If you’re preparing for Balance Sheet job interview and whether you’re experienced or fresher & don’t know what kind of questions will be asked in Balance Sheet interview, then go through the below Real Time 60+ Top Balance Sheet Interview Questions and Answers to crack your job interview.
Balance Sheet Interview Questions and Answers
Question: A Corporation Has A Large Balance In Retained Earnings. Does That Mean That Its Dividends To Stockholders Will Be Increasing?
Not necessarily. The balance in retained earnings means that the company has been profitable over the years and its dividends to stockholders have been less than its profits. It is possible that a company with billions of dollars of retained earnings has very little cash available today.
One possible explanation for the small amount of cash in relation to the retained earnings is that the company invested in new plant assets in order to expand its operations. Rather than distributing the company’s cash to its stockholders, the company used the cash to pay for the factory and equipment in order to meet demand for its new product line.
Corporations might have a stated policy on dividends. For example, a corporation might pay dividends equal to approximately 40% of its earnings. Another corporation might have a plan to increase the amount of dividends each year by more than the rate of inflation. A new corporation might pay no dividends until its ratio of debt to equity is a specified percentage.
Question: Does The Income Statement Explain The Change In The Equity Section Of A Balance Sheet?
The income statement could explain the change in the equity section of a balance sheet. However, there are likely to be some other explanations as well.
Here is a list of the items that would cause an increase in the total amount of a corporation’s stockholders’ equity:
Positive net earnings or net income reported on the corporation’s income statement.
- Some positive Other Comprehensive Income items occurred but they are not to be reported on the income statement.
- Additional shares of stock were issued in exchange for cash or other assets.
- Donated capital was received.
Here is a list of items that could cause a decrease in the total amount of a corporation’s stockholders’ equity:
Negative net earnings or a net loss reported on the corporation’s income statement.
- Some negative Other Comprehensive Income items occurred but they are not to be reported the income statement.
- The corporation declared cash dividends.
To see all of the explanations for the change in the equity section of a balance sheet, you should review the statement of stockholders’ equity. This financial statement should be issued along with a corporation’s balance sheet, income statement, and statement of cash flows.
Question: How Are Fully Depreciated Assets Reported On The Balance Sheet?
Fully depreciated assets that continue to be used are reported at cost in the Property, Plant and Equipment section of the balance sheet. The accumulated depreciation for these assets is also reported in this section. As a result, the combination of these assets’ costs minus their accumulated depreciation will likely be a net amount of zero. This net amount is the carrying amount, carrying value or book value.
The cost and accumulated depreciation will continue to be reported until the company disposes of the assets. The disposal might be the sale or the retirement of the assets.
Fully depreciated assets and their resulting book value of zero reinforces accountants’ position that depreciation is a process to allocate assets’ costs to expense; it is not a process for valuing assets.
Question: How Are The Balance Sheet And Income Statement Connected?
The balance sheet reports a company’s assets, liabilities, and owner’s equity as of the last instant of an accounting year. Generally, the amount of the owner’s equity will have changed from the previous balance sheet amount due to
- the company’s net income
- the owner’s additional investments in the business
- the owner’s withdrawals of business assets
If the owner did not invest or withdraw, the change in owner’s equity is likely to be the amount of net income earned by the business. The revenues, expenses, gains, and losses that make up the net income are reported on the company’s income statement.
To illustrate, let’s assume that a company’s balance sheets had reported owner’s equity of $40,000 as of December 31, 2012 and $65,000 as of December 31, 2013. If during the year 2013 the owner did not invest or withdraw business assets, the $25,000 increase in owner’s equity is likely to be the net income earned by the business. The details for the $25,000 of net income will appear on the company’s income statement for the year 2013. (If the owner had withdrawn $12,000 of business assets for personal use, the net income must have been $37,000 since the net increase in owner’s equity was $25,000.)
The connection between the balance sheet and the income statement results from the use of double-entry accounting or bookkeeping and the accounting equation Assets = Liabilities + Owner’s Equity.
Question: How Does An Expense Affect The Balance Sheet?
An expense will decrease the amount of assets or increase the amount of liabilities, and will reduce the amount of owner’s or stockholders’ equity.
For example an expense might 1) reduce a company’s assets such as Cash, Prepaid Expenses, or Inventory, 2) increase the credit balance in a contra-asset account such as Allowance for Doubtful Accounts or Accumulated Depreciation, 3) increase the balance in the liability account Accounts Payable, or increase the amount of accrued expenses payable such as Wages Payable, Interest Payable, and so on.
In addition to the change in the assets or liabilities, an expense will reduce the credit balance in the Owner Capital account of a sole proprietorship, or will reduce the credit balance in the Retained Earnings account of a corporation.
Question: How Does Revenue Affect The Balance Sheet?
Generally, revenues (sales, fees earned) will increase a corporation’s stockholders’ equity and its assets.
More specifically, revenues will increase the retained earnings section of stockholders’ equity. The assets that usually increase are cash or accounts receivable. However, it is possible that another asset would increase or that a liability would decrease.
Revenues are also reported as the top line on the income statement.
Question: How Should A Mortgage Loan Payable Be Reported On A Classified Balance Sheet?
First, let’s make it clear that the amount in the account Mortgage Loan Payable should be the principal amount owed to the lender. Any interest that has accrued since the last payment should be reported as Interest Payable, a current liability. (Future interest is not reported on the balance sheet.)
Let’s assume that a company has a mortgage loan payable of $238,000 and is required to make monthly payments of approximately $4,500 per month. Each of the monthly payments includes a $3,000 principal payment plus approximately $1,500 of interest. This means that during the next 12 months, the company will be required to repay $36,000 ($3,000 x 12 months) of principal. The required principal payments due within one year of the balance sheet date must be reported as a current liability. The remaining principal of $202,000 ($238,000 minus $36,000) will be reported as a long-term liability, since it is not due within one year of the balance sheet date.
You can find the amount of principal due within the next year by reviewing the loan amortization schedule for each loan or by asking your lender.
Question: If A Company Earns A Profit, Which Balance Sheet Items Change?
Since every transaction affects at least two accounts, there will likely be many changes to the balance sheet. One change is that the owner’s equity or stockholders’ equity will increase by the amount of the net income. (The amount of the profit or net income is the net of the revenues, expenses, gains and losses reported on the income statement.) The other changes to the balance sheet depend on the revenue transactions and the expense transactions.
If the revenues resulted from providing services on credit, the amount in the asset Accounts Receivable increased. When the client pays the amount owed, Accounts Receivable will decrease and the asset Cash will increase.
If the expenses incurred in earning the revenues were paid with cash, the amount in the Cash account decreased. If the company does not pay cash for an expense, its liability account Accounts Payable increases. When the company pays the supplier, the amount in Accounts Payable will decrease. If a company had prepaid its insurance and some of that insurance expired while the revenues were earned, the asset Prepaid Insurance will decrease. Similarly, the equipment used to earn revenues results in a credit to Accumulated Depreciation, a contra asset account that causes Property, Plant and Equipment to decrease.
If the revenues were sales of merchandise, the asset Inventory decreased. (The amount of the decrease in Inventory was reported as the Cost of Goods Sold on the income statement.)
As we have shown, when a company earns a profit there are many entries to various balance sheet accounts. However, the balances in those accounts might not change significantly. For example, a credit sale will increase Accounts Receivable, but the collection of the amount will decrease Accounts Receivable. A purchase on credit will increase Accounts Payable, but the remittance will decrease Accounts Payable.
Question: If An Accrual Adjusting Entry Increases An Expense And A Liability, How Does The Balance Sheet Remain In Balance?
An expense is a temporary account which reduces owner’s equity or stockholders’ equity. The decrease in owner’s equity will offset the increase in the liability account.
Question: Is It Okay To Have Negative Amounts In The Equity Section Of The Balance Sheet?
If the current year’s net income is reported as a separate line in the stockholders’ equity or in the owner’s equity section of the balance sheet, a negative amount of net income must be reported. The negative net income occurs when the current year’s revenues are less than the current year’s expenses.
If the cumulative earnings minus the cumulative dividends declared result in a negative amount, there will be a negative amount of retained earnings. This negative amount of retained earnings will be reported as a separate line within stockholders’ equity.
If the amount of negative retained earnings is greater than the amount of paid-in capital, the total of the stockholders’ equity section will also be a negative amount.
To recap, negative amounts can occur and the negative amounts must be reported.
Question: Is It Possible To Have A Balance Sheet For A Single Day?
A balance sheet presents the amounts of a company’s assets, liabilities, and owner’s equity as of an instant or moment in time within a day. Usually it is the instant as of the end of the day. In other words, you can have a balance sheet each day, but the balance sheet amounts represent the amount at the instant or moment after all of the transactions of the specified day have been recorded.
We avoid saying that the balance sheet is for the day, since the amounts are not for the 24-hour period. For example, the cash amount that is reported on the balance sheet is the cash as of the end of the day. For the day, the cash balance may have been $1000 at 8 a.m., $1200 at 9 a.m., $823 at 10 a.m., $3134 at 4 p.m., etc. Similarly, account balances such as accounts receivable and accounts payable are changing during the day.
If you do prepare a balance sheet as of the end of each day, you will need to make daily adjusting entries in order for the balance sheet to be meaningful. For example, each day more electricity is used and therefore each day there is an additional liability and an expense for electricity.
Question: List The Type Of Items Which Appear Under The Liability Side Of A Balance Sheet?
Items which appear under the liability side of Balance Sheet are:
- Long Term Liabilities
- Loan from bank
- Current Liabilities
- Sundry Creditors
- Advance from Customers
- Outstanding Expenses
- Income Received in Advance
Question: Should Trademarks Be Included On The Balance Sheet?
A trademark should be reported on the balance sheet as an intangible asset. However, the cost principle prevents the reported amount from being more than the cost of acquiring and defending the trademark. A trademark that was developed internally (rather than purchased) might have a cost of $0, and therefore it will not be listed on the balance sheet.
For example, Company X, a consumer products company, introduced a new product in 1960. It registered the trademark in 1960 for a small fee that was immediately expensed. Since then Company X has been very effective in promoting this trademarked brand. Consumers now pay a premium price for this recognized and superior product. A competitor offers to purchase the trademark from Company X for $300 million in cash. If Company X does not sell the trademark, Company X will not list the trademark as an asset. (Recall that the trademark’s cost was $0.)
If Company X were to sell the trademark to Company Y for $300 million, Company Y will report the trademark on its balance sheet at $300 million. The reason is that there was a transaction for $300 million and Company Y’s cost of the trademark was indeed $300 million.
Question: The Balance Sheet And Income Statement Are Connected?
In the tip of April 20, I mentioned that adjusting entries almost always involve both a balance sheet account and an income statement account. (For example, the cost of supplies that are no longer on hand is moved from the balance sheet to supplies expense on the income statement. Insurance premiums that are no longer prepaid are moved from the balance sheet to insurance expense on the income statement.) The first accounting course teaches us that the basic accounting equation is Assets = Liabilities + Owner’s Equity. Owner’s Equity or Stockholders’ Equity is a section of the balance sheet that increases when the company’s net income increases.
The point of these observations is the following tip: The number of balance sheet accounts is usually small in relation to the number of income statement accounts. If you can be certain that the relatively few balance sheet accounts have the correct ending balances, you can have some confidence that the bottom line of the income statement is proper. (The income statement may contain errors—perhaps you entered an amount into the wrong account—but the overall net income has a good chance of being correct.)
I received this tip from a CPA named Bob many years ago, when he helped me to delegate some accounting work. I continue to value his insight.
Question: What Are Adjustment Entries? Why Are They Passed?
Adjustment entries are the entries which are passed at the end of each accounting period to adjust the nominal and other accounts so that correct net profit or net loss is indicated in profit and loss account and balance sheet may also represent the true and fair view of the financial condition of the business.
It is essential to pass these adjustment entries before preparing final statements. Otherwise in the absence of these entries the profit and loss statement will be misleading and balance sheet will not show the true financial condition of the business.
Question: What Are Balance Sheet Accounts?
Balance sheet accounts are one of two types of general ledger accounts. (Income statement accounts make up the other type.) Balance sheet accounts are used to sort and store transactions involving assets, liabilities, and owner’s or stockholders’ equity. Examples of a corporation’s balance sheet accounts include Cash, Accounts Receivable, Investments, Buildings, Equipment, Accumulated Depreciation, Notes Payable, Accounts Payable, Payroll Taxes Payable, Paid-in Capital, Retained Earnings, etc.
Balance sheet accounts are described as permanent or real accounts because at the end of the accounting year the balances in these accounts are not closed. Instead, the end-of-the-accounting-year balances will be carried forward to become the beginning balances in the next accounting year. (This is different from the income statement accounts, which begin each accounting year with zero balances.)
The balances in the balance sheet accounts are presented in a company’s balance sheet, which is one of the main financial statements.
It will be helpful to keep in mind that every adjusting entry will require at least one balance sheet account and one income statement account.
Question: What Are The Limitations Of The Balance Sheet?
One limitation of the balance sheet is that only the assets acquired in transactions can be included. Therefore, some of a company’s most valuable assets will not be reported on the balance sheet. For example, assume that a company developed an internet business that now attracts millions of visitors each day and has $10 million in annual revenues.
Since the internet business was not purchased from another company and its cost to develop was not significant, the company’s balance sheet will include the business’s cash, receivables and some related payables. However, the company’s balance sheet will not be reporting the internet business at anywhere near the $30 million that the company was offered for the internet business.
Similarly, the immensely talented designers and content writers employed by an internet business cannot be reported as assets on the company’s balance sheet since they were not acquired (and accountants are not able to compute a precise amount for these human resources). This is also the case for a company’s reputation, its brand names that were developed through years of effective marketing, its customers’ future demand for its unique services, etc.
Another limitation of the balance sheet pertains to a company’s long-term (or noncurrent) assets which have increased in value since the time they were purchased in a transaction. For instance, a company’s land will be reported at an amount no greater than its cost (due to the accountant’s cost principle). Its buildings will be reported at their cost minus their accumulated depreciation (due to the cost principle and the matching principle). Hence, the amounts reported on the balance sheet for a company’s land and buildings could be much lower than their market value.
Question: What Does A Balance Sheet Tell Us?
A balance sheet reports the dollar amounts of a company’s assets, liabilities, and owner’s equity (or stockholders’ equity) as of a previous date.
Assets include cash, accounts receivable, inventory, investments, land, buildings, equipment, some intangible assets, and others. Generally assets are reported at their cost or a lower amount due to depreciation, the cost principle, and conservatism. The cost principle also means that some very valuable aspects of the company are not listed as assets. For example, a company’s outstanding reputation, its effective management team, and its amazing brand recognition are not reported as assets if they were not acquired in a transaction involving another party or entity.
Liabilities are obligations of a company as of the balance sheet date. These include loans payable, accounts payable, warranty obligations, taxes payable, and more.
The stockholders’ equity or owner’s equity reports the amount of the assets that came from the owners and not from its creditors.
The balance sheet allows you to easily determine the amount of a company’s working capital and whether the company is highly leveraged.
With every balance sheet distributed by a company there should be notes or footnotes. These notes provide important additional information about the company’s financial position including potential liabilities not yet appearing as amounts on the balance sheet.
Question: What Is A Balance Sheet And Why Is It Prepared?
The balance sheet is prepared in order to report an organization’s financial position as of a specified moment, such as midnight on December 31.
A corporation’s balance sheet reports its assets (resources that were acquired in past transactions), its liabilities (obligations and customer deposits), and its stockholders’ equity (the difference between the amount of assets and liabilities). Some people state that the balance sheet reports the amounts of the assets and the claims against those assets (liabilities and stockholders’ equity). Others state that the balance sheet reports a corporation’s assets and the amount that was provided by creditors (the liabilities) and the amounts provided by the owners (stockholders’ equity).
A classified balance sheet reports the current assets in a section that is separate from the long-term asset. Similarly, current liabilities are reported in a section that is separate from long-term liabilities. This allows bankers, owners, and others to easily compute the amount of an organization’s working capital. (Working capital is defined as current assets minus current liabilities.)
The balance sheet has some limitations. For example, land and buildings are usually reported at cost minus the accumulated depreciation of the buildings. If these assets have increased in value, the fair value is not reported due to the cost principle. Also, brand names and trademarks may have significant value, but are not reported on the balance sheet, if they were not acquired in a transaction.
The balance sheet should be read with the other financial statements (income statement, statement of cash flows, and the statement of changes in stockholders’ equity) and with the notes to the financial statements.
Question: What Is A Balance Sheet? Why Is It Prepared?
Balance Sheet is a Statement showing financial position of the business on a particular date. It has two side one source of funds i.e Liabilities, the left side of the balance sheet and application of funds i.e assets, the right side of the balance sheet. It is prepared after preparing trading and profit and loss account and has balances of real and personal accounts grouped and arranged in a proper way as assets and liabilities. It is prepared to know the exact financial position of the business on the last date of the financial year.
Question: What Is A Classified Balance Sheet?
A classified balance sheet is one that arranges the balance sheet accounts into a format that is useful for the readers. For example, most balance sheets use the following asset classifications:
- long-term investments
- property, plant and equipment
- intangible assets
- other assets
Liabilities are usually classified as:
- current, or
- long-term or noncurrent asset.
Question: What Is A Comparative Balance Sheet?
A comparative balance sheet usually has two columns of amounts that appear to the right of the account titles or other descriptions such as Cash and Cash Equivalents, Accounts Receivable, Accounts Payable, etc. The first column of amounts contains the amounts as of a recent moment or point in time, say December 31, 2012. To the right will be a column containing corresponding amounts from an earlier date, such as December 31, 2011. The older amounts appear further from the account titles or descriptions as the older amounts are less important.
Providing the amounts from an earlier date gives the reader of the balance sheet a point of reference—something to which the recent amounts can be compared.
Question: What Is An Unpresented Cheque Or Check And Does It Require An Adjustment To The Balance Sheet?
I define an unpresented cheque as a check that was written but has not yet been paid by the bank on which it is drawn. An unpresented check is also referred to as an outstanding check or a check that has not yet cleared the bank. Outstanding checks are deducted from the balance per the bank in order to arrive at the adjusted or corrected balance per bank.
When a check is written, it will be recorded as a credit to the Cash account in the company’s general ledger. Whether the check clears the bank or not, the company’s Cash account balance is proper. The Cash account balance will be presented on the balance sheet without any adjustment for unpresented or outstanding checks.
Question: What Is Meant By Events After The Balance Sheet Date?
Events after the balance sheet date are significant financial events that occur after the date of the balance sheet, but prior to the date that the financial statements are issued. For example, a company’s balance sheet that has the heading of December 31, 2012 might not be finalized and distributed until February 1, 2013. During January new information may arise that has financial significance. Perhaps there is an event that provides more information about the conditions actually existing on December 31. The second type of event would be a new January event that does not change the December 31 amounts, but needs to be disclosed to the readers of the December 31 financial statements.
An example of the first situation might be that a customer owes Jay Company $200,000 on December 31 and Jay Company assumed that the customer was financially sound. As a result Jay Company did not provide any allowance for the customer’s account being uncollectible. Then on January 28, the customer filed for bankruptcy and Jay Company learns that none of the $200,000 receivable will be collected. If the customer’s financial condition on December 31 was already in bankruptcy condition, Jay Company will need to adjust its December 31 balance sheet and its income statement for the year 2012 for this $200,000 of bad debts expense.
An example of the second situation might be a loss arising from a catastrophe occurring on January 16, 2013. The amounts reported as of December 31, 2012 will not be adjusted since those amounts were correct as of December 31. However, the readers of the December 31 balance sheet and the 2012 income statement should be informed through a disclosure that something significant has occurred to the company’s financial position since December 31.
The events after the balance sheet date are often referred to as subsequent events or post balance sheet events.
Question: What Is The Advantage Of Using Historical Cost On The Balance Sheet For Property, Plant And Equipment?
The main advantage of using historical cost on the balance sheet for property, plant and equipment is that historical cost can be verified. Generally, the cost at the time of purchase is documented with contracts, invoices, payments, transfer taxes, and so on.
The historical cost of plant and equipment (not land) is also used to determine the amount of depreciation expense reported on the income statement. The accumulated amount of depreciation is also reported as a deduction from the assets’ historical costs reported on the balance sheet. (In the case of impairment, some assets might be reported at less than the amounts based on historical cost.)
The use of historical cost is also a disadvantage to those users of the financial statements who want to know the current values.
Question: What Is The Difference Between A Balance Sheet Of A Nonprofit Organization And A For-profit Business?
One difference in the balance sheets of a nonprofit or not-for-profit organization and a for-profit business is the name or title shown in its heading. In a nonprofit, the name of this financial statement is the statement of financial position. In the for-profit business this financial statement is the balance sheet.
Another difference is the section that presents the difference between the total assets and total liabilities. The nonprofit’s statement of financial position refers to this section as net assets, whereas the for-profit business will refer to this section as owner’s equity or stockholders’ equity. The reason for this difference is the nonprofit does not have owners. This means that the nonprofit organization’s statement of financial position will reflect this equation: assets – liabilities = net assets.
The net assets section will consist of the following parts: unrestricted net assets, temporarily restricted net assets, and permanently restricted net assets. The amounts reported in each of these parts are based on the donor’s stipulations.
Question: What Is The Difference Between A Trial Balance And A Balance Sheet?
A trial balance is an internal report that will remain in the accounting department. It is a listing of all of the accounts in the general ledger and their balances. However, the debit balances are entered in one column and the credit balances are entered in another column. Each column is then summed to prove that the total of the debit balances is equal to the total of the credit balances.
A balance sheet is one of the financial statements that will be distributed outside of the accounting department and is often distributed outside of the company. The balance sheet is organized into sections or classifications such as current assets, long-term investments, property, plant and equipment, other assets, current liabilities, long-term liabilities, and stockholders’ equity. Only the asset, liability, and stockholders’ equity account balances from the general ledger or from the trial balance are then presented in the appropriate section of the balance sheet. Totals are also provided for each section to assist the reader of the balance sheet. The balance sheet is also referred to as the statement of financial position or the statement of financial condition.
Question: What Is The Double Declining Balance Method Of Depreciation?
The double declining balance method of depreciation, also known as the 200% declining balance method of depreciation, is a common form of accelerated depreciation. Accelerated depreciation means that an asset will be depreciated faster than would be the case under the straight line method.
Although the depreciation will be faster, the total depreciation over the life of the asset will not be greater than the total depreciation using the straight line method. This means that the double declining balance method will result in greater depreciation expense in each of the early years of an asset’s life and smaller depreciation expense in the later years of an asset’s life as compared to straight line depreciation.
Under the double declining balance method, double means twice or 200% of the straight line depreciation rate. Declining balance refers to the asset’s book value or carrying value at the beginning of the accounting period. Book value is an asset’s cost minus its accumulated depreciation. The asset’s book value will decrease when the contra asset account Accumulated Depreciation is credited with the depreciation expense of the accounting period.
Let’s illustrate double declining balance depreciation with an asset that is purchased on January 1 at a cost of $100,000 and is expected to have no salvage value at the end of its useful life of 10 years. Under the straight line method, the 10 year life means the asset’s annual depreciation will be 10% of the asset’s cost. Under the double declining balance method the 10% straight line rate is doubled to be 20%. However, the 20% is multiplied times the asset’s beginning of the year book value instead of the asset’s original cost.
At the beginning of the first year, the asset’s book value is $100,000 since there has not yet been any depreciation recorded. Therefore, under the double declining balance method the $100,000 of book value will be multiplied by 20% for depreciation in Year 1 of $20,000. The journal entry will be a debit of $20,000 to Depreciation Expense and a credit to Accumulated Depreciation of $20,000.
At the beginning of the second year, the asset’s book value will be $80,000. This is the asset’s cost of $100,000 minus its accumulated depreciation of $20,000. The $80,000 of beginning book value multiplied by 20% results in $16,000. The depreciation entry for Year 2 will be a debit to Depreciation Expense for $16,000 and a credit to Accumulated Depreciation for $16,000.
At the beginning of Year 3, the asset’s book value will be $64,000. This is the asset’s cost of $100,000 minus its accumulated depreciation of $36,000 ($20,000 + $16,000). The book value of $64,000 X 20% = $12,800 of depreciation expense for Year 3.
At the beginning of Year 4, the asset’s book value will be $51,200. This is the asset’s cost of $100,000 minus its accumulated depreciation of $48,800 ($20,000 + $16,000 + $12,800). The book value of $51,200 X 20% = $10,240 of depreciation expense for Year 4.
As you can see, the amount of depreciation expense is declining each year. Over the remaining six years there can be only $40,960 of additional depreciation. This is the asset’s cost of $100,000 minus its accumulated depreciation of $59,040. Some people will switch to straight line at this point and record the remaining $40,960 over the remaining 6 years in equal amounts of $6,827 per year. Others may choose to follow the original formula.
Question: What Is The Transaction Approach And Balance Sheet Approach To Measuring Net Income?
The transaction approach to measuring net income is the traditional bookkeeping and accounting method. That is, individual transactions such as each sale, each purchase, and every expense are recorded into general ledger accounts. At any point you can go to an account such as Salaries Expense for Sales Staff and see the year to date amount of such an expense. With the use of accounting software, an enormous quantity of transactions can be recorded into many detailed accounts.
I believe that the balance sheet approach is also referred to as the capital maintenance approach. Under the balance sheet approach one looks at the change in stockholders’ or owner’s equity to determine the amount of net income during the period between balance sheets. This approach requires that you exclude any additional capital from the owners as well as any dividends or withdrawals distributed to the owners.
For example, if stockholders’ equity increased by $5 million with $2 million caused by the issuance of new shares of stock, and $1 million distributed as dividends, the net income would have been $4 million. We can verify the calculation with the following: net income of $4 (an addition to equity) plus new investor money of $2 (an addition to equity) = $6 of additions to equity, minus dividends of $1 (a decrease to equity) = $5 (the net increase to equity). Under this balance sheet approach you will not have the detailed information on revenues and expenses that would be available under the transaction approach.
Question: What Types Of Items Appear Under The Assets Side?
Items which appear under the assets side of Balance Sheet are:
- Sundry Debtors,
- Cash Balance,
- Bank Balance,
- Prepaid Expenses
Question: When Does A Negative Cash Balance Appear On The Balance Sheet?
A negative cash balance appears on the balance sheet when the cash account in the general ledger has a credit balance. The credit or negative balance in the general ledger cash account is usually caused by a company or organization writing checks for more than the amount in the general ledger cash account.
When preparing the balance sheet, the negative balance in the cash account should appear as a current liability (Checks Written in Excess of Cash Balance) instead of reporting the negative cash as an current asset.
A negative cash balance in the general ledger (on the balance sheet) does not mean that the company’s bank account is overdrawn. For example, if a company writes checks for $100,000 and mails them at the end of the day to suppliers in another state, those checks might not clear the bank account for four days. The general ledger account might show a negative $40,000 but the bank’s checking account might be reporting a positive balance of $60,000. If the company deposits more than $40,000 tomorrow morning, the bank balance will not show an overdraft because the bank balance will be large enough to pay the $100,000 of checks when they clear the company’s checking account in a few days.
Question: Where Are Accruals Reflected On The Balance Sheet?
Accrued expenses are reported in the current liabilities section of the balance sheet. Accrued expenses reported as current liabilities are the expenses that a company has incurred as of the balance sheet date, but have not yet been recorded or paid. Typical accrued expenses include wages, interest, utilities, repairs, bonuses, and taxes.
Accrued revenues are reported in the current assets section of the balance sheet. The accrued revenues reported on the balance sheet are the amounts earned by the company as of the balance sheet date that have not yet been recorded and the customers have not yet paid the company.
Accrued expenses and accrued revenues are also reflected in the income statement and in the statement of cash flows prepared under the indirect method. However, these financial statements reflect a time period instead of a point in time.
Question: Where Can I Find An Illustration Of A Common Size Balance Sheet?
You will find an illustration of a common size balance sheet under AccountingCoach.com’s Explanation of Financial Ratios. The common size balance sheet appears in Part 1b, and it is based on the balance sheet presented in Part 1a.
Question: Where Does A Bond Sinking Fund Appear On The Balance Sheet?
A bond sinking fund is reported in the section of the balance sheet immediately after the current assets. The bond sinking fund is part of the long-term asset section that usually has the heading “Investments.”
The bond sinking fund is a long-term (noncurrent) asset even if the fund contains only cash. The reason is the cash in the fund must be used to retire bonds, which are long-term liabilities. In other words, because the money in the bond sinking fund cannot be used to pay current liabilities, it must be reported outside of the working capital section of the balance sheet. (Working capital is current assets minus current liabilities.)
Question: Where Does Accrued Interest On Notes Receivable Get Reported On The Balance Sheet?
Accrued interest on notes receivable is likely to be reported as a current asset such as Accrued Interest Receivable or Interest Receivable. The accrued interest receivable is a current asset if the interest amount is expected to be collected within one year of the balance sheet date.
I would expect that even a long-term note receivable that is due in five years will require that the interest on the note be paid quarterly, semiannually or annually. Hence the accrued interest will be a current asset.
If the interest on the note is not expected to be received within one year of the balance sheet date, then the accrued interest receivable should be reported as a long-term asset.
Question: Where Does Revenue Received In Advance Go On A Balance Sheet?
Revenues received in advance are reported as a current liability if they will be earned within one year. The accounting entry is a debit to the asset Cash for the amount received and a credit to the liability account such as Customer Advances or Unearned Revenues.
As the amount received in advance is earned, the current liability account will be debited for the amount earned and the Revenues account reported on the income statement will be credited. This is done through an adjusting entry.
Question: Where Is A Contract With A Customer Reported On The Balance Sheet?
A contract to perform future services for a customer is not reported on the balance sheet of the company that will be providing the services. For example, if Company Jay and one of its customers sign a contract in December agreeing that Company Jay will deliver $20,000 of services beginning in January, the contract is not reported on Company Jay’s December 31 balance sheet. (If the customer makes a deposit of $3,000 at the time of signing the contract, the $3,000 will be recorded by Company Jay in December with a $3,000 debit to Cash and a $3,000 credit to the liability account Customer Deposits or Unearned Revenues. With no downpayment or advance payment in December, there is no entry recorded.)
The $20,000 contract is not reported as an asset on Company Jay’s December 31 balance sheet. The reason is that Company Jay has not earned any of the contract amount and therefore does not have a right or a receivable to the $20,000 as of December 31. Similarly, Company Jay’s income statement for December and its December 31 owner’s equity cannot include any earnings associated with the contract.
Question: Where Is A Manufacturer’s Inventory Reported In The Balance Sheet?
A manufacturer’s inventory will be reported in the current assets section of the balance sheet and in the notes to the financial statements. In the current assets section the amount of the manufacturer’s inventory will be positioned after cash and cash equivalents, short-term investments, and receivables.
If only the sum of the manufacturer’s inventory categories is listed in the current assets section, then the notes to the financial statements will report the detailed amounts for raw materials and supplies, work-in-process and finished goods.
The notes to the financial statements will also described how the manufacturer’s inventory is valued. For example, the notes will disclose whether FIFO lower of cost or market, LIFO, weighted average, or other cost flow methods were used. If LIFO is used, then the excess of current cost over LIFO cost is also disclosed.
Question: Where Is Accrued Income Reported In The Balance Sheet?
Accrued income is reported as a current asset such as accrued receivables, accrued revenues, or part of accounts receivable.
The amount of the accrued income will also increase the corporation’s retained earnings. This occurs because the accrual adjusting entry included a credit to a revenue account—thereby increasing the corporation’s net income.
Question: Where Is The Premium Or Discount On Bonds Payable Presented On The Balance Sheet?
The unamortized premium on bonds payable and the unamortized discount on bonds payable will be presented with the related bonds as liabilities on the balance sheet. For example, if there is a premium on the bonds that will come due in 13 years, both the bonds payable and the premium on bonds payable will be reported together as a long-term liability. If the premium on bonds is associated with bonds that will be due in 11 months (and the corporation will be using its working capital to pay the bondholders), the premium and the bonds will be reported together as a current liability.
The discount on bonds payable will also cling to the bonds. If the bonds mature more than one year from the date of the balance sheet, both the bonds and the unamortized discount will be reported as a long-term liability. If the bonds are due in less than one year (and will require the use of the corporation’s working capital), the discount and the bonds are reported as a current liability.
The premium and discount accounts are viewed as valuation accounts. The unamortized premium on bonds payable will have a credit balance that increases the carrying amount (or the book value) of the bonds payable. The unamortized discount on bonds payable will have a debit balance and that decreases the carrying amount (or book value) of the bonds payable.
Question: Why Does A Company’s Profit Appear As A Credit On Its Balance Sheet?
The accounting equation and the double entry system provide an explanation why a company’s profit appears as a credit on its balance sheet.
Asset accounts usually have debit balances while liabilities and owner’s or stockholders’ equity usually have credit balances. When a company provides services for cash, its asset Cash is increased by a debit and its owner’s equity is increased by a credit. The credit is initially recorded in a revenue account, but revenue accounts are temporary accounts that cause owner’s equity to increase.
If the owner withdraws some cash for personal use, the asset Cash will decrease through a credit and the owner’s equity will decrease through the debit part of the accounting entry. The debit might initially be recorded in the sole proprietor’s Drawing account but this account is also a temporary account that will cause the owner’s equity to decrease.
Generally speaking, the credit balance reported in the owner’s or stockholders’ equity section of the balance sheet reflects the owners’ investments in the company plus the profits earned minus the amounts distributed to the owners since the time that the company began.
Question: Why Does Commitment And Contingencies Appear On The Balance Sheet Without An Amount?
The term or caption commitment and contingencies appears near the end of a balance sheet without an amount in order to direct a reader’s attention to the disclosures included in the notes to the financial statements.
An amount is not shown for a variety of reasons. For example, a chain of retail stores may have signed five-year, noncancelable leases to rent retail space for $1 million per year. This commitment needs to be disclosed to the readers of the balance sheet. However, if none of the $5 million is actually due as of the balance sheet date, there is no liability amount to be recorded in a liability account.
Another example of a commitment is an electric utility which has signed a noncancelable contract to purchase 100 million tons of coal during the following 10 years. This commitment also needs to be disclosed to the readers of the balance sheet. However, if none of the coal has been delivered as of the balance sheet date, the utility company will not report a liability since nothing is due as of the balance sheet date.
Question: Why Does Our Company’s Balance Sheet Report Its Land At Cost When It Is So Much More Valuable?
Accountants are guided by the cost principle. This requires accountants to report assets at their cost when acquired—not their replacement cost or market value. The historical cost is an objective amount that can easily be audited. In contrast, the market value is subjective: one person thinks the land is worth $1 million while another thinks it’s worth $1.5 million.
Further support for the cost principle is the accountants’ going concern assumption. A company is assumed to be continuing in business and will not be liquidating. If your company bought the land for possible expansion, its cost is more relevant than the amount the company could get if it were liquidating. After all your company is not liquidating. The revenue recognition principle would be another reason why market values are not reported.
(P.S. I should add that some businesses are required to report assets at market value. I believe those businesses are in industries with significant markets and verifiable quoted market prices.)
Question: Why Is A Negative Cash Balance Reported As A Liability?
The following will illustrate why a negative cash balance is reported as a liability instead of being reported as a negative asset amount.
Company X writes checks for more than its bank balance and sends them to its vendors. When the checks get back to Company X’s checking account, Company X’s bank will have two options when Company X’s checking account does not have sufficient funds to cover the checks:
- The bank could pay the checks and allow Company X’s checking account to be overdrawn. (Some call this an unauthorized loan by the bank.) Company X then has the obligation or liability to repay the bank for the courtesy extended to Company X.
- If Company X’s bank does not pay the checks because the account has insufficient funds, the bank will return the checks as NSF (not sufficient funds). These checks are returned through the banking system and eventually the bank of the payee will take the amount of the check from the payee’s checking account. The payee will in turn reinstate the liability amount owed to it by Company X. In essence Company X did not eliminate its liability to the payee by issuing a worthless check.
Hopefully these two bank options illustrate why accountants will report a negative cash balance as a liability.
By the way, checks not paid by the bank on which they are drawn are said to have “bounced” or are called “rubber checks” since they are bounced back through the banking system by the bank on which they were drawn.
Question: Why Is Depreciation On The Income Statement Different From The Depreciation On The Balance Sheet?
Depreciation on the income statement is the amount of depreciation expense that is appropriate for the period of time indicated in the heading of the income statement. The depreciation reported on the balance sheet is the accumulated or the cumulative total amount of depreciation that has been reported as expense on the income statement from the time the assets were acquired until the date of the balance sheet.
Let’s illustrate the difference with an example. A company has only one depreciable asset that was acquired three years ago at a cost of $120,000. The asset is expected to have a useful life of 10 years and no salvage value. The company uses straight-line depreciation on its monthly financial statements. In the asset’s 36th month of service, the monthly income statement will report depreciation expense of $1,000. On the balance sheet dated as of the last day of the 36th month, accumulated depreciation will be reported as $36,000. In the 37th month, the income statement will report $1,000 of depreciation expense. At the end of the 37th month, the balance sheet will report accumulated depreciation of $37,000.
Question: Why Is The P&l Profit Entered On The Credit Side Of The Balance Sheet?
The profit or net income belongs to the owner of a sole proprietorship or to the stockholders of a corporation. The owner’s or stockholders’ equity is reported on the credit side of the balance sheet. Recall that the balance sheet reflects the accounting equation, Assets = Liabilities + Owner’s Equity.
Let’s illustrate this with an example. Assume that you own a sole proprietorship and you provided a service to a customer. One of your business assets (cash or accounts receivable) increased and your liabilities were not involved. Therefore, your business liabilities will remain the same and your equity in the business will increase.
Accountants prepare an income statement or P&L to report the revenues and expenses, but the ultimate effect is that the business assets and owner’s equity will increase when there is a profit or net income.
Question: Why Isn’t A Key Employee Reported As An Asset On The Balance Sheet?
While an employee could be an organization’s most valuable asset, accountants record past transactions that can be measured.
Since an employee is not purchased, there is no past transaction and cost that the accountant can record in order to report this person as an asset owned by the entity. The salary and bonuses paid to a key employee are reported as expenses in the period in which the employee performed services.
Not being able to record a valuable employee as an asset is similar to a valuable brand name developed internally by a company over time. Since the brand name was not purchased from another entity, there is no past transaction and purchase cost to be recorded.
I assume that an entity’s payment made to another professional sports team for a professional athlete’s services for the next three years will result in recording the payment as an asset—a prepaid expense or deferred charge—that will then be amortized to expense over the three year contract.
Question: Why Will Some Asset Accounts Have A Credit Balance?
A few asset accounts intentionally have credit balances. For instance, the account Accumulated Depreciation (which is a plant asset account) will have a credit balance since it is credited for the amounts that are debited to Depreciation Expense. The account Allowance for Bad Debts will have a credit balance for the amounts in Accounts Receivable that are not likely to be collected.
The accounts Accumulated Depreciation and Allowance for Bad Debts are referred to as contra asset accounts because their credit balances are contrary to the expected debit balances found in most asset accounts.
There are also unexpected situations that result in asset accounts having credit balances. Here are five examples:
- An error caused by posting an amount to an incorrect account.
- Continuing to depreciate or amortize an asset after its balance has reached zero.
- Receiving and posting an amount that was greater than the recorded receivable.
- Expenses occurred faster than the agreed upon prepayments.
- The amount of checks written exceeded the positive amount in the Cash account.
Before issuing the balance sheet, any errors (such as items 1 and 2) need to be corrected. The accounts with credit balances in items 3, 4, and 5 need to be reclassified to the liability section of the balance sheet.
Question: Why Would Prepaid Insurance Have A Credit Balance?
Several situations could cause a credit balance in the asset account Prepaid Insurance. For example, let’s assume a company’s insurance has a cost of $600 every six months. As a result, the company decides to debit Prepaid Insurance when the amount is paid semiannually. It also prepares an automatic monthly adjusting entry to debit Insurance Expense $100 and to credit Prepaid Insurance for $100. If one of the $600 payments is debited to Insurance Expense (or another account) instead of Prepaid Insurance, the monthly adjusting entries will cause the balance in the Prepaid Insurance account to become a credit balance.
Another possibility is that the company simply failed to pay the insurance company and the monthly adjusting entries caused the balance in Prepaid Insurance to become a credit balance. Whatever the cause of the credit balance in Prepaid Insurance, the account balance needs to be adjusted before issuing a balance sheet. The Prepaid Insurance account must report the true amount that is prepaid (paid but not yet expired) as of the date of the balance sheet. If nothing is prepaid then the Prepaid Insurance account must show a zero balance. If an amount is owed to the insurance company, there should be a liability account with a credit balance for the amount owed as of the balance sheet date.
Because adjusting entries involve a balance sheet account and an income statement account, it is wise to also look at the amount being reported in the income statement account Insurance Expense. You should monitor both the Insurance Expense account balance and the Prepaid Insurance account balance throughout the year. The amount paid to the insurance company that has expired needs to be reported as an expense and the amount that has not yet expired needs to be reported as the asset Prepaid Insurance.
Question: Will The Adjusting Entry Amounts Appear In The Balance Sheet And Income Statement?
Absolutely. The adjusting entry amounts must be included on the income statement in order to report all revenues earned and all expenses incurred during the accounting period indicated on the income statement. The adjusting entry amounts must also be included in the amounts reported on the balance sheet as of the end of the accounting period.
In the following accounting period, the accrual-type adjusting entries will usually be reversed. They are reversed or removed because the actual invoices or other documents containing the accrued revenues or expenses will be arriving and will be entered into the accounting records by the bookkeeper or the accounts payable clerk.