CHAPTER 7 Preparing financial statements

Contents  Constructing financial statements  Accounting adjustments  Uses of financial statements

Constructing financial statements  Start with aggregate transaction data from the accounting database at the end of the accounting period  Quantify the adjustments necessary to convert the data to reflect GAAP  Bring aggregates and adjustments together in the approved statement format

Extended trial balance  A trial balance is the listing of all the balances on all the general ledger accounts at the end of the accounting period  At year-end, the trial balance data will be refined through the year-end adjustments  In the extended trial balance, the ledger balances and adjustments are added mathematically and the adjusted balance is entered in the income statement column or in the balance sheet column

Extended trial balance format Ledger+Adjustments=Profit andorBalance balanceslosssheet D / C €

Year-end adjustments 1. Calculation of cost of goods sold 2. Adjustments for accruals and deferrals 3. Charging annual depreciation 4. Updating provisions 5. Reviewing assets for potential impairment

Worked example –Trial balance

Extended trial balance worksheet

Income statement for the year ended 31 December 20X1 (format for use internally)

Income statement for the year ended 31 December 20X1 (published format)

Balance sheet as at 31 December 20X1

Additional accounting adjustments  Interest expense adjustments  Accrual adjustments at year-end  Income tax adjustments  Year-end accruals for estimated income tax on annual pre-tax profit  Dividend  Charged directly against reserves/retained profits in shareholders’ equity  Dividends declared after balance sheet date may not be recognised as a liability because they do not constitute a present obligation at balance sheet date

Presentation of interest and income tax expense The deduction of interest and tax expense normally figures separately in the income statement: Profit before interest and taxXXXXX Finance costs (Interest expense)(XXXX) Profit before taxXXXXX Income tax expense(XXXX) (Net) Profit for the period XXXX

Income statement for the year ended 31 December 20X1

Balance sheet as at 31 December 20X1

Uses of financial statements  To measure how much dividend might be paid  To provide reassurance of a company’s financial strength to creditors  To provide a basis for measuring future growth for stock market analysis  To measure management performance in a principal/agent context  To provide a basis of taxation of the company  To give employees an idea of the company’s strength