How Balance Sheet tallies by itself?
You may have found yourself blankly staring at hundreds of pages of numbers and tables, when flipping to the back of the company's Annual Report. You know that those numbers are important to your investment decision, but you're not sure what they mean. This information is likely a company's balance sheet, which depicts the financial health of a company.The balance sheet, together with the Notes to Accounts, Income statement and Cash flow statement, make up the cornerstone of any company's financial statements.
How any increase/decrease in the asset side is offset by an equal increase / decrease of liability or owner's equity or vice versa.
All business transactions have an impact on the Balance Sheet. Business Transactions occur on a daily basis as a result of doing business.
- Items are purchased or sold
- Credit is extended or borrowed
- Income is made or expenses are assumed
These business transactions result in changes to the basic accounting equation.
- A transaction that increases total assets must also increase total liabilities or owner’s equity.
- A transaction that decreases total assets must also decrease total liabilities or owner’s equity.
- Some transactions may increase one account and decrease another on the same side of the equation i.e. one asset increases and another decreases.
Regardless of the nature of the specific transaction, the accounting equation must stay in balance at all times.
- Possibility 1 - An increase in assets followed by an increase in liabilities
For instance, a business purchases a building for Rs 25 lakhs with a cash down payment of Rs 10 lakhs and a loan for the balance Rs 15 lakhs outstanding. More than two accounts are affected by this transaction. The asset “Building” increases by Rs 25 lakhs, the asset “Cash” decreases by Rs 10 lakhs, and the liability “Bank Loan” increases by Rs 15 lakhs. The net result is that both sides of the equation increase by Rs 15 lakhs, regardless of the transaction, the accounting equation must stay balanced.
- Possibility 2 - A decrease in assets followed by a decrease in liabilities
For instance, a Company pays Rs 50000 on existing supplier invoices. This reduces the cash (Asset) account by Rs 50000 and reduces the accounts payable (Liability) account by the same amount. Thus, the asset and liability sides of the transaction are equal.
- Possibility 3 - An increase in assets followed by an increase in equity
For instance, Issue of shares by the company. This leads to an increase in share capital (equity) and increase in cash (asset).
- Possibility 4 - A decrease in assets followed by a decrease in equity
For instance, the business’ owner withdraws Rs 20000 for his personal use. The effect of this transaction is the asset “Cash” is decreased by Rs 20000 and the drawing decreases Owner’s Equity by the same amount.
- Possibility 5 - An increase in assets followed by a decrease in another asset
For instance, the company purchases machinery in cash, it results in increase in asset (ie machinery) and decrease in cash.
- Possibility 6 - An increase in a liability followed by a decrease in another liability
For instance, bills Payable issued to Creditors.ie., This will reduce one liability (Creditors) on the one hand and increase another liability (Bills Payable) on the other hand.
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