Financial Statement Preparation: A Tutorial

Prepared by Dr. Angela H. Sandberg Professor of Accounting Jacksonville State University

Financial Statements

This tutorial illustrates how to prepare three basic financial statements

Financial Statements

This tutorial illustrates how to prepare three basic financial statements

The Income Statement

Financial Statements

This tutorial illustrates how to prepare three basic financial statements

The Income Statement The Statement of Retained Earnings

Financial Statements

This tutorial illustrates how to prepare three basic financial statements

The Income Statement The Statement of Retained Earnings The Balance Sheet

Financial Statements

This tutorial illustrates how to prepare three basic financial statements

The Income Statement The Statement of Retained Earnings The Balance Sheet

The purpose of these statements is to help users make better decisions.

The Income Statement

Income Statement

The first statement prepared is the Income Statement.

Income Statement

The first statement prepared is the Income Statement. The Income Statement reports a business performance for the period.

Income Statement

A simple format for an income statement is:

Income Statement

A simple format for an income statement is:

Revenues Expenses = Net Income

Income Statement

A simple format for an income statement is:

Revenues Expenses = Net Income

We will look at a more complex format later.

Income Statement

Revenues are earned for the sale of goods or services. Note that revenues occur when the sale is made. The payment may or may not have been received.

Income Statement

Revenues are earned for the sale of goods or services. Note that revenues occur when the sale is made. The payment may or may not have been received.
Examples of revenues include sales, service revenue and interest revenue.

Income Statement

Expenses are incurred when a business receives goods and services. Like revenues, payment may or may not have been made.

Income Statement

Expenses are incurred when a business receives goods and services. Like revenues, payment may or may not have been made.

Examples of expenses include salaries expense, utility expense and interest expense.

Income Statement

Most businesses require more information from their businesses than a simple income statement can provide. Therefore, they use a multi-step income statement format.

Income Statement

Most businesses require more information from their businesses than a simple income statement can provide. Therefore, they use a multi-step income statement format. A format for a multi-step income statement is:

Income Statement
Sales revenue Cost of goods sold Gross profit Operating expenses Income from operations +/- Non-operating items Income before taxes Income taxes Net income

Income Statement

Cost of goods sold represents the expense a business incurred to buy or make a product for resale.

Income Statement

Cost of goods sold represents the expense a business incurred to buy or make a product for resale.

Example - a book store buys a book for $25 and then sells it for $32. The cost of goods sold is $25.

Income Statement

Operating expenses are the usual expenses incurred in operating a business.

Income Statement

Operating expenses are the usual expenses incurred in operating a business.

Accounts such as salaries expense, utility expense, and depreciation expenses are all shown in this section.

Income Statement

Non-operating items are revenue, expenses, gains and losses that do not relate to the companys primary operations.

Income Statement

Non-operating items are revenue, expenses, gains and losses that do not relate to the companys primary operations.

Accounts include interest expense and gains and losses of the sale of equipment and investments.

Income Statement

Income taxes are computed by multiplying Income before taxes by the income tax rate.

Income Statement

Income taxes are computed by multiplying Income before taxes by the income tax rate.

Example Income before taxes is $50,000. The income tax rate is 30%. Income taxes = $50,000 * 30% = $15,000.

The Statement of Retained Earnings

Statement of Retained Earnings

The Statement of Retained Earnings reports how net income and dividends affected a companys financial position during the period.

Statement of Retained Earnings

The format of the statement is:

Statement of Retained Earnings

The format of the statement is:
Beg. balance, retained earnings + Net income - Dividends End. balance, retained earnings

Statement of Retained Earnings

Note that the Income Statement must be prepared before the Statement of Retained Earnings.

Statement of Retained Earnings

Note that the Income Statement must be prepared before the Statement of Retained Earnings. This is because you have to know the amount of net income in order to compute the ending balance of retained earnings.

The Balance Sheet

Balance Sheet

The purpose of the balance sheet is to report the financial position of an accounting entity at a particular point in time.

Balance Sheet

The purpose of the balance sheet is to report the financial position of an accounting entity at a particular point in time.

The basic format for the balance sheet is: Assets = Liabilities + Equity

Balance Sheet

Assets are economic resources owned by a company.

Balance Sheet

Assets are economic resources owned by a company.

Examples include cash, accounts receivable, supplies, buildings and equipment.

Balance Sheet

Liabilities are the companys debt or obligations.

Balance Sheet

Liabilities are the companys debt or obligations.

Examples are accounts payable, unearned revenues and bonds payable.

Balance Sheet

Equity is the residual balance. Assets liabilities = equity. Equity is commonly called stockholders equity if the business is a corporation as it represents the financing provided by the stockholders along with the earnings from the business not paid out as dividends.

Balance Sheet

There are two different types of assets shown on a balance sheet. These are current assets and non-current assets.

Balance Sheet

There are two different types of assets shown on a balance sheet. These are current assets and non-current assets.
Current assets + Non-current assets Total assets

Balance Sheet

Current assets are assets that will be used or turned into cash within one year.

Balance Sheet

Current assets are assets that will be used or turned into cash within one year.

Examples include cash, accounts receivable, inventory, short-term investments, supplies and prepaids.

Balance Sheet

Non-current assets comprise the remainder of the assets.

Balance Sheet

Non-current assets comprise the remainder of the assets.

These include accounts such as: long-term investments, land, building, equipment and patents.

Balance Sheet

There are two different types of liabilities shown on a balance sheet current liabilities and long-term liabilities.

Balance Sheet

There are two different types of liabilities shown on a balance sheet current liabilities and long-term liabilities.
Current liabilities + Long-term liabilities Total liabilities

Balance Sheet

Current liabilities are obligations that will be paid in cash (or other services) or satisfied by providing service within the coming year.

Balance Sheet

Current liabilities are obligations that will be paid in cash (or other services) or satisfied by providing service within the coming year.
Examples include accounts payable, short-term notes payable, and taxes payable.

Balance Sheet

Long-term liabilities are obligations that will not be paid or satisfied within the year.

Balance Sheet

Long-term liabilities are obligations that will not be paid or satisfied within the year.

Examples include mortgage payable and bonds payable.

Balance Sheet

Stockholders Equity is divided into two categories: contributed capital and retained earnings.
Contributed capital + Retained earnings Total stockholders equity

Balance Sheet

Contributed capital is the amount of cash (or other assets) provided by the shareholders.

Balance Sheet

Contributed capital is the amount of cash (or other assets) provided by the shareholders.
Common Stock and Additional Paid in Capital are accounts in this section.

Balance Sheet

Retained earnings is the total earnings that have not been distributed to owners as dividends.

The Balance Sheet

Current assets + Non-current assets Total assets Current liabilities + Long-term liabilities + Stockholders equity Total liabilities and stockholders equity

Balance Sheet

The Balance Sheet must be prepared after the Statement of Retained Earnings in order to have calculated the ending balance of Retained Earnings.

Order of Preparation
Income Statement

Net income

Statement of Retained Earnings Beginning Retained Earnings + Net income Dividends Ending retained earnings

Balance Sheet

Ending Balance Retained Earnings

Review
Income statementA summary of the revenue and expenses for a specific period of time. Statement of retained earnings a summary of the changes in the retained earnings that have occurred during a specific period of time. Balance sheetA list of the assets, liabilities, and owners equity as of a specific date.

Example Problem
Cash Utility Expense Common Stock Supplies Interest Expense Bonds Payable Salaries Expense Inventories Income Tax Rate 5,000 8,000 45,000 4,000 5,000 40,000 16,000 45,000 30% Sales Buildings Accounts Payable Cost of Goods Sold Additional Paid in Capital Supplies Expense Accounts Receivable Retained Earnings 100,000 65,000 12,000 58,000 20,000 3,000 10,000 5,000 (beg. bal.)

Step One

Classify the accounts as assets, liabilities, equity, revenue or expenses.

Assets
Cash Utility Expense Common Stock Supplies Interest Expense Bonds Payable Salaries Expense Inventories Income Tax Rate 5,000 8,000 45,000 4,000 5,000 40,000 16,000 45,000 30% Sales Buildings Accounts Payable Cost of Goods Sold Additional Paid in Capital Supplies Expense Accounts Receivable Retained Earnings 100,000 65,000 12,000 58,000 20,000 3,000 10,000 5,000 (beg. bal.)

Assets, Liabilities,
Cash Utility Expense Common Stock Supplies Interest Expense Bonds Payable Salaries Expense Inventories Income Tax Rate 5,000 8,000 45,000 4,000 5,000 40,000 16,000 45,000 30% Sales Buildings Accounts Payable Cost of Goods Sold Additional Paid in Capital Supplies Expense Accounts Receivable Retained Earnings 100,000 65,000 12,000 58,000 20,000 3,000 10,000 5,000 (beg. bal.)

Assets, Liabilities, Equity

Cash Utility Expense Common Stock Supplies Interest Expense Bonds Payable Salaries Expense Inventories Income Tax Rate 5,000 8,000 45,000 4,000 5,000 40,000 16,000 45,000 30% Sales Buildings Accounts Payable Cost of Goods Sold Additional Paid in Capital Supplies Expense Accounts Receivable Retained Earnings 100,000 65,000 12,000 58,000 20,000 3,000 10,000 5,000 (beg. bal.)

Assets, Liabilities, Equity, Revenues

Cash Utility Expense Common Stock Supplies Interest Expense Bonds Payable Salaries Expense Inventories Income Tax Rate 5,000 8,000 45,000 4,000 5,000 40,000 16,000 45,000 30% Sales Buildings Accounts Payable Cost of Goods Sold Additional Paid in Capital Supplies Expense Accounts Receivable Retained Earnings 100,000 65,000 12,000 58,000 20,000 3,000 10,000 5,000 (beg. bal.)

Assets, Liabilities, Equity, Revenues, Expenses

Cash Utility Expense Common Stock Supplies Interest Expense Bonds Payable Salaries Expense Inventories Income Tax Rate 5,000 8,000 45,000 4,000 5,000 40,000 16,000 45,000 30% Sales Buildings Accounts Payable Cost of Goods Sold Additional Paid in Capital Supplies Expense Accounts Receivable Retained Earnings 100,000 65,000 12,000 58,000 20,000 3,000 10,000 5,000 (beg. bal.)

Step Two

Prepare the Income Statement.

Sales revenue Cost of goods sold Gross profit Operating expenses Income from operations +/- Non-operating items Income before taxes Income taxes Net income

Income Statement
Sales - Cost of Goods Sold Gross Margin - Operating Expenses Income from Operations - Non-operating Items Income before Taxes - Income Taxes Net Income 100,000 -58,000 42,000 -27,000 15,000 -5,000 10,000 -3,000 7,000

Income Statement
Sales - Cost of Goods Sold Gross Margin - Operating Expenses Income from Operations - Non-operating Items Income before Taxes - Income Taxes Net Income 100,000 -58,000 42,000 -27,000 15,000 -5,000 10,000 -3,000 7,000

Operating expenses include:

Utility expense 8,000 Salaries expense 16,000 Supplies expense 3,000

Income Statement
Sales - Cost of Goods Sold Gross Margin - Operating Expenses Income from Operations - Non-operating Items Income before Taxes - Income Taxes Net Income 100,000 -58,000 42,000 -27,000 15,000 -5,000 10,000 -3,000 7,000

Non-operating items include: Interest expense 5,000

Income Statement
Sales - Cost of Goods Sold Gross Margin - Operating Expenses Income from Operations - Non-operating Items Income before Taxes - Income Taxes Net Income 100,000 -58,000 42,000 -27,000 15,000 -5,000 10,000 -3,000 7,000

Income taxes = Income before taxes * Income tax rate 10,000 * 30% = 3,000

Step Three

Prepare the Statement of Retained Earnings.

Beg. balance, retained earnings + Net income - Dividends End. balance, retained earnings

Statement of Retained Earnings

Beginning Balance, Retained Earnings + Net Income - Dividends Ending Balance, Retained Earnings 5,000 +7,000 -0 12,000

Net Income is brought forward from the Income Statement.

Step Four

Prepare the Balance Sheet.

Current assets + Non-current assets Total assets Current liabilities + Long-term liabilities + Stockholders equity Total liabilities and stockholders equity

Balance Sheet
Current Assets:
Cash Accounts Receivable Inventories Supplies Non-Current Assets: Buildings 65,000 5,000 10,000 45,000 4,000

Current Liabilities:
Accounts Payable Long-term liabilities: Bonds Payable Stockholders Equity: Common Stock Additional Paid in Capital Retained Earnings 45,000 20,000 12,000 129,000 40,000 12,000

Total Assets

129,000

Total Liabilities and Equity

Balance Sheet
Current Assets:
Cash Accounts Receivable Inventories Supplies Non-Current Assets: Buildings 65,000 5,000 10,000 45,000 4,000

Current Liabilities:
Accounts Payable Long-term liabilities: Bonds Payable Stockholders Equity: Common Stock Additional Paid in Capital Retained Earnings 45,000 20,000 12,000 129,000 40,000 12,000

End. Bal. is brought forward from the Statement of Retained Earnings

Total Assets

129,000

Total Liabilities and Equity

The End