Trial Balance & Financial

Statements

Lecture Slides #2
Trial Balance , Reading & Understanding
Basic Financial Statements
Learning Outcomes:
By the end of this session, you should be able to:
Trial Balance:
 Know the meaning and objective of preparation of a trial
balance
 Know the format of trial balance

 Prepare a pre-adjusted trial balance

 Preparation of a post-adjusted trial balance

Financial Statements:
 Understand and prepare a simple statement of
comprehensive income (income statement) and statement of
financial position
Trial Balance
Introduction and definition
 Trial balance is a list of debit and credit balances of all
ledger accounts. It is prepared at the end of an
accounting period.

 Prepared in a statement form which shows debit and

credit balances of ledger accounts, therefore it is also
called as a statement of balances.
 All accounts appearing in the trial balance will be categorised
into nominal accounts and real accounts.

 Real accounts form part of the statement of financial

position while the nominal accounts form part of the
statement of profit or loss.

 Even though the nominal accounts form part of the statement

of profit or loss, the difference between income and expenses
(profit) will affect the financial position through the owner’s
equity account.
 Real accounts : These are accounts of tangible assets
or property e.g. buildings, land, furniture, fittings,
machinery, inventory, cash (at bank and in hand)
 Nominal accounts : these are accounts of items that
relate to gains and losses and whose balances at the
end of the accounting period.
 All expenses, revenue, sales and purchases are nominal
accounts.
 E.g purchases, stationery, depr, printing , salaries, rent
etc
Objectives of trial balance
 Checking of arithmetical accuracy of the ledger accounts
 Locating errors
 Facilitate preparation of final accounts
Advantages of trial balance
 It helps to ascertain arithmetical accuracy of the book-
keeping work done during the period.
 It supplies in one place ready reference of all balances in
ledger accounts.
 If any error is found out on preparation of a trial balance,
the same can be rectified before preparing final
accounts.
 It is the basis on which final accounts are prepared.
Format of a trial balance
 Trial balance of XYZ limited as on
Points to be noted
 Date at which trial balance is prepared should be noted at the top
 Name of Account column contains the list of all ledger accounts
 Ledger folio of the respective account is entered in the next column
 In the debit column, debit balance of the respective account is
entered
 Credit balance of the respective account is written in the credit
column
 The last two columns are totalled at the end
 A debit balance is either an asset or loss or expense
 A credit balance is either a liability or income or gain
Trial Balance…example
Unadjusted trial balance
Date Particulars Folio Debit Credit

REAL ACCOUNTS
Capital B1 680 000
Bank B2 445 250
Motor vehicle B3 260 000
Furniture B4 120 000
Investments B5 50 000
Creditors B6 91 000
Debtors B7 40 000
Drawings B8 15 000
Lease payables B9 200 000
Rates prepaid B10
Revenue in advance B11
Accrued water expenses B12
Closing inventory B13

NOMINAL SECTION
Purchases N1 112 000
Purchases returns N2 6 000
Rates N3 6 000
Revenue N4 90 000
Telephone expenses N5 500
Advertising N6 5 000
Discount allowed N7 1 250
Salaries N8 12 000
Cost of sales N9
Depreciation N10
Water expenses N11
Interest expense N12
1 067 000 1 067 000
Suspense Account

 If all the efforts made to locate the errors, fail, trial

balance may be balanced temporarily by transferring the
amount to suspense account.

 The suspense account has to be put on the shorter side

E.g. if the credit total is higher, suspense will have a debit
balance and if debit total is higher, suspense account will
have a credit balance.
Limitations of trial balance

 Though a trial balance helps to ensure arithmetical

accuracy of books of accounts, it is possible only when
there is no compensating error.

 As all the errors made are not disclosed by the trial

balance, it would not be regarded as a conclusive proof
of correctness of the books of accounts maintained
Errors which are disclosed by
trial balance
• Partial omission of posting an amount in ledger
• Wrong totalling of subsidiary books
• Omission of balance of an account
• Errors in extraction of the trial balance
• Debit or credit entries are not entered at all
• Debit or credit entries are entered twice
Errors which are disclosed by
trial balance
 Debits are entered as credits by mistake and vice-versa.
 Errors in calculating the balance of an account.
 Balance of an account entered wrongly in trial balance.
 Difference in amount between the entries.
 Errors which are not disclosed
by trial balance
• Errors of omission – where a transaction happened but was
not recorded in the books of accounts.

• Errors of omission – it is an error that occurs when entries

are recorded in debit or credit to the correct account but to
the wrong subsidiary account or ledger.

• Compensating errors – A compensating error is an

accounting error that offsets another accounting error.

• Errors of Principle - here accounting entries recorded the

incorrect amount.
Errors which are not disclosed
by trial balance cont’d
• Entering both aspects of transactions twice in the books
of account
• Errors in entering a transaction on the correct side of a
wrong account
• Entering wrong amount in the books of original entry
Notes

 Closing stock / inventory is not found in the trial balance

since there is no double entry in the stock.
 The closing balance of the stock is obtained by actual
counting of the stock at hand at the end o the accounting
period.
 Opening businesses will have no opening stock, however
for the subsequent periods there may be opening stock.
The closing stock at the end of one period becomes the
opening stock for the next period.
UNDERSTANDING BASIC FINANCIAL
STATEMENTS
What are Financial Statements?

A financial statement (or financial reports) is the primary

source of information for most decision makers and is the first
indicator of how the business is performing.

The objective of financial statements is to provide information

about the financial position, performance and changes in
financial position of an enterprise that is useful to a wide range
of users in making economic decisions
Primary Financial Statements

Primary financial statements answer basic questions

including:
• What is the company’s current financial status?
• What was the company’s operating results for the
period?
• How did the company obtain and use cash during the
period?
Primary Financial Statements

Basic financial statements:

• Statement of financial position
• Statement of comprehensive income
• Statement of changes in equity
• Statement of Cash Flows
 Statement of financial position
Statement of financial position- formerly known as the balance
sheet is a statement which shows the assets of a business at a
given point in time and the claim thereof against the assets, the
claims can either by the capital injected or liabilities to third
parties.
 Assets: cash, accounts receivable, inventory, land, buildings,
equipment and intangible items.

 Liabilities: accounts payable, notes payable and mortgages

payable.

 Owners’ Equity: net assets after all obligations have been

satisfied
Statement of comprehensive income

 Statement of comprehensive income- formerly known as the

income statement basically represents the performance of a
business and further indicates:

 What goods were sold or services performed that provided

revenue for the company?

 What costs were incurred in normal operations to generate

these revenues?

 What are the earnings or company profit?

The main reasons for preparing the statement of
comprehensive income are:

i) To compare the actual profit to the expected profits.

ii) For planning purposes i.e. to identify areas that need
attention in future.
iii) To obtain funds from lenders based on one’s profitability.
iv) To inform prospective owners on the performance.
v) In computation of taxes to ensure that the correct amount
is remitted to the tax authorities.
An example of a Statement of
Comprehensive Income
An example of a Statement of
Financial Position
 ACCOUNTS ADJUSTMENTS
 Before preparing a statement of comprehensive income for
a particular period, there are adjustments that are made to
particular accounts to ensure the profit and loss statement
shows accurate results of profits and losses. These
accounts include:
i) Prepayments accounts
ii) Accruals accounts
iii) Credit losses and allowance for credit losses accounts
iv) Depreciation account
v) Discounts allowed accounts
vi) Discounts received accounts
vii) Commissions received accounts
viii) Commissions paid accounts
 Treatment of adjustments
1. Closing inventory
If this item is given inside the trial balance then only show it as a
current asset in the statement of financial position.

2. Outstanding expenses
( due to the accounting period but not paid).
Add this amount in the particular expense in the Profit or Loss
account and show as a current liability in the statement of
financial position.
E.g Salaries accrued
Dr Salaries expense a/c (expense)
Cr Salaries accrued (current liability)
3. Prepaid expenses
( Expenses paid in advance)
Deduct this particular expense in the Profit or Loss account
and show as a current asset in the statement of
financial position.

E.g Salaries expenses prepaid

Dr Salaries prepaid (current asset)
Cr Salaries expense (expense)
 Treatment of adjustments
cont’d:
4. Outstanding Income
(income due in an accounting period but not received)
Add this particular income in the in the Profit or Loss account
and show as a current asset in the statement of financial
position.
Dr Rent income accrued account (current asset)
Cr Rent income account (revenue/income
 Treatment of adjustments
cont’d:
5. Income Received in advance
(Income received in advance by business before it being earned
by the business). Deduct this amount in the particular income in
the Profit or Loss account and show as a current liability in the
statement of financial position.

E.g.
Dr Rent income account (Revenue)
Cr Rent income prepaid (current liability)
5. Depreciation
 Most assets lose their value over time through wear and tear
or becoming out of date. Depreciation is used to recognise
this decrease in value and spread the cost of assets like
computers and vehicles over their useful life.

 Deduct this amount in the Profit or Loss account and deduct

from the particular non-current asset in the statement of
financial position.
 There are three methods that businesses can use to
determine the depreciation of assets:
1. Straight-line method
2. Reducing or diminishing balance method
3. The units of production method

1.The Straight-Line Method

 This method of determining depreciation requires the
depreciable amount to be divided by its useful life. This
method of depreciation results in the same depreciation
amount through-out the life of the asset.
Depreciation = (cost-residual value)
Useful life
 Compute the depreciation using the Straight line
method
Vehicle
Cost SZL 120,000
Expected useful life 10 years
Expected residual value after its useful life SZL 15,000
 Depreciation = depreciable amount

useful life
 = 105,000/10

 = SZL 10,500

 The vehicle will depreciate by SZL 10,500 for the next

ten years
2.The Reducing/Diminishing Balance Method
 This method applies a percentage to the carrying value of an
asset at the end of each year. You will note that unlike the
straight-line method that uses the depreciable amount, this
method uses the carrying amount or value. The carrying value
of an asset is the cost of the asset minus the total amount of
depreciation that the asset has incurred since its first use.

 With this method, the asset losses much value at its earlier
years and less value towards the end of its useful life. With
this method an appropriate percentage or rate need to be
determined then applied to the carrying value. The
appropriate rates one that reduces
Compute the depreciation using the Straight line method

From the vehicle information given for Salem Trading in the previous
example, assume the reducing balance method is used and the asset will be
depreciated by 10%.
Note it!
Solution
In the first year of determining depreciation:
Depreciation = Cost x 10%
= 120,000x10%
= SZL 12,000
In the second year, depreciation will be;
Depreciation = (Cost – accumulated depreciation) x10%
= (120,000 – 12,000) x10%
= SZL 10,800
In the third year 10,800 and 12,000 will be deducted from the cost to get the
carrying amount and the 10% rate will be applied to get the depreciation
charge for the year.