Question

What is the purpose of the balance sheet? Be sure to discuss the three key elements that make up the balance sheet. How does the balance sheet related to the income statement?

Answer 1

Balance Sheet:-

Balance sheet is the statement showing the assets, liabilities and capital of business on a particular date. The main purpose of balance sheet is to know the financial position of business to specific point of time to multiple stakeholders.

Purpose of Balance sheet :-

• It indicate financial position of firm
• It provide information about asset, liabilities and capital of a business
• It helps to know solvency of business
• Different ratios can be calculated from balance sheet and find working capital of a firm

Three key elements that make up the balance sheet :-

A business Balance Sheet has 3 main components such as assets, liabilities and capital.

1. Asset : An asset is resource with economic value that a business owns with the expectation that it will provide future benefit to the business. There are two type assets current assets and non-current assets (fixed asset)

2. Liabilities : A business’s liabilities are obligations the business owes . it also two type current liabilities and non-current liabilities.

3. Capital : capital refers to value of ownership. Owners fund to invest the business.

There for Assets = Liabilities + Capital

Balance sheet related to the income statement :-

The income statement and balance sheet of a company are connected with net income for a period and the income that an entity earns over a period of time transferred to the equity portion (capital side) of the balance sheet. And also income and equity that in balance sheet and income statement reflect the total financial performance of business.

In income statement if positive income (profit) lead capital to increase while negative income (loss) lead capital to decrease.Income statement accounts balances will be closed at the end of each accounting year to the capital. And the link between balance sheet and income statement is helpful for accountants who want some assurance that the amount of net income appearing on the income statement is correct.