Balance Sheet of a Sole Proprietorship: Assets, Liabilities and Capital

Understand Balance Sheet: Assets, Liabilities and Capital

Key formulas to remember

Accounting equation

Assets = Liabilities + Capital

Total of both sides of the balance sheet must agree.

Closing capital

Closing capital = Opening capital + Additional capital + Net profit − Drawings (− Net loss, if any)

Interest on capital is added and interest on drawings is deducted, only if the question gives them.

Opening capital from assets and liabilities

Capital = Total assets − Outside liabilities

Used when capital is not given directly.

Net assets / working capital

Working capital = Current assets − Current liabilities

A positive figure means short-term assets cover short-term dues.

Order of liquidity

Assets: Cash → Bank → Debtors → Stock → ... → Fixed assets → Goodwill

Liabilities start with the one payable earliest, such as bank overdraft and creditors; capital comes last.

Order of permanence

Assets: Goodwill → Land → Building → Machinery → ... → Stock → Debtors → Bank → Cash

Liabilities start with capital, then long-term loans, then current liabilities.

How to solve Balance Sheet: Assets, Liabilities and Capital questions

1. 1Read the question for the required order: liquidity or permanence. Note the date of the balance sheet.
2. 2From the trial balance, pick out only the balance sheet items: assets, liabilities, capital and drawings. Items of trading and profit and loss accounts go to those accounts.
3. 3Compute net profit or loss from the final accounts or take it as given.
4. 4Work out closing capital: opening capital + additional capital + net profit − drawings.
5. 5Apply adjustments: add prepaid expenses and accrued income to assets, add outstanding expenses and income received in advance to liabilities, and reduce debtors and fixed assets by provisions and depreciation.
6. 6Group items under fixed assets, current assets, long-term liabilities and current liabilities, and arrange them in the required order.
7. 7Total both sides and check that they agree. If not, recheck capital, drawings and closing stock.

Quickest way: Capital-first tally check

Common mistakes in Balance Sheet: Assets, Liabilities and Capital

• Showing drawings as an expense in the profit and loss account.

  Drawings look like money going out of the business.

  Fix: Drawings reduce capital. Deduct them from capital in the balance sheet only.

• Adjusting closing stock a second time, or mixing up closing stock given in adjustments with closing stock in the trial balance.

  Students forget that closing stock given in adjustments is outside the trial balance and carries a double entry, while closing stock inside the trial balance has already been credited to the trading account.

  Fix: Closing stock given outside the trial balance: debit Closing Stock A/c (a current asset in the balance sheet) and credit Trading A/c. That is the full double entry, so do not adjust it again. Closing stock inside the trial balance: show it only in the balance sheet, as the trading account has already been credited with it and it is not carried to the trading account again.

• Putting outstanding expenses on the assets side or prepaid expenses on the liabilities side.

  Confusion between what is owed and what is paid in advance.

  Fix: Outstanding expenses are owed, so they are liabilities. Prepaid expenses are a benefit still to come, so they are assets.

• Mixing up the order of liquidity and order of permanence.

  Students memorise the names but not which item starts the list.

  Fix: Liquidity starts with cash. Permanence starts with goodwill or land. For liabilities, permanence starts with capital.

• Classifying machinery or furniture as current assets because they are used daily.

  Use is confused with resale.

  Fix: If the asset is held to use and not to sell, and lasts more than a year, it is fixed. Current assets are those turned into cash within the operating cycle.

• Forgetting to deduct provision for doubtful debts from debtors.

  Students stop after bad debts.

  Fix: Show debtors less bad debts written off, then less the new provision for doubtful debts, and show the net figure. The provision is a charge to the profit and loss account, where any old provision is adjusted first.

Worked examples