Topic 10 – Preparing Financial Statements Introduction to Accounting and Economics

Introduction to Accounting
and Economics
Topic 10: Preparing Financial
Statements

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Preparing Financial Statements Topic 10 - 10.‹#›

Summary of Lecture
• Introduction
• Words you must know
• Forms of business unit
• The income statement
• The balance sheet
• A comprehensive example

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Topic 10 – Preparing Financial Statements Introduction to Accounting and Economics

Preparing Financial Statements Topic 10 - 10.‹#›

Summary of Lecture
• How do we prepare a set of financial
statements from a trial balance?
• Other financial statements
• The annual report
• Review of topic

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Preparing Financial Statements Topic 10 - 10.‹#›

Words you must know

Financial Statements:
Reports providing information about the financial
performance and wealth of a business.

Income Statement:
A financial report showing how profit has been
calculated.

Balance Sheet:
A financial report showing the wealth of a
business.

Capital: Value the business owes to the owner (or owners)

of the business.

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Topic 10 – Preparing Financial Statements Introduction to Accounting and Economics

Preparing Financial Statements Topic 10 - 10.‹#›

Words you must know

Capital Account: The account used to record the interest of
the owner (or owners) of the business.

Drawings: Money taken out of the business by the

owner.

Share Capital: The capital of a limited company.

Assets: Things owned by the business.

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Preparing Financial Statements Topic 10 - 10.‹#›

Words you must know

Non-current Assets :Long-term assets such as buildings,
vehicles and machinery.

Current Assets: Short-term assets such as inventory,

receivables, prepayments and bank
balances.

Net Assets: Non-current assets plus current assets

minus current liabilities.

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Topic 10 – Preparing Financial Statements Introduction to Accounting and Economics

Preparing Financial Statements Topic 10 - 10.‹#›

Words you must know

Liabilities: Items the business owes.

Non-current Liabilities:
Long-term liabilities such as bank loans.

Current Liabilities:
Short-term liabilities such as payables, accruals
and overdrawn (negative) bank balances.

Annual Report:
The financial statements of a large business. An
annual report contains financial statements and
written reports explaining the results of the
business in detail.

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Forms of Business Unit

• Sole Trader

• Partnership

• Limited Company

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Topic 10 – Preparing Financial Statements Introduction to Accounting and Economics

Preparing Financial Statements Topic 10 - 10.‹#›

The Income Statement

This statement shows sales income, a

list of expenses and profit.

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Preparing Financial Statements Topic 10 - 10.‹#›

Marvel Mechanics
Income Statement for the year ended
31 December 20x1
£ £
Sales 375 000
Less: cost of sales
Opening inventory 0
Plus: Purchases 37 500
37 500
Less: closing inventory 5 000 32 500
Gross profit 342 500
Less: overhead expenses
Advertising 1 800
Bad debts 750
Depreciation 90 031
Electricity 3 104
Increase in doubtful debts prov. 1 500
Telephone 2 250
Wages 108 000
Property taxes 3 500 210 935
Net profit for the year 131 565

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Topic 10 – Preparing Financial Statements Introduction to Accounting and Economics

Preparing Financial Statements Topic 10 - 10.‹#›

The Balance Sheet

This is a list of assets and liabilities.

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Preparing Financial Statements Topic 10 - 10.‹#›

Marvel Mechanics
Balance Sheet as at
31 December 20x1
£ £ £
Non-Current Assets Cost Accumula Net book
depreciativalue
Cash Register 1 750 350 1 400
Computer 2 750 1 375 1 375
Motor Vehicles 68 240 25 931 42 309
Plant & Equipment 125 000 34 375 90 625
Freehold Premises 750 000 28 000 722 000
947 740 90 031 857 709

Current assets
Inventory 5 000
Receivables 15 000
Provision for doubtful debts -1 500 13 500
Prepayments 500
Bank 35 148
54 148
Current Liabilities
Payables 2 756
Accruals 250
3 006
Net current assets 51 142

Net assets 908 851

Capital
Capital account at start of year 777 286
Plus: profit for the year 131 565
908 851
Less: drawings 0
908 851

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Topic 10 – Preparing Financial Statements Introduction to Accounting and Economics

Preparing Financial Statements Topic 10 - 10.‹#›

A Comprehensive Example
Roger Carpenter:
• Makes high-quality furniture for individual clients
and for interior designers

• Accounting records are accurate

• Has been trading for many years

• Here is his trial balance for the year ended 31

December 20x2:

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Roger Carpenter Preparing Financial Statements Topic 10 - 10.‹#›

Trial balance for the year ended

31 December 20x2 £ £
Bank 17 650
Capital Account 9 650
Drawings 8 000
Insurance 900
Long-term Loan from Bank 25 000
Loan Interest 3 750
Miscellaneous Expenses 3 850
Motor Vehicles:
Cost 20 000
Accumulated
Depreciation 9 000
Machinery:
Cost 35 000
Accumulated
Depreciation 7 000
Provision for Doubtful Debts 1 000
Purchases 125 000
Property taxes 5 000
Sales 179 500
Inventory at 1 January 20X2 18 000
Payables 52 500
Receivables 46 500
283 650 283 650

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Topic 10 – Preparing Financial Statements Introduction to Accounting and Economics

Preparing Financial Statements Topic 10 - 10.‹#›

Period end adjustments

1 Inventory at 31 December 20x2 is £34 000
2 At 31 december 20x2 insurance pre-paid amounted to £100 and accrued
property taxes amounted to £1 000
3 Motor vehicles are depreciated at 25% on a straight line basis
assuming a scrap value of £2 000 and a useful life of 4 years
4 Machinery is depreciated at 20% on a reducing balance basis
assuming a scrap value of £14 000 and a useful life of 4 years
5 Bad debts of £6 500 are to be written off
6 The provision for doubtful debts is to be set at 10% of receivables
at 31 December 20x2

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Preparing Financial Statements Topic 10 - 10.‹#›

How do we Prepare a Set of Financial

Statements From a Trial Balance?
• Decide on the format of the financial statements. Decide on what will
appear in the income statement and balance sheet. Prepare the
statements ready to slot the numbers in

• Prepare an extended trial balance. This will contain all the headings
on the financial statements

• Work out the way in which the period end adjustments will appear on
the extended trial balance. This will involve calculating depreciation
and the increase in the doubtful debts provision. You can then
produce a schedule listing the adjustments

• Put the numbers into the extended trial balance and add them up

• Transfer the extended trial balance numbers to the financial

statements

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Topic 10 – Preparing Financial Statements Introduction to Accounting and Economics

Preparing Financial Statements Topic 10 - 10.‹#›

Format of Financial Statements

Roger Carpenter
Income Statement for the year ended
31 December 20x2
£ £
Sales
Less: cost of sales
Opening inventory
Plus: Purchases

Less: closing inventory

Gross profit
Less: overhead expenses
Insurance
Loan interest
Depreciation
Miscellaneous expenses
Increase in doubtful debts prov.
Bad debts
Property taxes

Net profit for the year

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Preparing Financial Statements Topic 10 - 10.‹#›

Format of Financial Statements

Roger Carpenter
Balance Sheet as at
31 December 20x2
£ £ £
Non-Current Assets Cost Accumulated Net book
depreciation value
Motor Vehicles
Machinery

Current assets
Inventory
Receivables
Provision for doubtful debts
Prepayments
Bank

Current Liabilities
Payables
Accruals

Net current assets

Non- current liabilities

Bank loan

Net assets

Capital
Capital account at start of year
Plus: profit for the year

Less: drawings

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Topic 10 – Preparing Financial Statements Introduction to Accounting and Economics

Preparing Financial Statements Topic 10 - 10.‹#›

Extended Trial Balance

Roger Carpenter
Extended trial balance for the year ended 31 December 20x1

Account names General Ledger Adjust- Adjust- Income Statement Balance Sheet
Balances ments ments
Debit Credit Debit Credit

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Preparing Financial Statements Topic 10 - 10.‹#›

Period-End Adjustments on Trial Balance

Roger Carpenter
Summary of period end adjustments on
extended trial balance Debit Credit
£ £
Additional or prepaid overhead charges
Accrual for propery taxes
Property taxes 1 000
Accruals 1 000
Prepayment for insurance
Prepayments 100
Insurance 100
Inventory (closing inventory)
Inventory on balance sheet 34 000
Inventory in income statement 34 000
Depreciation
Charges in income statement

Motor Vehicles 4 500

Machinery 5 600
Accumulated depreciation on
balance sheet
Motor Vehicles 4 500
Machinery 5 600
Receivables adjustments
Bad debt
Bad debt 6 500
Receivables 6 500
Increase in doubtful debts provision
Increase in doubtful debts provision 3 000
Doubtful debts provision 3 000

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Topic 10 – Preparing Financial Statements Introduction to Accounting and Economics

Roger Carpenter Preparing Financial Statements Topic 10 - 10.‹#›

Extended trial balance for the year ended 31 December 20x1

Account names General Ledger Adjust- Adjust- Income Statement Balance Sheet
Balances ments ments
Debit Credit Debit Credit
£ £ £ £ £ £ £ £
Sales 179 500 179 500
Purchases 125 000 125 000
Inventory in income statement 18 000 34 000 18 000 34 000
Insurance 900 100 800
Loan interest 3 750 3 750
Depreciation Charge:
Motor Vehicles 4 500 4 500
Machinery 5 600 5 600
Miscellaneous expenses 3 850 3 850

Increase in doubtful debts

provision 3 000 3 000
Bad debts 6 500 6 500
Property taxes 5 000 1 000 6 000
Motor vehicles at cost 20 000 20 000
Machinery at cost 35 000 35 000
Accumulated Depreciation:
Motor Vehicles 9 000 4 500 13 500
Machinery 7 000 5 600 12 600
Inventory in balance sheet 34 000 34 000
Receivables 46 500 6 500 40 000
Doubtful debts provision 1 000 3 000 4 000
Prepayments 100 100
Bank 17 650 17 650
Payables 52 500 52 500
Accruals 1 000 1 000
Bank loan 25 000 25 000
Capital 9 650 9 650
Drawings 8 000 8 000

283 650 283 650 54 700 54 700 177 000 213 500 154 750 118 250

Profit for the year 36 500 36 500

213 500 213 500 154 750 154 750

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Preparing Financial Statements Topic 10 - 10.‹#›

Roger Carpenter
Income Statement for the year ended
31 December 20x2
£ £
Sales 179 500
Less: cost of sales
Opening inventory 18 000
Plus: Purchases 125 000
143 000
Less: closing inventory 34 000 109 000
Gross profit 70 500
Less: overhead expenses
Insurance (900- 100) 800
Loan interest 3 750
Depreciation 10 100
Miscellaneous expenses 3 850
Increase in doubtful debts prov. 3 000
Bad debts 6 500

Property taxes ( 5 000 + 1000) 6 000

34 000
Net profit for the year 36 500

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Topic 10 – Preparing Financial Statements Introduction to Accounting and Economics

Roger Carpenter Preparing Financial Statements Topic 10 - 10.‹#›

Balance Sheet as at
31 December 20x2
£ £ £
Non-Current Assets Cost Accumulated Net book
depreciation value
Motor Vehicles 20,000 13,500 6,500
Machinery 35,000 12,600 22,400
55,000 26,100 28,900

Current assets
Inventory 34,000
Receivables 40,000
Provision for doubtful debts -4,000 36,000
Prepayments 100
Bank 17,650
87,750
Current Liabilities
Payables 52,500
Accruals 1,000
53,500
Net current assets 34,250

Non- current liabilities

Bank loan -25,000

Net assets 38,150

Capital
Capital account at start of year 9,650
Plus: profit for the year 36,500
46,150
Less: drawings 8,000
38,150

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Preparing Financial Statements Topic 10 - 10.‹#›

Other Financial Statements

• An Appropriation Account: used to record how
profit is divided between partners in a partnership
and between shareholders in a company.

• A Manufacturing Account: used to present the

cost of manufacturing goods for businesses that
engage in manufacturing products.

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Topic 10 – Preparing Financial Statements Introduction to Accounting and Economics

Preparing Financial Statements Topic 10 - 10.‹#›

Other Financial Statements

A Cash Flow Statement
- Used widely by larger businesses, particularly by
companies

- Presents cash flowing in and out of the business

- The cash flows are analysed into:

• cash flows from operations (running the business)
• cash flows related to investing (buying long-term assets)
• cash flows from financing (obtaining new loans or issuing
share capital)

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Preparing Financial Statements Topic 10 - 10.‹#›

Other Financial Statements

A statement of changes in equity
- Used by companies to show gains and losses
that are made in addition to trading profit

- Can include items such as:

• gains from the re-valuation of long-term assets
• gains/losses from holdings of foreign currency

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Topic 10 – Preparing Financial Statements Introduction to Accounting and Economics

Preparing Financial Statements Topic 10 - 10.‹#›

The Annual Report

• A detailed package of information that describes
the financial performance of a business

• Mainly used by companies

• Often a large document that exceeds 100 pages. It

contains financial statements and a number of
written statements

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Preparing Financial Statements Topic 10 - 10.‹#›

Review of the Topic

• This topic has explained how an income
statement and a balance sheet may be
constructed from a trail balance

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Topic 10 – Preparing Financial Statements Introduction to Accounting and Economics

Preparing Financial Statements Topic 10 - 10.‹#›

Review of the Topic

You should remember the method of producing financial statements:

• Decide on the format of the financial statements

• Prepare an extended trial balance

• Work out the way in which the period end adjustments will appear on
the extended trial balance

• Put the numbers into the extended trial balance and add them up

• Transfer the extended trial balance numbers to the financial

statements

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Preparing Financial Statements Topic 10 - 10.‹#›

Topic 10

Any questions?

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