Having spent way too much time dissecting a balance sheet today I thought it might be a good idea to put out a cash basis balance sheet basic overview post.
A balance sheet is a snap shot at a specific point in time – usually the end of a quarter or fiscal year – that depicts the value of an entity’s assets as they relate to its liabilities and equity. The basic formula or equation that needs to balance is …
ASSETS = LIABILITIES + OWNER’S EQUITY
I learned how to run a trial balance on a chart of accounts back in the 80′s at Marquette University and find myself to this day going back to the basic precept of ‘T’ accounts to untangle the most complicated balance sheets. Leave it to the Jesuits to know their accounting.
In the ‘T’ accounts most primitive form, whenever a transaction is recorded 2 entries are made, one on the left side of the ‘T’ account and the other on the right side of a corresponding ‘T’ account. This will be broken down further below but generally speaking when it comes to cash basis balance sheets if a chart of accounts is set up with the general idea of ‘T’ accounts in mind then running a trial balance at the end of a period should be a breeze.
In my opinion the basic rules of thumb for building or reconstructing a balance sheet are as follows:
1. Analyze the financial event or transaction.
2. Identify the accounts affected.
3. Classify the accounts affected.
4. Determine the amount of increase or decrease for each account.
5. Apply the left-right rules for each account affected. Make the entry in T-account form.
6. ‘T’ account names should ideally correspond to the line items listed on the balance sheet such as Cash, Prepaid Rent, Supplies, Account Payable and Equity,.
Again for a balance sheet to ‘balance’ as it were the value of the entity’s assets must equal the sum of its liabilities plus its owner’s equity.
Asset accounts show items of value owned by a business. For example say you invested $100,000 in a corporation. That cash infusion is now an asset of the corporation. Cash increases appear on the left side of the Cash ‘T’ account, an asset account. Decreases are shown on the right side. The cash investment of $100,000 (a) is recorded on the left side of the Cash account.
When you invested $100,000 in this corporation you become an owner or of the corporation. Owner’s equity appears on the right side of the accounting equation (Assets = Liabilities + Owner’s Equity). Increases in owner’s equity appear on the right side of the T account. Decreases in owner’s equity appear on the left side. In this case an investment of $100,000 (a) increases your capital account by $100,000 and is entered on the right side of the Capital account.
Shareholder ‘X’, Capital
In this case you invested $100,000 from your personal savings into the business checking account creating the following entries:
a. The asset account, Cash, is increased by $100,000.
a. The owner’s equity account is increased by $100,000.
Left-Right Rules for ‘T’ accounts
Again keeping in mind that the equation is basically
Asset ‘T’ Accounts = Liability ‘T’ Accounts + Owner’s Equity ‘T’ Accounts
Left – Increases to asset accounts are recorded on the left side of the T account, decreases on the right.
Right – Increases to owner’s equity and liability accounts are recorded on the right side of the T account, decreases on the left.
Recording an Asset Acquisition
The business issued a $5,000 check to purchase a computer and other equipment.
b. The asset account, Equipment, is increased by $5,000.
b. The asset account, Cash, is decreased by $5,000.
Recording a asset purchase using credit
Liabilities are amounts a business owes its creditors. Liabilities appear on the right side of the accounting equation (Assets = Liabilities + Owner’s Equity). Increases in liabilities are on the right side of liability T accounts. Decreases in liabilities are on the left side of liability T accounts. For this example let’s say the business bought office equipment for $6,000 on account from Office Plus.
c. The asset account, Equipment, is increased by $6,000.
c. The liability account, Accounts Payable, is increased by $6,000.
Purchasing Supplies with Cash
The business issued a check for $1,500 to North Shore Office Supply, Inc to purchase office supplies.
a. The asset account, Supplies, is increased by $1,500.
b. The asset account, Cash, is decreased by $1,500.
Notice that the Cash account now shows three transactions: the initial investment by the owner (a), the cash purchase of equipment (b), and the cash purchase of supplies (d).
RECORDING PAYMENT TO A CREDITOR
The business paid $2,500 to North Shore Office Supply to apply against the debt of $6,000 shown in Accounts Payable.
a. The asset account, Cash, is decreased by $2,500.
b. The liability account, Accounts Payable, is decreased by $2,500.
Recording Pre-Paid Rent
The business was required to pay rent in advance. You set up an asset account called Prepaid Rent.
a. The asset account, Prepaid Rent, is increased by $8,000.
b. The asset account, Cash, is decreased by $8,000.
An account balance is the difference between the amounts on the two sides of the ‘T’ account. First add the figures on each side of the ‘T’ account. Then subtract the smaller total from the larger total with the result being the account balance. If the total on the right side is larger than the total on the left then the balance is recorded on the right side. If the total on the left side is larger, the balance is recorded on the left side. This is true even if there is only one entry.