Balance Sheet - Comparison between the US and UK System - Essay Example

? BALANCE SHEET Table of Contents Table of Contents 2 Introduction 3 2.Balance Sheet Items 3 2.1Assets 4 2 1Fixed Assets 4 2 2Current Assets 6 2.2Liabilities 8 2.2.1Current Liabilities 9 2.2.2Long-term Liabilities 9 2.2.3Shareholders’ Funds 9 3.Dual Aspect of Balance Sheet 10 4.Application of Balance Sheet 10 5.Balance Sheet – A Comparison between US and UK System 11 6.Conclusion 12 References 13 1. Introduction This study entails about the balance sheet and its components. Balance sheet is a type of financial statement prepared by all the business organisations to represent its financial position at a particular point of time when the balance sheet is prepared by them. Balance sheets are generally prepared by a company at the end of its financial year. The balance sheets are presented in either horizontal or in vertical form. All the items present in the balance sheet of a company are discussed in details in this study. The dual aspect of balance sheet and the application of balance sheet have also been mentioned in this study. The users of balance sheets include the company managers to help them in analysing the financial conditions of the company, the investors and shareholders to help them in their decision making process regarding investment in the organisation and all other stakeholders of the company. With the increasing trend of globalisation most of the companies are trying to explore business opportunities in different parts of the world. As a result of this they need to comply with the regulatory requirements of different nations of the world. However with the advent of International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS), the accounting practices followed in different nations are converging to make the financial statements including balance sheets more comparable in nature. A comparison between the balance sheet formats followed by companies in US and UK has been discussed in this study. 2. Balance Sheet Items All the items of a balance sheet fall under two broad headings, namely “Assets” and “Liabilities”. The items falling under the categories of assets and liabilities have been discussed below: 2.1 Assets Assets which are possessed by a business concern are categorised into two types, namely, current assets and fixed assets. Fixed assets are considered to be the long term assets of the company and current assets are considered to be the short term assets of the company. All these assets of the company are valued and represented in the balance sheet of the company at its book value or historical costs of those assets that is the costs of the assets when it was first bought by the company. This is known as the historic cost convention (Horner, 2012, p. 42). However, as an exception to this convention or rule, some of the assets like the buildings possessed by the company are re-valued at its market price and then represented in its balance sheet. Sometimes, assets like goodwill generated internally by the company, including the values o different kinds of brands acquired by the company over a period of time are not included in its balance sheet. It is so because of the difficulty in accurately measuring the value of these kinds of assets. Let us now discuss in details about the assets of a company. 2.1.1 Fixed Assets Long term assets or fixed assets possessed by a company are sometimes referred to as non-current assets of the company. Fixed assets generally comprises of those assets of the company which are utilized by it for conducting its various business activities and are there with the company for a long period of time. They are not meant for resale by the organisation. The fixed assets of the company help it to generate sales or revenues through its business processes over a long period of time. Generally the fixed assets are required to be depreciated along its lifetime (Stittle, & Wearing, 2008, p. 60). Fixed assets of an organisation can further be grouped together into three different categories. They are: a) Tangible assets, b) Intangible assets, and c) Investments. Tangible Assets: Tangible assets are normally found in the balance sheets of all companies. Examples of tangible assets are plant and machinery, building and land, furniture, etc. In the balance sheet of a company these tangible assets are normally represented at its historical cost. The total depreciation amount that has been written-off and charged to the profit and loss account in relation to these assets is shown with a negative sign or with a "Less" sign prefixed to it in the asset side of the balance sheet (Horner, 2012, p. 42-43). Intangible Assets: Intangible assets include various items like brands, goodwill, trademarks, patents, licences, etc. These types of assets which are owned by the organisations cannot be seen or touched and felt with hand. However it has got some value that is measurable. These intangible assets can be seen presented in the balance sheet only if it can be identified separately from any other assets and if the company has spent money on its acquisition. After the introduction of IFRS, the accounting procedures for goodwill and other intangible assets followed in UK became comparable with the accounting practices followed internationally. Prior to that, i.e. before 1998, the UK accounting procedures for intangible assets were not in accordance with the international standards (Horner, 2012, p. 43). The intangible assets whose expected lives are limited are required to be amortised over the period of useful economic life to the profit and loss account of the company. In cases where the intangible assets presented in the balance sheet suffer impairment in its value, they are required to be written down in the balance sheet. Generally, it is assumed that the useful economic lives of intangible assets are less than 20 years calculated from the date from when it is acquired by the company (Horner, 2012, p. 43-44). Investments: Investments appear on the balance sheet under the head of fixed assets only if they are characterised being long term in nature. It means the investments are expected to yield return for the company which can be realised after a period of more than one year. Investments of the company presented in the balance sheet are generally a result of the stake of the company in its subsidiaries, related companies, joint ventures etc. At times companies are engaged in activities of buying shares of other companies and hold those shares for a long period of time. These types of shares are shown as investments under fixed assets or non-current assets of the company. Sometimes investments are shown under current assets of the balance sheet as well. Thos are the investment in shares of outside companies which is bought by the organisation in the form of short term investment and are held by the company for not more than one year (Walker, 2008, p. 52). 2.1.2 Current Assets Current assets are the assets of the company which are short term in nature that are already in the form of cash or which are supposed to be converted into cash in the due course of time during the normal course of business activities conducted by the company (Stittle, 2008, p. 60). There are three major components of current assets which are presented in the balance sheet of a company. They are: a) Stocks, b) Debtors, and c) Investments, bank and cash balances. They are discussed in details below. Stocks Depending on the type of business activities performed by a particular company, the stocks can be made of three different types. They are raw materials, finished goods and work-in-progress. If it is a manufacturing business concern then all these three types would be present in its balance sheet. However if it is a retail outlet, then only finished goods would appear in its balance sheet because its business process includes resale of goods purchased by them. Valuations of stocks are done by the companies on the basis of its cost or the value that can be realised from it. Realisable value implies its trading value and not the value at which it is sold to the customers. Valuation of the finished goods and work-in-progress of a company is not that easy and is a bit complex in nature because it is tough to identify and segregate all the cost components associated with these items. The direct costs in the form of labour costs or materials costs can be easily assigned to these items. However other assignment of other overhead costs associated with these items are not that easy. The accountancy bodies have been successful in providing some alternatives regarding stock valuation which are to be followed by the business organisations (Horner, 2012, p. 44-45). Debtors Debtors come into effect only if the business concerns are engaged in activities of selling its products on credit terms to its customers. However, credit sales forms a part of normal business procedures followed by most of the firms. Hence debtors are found in the balance sheet of most of the companies. Prepayments in the form of payments made in advance by the companies for the goods that they are yet to receive from its suppliers are also included under this head of debtors. Debtors are valued on the basis of the mentioned invoice price as presented to the customers of the company while selling its products or services to them. However, in normal business procedures not all due payments are cleared by the debtors due to various reasons like the customers going bankrupt or is unable to pay its dues. Hence, a provision is made by the companies in the form of provision for doubtful debts based on the previous experience of the company regarding non payment of dues by its customers. As a result of this, these doubtful debt amounts are charged as expenses in the profit and loss account and in the balance sheet the debtors’ value is reduced by the corresponding amount. Then again depending on the actual value of bad debts occurring in a particular year the debtors’ value is readjusted by the company and shown in its balance sheet (Horner, 2012, p. 45). Investments, Bank and Cash Balances Investments when presented as current assets in the company's balance sheet represent those investments made by the company which are short term in nature. The return of those investments are realised within one year and are utilised by the companies in its daily business operating activities. Bank and cash balances, as present in the balance sheet of a company represent all types of cash possessed by the company and the balances of the amount as present in the bank accounts of the businesses (Horner, 2012, p. 45). 2.2 Liabilities Liabilities include all the items which constitute the source of funds for the company. Liabilities are categorised into two broad groups as presented in the balance sheet of a company. They are the current liabilities and the long term liabilities of the company. Shareholders' funds or equity are present as separate heading under liabilities section of a balance sheet which is also a major source of fund for a company. These three components of liabilities are discussed in details below: 2.2.1 Current Liabilities The obligations of a business firm which are short term in nature are referred to as current liabilities in the balance sheet of the company. It includes various items like the amount owed by the company to its creditors who have provided the company with certain goods or services on credit terms. Current liabilities also include items in the form of expenses incurred by the company which has not been paid by the company as yet when its balance sheet was created. Generally all those obligations of a company which are due to be paid by a company within one year of the date when the balance sheet is prepared are considered to be the current liabilities of the company (Stittle, 2008, p. 61). 2.2.2 Long-term Liabilities Long-term liabilities are sometimes referred to as non-current liabilities as well. It includes those obligations of a company whose payments are to be made in the future after a long term which is usually taken as a period exceeding one year. Bank loans and other borrowed capital of a company mainly constitute its long-term liabilities (Stittle, 2008, p. 61). 2.2.3 Shareholders’ Funds Shareholders' funds mainly consist of the capital generated by a company through issue of its shares to the public. It actually represents the fund which has been invested by the shareholders of the company, the amount of profits retained by a company are also represented as shareholders' funds in the balance sheet of a company. Thus the issued share capital and the retained earnings in the form of reserves of a company are represented in the balance sheet of a company. Shareholders’ funds are sometimes referred to as owners’ fund as well. It is so because the shareholders of a company are considered to be the owners of the company. Shares issued by a company can be of different types like the common equity shares, preference shares, etc. They are all accounted for and mentioned in the balance sheet (Horner, 2012, p. 46-47). 3. Dual Aspect of Balance Sheet The dual aspect of any balance sheet can be better understood through the following equation which is sometimes termed as the balance sheet equation (Horner, 2012, p. 38): Assets = Liabilities The above equation suggests that the summation of all the items under the head “Assets” must equal the summation of all the items under the head “Liabilities” in balance sheet. Different types of items can come under assets and liabilities, as presented in a balance sheet of a particular business concern, have been explained previously. Now, since the assets and liabilities must balance each other in a balance sheet, any type of business transaction carried on by a business concern that leads to a change in the value of assets of the company must result in equivalent change in the liabilities of the company and vice versa. 4. Application of Balance Sheet The financial statement in the form of balance sheet of a company are utilised by its stakeholders mainly for the purpose of the decision making process followed by them. The stakeholders of the company using its balance sheet are mainly the investors of the company and the company managers. The investors take help of the balance sheet of the company for the purpose of interpreting the financial information present it and help them in their decision making process. Comparative and trend analysis are performed by the investors of the company to have knowledge about the financial performance of the company in past few years and then comparing those information with the industry standards or the financial information of its competitors to have a better idea about the performance of the company. This helps a great deal in the decision making process of the investors of the organisation. In addition to this, balance sheets are used by the internal managers of the company to gather financial information about the company’s performance, thereby helping in formulating strategies for increasing the growth of the company and enhance its performance in the future (Helfert, 2001, p. 53-54). 5. Balance Sheet – A Comparison between US and UK System Balance sheet is one of the financial statements which is prepared by all the business organisations, be it in UK or US. However, there are some differences in the presentation format of balance sheets prepared by the companies situated in these two countries. All the listed companies in both these nations are required to comply with the regulations and disclosure requirements as laid down by its regulatory bodies. Except few of the small sized enterprises in UK, all the companies are required to follow the standards of UK GAAP (Generally Accepted Accounting Practices) which is based on the company law. In UK the companies generally follow a format for preparing its balance sheet that can be divided into two broad divisions, namely the net assets and the shareholders’ equity. The net assets part comprises of fixed assets and current assets which sum up to give total assets. Then liabilities are subtracted from total assets to give net assets. The other part consists of the shareholders’ fund which gives an idea about how the net asset has been financed by the company. However, in case of companies in US, they are required to present balance sheets in a format where the total assets equal with the total liabilities and shareholders’ funds. The balance sheet items are generally presented in decreasing order of its liquidity. This explains the difference between balance sheet format of US and UK (Pwc, 2005, p. 23). 6. Conclusion Balance sheet is a type of financial statement prepared by all the business organisations. They are presented to all the stakeholders of the company. It gives an idea about the financial position of a company at the moment or date on which it is prepared by the company. All the assets owned by a company and the corresponding liabilities of the organisation are all represented in its balance sheet. The dual concept of balance sheet is also critical which explains why a balance sheet must balance its assets and liabilities. There are some minor differences that can be observed in the balance sheet formats found in US and UK and they are in accordance with the regulatory requirements of the respective countries. Lastly, the balance sheets along with other financial statements are utilised by the stakeholders of the company to interpret and analyse the financial information present in it to help in their decision making process. Hence, it evident from this study that knowledge of balance sheet is very critical for any of the stakeholders of the company. References Helfert, E. A., 2001. Financial Analysis: Tools and Techniques: A Guide for Managers. New York: McGraw-Hill. Horner, D., 2012. Accounting for Non-Accountants: A Manual for Managers and Students. 8th ed. London: Kogan Page Publishers. Pwc, 2005. Similarities and Differences: A Comparison of IFRS, US GAAP and UK GAAP. [pdf] Available at: [Accessed 31 August 2012]. Stittle, J., & Wearing, R., 2008. Financial Accounting. London: SAGE Publications Ltd. Walker, J., 2008. Accounting in a Nutshell: Accounting for the Non-Specialist. 3rd ed. Oxford: CIMA Publishing. Read More