets includes the following:

Inventories

Current investment

Trade receivables
 Cash, bank and equivalents

Other current assets

Non-current assets include the following:

Property, plant and equipment

Capital work-in-progress

Intangible assets

Non-current investments

Long-term loans and advances

Other non-current assets

The equity side of a balance sheet consists of the following line items:

Equity share capital

Other equity

The liability side of a balance sheet consists of the following:

Current liability

Short-term borrowings

Trade payables

Other current liabilities

Short-term provisions

Current tax liabilities (net)

Non-current liability

Long-term borrowings

Long-term provisions

Deferred tax liabilities

Other non-current liabilities

Contingent liabilities refers to a potential or a probable liability that

is actually based on some future event.

The balance sheet shows the following:

Liquidity position of an organisation

Solvency position of an organisation

In the balance sheet of a services company, there is a line item called

‘unbilled revenue’,
which refers to all the work that is still in progress and not yet completed by
a service company.