- 12 lessons
- 6 quizzes
- 1 week duration
2. The Balance Sheet
3. The Income Statement
4. The Statement of Cash Flows
5. Final Exams
2.2 Balance Sheet Preparation
Any transaction taking place in the company falls under some of the five key categories that you will see in the future:
- Balance Sheet
- Shareholders’ (Owners’) Equity
- Income Statement
- Revenue or Income
- Expenses (including cost of goods sold)
When you see a transaction, you have to figure out in which category the items fall.
It is a matter of common sense. With experience you will get the understanding.
Now let us take an example to apply this concept.
A customer buys a $100 smartphone from the company at $200. What will be its entry?
Now let us break things down first:
1. Company got some cash from this sale. So the current wealth of the company increased by $200. It is an asset. So $200 should be added in the Asset column of the Balance Sheet. Sub-category will be Cash.
2. Money came in, something has gone out. What it is? A smartphone. Where it was? In the inventory of the company. So company has one less smartphone. That smartphone was also part of the company’s wealth until that customer took it away. It was an asset that got reduced. But how much wealth reduced? $100 only. Because it was what company had spent to manufacture it. So $100 should be subtracted from the Asset column of the Balance Sheet. Sub-category will be Inventory.
3. Above two points are for Asset categories. Second category is Liabilities. Does the company has to pay anything to anyone in the future after this smartphone sale took place? No. So company is not liable to pay anything to anybody. I am talking about the new liabilities. It is possible that the company has lots of past liabilities, but ignore those at the moment.
4. Third category is Shareholders’ (Owners’) Equity. Has any of the owner exchanged any money in this sale? No. So no change in Shareholders’ Equity.
5. Fourth category is Revenue or Income. The sale increased the income of the company by $200. So you can write $200 in the revenue category in the Income statement.
6. Fifth category is the Expenses and the cost of goods sold. In order to sell the product, company had to incur some expenses. It is $100 – cost of goods sold. But how? Because when company calculates cost of a product, it adds up all the smallest of the cost it incurs for the production of the product. So this value will be in the Expenses category of the Income Statement.
Now with the above information, you can create a balance sheet, as well as income statement.