By the end of this presentation you should know: A.

The meaning of assets, liabilities, capital, net worth, revenue, expense B. The relationship between assets and liabilities

A. Introduction

Assets are equal to liabilities. The liabilities consist of claims of owners and claims of outsiders. The claims of owners mean the paid up capital plus balance of reserves and surplus. The sum of the capital and the balance of reserves and surplus is also called the net worth. For the business net worth is the liability of the business towards the owners. As per the accounting concept and the business and its owners are considered two separate and distinct entities.
2

B. Balance Sheet Equation

The total claims (i.e. those of outsiders such as creditors and of its proprietors; net worth ) will equal to the total assets of the business. We can express the equation as, Assets = Equities (Total claims) Or. Assets = Liabilities + Capital Or. Liabilities = Assets - Capital Or. Capital = Assets - Liabilities
3

C. Computation of Balance Sheet Equation If there is any change in the amount of asset and liabilities, the owners claim or the capital is bound to change correspondingly. If assets increase and liabilities do not, the capital will increase A reduction in the amount of assets or an increase in the amount of liabilities will mean a reduction in the amount of capital
Assets
Cash Bank Bills Receivable Debtors Stock In trade Furniture Machinery Building

Capital + Liabilities
Capital + Reserves and Surplus Creditors Bills payable Outstanding expenses Bank overdraft

D. Equation (Tabular Form)

Assets
Assets Liabilities Capital

=
= = =

Liabilities
Liabilities (+) Assets (-) Assets (-) Capital Capital Liabilities

E. Performa Balance Sheet

LIABILITIES Capital Reserves 200.00 200.00

ASSETS Fixed assets Current assets 700.00 300.00

Term Loans
Current Liabilities Total

300.00
300.00

1000.00

Total

1000.00

In this case the equation is satisfied ( ASSETS = LIABILITIES )

6

F. Balance Sheet Equation Examples EXAMPLE 1

(1) If the net worth of the business is Rs.1100,fixed assets are Rs. 600, current assets Rs.400, investments Rs.300, current liabilities Rs. Nil, what is the amount of claim to outsiders? Rs. 1300 Rs. 500 Rs.200* (Answer) Rs. Nil

EXAMPLE 2
(2) Identify the wrong pair Outstanding expenses - Nominal account Profit and Loss Account (Dr. balance) Application of funds Net worth less reserves & surplus - Balance in P & L Account* (Answer) Balance sheet - Financial position
7

F. Balance Sheet Equation Examples EXAMPLE 3

3. The Assets of a business are Rs.500000 and its capital is Rs.115000. Its liabilities on that date would be-----a) Rs.615000 b) Rs.385000* (Answer) c) Rs.500000 d) Rs. 115000

EXAMPLE 4
4. A had a capital of Rs.750000. He has also purchased goods of Rs.150000 on credit from Mr. Saha. The value of total assets of the entity is----a) Rs.750000 b) Rs.900000* (Answer) c) Rs.600000 d) Rs.1050000

G. Key Words

CAPITAL : It means the amount which the owner of the business has invested in the firm and can claim from the firm. LIABILITIES : It means the amount which the firm owes to the outsiders ( Long term and current liabilities ). ASSETS: Assets are things of value owned. (Fixed assets current assets). REVENUE: It means the amount which, as a result of operations, is received by the business. EXPENSE: It is the amount spent in order to produce and sell goods and services which produce the revenue. INCOME: The difference between revenue and expense is called the income. DEBTOR: A person who owes money to the firm, mostly on account of credit sales of goods is called a debtor. CREDITOR: A person to whom money is owed by the firm.

Summary

At any point of time the total Assets of a firm will be equal to the liabilities of the firm. The equation ASSETS=LIABILITIES will be always true The liabilities consist of liabilities towards owners (Capital + Reserves and Surplus = Net Worth) and towards outsiders. In other words Assets = Net Worth + creditors

10