Lesson 24: Preparing the Financial Statements
In this lesson, we will talk about the purpose of financial statements and how
we use the adjusted trial balance information. We will also learn how to
prepare 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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.