Lesson Objectives:- The purpose of financial statements
- Using the adjusted trial balance information
- Preparing the income statement, retained earnings statement and balance sheet
We created the adjusted trial balance in the previous lesson and listed all of the accounts that belong to the company and their final balances. Now we will move on to the second to last step of the accounting cycle, preparing the financial statements.
The financial statements serve as a snapshot of the company's performance that can be communicated to both internal and external parties. Whether it is an investor wanting to make sure it is a good position or a manager trying to figure out when to raise wages; financial statements provide vital information for financial decision making.
In order to analyze the statements, you must understand how to construct them. We will be pulling out information from the adjusted trial balance above in order to prepare the income statement, retained earnings statement and balance sheet.
Let's use sequential order to prepare the financial statement, starting with the income statement.
The income statement is the way the company summarizes how well they are doing financially. The information that is recorded is pulled directly from the revenue and expenses that are listed on the adjusted trial balance.
The total expenses are subtracted from revenue to come up with the final net income figure that is double underlined in the income statement above. Net income reflects how the company has performed financially for the given time period.
If the number calculates to a positive figure, it is considered net income. If the company isn't doing very well and they have a negative figure left after subtracting expenses from revenue, it will be considered a net loss.
As you can see, the income statement for ABC Building Supplies represents a net income of $10,477, which essentially means that the company is performing well and there is income left after expenses.
The net income figure will feed into the preparation of the next financial statement, the retained earnings statement.
The retained earnings statement gives the user an idea of the amount of earnings that have been retained since the inception or start of the company.
The purpose of compiling this particular statement is to see the amount of dividends paid out to shareholders and total value retained. Each year the net income is added to the previous year's retained earnings to come up with the new retained earnings value. The previous year's retained earnings can be found on the adjusted trial balance sheet. In this case, as there was a zero balance for the retained earnings the previous year, there was no entry for it.
In order to prepare this statement, we simply take the net income or net loss figure from the income statement and add it to the previous year. For ABC Building Supplies, they had a net income recorded of $10,477 and the retained earnings for the previous year was $0.
Since the final retained earnings figure is positive, the company will have a reserve earnings. This means the company has accumulated earnings and have not paid out any dividends to shareholders.
Let's take a look at how the third financial statement is prepared.
The last financial statement that we will cover in this lesson is the balance statement. There are more complex statements such as the cash flow statements, that we will talk about in future lessons.
First, the assets are listed by different account types and totaled at the bottom. If you want an idea of what the company owns, this is the section to review.
The next section of the balance statement represents the other side of the financial equation, the liability and equity accounts. In the equity accounts, we include the retained earnings from the statement of retained earnings. These accounts are also summarized and totaled at the bottom.
Now that we have listed out all of the balances for the asset, liability and equity accounts, we could proceed to further analyze the accounts. We could do this by coming up with many different ratios such as how many assets we have compared to liabilities.
Learning how to create the balance sheet by pulling out the final balances from the adjusted trial balance can help users to see the company's full financial picture and analyze the accounts in order to make decisions.
As you can see from the three statements we've reviewed, we pull the figures directly from the adjusted trial balance in order to prepare the income statement, retained earnings statement and balance sheet.