Statement of Financial Position

Now you know how to categorize assets and liabilities, but how is this categorization useful? Assets and liabilities are the foundation of the Statement of Financial PositionStatement of Financial Position:
One of the four financial statements prepared by companies in their reporting cycle. It tells users what the company owns, what it owes, and the ownership stake of shareholders. The Statement of Financial Position paints a picture of assets in place to create value through the company’s business model, as well as claims on value created by suppliers, debtholders, and shareholders. Also called a Balance Sheet.. The Statement of Financial Position is one of the four financial statements that are prepared every year by every company. Each financial statement provides different information on the company.

Let’s start with the Statement of Financial Position. It is presented in three sections: assets, liabilities, and equity. The good news here is that you know two of the three sections already! The three sections relate to each other through the basic accounting equation, so this is really important:

Assets = Liabilities + Equity

Like any equation, we can move the terms around. Another helpful way the accounting equation is presented is:

Equity = Assets − Liabilities

Now you’re likely wondering, what’s equity? Good question. Equity is defined as the residual interest in the assets of an entity after deducting all of its liabilities. It is literally defined using the equation above: Equity = Assets − Liabilities. That’s it! But who owns this residual interest? Equity holders or shareholders own the residual interest. That means that, if the company stopped operating and all the assets were sold for cash and the liabilities were paid off with that cash, all the residual interest, also known as the cash left in the company, would be split between the equity holders. That’s what residual interest means: what’s left over.

But who are these equity holders: the individuals who own the company? The equity holders may be the people who started the company and likely currently manage it. We call this a privately held company. But maybe it’s easier to understand if we compare privately held with publicly held.

If the company is public, shares are issued and traded on an exchange like the Toronto Stock Exchange (TSX)—this means that the company is owned by lots of different people/companies all over the world. If you buy a share, you get a proportional ownership interest in the company, usually quite a small proportion because the company likely has thousands of shares outstanding. And these shareholders can buy and sell shares of the company—exchange with other investors—without affecting the company’s accounting. The company only controls the number of shares they issue to the exchange.

The important thing to understand here is that private companies usually have very few shareholders, often just one, and public companies have many, many shareholders who are constantly changing as shares are traded. But regardless of whether a company is public or private, these shareholders get the residual interest in the company: Assets − Liabilities.

Now we know what assets, liabilities, and equity are, and their relation to each other. Let’s talk about the Statement of Financial Position. Draw a line lengthwise down a sheet of paper. You will list all the assets on the left-hand side, liabilities and equity on the right-hand side. When you add all your assets on the left side, and you add all your liabilities and equity together on the right, the two sides of the paper should equal. After all, Assets = Liabilities + Equity.

Let’s try it. The exercise below contains a list of assets, liabilities, and equity. This is called a Post-Closing Trial BalancePost-Closing Trial Balance:
A listing of company accounts after closing entries are made. This means that all income statement accounts and dividends declared are zero.. Assets are labeled with an A; Liabilities, L; and Equity, E.

Try another one! Here is a Post-Closing Trial Balance for KWH Ltd.