Key Takeaways
- The general-purpose financial statements of a business includes the statement of financial position, income statement, statement of cash flows, and statement of changes in equity.
- A worksheet is a useful tool for accountants when preparing the trial balance, adjusting entries and financial statements.
- The heading of each financial statement must include the company’s name, the title of the report, the period covered by the report, the type of currency used, and the level of rounding applied to the amounts in the financial statement.
Overview of the Accounting Cycle
Financial statements preparation is the next step in the accounting cycle of the business after the adjusted trial balance has been prepared. The Accounting Cycle refers to the steps that a company takes to prepare its financial statements.
Below are the steps in the accounting cycle, done in the following order:
- Gathering of business source documents
- Analyzing and journalizing business transactions
- Posting journalized transactions to the ledger
- Preparing an unadjusted trial balance
- Journalizing and posting adjusting entries
- Preparing an adjusted trial balance
- Preparing the financial statements
- Journalizing and posting closing entries
- Preparing a post-closing trial balance
- Journalizing and posting reversing entries
Preparing a Worksheet
A Worksheet is a columnar paper that is prepared to summarize data that is necessary for the preparation of the statement of financial position and income statement.
The Worksheet is a physical sheet of paper containing multiple columns that houses data for the preparation of the unadjusted trial balance, adjusting entries, adjusted trial balance, statement of financial position, and income statement.
Let’s assume that you own a graphic design services company. Below is an example of your company’s worksheet for the period covering the month of March 2023.
Notice that in the accounting cycle, there is no step for the preparation of a worksheet. The reason for this is that the worksheet is just an optional tool to aid accountants when preparing adjusting entries and the financial statements.
The worksheet is not a formal report but it provides a preview of how the statement of financial position and income statement will look. It is prepared at the end of the accounting period when the unadjusted trial balance is also prepared.
Below are some of the objectives for the use of a worksheet:
- To provide an overview of the company’s unadjusted and adjusted trial balances, adjusting entries and financial statements during an accounting period.
- To help with the analysis and preparation of adjusting entries before they are formally journalized and posted.
- To help facilitate the preparation of the statement of financial position and income statement using the adjusted trial balance.
With the advent of electronic spreadsheets and accounting software, the use of a physical worksheet became a thing of the past at the time when accountants still use physical books of accounts and large columnar papers. However, if you’re learning about basic accounting and bookkeeping, knowing how to manually prepare a worksheet will still provide you an idea of what happens behind the scenes when using an accounting software to generate financial statements.
Below are some of the steps for the preparation of a worksheet.
- Enter the general ledger account numbers and account titles.
- Enter the account balances of each ledger account under the debit and credit sub-columns of the unadjusted trial balance. Total each sub-column and identify any possible errors that may have been made during the recording process.
- Identify the accounts that need to be adjusted then input the amounts of the adjustments in either the debit or credit sub-columns of the adjustments column. The location of the amounts in the sub-columns depends on whether the ledger account will be increased or decreased.
- Carry forward to the adjusted trial balance column the balances of all ledger accounts including the adjusted balances of accounts that were adjusted in step 3 above. Compute the total of the debit and credit sub-columns of the adjusted trial balance to prove that they are balanced and identify any possible errors that may have been committed.
- Extend each ledger balance in the adjusted trial balance to the appropriate columns of financial statements where they belong. The balances of all assets, liabilities and equity accounts should be copied to the statement of financial position column while all revenue and expense accounts should be copied to the income statement column.
- Determine the total amounts of all debit and credit sub-columns under both the statement of financial position and income statement columns. You’ll notice that each set of columns will not be balanced by the same amount. This amount is actually the amount of net income or net loss for the covered period.
- Statement of financial position column – if the total amount in the debit column is greater than the total amount in the credit column, then the result is a net income. However, if total credits exceed total debits, then there is a net loss.
- Income statement column – if the total amount in the debit column is greater than the total amount in the credit column, then the result is a net loss. However, if total credits exceed total debits, then the result is a net income.
- Extend the total amount of net income or net loss to the opposite column of each financial statement as a balancing figure.
Preparing the Statement of Financial Position
The Statement of Financial Position, also called Balance Sheet, is a financial statement that presents the financial position of a company at a certain point in time. Financial position refers to the status of the company’s assets, liabilities and equity.
Using the adjusted trial balance in the example worksheet above, you can already build the company’s statement of financial position. Below is the statement of financial position prepared using the report form.
In this statement of financial position, the following line items are presented as follows:
- Cash – combined amounts of cash on hand and cash in bank
- Accounts receivable – presented net of allowance for doubtful accounts
- Equipment and vehicles – presented net of accumulated depreciation
- You, capital – presented net of drawing and net loss
Here are some guidelines that you can follow when preparing the statement of financial position.
Heading
The heading of the statement of financial position consists of three lines in the following order:
- Name of the company or business – this is the registered legal name of the company.
- Title of the report – the most common title used for this financial statement is the Balance Sheet though amendments made in the IAS replaced the term with Statement of Financial Position. However, you may actually use any title for the report based on your judgment of the best way to present the financial position of the company. The International Accounting Standards (IAS 1) allows for the use of titles other than those used in the standard, although it also requires the company to clearly identify each financial statement and distinguish them from other reports.
- Date – the report date of the statement of financial position is a particular point in time which refers to the date at the end of the reporting period. For example, if the reporting period is for calendar year 2023, then the end of the reporting period would be December 31, 2023. This will be the date that you should indicate in the statement of financial position.
Presentation of Amounts
The currency used in the statement of financial position must be clearly shown below the heading. If the company uses US dollars, Philippine Peso or Euro, then it must be clearly indicated in the report.
For large companies with financial figures that reach millions to billions in amounts, the financial statements can be made more understandable by presenting the amounts in thousands or millions of units of the currency. In this case, the level of rounding used in presenting amounts must be disclosed by the company.
For example, a company may present $2,000,000 as $2,000 in the statement of financial position and disclose the level of rounding as “figures in $1,000’s or amounts in thousands of USD” at the top portion of the report.
Account Column and Money Column
The account column in the left side of the report describes the assets, liabilities, and equity line items presented in the statement of financial position. The assets and liabilities can either be classified into current or non-current, or presented in the order of liquidity.
- Extreme Left Margin – used for describing the major classifications of line items like current assets, non-current assets, current liabilities, non-current liabilities, and equity.
- Inner Left Margin – used for describing the ledger accounts under each major classifications. For example, cash, accounts receivable and inventory are placed in the inner margin under current assets.
Opposite the account column to the right side is the money column where the amounts for each line items will be placed. The placement of the amounts follows the alignment of items in the left margin of the account column.
- The amounts for the major classifications found in the extreme left margin of the account column will be placed to the Extreme Right Margin of the money column.
- The amounts for the items under the major classifications found in the inner left margin of the account column will be placed in the Inner Right Margin of the money column.
- A single line will be placed under the last figure that will be added or subtracted.
- A double line or double rule will be placed under the final or bottom line figure of the report.
The statement of financial position can also be presented using the account form which follows the positioning of elements in the accounting equation. This form shows assets listed on the left side column of the report while liabilities and equity items listed on the right side column.
The alignment of items in the account column and money column of the statement of financial position may be slightly different from our example above when comparative figures for two or more periods are to be presented. Below is an example of the same statement of financial position but with figures presented for two different periods.
Preparing the Income Statement
The Income Statement is a financial statement that shows the financial performance of a company over a period of time. Financial performance refers to the results of operations of the company.
Similar to the statement of financial position, the income statement is prepared based on the revenue and expense account balances presented in the adjusted trial balance. Below is the income statement prepared using the natural or single-step form.
Here are some guidelines to be followed when you’re preparing an income statement.
Heading
The heading of the income statement consists of three lines in the following order:
- Name of the company or business – this is the registered legal name of the company.
- Title of the report – the most common title used for this financial statement is Income Statement. A company can use any title for the report where based on their judgment, is the best way to present the financial performance of the company. IAS 1 does not prescribe any particular name but it requires the company to clearly identify each financial statement and distinguish them from other reports.
- Time Period – compared to the statement of financial position which is presented at a certain point in time, the income statement presents information over a period of time. For example, the time period for an income statement that covers the whole calendar year 2023 will state “For the year ended December 31, 2023”. If the period only covers operations from January 1 to 31, 2023, then the time period will be “For the month ended January 31, 2023”.
Presentation of Amounts
The type of currency used to present the figures in the income statement must be clearly indicated below the heading. The level of rounding off used in presenting large amounts must also be disclosed in the report to avoid any confusion to any users of the income statement.
Account Column and Money Column
The account column in the left side of the report describes the income and expense line items presented in the income statement. The presentation of these items depends on whether the income statement is prepared under the nature of expense form or function of expense form.
The Extreme Left Margin is used for describing the major sections of line items while the Inner Left Margin is used for describing the accounts under the major sections.
The money column to the right side of the report is where the amounts for each line item will be placed. The placement of these amounts follows the alignment of items in left margin of the account column.
The amounts for the major sections found in the extreme left margin will be placed in the Extreme Right Margin of the money column. The amounts for the items under the major sections found in the inner left margin will be placed in the Inner Right Margin of the money column.
A single line will be placed under the last figure that will be added or subtracted while a double line or double rule will be placed under the final or bottom line figure of the report.
Preparing the Statement of Cash Flows
The Statement of Cash Flows is a financial statement that provides information regarding cash flows related to the operating, investing and financing activities of a company over a period of time. Cash flow is the flow of money in and out of the company.
When preparing the statement of financial position and income statement, you only have to copy the ledger accounts and their balances from the adjusted trial balance and then arrange them in a meaningful way that users may find useful. However, preparing the statement of cash flows requires a bit more analysis because you need to extract information from both the statement of financial position and income statement.
Below is an example of a statement of cash flows presented using the direct method for operating activities. The purpose of this example is to only show how this statement should be presented and not how the amounts were obtained.
Here are some guidelines to follow when you’re preparing a statement of cash flows.
Heading
Similar to the statement of financial position and income statement, the heading of the statement of cash flows also consists of three lines in the following order:
- Name of the company or business – this is the registered legal name of the company.
- Title of the report – the most common title used for this financial statement is Statement of Cash Flows. Any other title can also be used for this report if it warrants a better way to present the cash flows of the company. There is no particular name that is prescribed by IAS 1, but it requires the company to make it easier to distinguish from other reports.
- Time Period – similar to the income statement, the statement of cash flows is presents information over a period of time. In the example above, the heading shows “For the year ended December 31, 2023” to indicate that the report covers cash flow information from January 1, 2023 to December 31, 2023.
Presentation of Amounts
The type of currency and the level of rounding used to present the figures in the statement of cash flows must be clearly indicated below the heading.
Account Column and Money Column
The account column in the left side of the report describes the cash flow information presented in the statement of cash flows. While there is only one standard presentation for cash flows from both investing and financing activities, the presentation of cash flows items for operating activities will depend on whether the direct method and indirect method is used.
The direct method shows the major classes of gross cash receipts and disbursements such as cash receipt from customers and cash paid to suppliers. On the other hand, a statement of cash flows prepared using the indirect method will always begin its operating activities with the net income or net loss during the period and then subsequently adjusted for non-cash transactions, accruals, deferrals, and income and expense items associated with investing or financing activities. The example statement of cash flows above reports cash flows from operating activities using the indirect method.
The Extreme Left Margin is used for the headings of the cash flow activities while the Inner Left Margin is used for describing the items under each cash flow activity.
Similar to the first two financial statements discussed above, the money column in the right side of the report is where the amounts for each cash flow activity will be placed. The location of the amounts follows the alignment of items in the left margin of the account column.
The total amounts for each cash flow activity will be placed in the Extreme Right Margin of the money column, while the amounts for the items under each activity are placed in the Inner Right Margin of the money column. Place a single line under the last figure that will be added or subtracted and a double line or double rule under the final or bottom line figure of the report.
Preparing the Statement of Changes in Equity
The Statement of Changes in Equity is a financial statement that shows in detail the movements in equity components over a period of time. Equity is the owners’ residual interest in the assets of the company after all liabilities have been deducted.
How your statement of changes in equity is prepared may depend on the legal structure of your company, i.e. whether it is a sole proprietorship, a partnership or a corporation. However, regardless of the legal form of your company, this financial statement will always provide information about the following elements:
- Investment by owners
- Distributions to owners
- Comprehensive income
Below is an example of a statement of changes in owner’s equity of a sole proprietorship.
Here’s an example of a statement of changes in partners’ equity of a partnership form of business.
Lastly, below is an example of the statement of changes in shareholders’ equity of a corporation.
Among the three statements above, you’ll notice that the one for a sole proprietorship seems to be the simplest to prepare since it only involves a few elements.
Here are some guidelines to be followed when you’re preparing any of the statement of changes in equity above.
Heading
You may have already guessed by now what information is presented in the statement of changes in equity. It’s also the same with the other financial statements.
- Name of the company or business – this is the registered legal name of the company.
- Title of the report – you can based the title of this financial statement on the legal structure of your company. For example:
- Statement of changes in owner’s equity for sole proprietorship
- Statement of changes in partners’ equity for partnership
- Statement of changes in shareholders’ equity for corporation
- Any other title can also be used for this report since there really is no particular name that is prescribed by IAS 1. However, make sure that the title makes it easier to distinguish this financial statement from the others.
- Time Period – the statement of changes in equity also covers a specific time period. For example, the statement “For the year ended December 31, 2023” indicates that the information being presented in the financial statement covers January 1, 2023 to December 31, 2023.
Presentation of Amounts
The type of currency and the level of rounding used to present the figures in the statement of changes in equity must also be clearly stated below the heading to provide more context for the users of the financial statement.
Account Column and Money Column
The account column in the left side of the statement of changes in equity is where the particulars of the report are describe. This includes pertinent information regarding the transactions that affected each component of equity such as net income, additional investments, withdrawals, dividends, etc.
Opposite the account column to the right is the money column. This contains the amounts related to the particulars in the account column.
In a sole proprietorship, you only have to use a single column for the amounts. However, for a partnership, you can use several money columns for each partner. For a corporation, you may also use multiple columns containing the amounts affecting the share capital, retained earnings and any reserves.
Finally, use a single line under the last figure that will be added or subtracted, and a double line or double rule under the final or bottom line figure of the report.
Review Questions
- What is the period covered by the statement of financial position?
- Can you use other names for the title of the financial statements?
- Why is there a need to round off large figures in the financial statements?
- Is the worksheet considered a formal report to be given to external stakeholders?
- Where is a double line or double rule usually placed in the financial statement?