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

ADVERTISEMENT

 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.