Analysis by Trial Balance-Part II

In analysis by trial balance, there is more than one way to discover what has happened to a firm's financial position since its last balance sheet A financial statement listing the assets, liabilities and owner’s equity of a business entity as of a specific date. and income statement were issued. We now consider the break-even inventory Goods held for sale or leas A contract granting the use and possession of real property for a specified time and for fixed payments. e that are furnished under contracts of service, usually raw material Industrial products that are composed of farm and natural products. s, work in proces The direct material costs, the direct labor costs and the factory overhead costs, that have entered into the manufacturing process but are associated with products that have not been finished. s, or materials used or consumed in a business. procedure of trial balance analysis.

The method of trial balance analysis we last considered is usually referred to as the "maintained gross profit The excess of net over the cost of merchandise sold. procedure." As you will recall this involves the construction, of an interim balance sheet, and its accuracy depends largely on how precisely you are able to estimate the firm's gross profit percentage during the period covered by the trial balance. In assets where gross profit is difficult or impossible to estimate, another method is more suitable. This is called "break-even inventory procedure."

The logic of this procedure is quite simple: If the firm being analyzed has maintained the net worth it had at the start of the trial balance period, the sum of that net worth plus the new liabilities shown in the trial balance must equal total assets. Of course, the inventory as of the trial balance date is not given. But when the assets that are listed are subtracted from the sum of the beginning net worth and the liabilities, a figure is obtained that is the equivalent of the inventory needed to produce neither a gain nor a loss in the net worth for the period. By comparing this "break-even" figure with a rough count of the amount of inventory on hand, you can get a fair idea of how the firm is doing.

In the March 31, 19_, trial balance of the Robb Company, the previous financial statement had been issued three months before at the end of the preceding year. To determine the break-even inventory you would first total up the liabilities and net worth:

Next you total up the listed assets:

Then by subtracting the assets from the sum of the liabilities and net worth you get the break-even inventory figure ($37,000 - $27,000 = $10,000):

And when inserted into the cost of goods sold section of the Robb Company's March 31 income statement, the break-even inventory figure is such that there can be neither profit nor loss:

If you find that, in making your rough count of the company's inventory, its value is more than $10,000, you can assume that progress is being made; if it is less than $10,000, you have spotted trouble-the company's financial position having declined since its last balance sheet was issued.