Question

The balance sheet shows all of the permanent accounts with balances at a point in time. There are many advantages and disadvantages that can be discussed regarding the balance sheet. What would you see as one of the major advantage and disadvantage to the balance sheet?

Answer 1

1. A Balance Sheet is a statement of financial position of a business concern at a given date. It is called a Balance Sheet because it is a sheet of balances of those ledger accounts which have not been closed till the preparation of Trading and Profit and Loss Account.
2. After the preparation of Trading and Profit and Loss Account the balances left in the trial balance represent either personal or real accounts.
3. In other words, they either represent assets or liabilities existing on a particular date. Excess of assets over liabilities represent the capital and is indicative of the financial soundness of a company.
4. A Balance Sheet is also described as a "Statement showing the Sources and Applications of Capital".
5. It is a statement and not an account and prepared from real and personal accounts.
6. The left hand side of the Balance Sheet may be viewed as description of the sources from which the business has obtained the capital with which it currently operates and the right hand side as a description of the form in which that capital is invested on a specified date.
7. A Balance Sheet is only a statement and not an account. It has no debit side or credit side. The headings of the two sides are 'Assets' and 'Liabilities
8. A Balance Sheet is prepared at a particular point of time and not for a particular period. The information contained in the Balance Sheet is true only at that particular point of time at which it is prepared.
9. A Balance Sheet is a summary of balances of those ledger accounts which have not been closed by transfer to Trading and Profit and Loss Account

Advantages:

1. It determines risk and return.
2. It can be used to secure loans and other capital.
3. It provides helpful ratios

Major Advantage is Make financial reporting priority

Disadvantages:

1. Valuation of Internally Generated Assets:

* The major limitation of the balance sheet is that only acquired assets are accounted for.

* Hence, when the assets are developed internally by going through research and development works.

* These assets are not recognized at market value, rather at a cost which tends to generally lower than the value or sometimes higher than the market value.

* Suppose, the business builds the website and starts e-commerce.

* The balance sheet largely ignores the value capability of the cost of the website.

2. Mis-stated Long-term assets:

* Long term assets are expected to last more than one year and include plant and machinery, building, etc.

* The Balance Sheet records the value of the assets at historical or book value. The depreciation that has been calculated is for tax purposes or is reliably estimated as per accepted policies.

However, this does not reflect the true wear and tear of assets. Balance Sheet also ignores money value that the business would require to replace the assets in use.

3. Snapshot at a particular date:

* As a balance sheet depicts financial position as on a particular date, the management or the owners want a balance sheet as healthy as possible.

* They would just repay the bank debt on the last date, so, as to reduce the debt as on that date.

* Businesses can manipulate the cash, debtors and creditors data so as to manipulate the lenders. For instance, a high cash balance at the end date of the accounting period should confirm strong liquidity reserves.

* However, the company’s intention for the application of cash can be different. Hence, at a given period of time, the figures for the balance sheet can be misleading.

4. Needs Comparison