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Elements of the Balance Sheet in Financial Accounting
This chapter focuses solely on the balance sheet, which is often called the statement of financial position. At any given date, the balance sheet shows the sources from which the firm has obtained its resources and the ways in which those resources are currently employed. Recall the basic accounting equation:
ASSETS + LIABILITIES = OWNERS’ EQUITY (capital)
Another way to state this relationship is
Uses of resources = Sources of resources
assets + liability = capital () owners' equty
In other words, liabilities and owners’ equity are the sources from which the firm has obtained its funds, and the listing of assets shows the way in which the firm’s managers have put those funds to work. This relationship is illustrated as follows, based on the balance sheet for Sample Company at the end of 2000, which is presented in Figure 2.1.
Figure 2.1 - A Balance Sheet
Viewed in this manner, there is no mystery to the fact that both sides of the balance sheet have the same total; they are merely two sides of a single coin, or two ways of describing the total wealth of the firm. The firm’s wealth can be viewed in terms of sources of financing (from creditors and owners) and in terms of uses of resources (owning or controlling assets).
Another useful way to view the balance sheet is as the cumulative result of the firm’s past activities. Liabilities represent the total amount the firm has borrowed during its existence, minus the amounts that have been repaid to date. The owners’equity items show the total amount invested by owners, plus the total profits earned by the firm during previous periods, minus any amounts that have been distributed to owners. Similarly, the assets of the firm represent the total resources obtained by the firm from lenders and owners, minus those that have been consumed in the firm’s operations, repaid to lenders, or distributed to owners.
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