PREPARATION OF FINANCIAL STATEMENTS

END OF THE YEAR ADJUSTMENTS

There are adjustments that are required to be made to the accounts in order to have the
books of accounts up to-date. These adjustments are usually done at the end of each
financial year (i.e. accounting year). Certain accounts are adjusted by making entries to
reflect the current status of the organization and thus prepare the financial statement.
These adjustments affect some of the following accounts:
 Bad debts  Prepaid incomes
 Depreciation,  Accrued expenses
 Prepaid expenses  Accrued incomes etc

ACCRUALS AND PREPAYMENTS

When the trading, profit and loss account (income statement) is being prepared for a
specified period, we must bring into account all incomes whether these have been actually
received or not and must take note of all expenses whether these have been paid for in
advance or are still outstanding.

a. Accrued expenses
These are expenses which are outstanding and have not yet been paid for at the time of
closing the financial year. These are current liabilities which can also be called expenses
payable/expenses outstanding/expenses due to be paid. They are liabilities to be settled in
the next financial year or accounting period or next 12 months. The journal entries to
record this accrual will be follows:

Dr. Expenses A/c

Cr. Accrued Expenses/Expenses payable/ Outstanding Expenses A/c

Example: A company’s financial year ends on 31 st December. During the financial year that
has just ended the workers salaries amounting to Uganda shillings 300,000/= cannot be paid
until the end of January the following year.

Dr. Salaries A/c 300,000/=

Cr. Salaries payable A/c 300,000/=

b. Prepaid expenses
These are expenses which have already been paid for in advance but relate to the following
financial period or normal operating cycle. These are current assets not yet expired or used.
They are expenses paid in advance but they benefit the following year. The journal entries
to record prepaid expenses are as follows.

Dr. Prepaid Expenses (asset) A/c

Cr. Expenses A/c

Example: A business paid for the rent amounting to 6,000,000/= for the financial year 2006
on the first of January 1 st, 2006. When the financial statement are being prepared as at the
end of June 2006 there is need to make an adjustment for the six month that were paid for
but the rent has not been used yet i.e. prepaid rent.

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Steps to follow are:
1. Determine the amount to be paid per month = 6,000,000/12= 500,000/=
2. Determine the amount prepaid for six months = 500,000x 6 = 3,000,000/=
3. Adjust the entry for prepaid rent as follows
Dr. Prepaid rent A/c 3,000,000/=
Cr. Rent A/c 3,000,000/=

c. Prepaid incomes
Some income may be received by the business in advance before it is earned. For example a
tenant may pay rent in advance or a student may pay hostel dues for the whole semester in
the first week. Adjustments must be made for that income which was received but the
services were not offered to the customer when the final accounts are being made.
Unearned income is treated as a current liability in the balance sheet.

Example: A student was made to pay for hostel accommodation amounting to 1,200,000/=
for a full year in January 2008. Required: 1) Prepare journal entries when the rent is paid. 2)
Make journal entries to adjust the entries at the end of June 2008.

1) Journal entries when the rent is paid.

Dr. Cash A/c 1,200,000/=
Cr. Unearned Rent Income/Prepaid Rent 1,200,000/=

2) Journal entries to adjust the entries at the end of June 2008.

Step 1: Determine the monthly rent payment = (1,200,000/12=100,000/=)

Step 2: Determine the total rent paid up to June 2008= (100,000x 6= 600,000/=)
Step 3: Determine the total rent prepaid up to December 2008.
Prepaid rent = (1,200,000-600,000=600,000/=)
Step4: Make entries to recognize the income which was hitherto unearned that has now
been earned.
Dr. Unearned Rent A/c 600,000/=
Cr. Earned rent A/c 600,000/=

BAD DEBTS AND PROVISION FOR BAD OR DOUBTFUL DEBTS

a. Bad and Doubtful debts

Bad debts are those debts that debtors will possibly fail to pay or debts that have become
irrecoverable. The debts must be written off to show a true and fair view of
receivables/debtors as at the balance sheet date. The bad debts written off are regarded as
a risk or loss to the business and therefore are treated as an expense posted to the Profit
and Loss A/c. The journal entries to record bad debts are as follows.

Dr. Bad debts (written off) A/c

Cr. Receivables/ Debtors A/c

a) At the end of the year the debit entry (bad debts/written-off) is taken to Profit and Loss
A/c under operating expenses.
b) The credit entry is shown as a reduction from debtors to arrive at the true figure of
debtors in the balance sheet.

b. Provision for Bad and doubtful debts

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Debts outstanding at the last day of the accounting period may be doubted or assumed to
be bad by the entity (i.e. Not likely to be settled by the customers). These may be debts for
which customers have been owed for so long, the business entity therefore anticipates a
future loss. A provision for bad debts is created to cater for the anticipated future loss in
form of none payment of debts. This provision is the estimated amount of debtors assumed
to be doubtful or bad by the entity. The journal entries to record Provision for Bad &
doubtful debts are as follows.

Dr. Bad debts/ Bad debts expenses A/c 300,000/=

Cr. Provision for bad debts A/c 300,000/=

c. Increase/ Decrease in the provision for bad debts.

When a provision for bad debts increases, the following journal entries are made. The
journal entries to record increase or decrease in Provision for Bad & doubtful debts are as
follows.

i) When a provision for bad debts increases, the journal entries showing the amount by
which the bad debts have increased will be made.

Example: If the provision for bad debts has increased from 300,000/= to 500,000/=. The
entries will appear as follows:
Dr. Bad debts A/c 200,000/=
Cr. Provision for bad debts A/c 200,000/=

ii) When a provision for bad debts decreases, the journal entries showing the amount by
which the provision for bad debts have decreased will be made. When there is little doubt
about the amounts being collected, i.e. some debtors start paying and some revenue is
realized, then the provision for bad debts can be decreased. This is treated as miscellaneous
income which is credited to the Profit & Loss A/c or added to gross profit.

Example: If the provision for bad debts of 500,000/= had been made against bad debts and
the provision is now to reduce to 300,000/=. The entries will appear as follows:
Dr. Provision for Bad debts A/c 200,000/=
Cr. Profit and Loss A/c 200,000/=

DEPRECIATION OF NON-CURRENT ASSETS

This is like any other operating expense charged against revenues. The expense of
depreciation creates another account called Accumulated Depreciation account or Provision
for depreciation a/c.

Dr. Depreciation expense a/c (Operating expense to P&L a/c)

Cr. Accumulated Depreciation a/c (the amount reduces the cost of the asset to arrive at the
net book value (NBV) in the Balance Sheet).

PREPARATION OF FINANCIAL STATEMENTS

INTRODUCTION
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Financial statements are the outputs of an accounting system. They are prepared at the end
of the financial year, and that is why they are often referred to as final accounts. Final
accounts are prepared from the trial balance after incorporating the end of year
adjustments. A complete set of financial statements includes the following components:-
 Balance sheet.  Cash flow statement.
 Income statement (Trading and  Accounting policies and
Profit and Loss Account) explanatory notes.
 Statement of changes in equity

For the purpose of this course we shall restrict ourselves to the income statement (Profit
and Loss Account and Balance Sheet.

INCOME STATEMENT

The trading and profit and loss account or simply the profit and loss account is a statement
that discloses the financial performance of the enterprise during a given year/operating
cycle. It shows an organization’s revenues or incomes and expenditures or costs for a
particular period ended. The resulting figure of profit or loss is transferred to the balance
sheet. The income statement takes a vertical (narrative) or horizontal (T- account format)
format:

SES income statement for the year ended xxx

Sales revenue xxx
Less: Sales returns (xxx)
Net sales xxx

Less: Cost of goods sold

Opening stock xxx
Add: Purchases xxx
Add: Carriage in-ward xxx
Less: Purchases returns (xxx)
xxx
Less: Closing inventory/Stock xxx xxx
Gross Profit xxx

Less: Operating expenses e.g.

Rent xxx
Electricity xxx
Salaries xxx
Deprecation xxx
E.t.c xxx xxx
Net profit before finance costs & taxation xxx
Less: Finance costs (xxx)
Net profit before taxation xxx
Less: Taxation (xxx)
Net profit for the year xxx

Main Components of the Income Statement

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The first component is the trading account which shows the gross profits. The second
component is the profit loss and loss account which shows the net profits. In organisations
that give out dividends then there will be a third component that shows how the profits are
appropriated.

BALANCE SHEET

This statement shows the financial position of an organization as at a particular date. The
balance sheet satisfies the accounting equation which is:
ASSETS = OWNERS EQUITY + LIABILITIES.

The balance sheet can take horizontal (T-account) format or the vertical format.

NTV LTD BALANCE SHEET AS AT……………..

ASSETS
Fixed Assets cost Acc. Depn. NBV
Land xxx Nil xxx
Motor vehicle xxx xxx xxx
Equipment xxx xxx xxx
xxx xxxx xxx

Current assets:
Inventories/Stock xxx
Trade debtor’s xxx
Less: Prov. for bad debts (xxx) xxx
Prepayments xxx
Cash and cash equivalents xxx xxx
xxx
Less: Current liabilities:
Trade Creditors xxx
Short term loans xxx
Taxation xxx xxx
Working Capital (Net Current Assets xxx
Total Net Asset xxx

TOTAL EQUITY AND LIABILITIES

Capital and reserves
Capital xxx
Add: Net profits (net of drawings) xxx
Less: Drawings xxx

Long term liabilities

Bank loans xxx
Debentures xxx
Capital Employed xxx

ILLUSTRATION 1

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The following is a trial balance prepared from ledger accounts of BINTUBIZIBU & Co. Ltd as
at 31/12/2004.
Accounts titles Dr. ‘000 shs. Cr. ‘000 shs.
Rent 7,153
Cash 30,816
Debtors 38,916
Stock (01/01/2004) 59,584
Insurance 1,125
Land at cost 16,024
Building at cost 60,800
Equipment at cost 23,587
Creditors 50,264
Capital 103,821
Drawings 8,700
Sales 328,768
Returns inward 4,264
Purchases 192,888
Returns outwards 3,332
Carriage inwards 3,744
Salaries& wages 38,584
Total 486,185 486,185

Closing stock was valued at 40, 000,000/=

Required:
Prepare the Bintubizibu Co. Ltd trading, profit & loss A/c for the year ended 31/12/2004 and
balance sheet as at that date.

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ILLUSTRATION 2

The following is a trial balance prepared from the ledger accounts of SIBYANGU LTD as at a
December 31, 2003.

Accounts title Dr. Shs ‘000 Cr. Shs ‘000

Cash 30,816
Debtors 38,916
Stock (01/01/2003) 59,584
Insurance 1,125
Land cost 16,024
Building at cost 60,800
Accumulated depreciation-Building 14,092
Equipment at cost 23,587
Accumulated Depreciation ( Equipment) 2,560
Creditors 50,264
Capital 80,512
Drawings 8,700
Sales 328,768
Returns in words 4,264
Purchases 192,888
Returns outwards 3,332
Carriage inwards 3,744
Salaries and wages 38,584
Bad debts 996
Provision for bad debts 500
Total 480,028 480,028

Additional information:
a) Stock on December 31, 2003 was valued at shs.40,000,000/=
b) Provisions for bad debts are to be increased to shs.1,000,000/=
c) Prepaid insurance amounted to Shs. 500,000/=
d) Buildings are to be depreciated at 15% and equipment at 25% per year on cost
values using straight line method.

Required.
i. Prepare journal entries for additional information (narrations not required)
ii. Prepare a trading, profit and loss account for the year ended December 31, 2003 and
the balance sheet as at that date.

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ILLUSTARATION 3

The bookkeeper of DEHEZI INTERNATIONAL (U) LTD prepared the following trial balance at
the end of its financial year on December 31.
Dr. (UGX.000) Cr. (UGX.000)
Accounts title Dr. Shs ‘000 Cr. Shs ‘000
Cash at hand 2,000
Cash at bank 4,000
Land at cost 100,000
Motor vehicle at cost 10,000
Accumulated Depreciation- Motor Vehicle 2,000
Equipment at cost 20,000
Accumulated Depreciation-equipment 4,000
Inventory (opening inventory) 1,000
Receivables 5,000
Provision for bad debts 2,000
Trade creditors 3,000
Sales 200,000
Purchases 110,000
Discount allowed 2,000
Discount received 1,000
Purchase returns 5,000
Sales return / returns inwards 10,000
Carriage inwards 6,000
Salaries 8,000
Salaries payable /accrued salaries 15,000
Rent 1,800
Electricity 7,000
Bade debts 1,200
Capital 26,000
Long term loan 30,000
Total 288,000 288,000

You ascertain the following.

a) Closing inventory at the end of the year was valued at UGX.20,000,000/=
b) Salaries of UGX. 2, 000,000/= accrued or remained outstanding at the end of the
year and was not recorded in the trial balance.
c) Half of the rent paid is for the forthcoming financial year.
d) Depreciate tangible non-current assets by 20% on cost at the end of the year
e) 20% of trade debtors are expected to default; a provision against bad debts needs to
be made.

Required: As the company’s accountant you are required to:-

a. Journalize adjusting entries and,
b. Prepare the company’s income statement for the year ending December 31, and,
c. Prepare the company’s balance sheet as at December 31.

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