Of the two traditional types of financial statements, the balance sheet relates to an entity’s financial position at a point in time, and the income statement relates to its activity over an interval of time. The balance sheet provides information about an organization’s assets, liabilities, and owners’ equity as of a particular date—namely, the last day of the accounting or fiscal period. The format of the balance sheet reflects the basic accounting equation: Assets equal equities. Assets are economic resources that are expected to provide future service to the organization. Equities consist of the organization’s liabilities, which are its obligations together with the equity interest of its owners. For example, assume that a business owns a building worth $7 million and that the amount left to pay on the mortgage loan is $5 million. On the business’s balance sheet, the building would be considered an asset worth $7 million, the unpaid mortgage loan balance would be considered a liability of $5 million, and the $2-million difference between the value of the building and the outstanding loan would be the business’s equity.
Assets are categorized as current or long-lived. Current assets are usually those that management could reasonably be expected to convert into cash within one year; they include cash, receivables (money due from customers, clients, or borrowers), merchandise inventory, and short-term investments in stocks and bonds. Long-lived assets include the land, buildings, machinery, motor vehicles, computers, furniture, and fixtures belonging to the company. Long-lived assets also include real estate being held for speculation, patents, and trademarks.
Liabilities are obligations that the organization must remit to other parties, such as vendors, creditors, and employees. Current liabilities generally are amounts that are expected to be paid within one year, including salaries and wages, taxes, short-term loans, and money owed to suppliers of goods and services. Noncurrent liabilities include debts that will come due beyond one year, such as bonds, mortgages, and other long-term loans. Whereas liabilities are the claims of outside parties on the assets of the organization, the owners’ equity is the investment interest of the owners in the organization’s assets. When an enterprise is operated as a sole proprietorship or as a partnership, the balance sheet may disclose the amount of each owner’s equity. When the organization is a corporation, the balance sheet shows the equity of the owners (the stockholders) as consisting of two elements. These two elements which constitute the balance sheet are the amount originally invested by the stockholders and the corporation’s cumulative reinvested income, or retained earnings—that is, income not distributed to stockholders as dividends.