Balance Sheet: Total Assets = Total Liability + Total Equity
Yes, this was very strange for me as well when I first saw the formula of total assets equal to the sum of total liability and total equity. Don't worry, an example below will help you have a better understanding about the role of balance sheet in a company.
Example:
At the beginning of year 0:
The balance sheet of company X at the beginning of year 0 is shown below:
Non-Current Assets Property, plant and equipment: $200.00 Current Assets Inventory : $200.00 Cash and cash equivalents: $800.00 Total Assets: $1200.00 | Non-current Liabilities Long term borrowing : $200.00 Total Liabilities: $200.00 Equity Share capital: $1,000.00 Total Equity: $1,000.00 |
At the beginning of year 1:
After one year, let's assume the company has sold out $100.00 goods with net profit of $50.00. But only $30 has been received and the remainder becomes a receivable payment with a period of one year.
Therefore, the balance sheet at the beginning of year 1 becomes:
Non-Current Assets Property, plant and equipment: $400.00 Current Assets Inventory: $500.00 ($100 + $400) Accounts receivable: $120.00 Cash and cash equivalents: $430.00 Total Assets: $1,450.00 | Non-current Liabilities Long term borrowing: $150.00 Current Liabilities Short term borrowing: $50.00 Accounts payable: $200.00 Total Liabilities: $400.00 Equity Share capital: $1,000.00 Retained Profit: $50.00 Total Equity: $1,050.00 |
Adding inventory of $400 = $200(cash) + $200(payable)
Selling Profit ($50) + cost ($100) = $150 = Received Cash of $30 + Receivable of $120
Cash equivalents = $800 + $30 - Increase of inventory ($400) = $430
Note: $50 from long term borrowing is shifted to current liabilities. At the beginning of year 2:
Company X has successfully sold its goods with cost of $300.00 and profit of $200.00. However, the company is required to clear its current liabilities now.
Therefore, the balance sheet at the beginning of year 2 becomes:
Non-Current Assets Property, plant and equipment: $400.00 Current Assets Inventory: $200.00 Accounts receivable: $300.00 Cash and cash equivalents: $500.00 Total Assets: $1,400.00 | Non-current Liabilities Long term borrowing: $100.00 Current Liabilities Short term borrowing: $50.00 Accounts payable: $0.00 Total Liabilities: $150.00 Equity Share capital: $1,000.00 Retained Profit: $250.00 Total Equity: $1,250.00 |
Inventory: $500 - selling cost of $300 = $200.00
Cash equivalents: $500 = $430 + received cash from selling of $200 + previous receivable of $120 - payable of $200 - borrowing installment of $50
Retained Profit: $250 = previous profit of $50 + current profit of $200
Now, the company has decided to reward their investors with dividend of $0.10 per share or total amount of $100.00. Since the dividend is paid by cash, both amount in Cash and cash equivalent and Retained profit is
Therefore, the balance sheet at the end of year 2 becomes:
Non-Current Assets Property, plant and equipment: $400.00 Current Assets Inventory: $200.00 Accounts receivable: $300.00 Cash and cash equivalents: $400.00 Total Assets: $1,300.00 | Non-current Liabilities Long term borrowing: $100.00 Current Liabilities Short term borrowing: $50.00 Accounts payable: $0.00 Total Liabilities: $150.00 Equity Share capital: $1,000.00 Retained Profit: $150.00 Total Equity: $ 1,150.00 |
As you can see, Total Assets = Total Liability + Total Equity. That's why we always say balance sheet must always BALANCE. Feel free to give me a comment about this topic. It will be a great support to Xaivier Blog.
Written by: Xaivier Chia
First edited at Oct 2010
Second edit: October 2014, by Xaivia Lim
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