Balance sheet

Balance Sheet
Liabilities defined very broadly represent what the business entity owes others. The Companies Act
classifies them as follows:
1. Share capital
2. Reserve and surplus
3. Secured loans
4. Unsecured loans
5. Current liabilities and provisions.
Share Capital: This is divided into two types: equity capital and preference capital. The first represents the contribution
of equity shareholders who are theoretically the owners to the firm. Equity capital, being risk capital, carries no fixed
rate of dividend. Preference capital represents the contribution of preference shareholders and the dividend rate
payable onmay be fixed and cumulative. Reserves and surplus : Reserves and surplus are profits which have been
retained in the firm. There are two types of reserves: revenue reserves and capital reserves. Revenue reserves
represent accumulated retained earnings from the profits of normal business operations. These are held in various
forms: general reserve, investment allowance reserve, capital redemption reserve, dividend equalisation reserve,
etc. Capital reserves arise out of gains which are; not related to normal business operations. Examples of such
gains are the premium on issue of shares or gain on revaluation of assets. Surplus is the balance in the profit and
loss account which has not been appropriated to any particular reserve account. Note that reserves and surplus
along with equity with equity capital represent owners' equity.
Secured Loans: These denote borrowings of the firm against which specific securities have been provided.
The important components of secured loans are: debentures, loans from financial institutions, and loans
from commercial banks.
Unsecured Loans: These are the borrowings of the firm against which no specific security has been provided. The
major components of unsecured loans are: fixed deposits, loans and advances from promoters, inter-corporate
borrowings, and unsecured loans from banks.
Current Liabilities and Provisions: Current liabilities and provisions, as per the classification under the
Companies Act, consist of the following: amounts due to the suppliers of goods and services bought on credit;
advance payments received; accrued expenses; unclaimed dividend; provisions for taxes, dividends, gratuity,
pensions, etc. Current liabilities for managerial purposes (as distinct from their definition in the Companies Act) are
obligations which are expected tomature in the next twelve months. So defined, they include the following:
(i) loans which are payable within one year fromthe date of balance sheet,
(ii) accounts payable (creditors) on account of goods and services purchased on credit for which
payment has to be made within one year,
(iii) Provision for taxation for taxation,
(iv) accruals for wages, salaries, rentals, interest, and other expenses (these are expenses for services that

have been received by the company but for which the payment has not fallen due), and
(v) advance payment received for goods or services to be supplied in the future.
Assets
Broadly speaking, assets represent resources which are of some value to the firm. They have been acquired at a
specific monetary cost by the firm for the conduct of its operations. Assets are classified as follows under the
Companies Act:
1. Fixedassets
2. Investments
3. Current assets, loans and advances
4. Miscellaneous expenditures and losses
Fixed Assets: These assets have two characteristics: they are acquired for use over relatively long periods for
carrying on the operations of the firmand they are ordinarily notmeant for resale. Examples of fixed assets are land,
buildings, plant,machinery, patents, and copyrights.
Investments: These are financial securities owned by the firm. Some investments represent long-term commitment
of funds. (Usually these are the equity shares of other firms held for income and control purposes). Other; investments
are short-term in nature and may rightly be classified under current assets for managerial purposes. (Under
requirements of the Companies Act, however, short-term holding of financial securities also has to be shown under
investments, and not under current assets).
Current assets, loans, and advances: This category consists of cash and other resources which get converted into
cash during the operating cycle of the firm. Current assets are held for a short period of time as against fixed assets
which are held for relatively longer periods. The major components of current assets are: cash, debtors, inventories,
loans and advances, and pre-paid expenses. Cash denotes funds readily disbursable by the firm. The bulk of it is
usually in the form of bank balance; the rest comprises of currency held by the firm. Debtors (also called accounts
receivable) represent the amounts owned to the firm by its customers who have bought goods, services on credit.
Debtors are shown in the balance sheet at the amount owed, less an allowance for the bad debts. Inventories (also
called stocks) consist of raw materials, work-in-process, finished goods, and stores and spares. They are usually
reported at the lower of the cost or market value.
Loans and advances: are the amounts loaned to employees, advances given to suppliers and contractors, and
deposits made with governmental and other agencies. They are shown at the actual amount. Pre-paid expenses
are expenditure incurred for services to be rendered in the future. These are shown at the cost of unexpired
service.
Miscellaneous expenditures and losses: This category consists of two items: (i) miscellaneous expenditures
and (ii) losses. Miscellaneous expenditure's represent certain outlays such as preliminary expenses and preoperative
expenses which have not been written off. From the accounting point of view, a loss represents a
decrease in owners equity. Hence, when a loss occurs, the owners' equity should be reduced by that amount.
However as per company law requirements, the share capital (representing owners' equity) cannot be reduced
when a loss occurs. So the share capital is kept intact on the left hand side (the liabilities side) of the balance sheet
and the loss is shown on the right hand side (the assets side) of the balance sheet Profit And Loss Account
It is a statement of income and expenditure for a accounting period. The items of P& L account are:
 Gross and Net sales
 Cost of goods sold
 Gross profit
 Operating expenses
 Operating profit
 Non-operating surplus/deficit
 Profit before interest and tax
 Interest
 Profit before tax
 Tax
 Profit after tax (Net Profit)
Gross and Net Sales:Total price of goods sold is called Gross sales. Net sales are Salesminus excise duty. Cost of
goods sold is the sumof costs incurred formanufacturing the goods sold during the accounting period. It consists of
directmaterial cost, direct labour cost, direct labour cost, and factory overheads. It should be distinguished form the
cost of production. The latter represents the cost of goods produced in the accounting year, not the cost of goods
sold during the same period.
Gross profit is the difference between net sales and cost of goods sold. Most companies show this amount
as a separate item (as in the table here). Some
Operating expenses consist of general administrative expenses, selling and distribution expenses, and
depreciation. (Many accountants include depreciation under cost of goods sold as a manufacturing
overhead rather than under operating expenses. This treatment is also quite reasonable).
Operating profit is the difference between gross profit and operating expenses. As a measure of profit it reflects
operating performance and is not affected by non-operating gains/losses, financial leverage, and tax factor. Nonoperating
surplus represents gains arising from sources other than normal operations of the business. Its major
components are income from investments and gains from disposal of assets. Likewise, non-operating deficit
represents losses from activities unrelated to the normal operations of the firm.
Profit before interest and taxes is the sum of operating profit and non-operating surpiusideficit. Referred to also as
earnings before interest and taxes (EBIT), this represents a measure of profit which is not influenced by financial
leverage and the tax factor.
Interest is the expenses incurred for borrowed funds, such as term loans, debentures, public deposits, and
working capital advances.
Profit before tax is obtained by deducting interest fromprofits before interest and taxes.
Tax represents the income tax payable on the taxable profit of the year.
Profit after tax is the difference between the profit before tax and tax for the year.
Dividends represent the amount earmarked for distribution to shareholders.
Retained earnings are the difference between profit after tax and dividends.