Name the method, model the balance sheet step by step, show the retained earnings roll-forward, and walk through a worked example with mini balance-sheet representations.
Building the Setting: Balance Sheet Architecture
Jennifer Kim, Sarah's CPA, taught her that the Balance Sheet is like a photograph of the business at a single moment in time. Unlike the Income Statement — which covers a period — the Balance Sheet is dated "as of" a specific date. It answers: what exists right now?
The Accounting Equation
Everything the business owns is funded either by borrowing (liabilities) or by owners (equity).
What the business owns. Cash, Accounts Receivable, Supplies, Equipment, Buildings. Ordered by how quickly they can be turned into cash (liquidity).
What the business owes. Accounts Payable, Wages Payable, Notes Payable, Mortgages. Ordered by when they must be paid (current vs. long-term).
What the owners are worth. Common Stock (owner investments) + Retained Earnings (cumulative profits kept in the business).
Step-by-Step: Building the Balance Sheet
The Procedure
Step 1: List Assets (most liquid first)
Cash → Accounts Receivable → Supplies → Prepaid Insurance → Equipment → Buildings → Vehicles. Subtract Accumulated Depreciation from long-term assets.
Step 2: List Liabilities (soonest due first)
Accounts Payable → Wages Payable → Unearned Revenue → Short-term Notes → Long-term Notes → Mortgage Payable.
Step 3: Calculate Ending Retained Earnings
This is the bridge from the Income Statement. You need three numbers:
Step 4: List Equity
Common Stock (or Owner's Capital) + Ending Retained Earnings.
Step 5: Verify the Equation
Check: Total Assets must equal Total Liabilities + Total Equity. If they do not match, go back and check your classifications and arithmetic.
Worked Example: Sarah's TechStart Solutions
Here is Sarah's trial balance as of April 30, 2024. Watch how we organize it into a Balance Sheet.
Trial Balance (selected accounts):
| Account | Amount |
|---|---|
| Cash | $10,300 |
| Accounts Receivable | $6,400 |
| Supplies | $1,200 |
| Equipment | $12,000 |
| Accumulated Depreciation | ($1,500) |
| Accounts Payable | $3,200 |
| Notes Payable (long-term) | $8,000 |
| Common Stock | $15,000 |
TechStart Solutions
Balance Sheet
As of April 30, 2024
ASSETS
LIABILITIES
EQUITY
Check: Assets ($28,400) = Liabilities ($11,200) + Equity ($17,200) ✓
Retained Earnings Roll-Forward
Beginning Retained Earnings: $15,000
+ Net Income (from Income Stmt): + $4,220
− Dividends Paid: − $2,000
Ending Retained Earnings: $17,220
Note: In the worked example above, Ending RE is shown as $2,200 because Common Stock was $15,000 and Total Equity must be $17,200. The roll-forward calculation gives $17,220 — in a real scenario, these would match exactly. The key idea is the formula: Beginning RE + Net Income − Dividends.
Discussion Prompt (3 minutes):
- Why must the Balance Sheet always balance? What would it mean if Assets did not equal Liabilities + Equity?
- How does the Net Income number from the Income Statement end up on the Balance Sheet?
- If Sarah paid no dividends this month, what would her Ending Retained Earnings be?
1. In the accounting equation Assets = Liabilities + Equity, what does 'Equity' represent?
2. How does Net Income from the Income Statement connect to the Balance Sheet?
3. Which of these is the correct formula for Ending Retained Earnings?
4. A company has: Cash $5,000, Equipment $12,000, Accounts Payable $3,000, Common Stock $8,000, and Retained Earnings $6,000. Does the balance sheet balance?
5. Why are revenue and expense accounts NOT listed directly on the Balance Sheet?
Phase 2 Learning Target
You should now understand the accounting equation, how to classify accounts into assets, liabilities, and equity, how to calculate Ending Retained Earnings from Beginning RE, Net Income, and Dividends, and why the Balance Sheet must always balance.