Account Debit Credit

Assets Increases Decreases

Liabilities Decreases Increases

Income Decreases Increases

Expenses Increases Decreases

Financial statements are:

1) Income statement
2) Cash flow statement
3) Balance sheets

Trial balance may be defined as an informal accounting schedule or statement that lists the ledger account
balances at a point in time compares the total of debit balance with the total of credit balance.

The fundamental principle of double entry system is that at any stage, the total of debits must be equal to the
total of credits. If entries are recorded and posted correctly, the ledger will reflect equal debits and credits,
and the total credit balance will then be equal to the total debit balances.

Every business concern prepares final accounts at the end of the year to ascertain the result of the activities of
the whole year. To ensure correct result, the concern must be free from doubt that the books of accounts
have been correctly recorded throughout the year. Trial balance is prepared to test the arithmetical accuracy
of the books of accounts. As we know that under double entry system for each and every transaction one
account is debited, and other account is credited with an equal amount. If all the transactions are correctly
recorded strictly according to this rule, the total amount of debit side of all the ledger accounts must be equal
to that of credit side of all the ledger accounts. This verification is done through trial balance.

If the trial balance agrees we may reasonably assume that the books are correct. On the other hand, if it does
not agree, it indicates that the books are not correct - there are mistakes somewhere. The mistakes are to be
detected and corrected otherwise correct result cannot be ascertained. There are however, a few types of
errors which the trial balance cannot detect. In other words, the trial balance will agree in spite of the
existence of those errors.

The trial balance is not an absolute or solid proof of the accuracy of books of accounts. Thus, if trial balance
agrees, there may be errors or may not be errors. But if it does not agree, certainly there are errors.

Purposes of Trial Balance:

The trial balance serves two main purposes. These are as under:

To check the equality of debits and credits - an arithmetical or mathematical test of accuracy.

To provide information for use in preparing final accounts.

Methods of Preparing Trial Balance:

There are three methods for the preparation of trial balance. These methods are:

Total or gross trial balance

Balance or net trial balance

Total - cum - balance trial balance

The method 1 and 2 are described below:

Total or Gross Trial Balance:

Under this method the two sides of all the ledger accounts are totalled up. Thereafter, a list of all the accounts
is prepared in a separate sheet of paper with two "amount" columns on the right-hand side. The first one for
debit amounts and the second one for credit amounts. The total of debit side and credit side of each account
is then placed on "debit amount" column and "credit amount" column respectively of the list. Finally, the two
columns are added separately to see whether they agree of not. This method is generally not followed in
practice.

Balance or Net Trial Balance:

Under this method, first the balances of all ledger accounts are drawn. Thereafter, the debit balances and
credit balances are recorded in "debit amount" and "credit amount" column respectively and the two columns
are added separately to see whether they agree or not. This is the most popular method and generally
followed.

The various Steps involved in the preparation of Trial Balance under this method are given below:

Find out the balance of each account in the ledger.

Write up the name of account in the first column.

Record the account number in second column.

Record the debit balance of each account in debit column and credit balance in credit column.

Add up the debit and credit column and record the totals.

Example:
Enter the following transactions

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in journal and post them into the ledger and also prepare a trial balance.

2005

Jan. 1 Mr. X started business with cash $80,000 and furniture $20,000.

Jan. 2 Purchased goods on credit worth $30,000 from Y.

Jan. 3 Sold goods for cash $16,000.

Jan. 4 Sold goods on credit to S for $10,000

Jan. 8 Cash received from S $9,800 in full settlement of his account.

Solution:

Journal

Date Particulars L.F DR. Cr.

2005 Amount ($) Amount ($)

Jan. 1 Cash A/C 5 80,000

Furniture A/C 7 20,000

Capital A/C 9 1,00,000

(Owner invested cash and furniture)

Jan. 2 Purchases Account 11 30,000

Y 13 30,000

(Bought goods on credit)

Jan. 3 Cash A/C 5 16,000

Sales A/C 15 16,000

(Sold goods for cash)

Jan. 4 S A/C 17 10,000

Sales A/C 15 10,000

(Sold goods on credit)

Jan. 8 Cash A/C 5 9,800

Discount A/C 19 200

S A/C 17 10,000

(Cash received, and discount allowed)

Ledger

Cash Account (No.5)

Date references J.R Debit Credit Balance

2005 Dr. Cr.

Jan. 1 Capital A/C 5 80,000 80,000

Jan. 3 Sales A/C 5 16,000 96,000

Jan. 8 S A/C 5 9,800 105,800

Furniture Account (No.7)

Date references J.R Debit Credit Balance

2005 Dr. Cr.

Jan. 1 Capital A/C 5 20,000 20,000

Capital Account (No.9)

Date references J.R Debit Credit Balance

2005 Dr. Cr.

Jan. 1 Cash A/C 5 80,000 80,000

Jan. 1 Furniture A/C 5 20,000 1,00,000

Purchases Account (No.11)

Date references J.R Debit Credit Balance

2005 Dr. Cr.

Jan. 2 Y A/C 5 30,000 30,000

Y Account (No.13)

Date references J.R Debit Credit Balance

2005 Dr. Cr.

Jan. 2 Purchases A/C 5 30,000 30,000

Sales Account (No.15)

Date references J.R Debit Credit Balance

2005 Dr. Cr.

Jan. 3 Cash A/C 5 16,000 16,000

Jan. 4 S A/C 5 10,000 26,000

S Account (No.17)

Date references J.R Debit Credit Balance

2005 Dr. Cr.

Jan. 4 Sales A/C 5 10,000 10,000

Jan. 8 Cash A/C 5 9,800

Jan. 8 Discount A/C 5 200 Nil

Discount Account (No.19)

Date references J.R Debit Credit Balance

2005 Dr. Cr.

Jan. 8 S A/C 5 200 200

Trial Balance

S. No. Account Name A/C No. Debit Credit

1 Cash Account 5 105,800

2 Furniture Account 7 20,000

3 Capital Account 9 -- 100,000

4 Purchases Account 11 30,000

5 Y Account 13 -- 30,000

6 Sales Account 15 -- 26,000

7 S Account 17 -- --

8 Discount Account 19 200 --

Total 156,000 1,56,000

Financial statements are written records that convey the business activities and the financial performance of a
company. Financial statements are often audited by government agencies, accountants, firms, etc. to ensure
accuracy and for tax, financing, or investing purposes. Financial statements include:

 Balance sheet
 Income statement
 Cash flow statement.

Using Financial Statement Information

Investors and financial analysts rely on financial data to analyze the performance of a company and make
predictions about its future direction of the company's stock price. One of the most important resources of
reliable and audited financial data is the annual report, which contains the firm's financial statements.

The financial statements are used by investors, market analysts, and creditors to evaluate a company's
financial health and earnings potential. The three major financial statement reports are the balance sheet,
income statement, and statement of cash flows.

KEY TAKEAWAYS

 Financial statements are written records that convey the business activities and the financial
performance of a company.
 The balance sheet provides an overview of assets, liabilities, and stockholders' equity as a snapshot in
time.
 The income statement primarily focuses on a company’s revenues and expenses during a particular
period. Once expenses are subtracted from revenues, the statement produces a company's profit
figure called net income.
 The cash flow statement (CFS) measures how well a company generates cash to pay its debt
obligations, fund its operating expenses, and fund investments.
Understanding Balance Sheets
The balance sheet provides an overview of a company's assets, liabilities, and stockholders' equity as a
snapshot in time. The date at the top of the balance sheet tells you when the snapshot was taken, which is
generally the end of the fiscal year.

The Balance Sheet Formula

\display style \text {Assets}=(\text{Liabilities}+\text{Owner's Equity})Assets=(Liabilities Owner’s Equity)

The balance sheet totals will be calculated already, but here's how you identify them.

1. Locate total assets on the balance sheet for the period.

2. Total all liabilities, which should be a separate listing on the balance sheet.
3. Locate total shareholder's equity and add the number to total liabilities.
4. Total assets should equal the total of liabilities and total equity.

Data from the Balance Sheet

The balance sheet identifies how assets are funded, either with liabilities, such as debt, or stockholders'
equity, such as retained earnings and additional paid-in capital. Assets are listed on the balance sheet in order
of liquidity.

Liabilities are listed in the order in which they will be paid. Short-term or current liabilities are expected to be
paid within the year, while long-term or noncurrent liabilities are debts expected to be paid in over one year.

Items Included in the Balance Sheet

Below are examples of items listed on the balance sheet.
Assets

 Cash and cash equivalents are liquid assets, which may include Treasury bills and certificates of
deposit.
 Accounts receivables are the amount of money owed to the company by its customers for the sale of
its product and service.
 Inventory

Liabilities

 Debt including long-term debt

 Rent, tax, and utilities
 Wages payable
 Dividends payable

Shareholders' Equity

 Shareholders' equity is a company's total assets minus its total liabilities. Shareholders' equity
represents the amount of money that would be returned to shareholders if all of the assets were
liquidated and all of the company's debt was paid off.
 Retained earnings are part of shareholders' equity and are the percentage of net earnings that were
not paid to shareholders as dividends.

Example of a Balance Sheet

Below is a portion of Exxon Mobil Corporation's (XOM) balance sheet as of September 30, 2018.

 Total assets were $354,628 (highlighted in green).

 Total liabilities were $157,797 (1st red highlighted area).
 Total equity was $196,831 (in red).
 Total liabilities and equity were $354,628, which equals the total assets for the period. Exxon Balance
Sheet example. Investopedia

Income Statements
Unlike the balance sheet, the income statement covers a range of time, which is a year for annual financial
statements and a quarter for quarterly financial statements. The income statement provides an overview of
revenues, expenses, net income and earnings per share. It usually provides two to three years of data for
comparison.

Income Statement Formula and Calculation

\text {Net Income}=(\text{Revenue}-\text{Expenses})Net Income=(Revenue−Expenses)

1. Total all revenue or sales for the period.

2. Total all expenses and costs of operating the business.
3. Subtract total expenses from revenue to achieve net income or the profit for the period.

Data from Income Statements

An income statement is one of the three important financial statements used for reporting a
company's financial performance over a specific accounting period. Also known as the profit and loss
statement or the statement of revenue and expense, the income statement primarily focuses on a company’s
revenues and expenses during a particular period.

Once expenses are subtracted from revenues, the statement produces a company's profit figure called net
income.
Types of Revenue
Operating revenue is the revenue earned by selling a company's products or services. The operating
revenue for an auto manufacturer would be realized through the production and sale of autos. Operating
revenue is generated from the core business activities of a company.

Non-operating revenue is the income earned from non-core business activities. These revenues fall outside
the primary function of the business. Some non-operating revenue examples include:

 Interest earned on cash in the bank

 Rental income from a property
 Income from strategic partnerships like royalty payment receipts
 Income from an advertisement display located on the company's property

Other income is the revenue earned from other activities. Other income could include gains from the sale of
long-term assets such as land, vehicles, or a subsidiary.

Types of Expenses
Primary expenses are incurred during the process of earning revenue from the primary activity of the
business. Expenses include the cost of goods sold (COGS), selling, general and administrative expenses
(SG&A), depreciation or amortization, and research and development (R&D). Typical expenses include
employee wages, sales commissions, and utilities such as electricity and transportation.

Expenses that are linked to secondary activities include interest paid on loans or debt. Losses from the sale of
an asset are also recorded as expenses.

The main purpose of the income statement is to convey details of profitability and the financial results of
business activities. However, it can be very effective in showing whether sales or revenue is increasing when
compared over multiple periods. Investors can also see how well a company's management is controlling
expenses to determine whether a company's efforts in reducing the cost of sales might boost profits over
time.

Example of an Income Statement

Below is a portion of Exxon Mobil Corporation's (XOM) income statement as of September 30, 2018.

 Total revenues were $76,605 for the period.

 Total costs were $67,525.
 Net income or profit was $6,240.
 Exxon Income Statement 09-30-2018. Investopedia

The Cash Flow Statement

The cash flow statement (CFS) measures how well a company generates cash to pay its debt obligations, fund
its operating expenses, and fund investments. The cash flow statement complements the balance
sheet and income statement.

Data From the Cash Flow Statement

The CFS allows investors to understand how a company's operations are running, where its money is coming
from, and how money is being spent. The CFS also provides insight as to whether a company is on a solid
financial footing.

There is no formula, per se, for calculating a cash flow statement, but instead, it contains three sections that
report the cash flow for the various activities that a company has used its cash. Those three components of
the CFS are listed below.
Operating Activities
The operating activities on the CFS include any sources and uses of cash from running the business and selling
its products or services. Cash from operations includes any changes made in cash, accounts
receivable, depreciation, inventory, and accounts payable. These transactions also include wages, income tax
payments, interest payments, rent, and cash receipts from the sale of a product or service.

Investing Activities
Investing activities include any sources and uses of cash from a company's investments into the long-term
future of the company. A purchase or sale of an asset, loans made to vendors or received from customers or
any payments related to a merger or acquisition is included in this category.

Also, purchases of fixed assets such as property, plant, and equipment (PPE) are included in this section. In
short, changes in equipment, assets, or investments relate to cash from investing.

Financing Activities
Cash from financing activities include the sources of cash from investors or banks, as well as the uses of cash
paid to shareholders. Financing activities include debt issuance, equity issuance, stock repurchases, loans,
dividends paid, and repayments of debt.

The cash flow statement reconciles the income statement with the balance sheet in three major business
activities.

Example of a Cash Flow Statement

Below is a portion of Exxon Mobil Corporation's (XOM) cash flow statement as of September 30, 2018. We can
see the three areas of the cash flow statement and their results.

 Operating activities generated a positive cash flow of $27,407 for the period.
 Investing activities generated negative cash flow or cash outflows of -$10,862 for the period.
Additions to property, plant, and equipment made up the majority of cash outflows, which means
the company invested in new fixed assets.
 Financing activities generated negative cash flow or cash outflows of -$13,945 for the period.
Reductions in short-term debt and dividends paid out made up the majority of the cash outflows.

Financial Statement Limitations

Although financial statements provide a wealth of information on a company, they do have limitations. The
statements are open to interpretation, and as a result, investors often draw vastly different conclusions about
a company's financial performance.

For example, some investors might want stock repurchases while other investors might prefer to see that
money invested in long-term assets. A company's debt level might be fine for one investor while another
might have concerns about the level of debt for the company. When analysing financial statements, it's
important to compare multiple periods to determine if there are any trends as well as compare the company's
results its peers in the same industry.