What is a balance sheet and why is it prepared?

Definition of Balance Sheet

The balance sheet is prepared in order to report an organization's financial position at the end of an accounting period, such as midnight on December 31.

A corporation's balance sheet reports its:

You can view the balance sheet as reporting the assets and the claims against those assets (liabilities and stockholders' equity). You can also view the balance sheet as reporting a corporation's assets and the amounts that were provided by creditors (the liabilities) and the amounts provided by the owners (the stockholders' equity).

A classified balance sheet reports the current assets in a section that is separate from the long-term assets. Similarly, current liabilities are reported in a section that is separate from long-term liabilities. This allows bankers, owners, and others to easily compute the amount of an organization's working capital and current ratio.

The balance sheet has some limitations. For example, the property, plant and equipment are reported at cost minus the accumulated depreciation (except land). If these assets have increased in value, the fair value is not reported because of the cost principle. Also, brand names and trademarks may have significant value, but cannot be reported on the balance sheet unless they were acquired in a business transaction.

The balance sheet should be read with the other financial statements (income statement, statement of comprehensive income, statement of cash flows, and the statement of changes in stockholders' equity) including the notes to the financial statements.

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