In our last lesson, we're going to look at preparing financial statements from a trial balance, time to go. Our journey started three lessons ago when I discussed the difference between debits and credits, and which accounts have which sort of balance. Then two lessons ago, we started with analyzing a variety of different transactions and preparing the journal entries. In the last lesson, we posted the journal entries to create a general ledger headed trial balance. And to complete the circle of our journey, I'm going to show you how to prepare financial statements. This was the conceptual model I introduced in the first lesson.

I told you assets were debit balance accounts that represents something we own and that is either cash or convertible to cash in the future. Liabilities, alright credit balance that represents money we currently owe or owing the Future. However, both of these groups of accounts represent a value at a moment in time that we call the reporting date. December 31, is probably the most common reporting date, though any day of the year could be a reporting date, as we saw with Home Depot and it's February 2 reporting date. So a balance sheet represents what the entity owns and owes had a reporting date. For this reason, you will notice that the title to the balance sheet reads as at December 31, which is unintentional reference to a specific moment in time, in this case, midnight of December 31.

We also discussed that equity is a residual account. For this reason, it's conceptually the hardest for students to grasp and understand what is in here and what goes on. If you are wondering yourself, you aren't alone. The accounting Gods devised a number of different supplementary statements to include in a set of financial statements to better explain the equity section. The first of these statements is the statement of changes in equity. This statement gets no respect.

Few people understand it. And if accounting students make an error, it's most likely to happen here. There are basically two types of transactions that go through the statement, capital transactions and income transactions. Capital transactions are when the owners either contribute or withdraw funds from the business income transactions record the net income from the operations of the business all in one line, because net income is a pretty important number. readers of the financial statements typically was much more information about this amount. So the accounting Gods gave us the income statement.

The income statement gets all the attention everyone focuses on on the income statement, you could know nothing about accounting and read an income statement because it's generally dirt simple. Take your revenues and subtract your expenses. Positive income is good. A negative loss is bad. For this reason, most accounting courses start with the income statement. You may have noticed that I'm discussing this last.

But that's not because I disagree with it's important. No, I put it last because it logically flows last, what our conceptual starting place is assets equal liabilities plus equity. When we go to prepare our financial statements, I'm actually going to start with the income statement and work backwards to the balance sheet. Now these two statements, the statements of changes in equity and the income statement differ from the balance sheet and one very important respect. These accounts accumulate activity throughout a period. Be that a month, a quarter or a year.

If you recall, the balance sheet gave Was information at a moment in time. So when we titled these statements, we typically include labels that say, for the month ending, or for the year ending, the income statement typically has an incredible number of general ledger accounts set up in the chart of accounts. Remember, the account is like a bucket. it accumulates transactions for everything from sales to specific customers, to meals and entertainment expenses for specific employees. The last important point for me to tell you is that these income statement accounts get cleared each year. In other words, we dump these buckets out once a year at the end of the year.

And in doing so the account starts from zero at the beginning of the next fiscal period, which makes sense if you think about it, textbooks will dedicate a chapter to the notion of the closing entry, but the long and the short of it is all the income statement accounts get dumped into an equity account. typically called retained earnings at the end of each year. I'm now going to show you how this all comes together. To bring you up to speed quickly, Simple Simon incorporated a company on May 1. Now, a month and a half later, he needs financial statements for the first month of operation. Yes, that's an air conditioner and that's what his company sells and installs.

Our last lesson left off with the preparation of this trial balance. We had 13 journal entries to post in the month of May, I have taken the liberty to highlight the classification of each account in the chart of accounts, the assets, liabilities, equity, and the income accounts, which in my model are subcomponent of equity. The balances in column mo are our closing balances. So now we're ready to begin drafting our financial statements. First, I'm going to hide all the columns with my journal entries, just so that I can fit this all in one screen. You shouldn't need to go back to them for this exercise.

Next, I want to include another integrity check in self Oh 35. I'm simply summing up the income accounts so that I know what my net income is in debit and credits. Right now it's showing Hey 1900 and $10 credit, pop quiz. Did the company make money or lose money during the month of May? Yes, that's right. A credit balance is increasing equity, which means the company made money, we're still in debit and credit land on this side of the spreadsheet.

Next, I want to sort out the accounts between the three statements I discussed earlier. The income statement account balances are copied to column p, the equity accounts are copy to column Q, and the asset and liability accounts are copied to column R. Now you really don't need to do this step in practice, but I'm doing it now, just so that you begin to see how the accounts will tie together with our three statements. As we discussed earlier, I would suggest that you start drafting from the bottom up. And that is from the income statement, which will lead into the statement of changes in equity, which will in turn lead into the balance sheet. So to begin this, let's put on a proper header, which should include the company name, the statement name, and the appropriate reporting period, which in this case is for the month ending may 31.

Then we set our first statement, keeping in mind that an income statement is basically presented has revenues minus expenses, the accounts and the balance has come right from our trial balance. We may group two or more accounts together if we like. For instance, it would be totally acceptable to group bad debt expense with operating expenses. cost of sales, depreciation and interest expense are always separately disclosed. In fact, there's a whole bunch of accounting rules that talk about how numbers should be presented in financial statements. These rules are called generally accepted accounting principles or gap.

Also notice that I present all the numbers as positive numbers. This is a standard presentation format. At this point, we're going to set aside my methodology of debits as positive numbers and credits as negative numbers. The only time you'll see a negative number on these financial statements is when you have a loss from something or there is a withdrawal from equity. However, notice that my net income of $1,910 agrees to my check total in my trial balance. That's how I know I got all the accounts presented correctly.

And lastly, a subtle but important point about formatting. Make your statements pretty. Your dollars should be rounded never show sense. You should have $1 sign in front of the first and the last number only. And finally, it's standard for accountants to use either a double underline or a heavy underline to mark the bottom line totals few educators tell students about this. But if you ever get the opportunity to spend a summer in the type checking pool in an accounting firm, these practices get burned into your memory.

Now we move on to the statement of changes in equity. Each equity account typically gets reconciled in this statement. Basic companies have two types of equity accounts, capital stock, and retained earnings. There are other types of equity accounts as we saw in the Home Depot statements, but that's beyond the scope of introductory accounting. In our situation, we issued $5,000 of common shares during May. So that is both our activity and our ending balance.

The retained earnings account is where we close all of our income accounts and our dividends to remember those buckets that we talked about earlier. All the income accounts get poured into the retained earnings at the end of the period. So the 1900 and $10 of net income flows from the income statement into the retained earnings. Then, of course, we have to click close our dividend account to retained earnings as well. As Simple Simon withdrew 1500 dollars as a dividend. We now have the balances of our equity accounts that will carry over to complete the balance sheet in a moment.

So let's work through the balance sheet. The asset accounts from our trial balance, get transposed over to the assets section of the balance sheet, a couple of points. First, notice that I've separately presented current assets from long term assets. Our current asset is an asset that is convertible to cash within the next 12 months. hazards presented below this are assets with long lives. Secondly, notice our contra accounts for my receivables, I've netted the allowance for doubtful accounts against the receivables.

I've done the same for capital assets and accumulated depreciation. So our total assets are $17,800 as at midnight, on May 31. Next are liabilities, which are presented the same way as our assets and that they are broken out between current and long term amounts owing within the next 12 months are classified as a current liability. Those owing after 12 months are classified as long term liabilities. And finally, the moment of truth, the equity section, if your statement of changes in equity was prepare correctly, it should be a matter of transposing the ending balances of capital stock and retained earnings over to the balance sheet. And that's it, you're done.

And if you've done everything correctly, your balance sheet should and must balance. If it doesn't, you've made a mistake somewhere along the way. Wow, that was pretty cool how it all came together like that, huh? The only way for you to really learn this is to do it for yourself. If you encounter any challenges at any stage of the process, you may want to refer back to these video lessons. So what do we just learned?

Once you have your trial balance, you can begin preparing a set of financial statements. Start by sorting your accounts into the three statements to which they pertain. Remember to set up your net income integrity check, then we start with grafting our income statement. At this point we abandon my debits are positive numbers and credits or negative numbers. When you are drafting financial statements all balances show as positive numbers. Unless the account is in an abnormal position, such as a loss from something or a negative withdrawal from equity.

Your balances represent all the activity that occurred during the reporting period. Next, you prepare the statement of changes in equity. Calculate the continuity of the various equity accounts, remembering to close the income statement and the dividends to retained earnings. And finally, prepare your balance sheet. Remember to net the Contra accounts for presentation purposes. and separate the long term assets and liabilities from the current ones.

Keep in mind that the balance sheet represents the balances of each of these accounts as at the reporting date, which is a specific moment in time. If your balance sheet balances, then there's a high probability that you've got all your balances reported in the right places. Don't forget to format your statements and make them look pretty. This is as much a communication exercise as it is an accounting one. That's all for this lesson. Until next time, don't stop to get stuck when it gets tough.

Don't stop