From ledger accounts to financial statements

In this lesson you will learn:

• how to extract the values to be used to write de financial statements from the ledger accounts and how to prepare the accounts for the next accounting period
• how to verify that the information in correct
• how to correct the accounts so as to have the correct values

and we will write our first set of financial statements!

Closing the accounts

 

The trial balance

 

Year end adjustments

 

Our first draft of financial statements

 

The Statement of Financial Position

 

The Statement of Profit or Loss

 

This lesson in a nutshell:

The balance of an account = opening balance + additions – decreases = closing balance

If the sum of the amounts from the debit side of the account > the sum of the amounts from the credit side => the closing balance is a debit balance

Before closing the accounts, each account has to be individually check to ensure that it reflect the correct values.

One of the first „year end adjustments” to be recorded is to record the cost of sales.

Cost of sales = Opening balance of inventory account + net purchases made during the period – Closing balance of inventory account.

Since in our example, it’s the firs year of business for The Big Tomato => the opening balance of inventory = 0

Also in our example The Big Tomato sold all tomatoes => the closing balance of inventory = 0

=> Cost of sales = Net purchases – to arrive to have this information in the accounts we need to transfer* the balance of „purchases” accounts to the account „Cost of sales”

 

At the end of the accounting period:

The balance sheet accounts (the accounts used for assets and liabilities) are closed by:

• debiting them – if their closing balance is a credit balance or by
•  crediting them – if their closing balance is a debit balance

at the beginning of the next accounting for period these accounts we simply write the closing balance on the other side (so, on the correct side) and this become the opening balance for the next accounting period.

The closing balance of the „balance sheet accounts” is used to write the Statement of Financial Position.

The profit or loss accounts (the accounts used for revenues and expenses) are closed by:

• debiting them with the difference (total credit – total debit) if their total credit amounts > total debit amounts using the account „profit or loss of the period” as a corresponding account. Normally, this happens for the revenues accounts => we close the revenues accounts by debiting them with total credit amounts – total debit amounts => at the end of the period these accounts will have a zero balance and are prepared to record the revenues from the next period WHILE the revenues of this period appear (all) on the credit side of the account „profit or loss of the period”
• crediting them with the difference (total debit – total credit) if their total debit amounts > total credit amounts using the account „profit or loss of the period” as a corresponding account. Normally, this happens for the expenses accounts => we close the expenses accounts by crediting them with total debit amounts – total credit amounts => at the end of the period these accounts will have a zero balance and are prepared to record the expenses from the next period WHILE the expenses of this period appear (all) on the debit side of the account „profit or loss of the period”
• At the end of the period in the „profit or loss of the period” account we’ll have all the incomes on the credit side and all the expenses on the debit side => the balance of this account equals the profit (if total credit > total debit) or the loss (if total debit > total credit) of the period. At this stage, the information from this account is used to write the Statement of Profit or Loss for the period.
• After the above stage, the balance of „profit or loss” account is transferred* to an account called „retained earnings”. By this record, at the end of the accounting period the balance of the account „profit or loss for the period” becomes zero and this account is prepared for the next period, while the profit of the current period is showed in the account „retained earnings” = an account from the equity used to keep the evidence of all profits made by the entity since its incorporation which were not distributed (as dividends, for example)

The trial balance is one of the „tool” used to check if the records made over the accounting period were correct.

 

Dictionary:

to transfer the balance of an account = make the total of debit the amounts and the total of credit amounts and:

• if total debit amounts > total credit amounts => by transferring the balance of the account, the account must be credited with the difference total debit amounts – total credit amounts and this difference will be debited in the corresponding account. After this record (for this account) the total debit amounts = the total credit amounts and the accounts can be considered clean/balanced and prepared for the next period.
• if total credit amounts > total debit amounts => by transferring the balance of the account, the account must be debited with the difference total credit amounts – total debit amounts and this difference will be credited in the corresponding account. After this record (for this account) the total debit amounts = the total credit amounts and the accounts can be considered clean/balanced and prepared for the next period.

You know it!

This lesson is not to be considered complete until you successfully solve the questions below 🙂

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