Uses and Limitations of the Balance Sh ...
The balance sheet can provide very useful information to users of financial statements.... Read More
The balance sheet is also known as the statement of financial position or statement of financial condition. It is a financial statement that gives a snapshot of a company’s assets, and its sources of capital, i.e., liabilities and shareholder’s equity, at a specific point in time. This provides vital information on what a company owns, what it owes, and what its owners’ claims are.
The three basic elements of the balance sheet are assets, liabilities, and equity.
The three basic elements may be represented in the form of the basic accounting equation:
$$ \text{Assets} = \text{Liabilities} + \text{Equity} $$
Question 1
Which of the following statements is correct?
A. Equity is equal to Assets less Liabilities.
B. Equity refers to the resources of a company.
C. Liabilities refer to things which a company owns.
Solution
The correct answer is A.
Rearranging the basic accounting equation, ‘Assets = Liabilities + Equity’, and making ‘Equity’ the subject, we see that ‘Equity = Assets – Liabilities’.
B is incorrect because ‘Assets’, and not ‘Equity’, refer to the resources of a company.
C is incorrect because ‘Assets’, and not ‘Liabilities’, refer to things which a company owns.
Question 2
ABC Company reported a total assets value of $250,000 and a total equity value of $100,000. What is the value of the company’s liabilities?
- $150,000
- $175,000
- $350,000
Solution
The correct answer is A.
As a company’s assets could be calculated as the sum of its liabilities and its equity:
$$ \text{Assets} = \text{Liabilities} + \text{Equity} $$
Hence, the value of a company’s liabilities is the result of deducting that company’s equity from its liabilities.
L = A – E = $250,000 – $100,000 = $150,000