Relation between Balance Sheet and Trial Balance
A balance sheet when made up from a double-entry set of books bears a close resemblance to the trial balance. The trial balance is simply a list of ledger balances. Due to practical considerations in making the record from day to day, the ledger seldom reflects the true condition of the business, as there is no distinct separation of assets, liabilities, expenses, and income. Some accounts take on a mixed character, making necessary the periodic separation of their elements. This separation is effected by the adjusting entries explained in Volume I. A trial balance of the ledger after the adjusting entries are made contains the data for both the financial statement and the operating statement. After the operating data, i.e., the income and expenses, have been summarized through the Profit and Loss account and its balance has been transferred to some vested proprietorship account, the records left on the books relate only to assets, liabilities, and vested proprietorship. A trial balance now taken—a post-closing trial balance—contains only balance sheet items and to all intents and purposes is a balance sheet. While, as we shall see, the form in which the data of the balance sheet are presented is a matter of serious importance, any showing of assets, liabilities, and net worth constitutes a balance sheet.
Form of Balance Sheet
A balance sheet is not an account, nor is it the statement of an account. It is simply a statement of assets, liabilities, and proprietorship, arranged in whatever form best suits the purpose. Where set up in parallel columns, it is frequently called the account form; when shown vertically on the page, assets followed by liabilities and the difference indicated as net worth, it is called the report form. A balance sheet therefore being only a statement cannot properly be said to have either a debit or a credit side. It is not a complete system for the record of the transactions of a business set up in debit and credit form for the sake of proof, although on its statement of fundamental equality may rest the whole scheme of debit and credit. While usually made up from a system of double-entry books and so often spoken of as the goal of record-keeping, it may be made up from sources entirely extraneous to the books.
Purpose and Uses
The purpose of the balance sheet is, as indicated, to show financial condition. It may be made also to show the amount of profit for the period by elaborating the information given in the net worth section. If there has been during the period neither a withdrawal of any funds nor an additional investment, a comparison of net worths as at the beginning and at the end of the period will bring out the increase or decrease in net worth and therefore establish the amount of profit or loss, though telling little or nothing as to its source. If there has been withdrawal or investment or both during the period, adjustment must be made on account of these before the amount of profit or loss for the period can be determined from the balance sheet. The balance sheet may thus be made to show profit, though that is an incidental rather than an essential purpose of the statement.
As a statement of financial condition the balance sheet should make possible the determination of several facts. It may be used as the basis for short-time credit. If so, its purpose then is to show facts as to solvency. It may be used as the basis for floating a bond issue. If so, other groups of data in addition to the solvency facts must be held under view. It may be used for determining the advisability of an investment in the business. If so, its data must be examined from still another angle. In all of these cases the balance sheet must set forth clearly the relationship of the interests of the various parties in the business. The assets of a corporation are listed usually so as to show the total properties to which all the parties may look for the satisfaction of their claims. Of the claimants there are first, then, those whose claims are redeemable within a short time. Failure to meet these claims may mean insolvency. There are those also whose claims are not necessarily of immediate urgency, though they may be. Inability to meet these claims may mean bankruptcy and dissolution. Finally, the owners themselves have a proprietor’s right only to any residue of assets left after the claims of all outsiders have been satisfied or are capable of being satisfied. Thus the balance sheet may serve many purposes.
Types of Balance Sheet
As the balance sheet must serve, or can be made to serve, several definite purposes, the best way to accomplish the end in view must receive careful consideration. It is here that the question of form enters. The various problems in connection therewith will next be discussed.
As to types of form there are in the main two, the English and the Continental or American, both of them well standardized, although many variations from the types are found. The chief difference between the two types lies in the showing of assets on the right side and liabilities and capital on the left under the English form, and a reversal of the sides under the Continental form. So much useless controversy has been carried on with such a waste of effort and words over the relative merits of the two types, that a writer now scarcely dares venture into the subject. As a matter of historical interest and information to the student, an effort will be made to summarize briefly the two positions.