Breakdown of the Balance Sheet

How to identify assets and liabilities on the balance sheet.

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Putting together the balance sheet is just a matter of organizing things that you already know into the right place.

First we have to figure out what the assets are: assets are things that have future economic value as a result of a past transaction. We can look at different accounts and ask ourselves does this have future economic benefit, and if the answer is yes then it is probably an asset. Think about cash: future economic benefit? You bet! You can go to the store and buy whatever you want with cash. Accounts receivable ––money that your clients owe you as a result the result of a past transaction –– that is services or goods provided to them, and the future economic benefit is that they are going to pay you. Future economic benefit? Yes, you are going to get cash. You are going to get paid of that past transaction of providing services. Inventory, future economic benefit? You can sell the inventory for cash. Past transaction is you bought the inventory. Asking yourself that questions for the different accounts will help you determine if a particular account is an asset, and if it is an asset, then you put it in the asset side on the balance sheet.

On the right of the balance sheet you have liabilities, and liabilities are future obligations as a result of a past transaction. So if you aren’t sure if something is a liability, ask yourself: is there a future obligation? For example we have unearned revenues; maybe your clients gave you a deposit for goods that will be provided at a later time. So the past transaction is that they gave you a deposit, and the future obligation is that you still have to provide the services. A loan, what’s the future obligation? You’ve got to pay the loan back. The past transaction is that the bank gave you money. As you explore the different accounts, ask yourself: is there a future obligation, or is there a future economic benefit as a result of a past transaction? Going through these questions will help you figure out which category, an asset or a liability, does the different accounts go into.

Owners’ equity is the third account on the balance sheet and that’s basically contributed capital; what the investors have put in, what you as an owner have put into the company, as well as the retained earnings, the net income that the company is generating through the course of operations. There is not really a future economic benefit or obligation; it’s basically the value that the owners have in the company.

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