Financial Reporting and Analysis Unit 2

Financial Statement Preparation

• Before preparing financial statements, certain events must have taken place, including:
  • Occurrence of transactions during the financial year
  • Entering transaction data on source documents
  • Recording transactions in journals from source documents
  • Posting information from journals to ledger accounts
  • Preparing a trial balance to ensure correct application of the double-entry principle

Pre-Adjustment Trial Balance

• A pre-adjustment trial balance is a list of accounts and their balances at a given time
• It is usually prepared at the end of an accounting period
• Accounts are listed in the order they appear in the general ledger
• The trial balance includes:
  • Debit balances in the left column
  • Credit balances in the right column
• The main purpose of the trial balance is to ensure that:
  • The total of all debit entries equals the total of all credit entries after posting is completed

Preparing Financial Statements

• The process of preparing financial statements involves several stages, including:
  • Transactions occurring during the financial year
  • Recording transactions in source documents and journals
  • Posting information from journals to ledger accounts
  • Preparing a trial balance to check for errors
  • Making adjustments to the trial balance to comply with GAAP concepts
• A pre-adjustment trial balance is a list of accounts and their balances at a given time, usually prepared at the end of an accounting period
• The trial balance includes debit balances listed in the left column and credit balances in the right column, with the totals of the two columns being equal

Trial Balance Accounts

• Balance sheet accounts:
  • Capital: represents the amount invested by the proprietor plus retained profits
  • Drawings: refers to cash or goods taken by the proprietor for personal use
  • Land and buildings, Equipment, and Vehicles at cost: reflect the purchase price of these assets
  • Fixed deposit: represents an investment account earning interest
  • Accumulated depreciation: represents the cumulative total of depreciation recorded on assets
  • Trading inventory: represents the cost price of merchandise purchased for resale
  • Debtors control: represents the amount owing by customers
  • Provision for bad debts: represents the expected amount of bad debts
  • Bank and Petty cash: represent cash balances
  • Creditors control: represents the amount owing to suppliers
  • Loan: represents a loan from a bank or other lender
• Nominal accounts:
  • Sales: include cash and credit sales made during the year
  • Cost of sales: represents the cost price of merchandise sold
  • Sales returns: represents merchandise returned by debtors
  • Advertising and other expenses: represent other expenses incurred by the entity
  • Discount received, Interest on fixed deposit, and Rent income: represent other income accounts

Year-End Adjustments

• Adjustments are necessary to ensure that financial statements accurately reflect the financial position and performance of the entity
• Types of adjustments include:
  • Bad debts: writing off debtors who are unlikely to pay
  • Provision for bad debts: making a provision for expected bad debts
  • Depreciation: providing for the wear and tear of assets
  • Accrued income: recognizing income earned but not yet received
  • Accrued expenses: recognizing expenses incurred but not yet paid
  • Prepaid expenses: recognizing expenses paid for in advance
  • Income received in advance: recognizing income received but not yet earned
  • Consumable inventory: recognizing unused consumable items

Preparing Financial Statements from a Pre-Adjustment Trial Balance

• Financial statements can be prepared directly from the pre-adjustment trial balance and additional information
• The recommended method involves:
  1. Preparing the formats of the financial statements without entering any amounts
  2. Taking the figures from the pre-adjustment trial balance and writing them down next to the relevant detail in the financial statements
  3. Studying each adjustment and making the necessary adjustments to the pre-adjusted amounts
  4. Entering the final figures and completing the financial statements with the necessary calculations

Learn about the steps that occur before preparing financial statements, including transactions, journal entries, and trial balances.