ICAEW - Chapter 5 - Preparing Basic Financial Statement

Chapter 05
Preparing basic
financial statements
21-Sep-23 201109 – Chapter 5: Preparing basic financial statement 1

Learning outcomes
- Prepare the trial balance from accounting records and

identify the uses of a trial balance.
- Prepare and present a statement of financial position,
statement of profit or loss (P/L), statement of cash flows
(or extracts) from the accounting records and trial
balance in a format which satisfies the information
requirements of the entity.

Topic list
1. The trial balance
2. Balancing of ledger accounts
3. Preparing the statement of profit or loss
4. Preparing the statement of financial position
5. Preparing basic financial statements

Trial balance: A list of nominal ledger balances shown in debit and credit
columns, as a method of testing the accuracy of double entry bookkeeping.
If double entry
principles have
been correctly
applied
throughout the
period, total
credit balances
will equal total
debit balances
and so the
totals will
balance

Next step after balancing each account in Ledgers is to

TRIAL BALANCE
check that the double-entry has been completed by using
Trial balance system.
Trial balance is “working paper” and not form part of
double-entry process.
Trial balance lists all the debit balances and credit

balances are extracted from each of the account through
the Ledger system
Total Credit balance to be compared with total Debit

balance and must be equal.

Potential errors in a trial balance
 Transportation errors: two digits in an amount are accidently
recorded the wrong way round.
 Omission errors: a transaction is completely omitted, either
in the nominal ledger, or the trial balance itself, so neither a
debit nor a credit is made.
 Commission errors: a debit or credit is posted to the correct
side of the nominal ledger, but to a wrong account. Eg, wages
paid are debited to the rent account instead of the wages
account.
 Compensating errors: one error is exactly cancelled by
another error elsewhere.
 Errors of principle, such as cash from receivables being
debited to trade receivables and credited to cash at bank
instead of the other way round.
Potential errors in a trial balance (cont.)
Example:
• $5,000 cash payment that goes to one supplier but pays for
two different products may be listed correctly as a $5,000 debit
but also as a $3,000 credit to the seller and a $2,500 credit to
the seller, for an incorrect credit total of $5,500 and a $500
imbalance.
• If a business receives an invoice from a supplier for $250, the
transaction might be omitted from the books entirely. As a
result, both the total debits and the total credits of the business
will be incorrect by $250.
• If a business receives an invoice from a supplier for $300, the
payables control account might be credited, but the debit entry
in the purchases account might be omitted. In this case, the
total credits would not equal total debits (because total debits
are $300 less than they ought to be).
The Extended Trial Balance (ETB)
= The final trial balance
= Adjusted trial balance
 This has debit and credit columns for the initial trial
balance, plus debit and credit columns for adjustment
journals.
 A revised trial balance is then created by cross-casting
horizontally.
We often need to make

adjustments (eg, for errors or
period end journals) after the trial
balance has been extracted.
Worked example – p.123 (Study Manual)

The Extended Trial Balance (ETB)

2. Balancing off ledger accounts
Hint. Balance off = closing entries
• At the end of a reporting period, once all

adjustments have been posted, the accounts
in the nominal ledger are balance off.
• Key term: balance carried down; balance
brought down

3. Preparing the statement
of profit or loss (P/L statement)
 Create a new ledger account in the nominal ledger,

called the profit and loss ledger account.
 Identify the ledger accounts which relate to income and
expenses.
 Transfer these balances to the profit and loss ledger
account.
 Sales and purchases are included in gross profit.
 All other income is added, and all other expenses are
deducted, to arrive at profit for the period.
Hint. Profit & loss ledger account = Income summary account

of profit or loss (P/L statement)
Interactive question 1: Statement of profit or loss
Draw up Ron Knuckle’s statement of profit or loss

(Information of Ron Knuckle for the period on p. 122)
Ron Knuckle
Statement of Profit or Loss
Fot the first trading period
£ £

of financial position
• All the remaining balances (on the asset, capital and
liabilities accounts) in the nominal ledger are then listed out
in the vertical format statement of financial position to show:
non-current and current assets (total assets), which are
equal to capital plus non-current and current liabilities (total
capital and liabilities).
• Accounts represent assets, capital and liabilities of the
business (not income and expenses) , their balances are
carried down in the books of the business. They become
opening balances for the next reporting period.
• The profit and loss ledger account balance is transferred
to the capital ledger account.
(Interactive question 2 - p.128)
5. Preparing basic financial
statements
To prepare the statement of profit or loss and

statement of financial position together, you
need to follow through methodically the steps
involved:

statements
Step 1: Calculate balances on all nominal ledger accounts
Step 2: Prepare trial balance
Step 3: Transfer income and expense balances to the profit

and loss ledger account and calculate profit/(loss) for the period
Step 4: Prepare statement of profit or loss
Step 5: Transfer profit and loss ledger account and drawings

balance to capital account
Step 6: Prepare statement of financial position

statements
Interactive question 3 – p. 133

Profit and loss ledger account

End of chapter 5
Study Manual – chapter 5: self test (10

MCQs)
Question bank - chapter 5

ICAEW - Chapter 5 - Preparing Basic Financial Statement

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Chapter 05

21-Sep-23 201109 – Chapter 5: Preparing basic financial statement 1

- Prepare the trial balance from accounting records and

21-Sep-23 201109 – Chapter 5: Preparing basic financial statement 2

21-Sep-23 201109 – Chapter 5: Preparing basic financial statement 3

21-Sep-23 201109 – Chapter 5: Preparing basic financial statement 4

Next step after balancing each account in Ledgers is to

Trial balance lists all the debit balances and credit

Total Credit balance to be compared with total Debit

21-Sep-23 201109 – Chapter 5: Preparing basic financial statement 5

We often need to make

Worked example – p.123 (Study Manual)

21-Sep-23 201109 – Chapter 5: Preparing basic financial statement 11

• At the end of a reporting period, once all

21-Sep-23 201109 – Chapter 5: Preparing basic financial statement 12

 Create a new ledger account in the nominal ledger,

Hint. Profit & loss ledger account = Income summary account

Draw up Ron Knuckle’s statement of profit or loss

21-Sep-23 201109 – Chapter 5: Preparing basic financial statement 14

To prepare the statement of profit or loss and

21-Sep-23 201109 – Chapter 5: Preparing basic financial statement 16

Step 2: Prepare trial balance

Step 3: Transfer income and expense balances to the profit

Step 4: Prepare statement of profit or loss

Step 5: Transfer profit and loss ledger account and drawings

Step 6: Prepare statement of financial position

Interactive question 3 – p. 133

21-Sep-23 201109 – Chapter 5: Preparing basic financial statement 18

Study Manual – chapter 5: self test (10

21-Sep-23 201109 – Chapter 5: Preparing basic financial statement 19

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