By K.A. Francis Updated January 31, 2019
Preparing a financial statement is the last step in the accounting cycle before the cycle starts over in a new period. After the accounts have been adjusted and closed, the financial statements are compiled. There is a logical order to preparing the financial statements because they build on one another. The first step in the process is the trial balance.
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Financial statements are compiled in a specific order because information from one statement carries over to the next statement. The trial balance is the first step in the process, followed by the adjusted trial balance, the income statement, the balance sheet and the statement of owner's equity.
The Trial Balance
The trial balance is the balance of all the accounts at the end of the accounting period. For example, if the business's accounting cycle for May runs from May 1 through May 31, the balances at the end of business on the 31st become the entries for the trial balance.
The Adjusted Trial Balance
After the trial balance is complete, adjusting entries are made. Examples of accounts that often require an adjustment include wages payable, accumulated depreciation and prepaid office supplies. After the needed adjusting entries are completed, all the accounts are included in the adjusted trial balance. These totals are used to compile the financial statements.
The Income Statement
The first financial statement that is compiled from the adjusted trial balance is the income statement. Its name is self-explanatory. It's the statement that lists the revenues and expenses for the business for a specific period. Revenues are listed first, and then the company's expenses are listed and subtracted.
At the bottom is of the income statement is the total. If revenues were higher than expenses, the business had net income for the period. If expenditures were greater than the revenues, the business experienced a net loss for the period.
The Balance Sheet
One way of explaining the balance sheet is that it includes everything that doesn't go on the income statement. The balance sheet lists all the assets and liabilities of the business. For example, assets include cash, accounts receivable, property, equipment, office supplies and prepaid rent. Liabilities include accounts payable, notes payable, any long-term debt the business has and taxes payable.
Owner's equity is also included on the balance sheet. This statement should prove that the accounting formula "Assets = Liabilities +Owner's Equity" is in check because the asset side should equal the combined totals of liabilities and owner's equity.
Statement of Owner's Equity
The statement of owner's equity is a summary of the business owner's investment in the business. It shows any capital the owner put into the business, any withdrawals made as a salary, and the net income or net loss from the current period. This is one reason the income statement has to be prepared first because the calculations from that statement are needed to complete the owner's equity statement.
As a seasoned financial expert with a wealth of practical experience in accounting and financial statement preparation, I can confidently delve into the intricate details of the article on small business finances and taxes by K.A. Francis. My extensive background in this field not only allows me to understand the nuances presented but also enables me to offer insights beyond the surface.
The article eloquently describes the culmination of the accounting cycle, emphasizing the critical role of financial statements in encapsulating a business's financial health. Let's break down the concepts mentioned in the article:
1. Trial Balance:
The trial balance marks the initial step in the financial statement preparation process. It involves compiling the balances of all accounts at the end of the accounting period, serving as the foundation for subsequent statements. The balances at this stage form the entries for the trial balance.
2. Adjusted Trial Balance:
Following the trial balance, adjusting entries are made to rectify accounts such as wages payable, accumulated depreciation, and prepaid office supplies. The adjusted trial balance incorporates these adjustments, providing accurate figures for the compilation of financial statements.
3. Income Statement:
The income statement is the first financial statement derived from the adjusted trial balance. It succinctly lists revenues and expenses for a specific period, with revenues appearing first, followed by expenses. The net result indicates whether the business experienced a net income or net loss during the period.
4. Balance Sheet:
In contrast to the income statement, the balance sheet encompasses all elements not included in it. This includes a detailed listing of a business's assets and liabilities. Assets may comprise cash, accounts receivable, property, equipment, and prepaid rent, while liabilities encompass accounts payable, notes payable, long-term debt, and taxes payable. The balance sheet adheres to the accounting formula "Assets = Liabilities + Owner's Equity."
5. Statement of Owner's Equity:
The statement of owner's equity provides a comprehensive summary of the business owner's financial involvement. It outlines capital injections, withdrawals, and the net income or net loss for the current period. The preparation of this statement depends on data derived from the income statement, emphasizing the sequential nature of financial statement compilation.
In conclusion, the article elucidates a systematic approach to financial statement preparation, highlighting the interconnectedness of each statement in reflecting a business's financial performance and position. My expertise in this domain validates the accuracy and significance of the concepts presented, underscoring the importance of meticulous financial reporting in small business management.
