The ground rules, concepts and conventions

The balance sheet is a part of accounting and accounting is certainly not an exact science. There is a considerable scope for interpretation and educated guesswork. If this were to go on unbridled no one inside or outside the business would place any reliance on the figures, so certain ground rules have been laid down by the profession to help get a level of consistency into accounting information.

Money measurement

In accounting, a record is kept only of the facts that can be expressed in money terms.  But, there is one great danger with expressing things in money terms. It suggests that all the penny is identical. This is not always so. Pounds currently shown as cash in balance sheet are not exactly the same. For example, the debtor’s pounds that not be turned into cash for many months. And we can continue away with other cases. 

Business entity

The concept “Business entity” states that assets and liabilities are always defined from the business point. This concept forces us to see the business as an entity separate from all outside parties. For example: If an owner puts a short-term cash injection into the business, it will appear as a loan. You can see it in current liabilities in the business account. On the personal account, the same money appears as asset. So, depending on the point of view you take. Such money can be considered as liability, or assets. 

Cost concept

In the accounts are assets entered usually as a cost. What you can see, real worth of an assets is changing over time. As this category is subject of subjective estimate, it is hard to receive the same result at this item, if two accountants will be processing the same input data. The whole process is, of course, quite complicated. The assets themselves are not usually subject of sale and accountants have settled for cost as the figure to record. Here you should be made aware that the balance sheet does not illustrate the actual value of the company. And it's not even its mission. It is important to again remind you that the balance sheet is a statement of what the company currently own and what they owe. The difference between what the company owns and owes what appears in its own capital. The way how the assets for their life time are being consumed over the time are affected depreciation. For example, take a car that costs e.g. € 15 385. How will its value change within time? A simple example is given in the table.

Going concern

Each entrepreneur start his business with assumption, that trading will continue indefinitely into the future. This not mean, that anytime can arise a good evidence to contrary. By then is clear that assets of the business are looked as profit generators and not being available for sale. But, once a business stops trading, assets are no longer being used in the business to help generate sales and profits. It is time to sell assets. And now we can notice some differences between book value of assets market at the balance sheet (here the balance sheet is based on the principle of unlimited duration of the accounting unit) and “market price” – in other words the price at which you were able to sell the property.

Dual aspect

In the business you need to know, not only where money came from, but also how the money was used. It is not enough simply to say, for example if somebody has put let say 2000 € into their business. We have to see how the money has been used.

See the example:

Column 1 shows the balance sheet status before the owner has invested additional capital of € 100 in his business.

In column 2, you can see what happens to the financial part after you deposit the amount. Note, however, that the balance sheet has been "not balanced" and the value of assets and liabilities does not match. It is clearly logical, because after we receive more money, we have to do something about them

Column 3 shows how we treated them: They are involved in the rest money at our disposal. So, for example, we can finance more of our business partners when purchasing our products by a business loan, given by the maturity of invoices, or buy additional inventory, or pay some liabilities, etc. However, the basic relationship must be respected:

Assets  = Capital + Liabilities

Therefore, our current assets will also be increased by the amount of money invested.

That's the principle of double accounting. You can think of it as the accounting equivalent of Newton's law: "For every force there is an equal and opposite reaction."

Tweet