21 Standardizing Financial Statements

A standard balance sheet has three parts: assets, liabilities, and ownership equity; Asset = Liabilities + Equity.

In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership, a corporation or other business organization, such as an LLC or an LLP. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a “snapshot of a company’s financial condition. ” Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time of a business’ calendar year.

A standard company balance sheet has three parts: assets, liabilities, and ownership equity. The main categories of assets are usually listed first, and typically in order of liquidity. Assets are followed by the liabilities. The difference between the assets and the liabilities is known as “equity. ” Equity is the net assets or net worth of the capital of the company. According to the accounting equation, net worth must equal assets minus liabilities.

Types

A balance sheet summarizes an organization or individual’s assets, equity, and liabilities at a specific point in time. We have two forms of balance sheet. They are the report form and the account form. Individuals and small businesses tend to have simple balance sheets. Larger businesses tend to have more complex balance sheets, and these are presented in the organization’s annual report. Large businesses also may prepare balance sheets for segments of their businesses. A balance sheet is often presented alongside one for a different point in time (typically the previous year) for comparison.

Personal Balance Sheet

A personal balance sheet lists current assets, such as cash in checking accounts and savings accounts; long-term assets, such as common stock and real estate; current liabilities, such as loan debt and mortgage debt due; or long-term liabilities, such as mortgage and other loan debt. Securities and real estate values are listed at market value rather than at historical cost or cost basis. Personal net worth is the difference between an individual’s total assets and total liabilities.

U.S. Small Business Balance Sheet

A small business balance sheet lists current assets, such as cash, accounts receivable and inventory; fixed assets, such as land, buildings, and equipment; intangible assets, such as patents; and liabilities, such as accounts payable, accrued expenses, and long-term debt. Contingent liabilities, such as warranties, are noted in the footnotes to the balance sheet. The small business’s equity is the difference between total assets and total liabilities.

Public Business Entities Balance Sheet Structure

Guidelines for balance sheets of public business entities are given by the International Accounting Standards Board and numerous country-specific organizations/companies.

Balance sheet account names and usage depend on the organization’s country and the type of organization. Government organizations do not generally follow standards established for individuals or businesses.

If applicable to the business, summary values for the following items should be included in the balance sheet: Assets are all the things the business owns, including property, tools, cars, etc.

1. Current assets

• Cash and cash equivalents
• Accounts receivable
• Inventories
• Prepaid expenses for future services that will be used within a year

2. Non-current assets (fixed assets)

• Property, plant, and equipment.
• Investment property, such as real estate held for investment purposes.
• Intangible assets.
• Financial assets (excluding investments accounted for using the equity method, accounts receivables, and cash and cash equivalents).
• Investments accounted for using the equity method
• Biological assets, which are living plants or animals. Bearer biological assets are plants or animals which bear agricultural produce for harvest, such as apple trees grown to produce apples and sheep raised to produce wool.

Liabilities:

• Accounts payable.
• Provisions for warranties or court decisions.
• Financial liabilities (excluding provisions and accounts payable), such as promissory notes and corporate bonds.
• Liabilities and assets for current tax.
• Deferred tax liabilities and deferred tax assets.
• Unearned revenue for services paid for by customers but not yet provided.

Equity:

• Issued capital and reserves attributable to equity holders of the parent company (controlling interest).
• Non-controlling interest in equity.

Regarding the items in equity section, the following disclosures are required:

• Numbers of shares authorized, issued and fully paid, and issued but not fully paid.
• Par value of shares.
• Reconciliation of shares outstanding at the beginning and the end of the period /
• Description of rights, preferences, and restrictions of shares.
• Treasury shares, including shares held by subsidiaries and associates.
• Shares reserved for issuance under options and contracts.
• A description of the nature and purpose of each reserve within owners’ equity.

Income statement is a company’s financial statement that indicates how the revenue is transformed into the net income.

Income Statement

Income statement (also referred to as profit and loss statement [P&L]), revenue statement, a statement of financial performance, an earnings statement, an operating statement, or statement of operations) is a company’s financial statement. This indicates how the revenue (money received from the sale of products and services before expenses are taken out, also known as the “top line”) is transformed into the net income (the result after all revenues and expenses have been accounted for, also known as “Net Profit” or the “bottom line”). It displays the revenues recognized for a specific period, and the cost and expenses charged against these revenues, including write offs (e.g., depreciation and amortization of various assets) and taxes. The purpose of the income statement is to show managers and investors whether the company made or lost money during the period being reported.

The important thing to remember about an income statement is that it represents a period of time. This contrasts with the balance sheet, which represents a single moment in time.

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Two Methods

• The Single Step income statement takes a simpler approach, totaling revenues and subtracting expenses to find the bottom line.
• The Multi-Step income statement (as the name implies) takes several steps to find the bottom line, starting with the gross profit. It then calculates operating expenses and, when deducted from the gross profit, yields income from operations. Adding to income from operations is the difference of other revenues and other expenses. When combined with income from operations, this yields income before taxes. The final step is to deduct taxes, which finally produces the net income for the period measured.

Operating Section

• Revenue – cash inflows or other enhancements of assets of an entity during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major operations. It is usually presented as sales minus sales discounts, returns, and allowances. Every time a business sells a product or performs a service, it obtains revenue. This often is referred to as gross revenue or sales revenue.
• Expenses – cash outflows or other using-up of assets or incurrence of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major operations.
• Cost of Goods Sold (COGS)/Cost of Sales – represents the direct costs attributable to goods produced and sold by a business (manufacturing or merchandizing). It includes material costs, direct labor, and overhead costs (as in absorption costing), and excludes operating costs (period costs), such as selling, administrative, advertising or R&D, etc.
• Selling, General and Administrative expenses (SG&A or SGA) – consist of the combined payroll costs. SGA is usually understood as a major portion of non-production related costs, in contrast to production costs such as direct labour.
• Selling expenses – represent expenses needed to sell products (e.g., salaries of sales people, commissions, and travel expenses; advertising; freight; shipping; depreciation of sales store buildings and equipment, etc.).
• General and Administrative (G&A) expenses – represent expenses to manage the business (salaries of officers/executives, legal and professional fees, utilities, insurance, depreciation of office building and equipment, office rents, office supplies, etc.).
• Depreciation/Amortization – the charge with respect to fixed assets/intangible assets that have been capitalized on the balance sheet for a specific (accounting) period. It is a systematic and rational allocation of cost rather than the recognition of market value decrement.
• Research & Development (R&D) expenses – represent expenses included in research and development.
• Expenses recognized in the income statement should be analyzed either by nature (raw materials, transport costs, staffing costs, depreciation, employee benefit, etc.) or by function (cost of sales, selling, administrative, etc.).

Non-operating Section

• Other revenues or gains – revenues and gains from other than primary business activities (e.g., rent, income from patents).
• Other expenses or losses – expenses or losses not related to primary business operations, (e.g., foreign exchange loss).
• Finance costs – costs of borrowing from various creditors (e.g., interest expenses, bank charges).
• Income tax expense – sum of the amount of tax payable to tax authorities in the current reporting period (current tax liabilities/tax payable) and the amount of deferred tax liabilities (or assets).
• Irregular items – are reported separately because this way users can better predict future cash flows – irregular items most likely will not recur. These are reported net of taxes.

Bottom Line

Bottom line is the net income that is calculated after subtracting the expenses from revenue. Since this forms the last line of the income statement, it is informally called “bottom line. ” It is important to investors as it represents the profit for the year attributable to the shareholders.