CHAPTER 6

Learning Objectives:

1. Describe the flow of accounting information from the unadjusted trial balance into the adjusted
trial balance and finally, into the income statement and balance sheet columns of the worksheet.
2. Prepare accurately and in good form a ten-column worksheet.
3. Understand and appreciate the usefulness of financial statements.
4. Develop skills in the preparation of financial statements.
5. Explain how the financial statements are interrelated.
6. Explain why temporary accounts are closed each period.
7. Recognize the need for a post-closing trial balance and reversing entries in particular instances.
8. Prepare and post adjusting entries, closing entries and reversing entries.
9. Prepare a post-closing trial balance.

THE WORKSHEET

Accountants often use a worksheet to help transfer data from the unadjusted trial balance to the financial
statements. This multi-column document provides an efficient way to summarize the data for financial
statements.

The worksheet simplifies the adjusting and closing process. It can also reveal errors. The worksheet is not
part of the ledger or the journal, nor is it a financial statement. It is a summary device used by the accountant
for his convenience.

PREPARING THE WORKSHEET (Step 5)

1. Enter the account balances in the unadjusted trial balance columns and total the amounts.
2. Enter the adjusting entries in the adjustments columns and total the amounts.
3. Compute each account’s adjusted balance by combining the unadjusted trial balance and the adjustment
figures. Enter the adjusted amounts in the adjusted trial balance columns.
4. Extend the asset, liability and owner’s equity amounts from the adjusted trial balance columns to the
balance sheet columns. Extend the income and expenses amounts to the income statement columns. Total
the state columns.
5. Compute profit or loss as the difference between total revenues and total expenses in the income
statement. Enter profit or loss as a balancing amount in the income statement and in balance sheet, and
compute the final column totals.

ESSENCE OF FINANCIAL STATEMENTS

The financial statements are the means by which the information accumulated and processed in financial
accounting is periodically communicated to the users. Without accounting information embodied in the
financial statements, users may not be able to arrive at sound economic decisions. The objective of financial
statements is to provide information about the financial position, financial performance, and cash flows of
an entity that is useful to a wide range of users in making economic decisions.

COMPELETE SET OF FINANCIAL STATEMENTS

1. A statement of financial position as at the end of the period;
2. A statement of comprehensive income for the period;
3. A statement of changes in equity for the period;
4. A statement of cash flows for the period;
5. Notes, comprising a summary of significant accounting policies and other explanatory information; and
5. A statement of financial position as at the beginning of the earliest comparative period when an entity
applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial
statements or when it reclassifies items in its financial statements.

The statement of financial position (or balance sheet) lists all the assets, liabilities and equity of an entity
as at a specific date. The income statement presents a summary of the revenues and expenses of an entity
for a specific period. The statement of changes in equity presents a summary of the changes in capital such
as investments, profit or loss, and withdrawals during a specific period. The statement of cash flows reports
the amount of cash received and disbursed during the period. Accounting policies are the specific
principles, bases, conventions, rules and practices adopted by an enterprise in preparing and presenting
financial statements. Notes to financial statements provide narrative descriptions or disaggregation of items
presented in the statements and information about items that do not qualify for recognition in the statements.

PREPARING THE FINANCIAL STATEMENTS (Step 6)

Once the worksheet is completed, it is easy to prepare the financial statements for the account balances
have been extended to the appropriate income statement and balance sheet columns. Most of the
information needed to prepare the income statement, statement of changes in equity and balance sheet are
available from the worksheet.

Income Statement

The income statement is a formal statement showing the performance of the enterprise for a given period
of time. It summarizes, the revenues earned and expenses incurred for that period.

Information about the performance of an enterprise, in particular its profitability, is required in order to
assess potential changes in the economic resources that it is likely to control in the future. It is also useful
in predicting the capacity of the enterprise to generate cash flows from its existing resource base.

Statement of Changes in Equity

The statement of changes in equity summarizes the changes that occurred in owner’s equity. This statement
is now a required statement. Changes in an enterprise’s equity between two balance sheet dates reflect the
increase or decrease in its net assets during the period.

In the case of sole proprietorships, increases in owner’s equity arise from additional investments by the
owner and profit during the period. Decreases result from withdrawals by the owner and from loss for the
period. The beginning balance and additional investments are taken from the owner’s capital account in the
general ledger. The profit or loss figure comes directly from the income statement while the withdrawals
from the balance sheet columns in the worksheet.
Balance Sheet

The balance sheet is a statement that shows the financial position or condition of an entity by listing the
assets, liabilities and owner’s equity as at a specific date. The information needed for the balance sheet
items are the net balances at the end of the period, rather than the total for the period as in the income
statement. This statement is also called the statement of financial position.

Users of financial statements analyze the balance sheet to evaluate an entity’s liquidity, its financial
flexibility, and its ability to generate profits, and its solvency. Liquidity refers to the availability of cash in
the near future after taking account of the financial commitments over this period. Financial flexibility is
the ability to take effective actions to alter the amounts and timings of cash flows so that it can respond to
unexpected needs and opportunities. This includes the ability to raise new capital or tap into unused lines
of credit. Solvency refers to the availability of cash over the longer term to meet financial commitments as
they fall due.

Statement of Cash Flows

The statement of cash flows provides information about the cash receipts and cash payments of an entity
during a period. It is a formal statement that classifies cash receipts (inflows) and cash payments (outflows)
into operating, investing and financing activities. This statement shows the net increase or decrease in cash
during the period and the cash balance at the end of the period; it also helps project the future net cash
flows of the entity.