How to prepare balance sheet

2.5. Equity on classified balance sheet

Equity is the owners' claim on assets. Equity, as noted above, is also the difference between assets and liabilities. Equity may include multiple financial elements. The most common equity elements are capital (common stock), current year earnings, and retained earnings. Let's review them in more detail.

Capital (common stock for corporations) represents the amounts contributed by owners to the business. Depending on the legal form of a business, capital can be named differently.

Current year earnings are the net income or loss of the business for the current year. This amount is the difference between all revenues and all expenses on the income statement. Current year earnings are presented on the balance sheet only until they are transferred to retained earnings.

Retained earnings are net income (loss) retained (accumulated) by your company.

For a company with relatively simple operations, retaining earnings are cumulative net incomes (losses) less dividends paid out since the company's origination. Note that when dividends are paid out, they reduce retaining earnings. Also note that retained earnings may be a negative amount in situations when the company is not profitable (i.e. more losses than net incomes).

3. Balance sheet format

A balance sheet is a financial statement that has a certain commonly used format.

First of all, a balance sheet has a header. The header needs to include your company name, the title of the financial statement (i.e. balance sheet), and period(s) presented in the financial statement. Note that some balance sheets are presented for one year, while others are presented for two years in a comparable format (e.g. comparable balance sheets of public companies). An example of the header for a single-year balance sheet is presented below:

Your Company Name
Balance Sheet
December 31, 2010

Next, the balance sheet with related captions is presented. Major captions (Assets, Liabilities, Equity) are presented first. Then, the next level captions are shown. The next level captions are the categories (classifications) we reviewed earlier (current assets, investments, etc.). Under each caption, components of the caption are presented. An example of the current assets caption is presented below:



Current Assets
Marketable Securities
Accounts Receivable
Prepaid Expenses

Note how the components of current assets are intended to the right so it's easier to read the balance sheet.

Finally, let's recall that assets can be shown on the left side while liabilities and equity are shown on the right side (horizontal presentation). Alternatively, assets can be shown first with liabilities and equity presented underneath the assets. If a balance sheet for a single period is shown, it seems to be more readable to show assets on the left and liabilities and equity on the right side. However, if comparable balance sheets (i.e. a balance sheet for two or more periods) are prepared, then it makes more sense to show liabilities and equity under assets.

Not a member?
See why people join our
online accounting course: