BAF3M-U2-L04 · BAF3M
The balance sheet and statement links
Learning goals
- Prepare a simple classified balance sheet for a sole proprietorship.
- Distinguish current and non-current items using problem facts.
- Trace net income and ending capital through the statement sequence.
- Use the equation and cross-statement links as checks.
Prerequisite check
If net income is $5,000 and drawings are $1,200, what is the net equity effect before new investment? An increase of $3,800.
Vocabulary
- Balance sheet: reports assets, liabilities, and equity at a date; it may also be called a statement of financial position.
- Current asset: expected to be realized, sold, or used in the business's normal cycle or within the stated short-term criteria.
- Non-current asset: held for use beyond the short term, such as equipment.
- Current liability: due in the normal cycle or within the stated short-term criteria.
- Working capital: current assets minus current liabilities.
- Liquidity: ability to meet obligations as they come due.
Core idea
The balance sheet is a dated picture of resources and claims. It connects to the period statements: income statement profit flows into owner's equity, and ending capital flows into the equity section of the balance sheet.
Why this treatment makes sense
Users need both performance and position. A profitable business can still face a cash shortage. Classification helps users see resources expected soon and obligations due soon, but a label alone does not guarantee collection or payment ability.
A repeatable method
- Use the business name, “Balance Sheet,” and “As at [date].”
- List current assets, then non-current assets under the problem's assumptions.
- Total assets.
- List current liabilities, then non-current liabilities.
- Insert ending capital from the statement of owner's equity.
- Prove Assets = Liabilities + Owner's Equity.
- Cross-check statement dates, account balances, and classifications.
Worked example
Silver Birch Studio from the previous lesson has ending capital of $25,700 and these adjusted balances at September 30:
| Account | Amount |
|---|---|
| Cash | $10,400 |
| Accounts Receivable | 4,200 |
| Supplies | 1,100 |
| Prepaid Insurance | 1,500 |
| Equipment | 16,000 |
| Accounts Payable | 3,200 |
| Bank Loan, due in two years | 4,300 |
Current assets = $10,400 + $4,200 + $1,100 + $1,500 = $17,200. Total assets = $17,200 + $16,000 = $33,200.
Total liabilities = $3,200 + $4,300 = $7,500. Liabilities plus equity = $7,500 + $25,700 = $33,200.
Working capital = Current assets $17,200 − Current liabilities $3,200 = $14,000. The loan is classified non-current only because the problem states it is due in two years and gives no current instalment.
Reasonableness checks:
- ending capital matches the statement of owner's equity;
- assets equal liabilities plus equity;
- the heading is at September 30, not for the month ended;
- revenue and expense accounts do not appear as separate balance-sheet accounts.
Journal, ledger, and statement connection
The adjusted ledger produces an adjusted trial balance. Revenue and expenses first create net income; capital then updates through the statement of owner's equity. Asset, liability, and ending capital balances form the balance sheet. Closing later resets temporary accounts but preserves these permanent balances.
Common mistakes
- Using beginning capital instead of ending capital.
- Including Revenue, Expenses, or Drawings as balance-sheet sections.
- Calling all assets current because they are owned now.
- Classifying a loan without reading its due date.
- Forcing equality by changing capital rather than tracing an error.
- Interpreting positive working capital as a guarantee of cash; receivables may be slow or uncollectible.
Guided practice
Prepare totals for a balance sheet with Cash $6,800; Accounts Receivable $2,900; Supplies $500; Equipment $9,600; Accounts Payable $2,400; Loan due in three years $5,000; ending capital $12,400. Calculate working capital.
Independent practice
Fir & Field Landscaping reports Cash $7,200; Accounts Receivable $5,600; Supplies $1,400; Prepaid Insurance $800; Equipment $21,000; Accounts Payable $4,300; wages payable $900; bank loan due in four years $10,000.
- Find missing ending capital.
- Calculate working capital.
- Explain two facts needed before judging liquidity.
- State the effect if a $900 current liability were omitted.
Self-check and solutions
Guided practice: Current assets = $6,800 + $2,900 + $500 = $10,200. Total assets = $19,800. Liabilities = $2,400 + $5,000 = $7,400. Liabilities plus equity = $7,400 + $12,400 = $19,800. Working capital = $10,200 − $2,400 = $7,800.
Independent practice: Total assets = $7,200 + $5,600 + $1,400 + $800 + $21,000 = $36,000. Liabilities = $4,300 + $900 + $10,000 = $15,200. Ending capital = $20,800. Current assets = $15,000; current liabilities = $5,200; working capital = $9,800. Useful facts include receivable collection dates/quality, cash needs, loan instalments, seasonal demand, and supplier due dates. Omitting the $900 wages payable understates liabilities and overstates equity by $900 if the related expense is also omitted; the statements may still balance.
Retrieval practice
Sketch the three-statement flow: income statement → statement of owner's equity → balance sheet. Label which statements cover a period and which is at a date.
Exam-style application
A balance sheet has total assets $58,000 and liabilities $22,500. Beginning capital was $30,000, investment $2,000, drawings $1,500, and revenue $28,000. Find ending capital, net income, and expenses.
Answer outline: Ending capital = $58,000 − $22,500 = $35,500. $35,500 = $30,000 + $2,000 + Net income − $1,500, so net income = $5,000. Expenses = Revenue $28,000 − Net income $5,000 = $23,000.
Lesson summary
The balance sheet reports financial position at one date. Ending capital links the period's performance and owner activity to that dated equation.