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CHAPTER 3: PREPARING A TRIAL BALANCE

AND BASIC FINANCIAL STATEMENTS

CONTENT

3.1 Preparing a trial balance

3.2 Preparing basic financial statements

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3.1 PREPARING A TRIAL BALANCE

- Control accounts

- Bank reconciliations

- Correction of errors

SOURCE BOOKS OF LEDGER

TRIAL BALANCE
DOCUMENTS PRIME ENTRY ACCOUNT
S

A trial balance is a list of ledger balances shown in debit and credit

columns. Steps to prepare the Trial Balance (TB):
► Step 1: Collect of ledger accounts
► Step 2: Balance ledger accounts
► Step 3: Collect the balances
► Step 4: Check and reconcile

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3.1.1 Control accounts

• A control account is an account in the nominal ledger in
which a record is kept of the total value of a number of
similar but individual items.
• The two most important control accounts are those for
receivables and payables

The situation may arise where a customer is

also a supplier.
The double entry for this type of contra is:
Dr Payables ledger control account
Cr Receivables ledger control account

CONTROL
ACCOUNT

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EXAMPLE 1 During a period, A Co has the following transactions on receivables

control account: sales $125,000, cash received $50,000, discounts allowed
$2,000. The balance carried forward is $95,000. What was the opening balance at
the beginning of the period?
A. $22,000 debit C. $18,000 debit
B. $22,000 credit D. $20,000 debit

EXAMPLE 2 You are given the following information:

Receivables at 1 January 20X3 $10,000
Receivables at 31 December 20X3 $9,000
Total receipts during 20X3 (including cash sales of $5,000) $85,000
What is the figure for sales on credit during 20X3?
A. $81,000 B. $86,000 C. $79,000 D. $84,000

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3.1.2 Correction of errors

There are five main types:

Errors of transposition

Errors of omission

Errors of principle

Errors of commission

Compensating errors

Errors of
transposition

An error of transposition is when

two digits in a figure are
accidentally recorded the wrong
way round.
The error is the transposition
For example, suppose that a sale is
recorded in the sales account as of the 4 and the 8. The
$6,843, but it has been incorrectly consequence is that total
recorded in the total receivables debits will not be equal to
account as $6,483. total credits.

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Error of
omission
- Entirely
- Or make a debit or
credit entry

e.g: a cash sale of $100

was not recorded ?

A transaction has Telephone expenses of $500

been recorded in has been debited to the
the wrong electricity expenses account
account
Error of The total daily credit sales in
commission the sales day book should be
$28,425, but are incorrectly
added up as $28,825. The
Errors of casting total sales in the sales day
(adding up) book are then used to credit
total sales and debit total
receivables in the ledger
accounts. Although total
debits and total credits are
still equal, they are incorrect
by $400.

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Error of principle

e.g: a non- current asset

purchase of $1,000 has been
debited to the repair expense ?

Error:

Compensating errors

Compensating errors are errors which are coincidentally,

equal and opposite to one another.

Two transposition errors of $540 might occur in extracting ledger

balances, one on each side of the double entry. In the administration
expenses account, $2,282 might be written instead of $2,822 while, in the
sundry income account, $8,391 might be written instead of $8,931. Both
the debits and credits would be $540 too low, and the mistake would
not be apparent when the trial balance is cast.

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Errors
which leave Otherwise
total debits a
and credits suspense
in the account
ledgers has to be
accounts in opened
balance first, and
can be later
corrected cleared by
by using a journal
journal entry.
entries.

Errors that can be detected by a trial balance:

• Errors of transposition
• Errors of omission (if the omission is one sided)
• Errors of commission (if one – sided or two debit entries are made)

Other errors will not be detected by extracting a trial

balance, but may be spotted by other controls (such as
bank and control account reconciliations)

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EXAMPLE 3 Which one of the following would be an error of principle?

A. Plant and machinery purchased was credited to a non-current assets
account.
B. Plant and machinery purchased was debited to the purchases account. C.
Plant and machinery purchased was debited to the equipment account. D.
Plant and machinery purchased was credited to the equipment account

EXAMPLE 4 A payment of $1,234 for a telephone bill is correct entered in the

cash book but debited to telephone account as $1,243.

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Chapter 3: Preparing basic financial statements (Cont)

3.2 Incomplete Records

Incomplete records
Cash and cash equivalents Tiền và cá c khoả n tương
đương tiền
Accounting and business equations Phương trình kế toá n và
phương trình kinh doanh
Cost of sale Giá vố n hà ng bá n

Drawing Rú t vố n
Gross profit Lợ i nhuậ n gộ p

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Incomplete
records

The accounting
and business Establishing cost
of sales
equations

Incomplete records problems occur when

a business does not have a full set of
accounting records for one of the
following reasons:

The proprietor of the business

does not keep full set of
accounts

Some of business accounts are

accidentally lost or destroyed (by
fire, by accident)

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3.2.1 The accounting and business equations

Assets = Capital + Liabilities

Closing
net opening capital + profit - Drawings
= net assets + introduced
assets

Example 1: Exercise 4 page 65

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DRAWINGS

The business owner may pay The business owner may pay
money out of the business income into their bank account
bank account for items which
are not business expenses which has nothing whatever to do
with the business operations.

For example, the owner might

pay dividend income into the
Life A payment for
Trader has bank, from stocks and shares
taken goods which they own personally,
insurance their family’s
premiums holiday inventory for
personal use separate from the business itself.

The business entity concept means that the personal transactions of the
trader should be kept separate from the transactions of the
business.

A business owner receives The trader has taken goods

$600 in dividend income from inventory for personal
from investments not owned use. The goods should be
Payments should be
by the business and pays it charged to drawings on taken out of purchases and
into their business bank account: not included in inventories.
account, then the
accounting entry is: DEBIT Drawings DEBIT Drawings
DEBIT Cash CREDIT Cash
CREDIT Purchases
CREDITDrawings
The value of the goods taken is
recorded at cost to the
business, not at sale price.

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Example 2: Exercise 2 page 65

3.2.2. Establishing cost of sales

Gross profit = sales – cost of goods sold

Mark-up is the Gross profit

profit as a margin is the profit
percentage of cost as a percentage of
sales

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Example 4: Exercise 1 page 64

Incomplete
records

The accounting and Establishing cost of

business equations sales

Assets= Closing net assets= Mark- up

opening net asset+ Gross profit
liabilities+ profit+ capital- margin
captital drawings

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3.3 Preparation of financial

statements for sole traders

Content
1 Statements of profit or loss and other
comprehensive income
2 Statements of financial position

The process of preparing financial statements

Ledger
Transactions recorded accounts Trial balance
in ledger accounts balanced and extracted
closed off

Trial balance used to Year end adjustments

prepare Financial made and ledger
statements accounts closed off

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3.3.1. Statements of profit or loss

Objective:
The statement of profit or loss (P&L) is a financial
statement that summarizes the revenues, costs, and
expenses incurred during a specified period, usually a
fiscal quarter or year

1.2 Structure X COMPANY

STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED …….
$ $
Revenue X Cost of sales
Opening inventory X
Purchases X
Closing inventory (X)
(X)
Gross profit X Other income
– discounts received X Expenses
General expenses (X)
Depreciation (X)
(X)
Profit for the year X

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Example 1: Donal Brown, a sole trader, extracted the

following trial balance on 31 December 20X0

The following information as at 31 December is also available.

a) Depreciation is to be charged for the year as follows.
- Motor vehicles: 20% on cost
- Fixtures and fitting: 10% on cost
(b) Inventory at the close of business was valued at $ 19,926
Required:
1. Prepare Donald Brown’s statement of profit or loss for the year
ended 31 December 20X0
2. Prepare Donald Brown’s statement of financial position for the year
ended 31 December 20X0

01/01/20X
0

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DONAL
1.2 BROWN
Structure
STATEMENT OF PROFIT OR LOSS FOR THE
YEAR ENDED 31 DECEMBER 20X0
$ $
Revenue
Cost of sales
Opening inventory
Purchases
Expenses
Closing inventory Lighting and
heating

Gross profit Motor expenses

Other income – Rent

discounts received General expenses
Depreciation

Profit for the year

3.3.2. Statements of financial position

The statement of financial position also

known as the Balance Sheet, presents the
financial position of an entity at a given date. It
is comprised of three main
components: Assets, liabilities and equity.

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X COMPANY
STATEMENT OF FINANCIAL POSITION AS
AT ….
$ $
Non-current assets
Fixtures and fittings
- Cost X
- Accumulated depreciation (X)
X1
Motor vehicle
- Cost Current assets
X
- Accumulated depreciation (X) Inventory X X2
Receivables X Prepayments
X
X Cash in hand X

Capital
Balance as at X
….
Profit for the X
year
X
Less (X)
Drawings
X
Current
liabilities
Payables
X

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$ $
Non-current assets
Capital
Fixtures and fittings Balance as at 1
Accumulated January 20X0
Motor vehicles Profit for the year
Accumulated

Less Drawings
Current

Inventory
Current
liabilities
Receivables
Cash in hand Payables
Bank overdraft

3.4
Preparation IAS 1 Presentation of
financial statements
of financial
statements Statement of financial position
for
Statement of profit or loss and other
companies comprehensive income

Statement of changes in equity

Statement of cash flows

Notes, including a summary of significant

accounting policies and other explanatory
information

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ABC CO
1.2 Structure STATEMENT OF FINANCIAL POSITION AS
AT ….
20X2
20X1
Assets $ $ $ $
Non-current
assets
Property, plant and equipment X
X Goodwill X
X Other intangibles assets X
X
X X
Current assets
Inventories X X
Trade receivables X X
Other current assets X X
Cash and cash equivalents X X
X X
Total assets X X

ABC CO
STATEMENT OF FINANCIAL POSITION AS
AT ….
20X2
20X1
Equity and $ $ $ $
liabilities
Equity
Share capital X X
Retained earnings X X
Other components of equity X X
X X
Non-current liabilities
Long-term borrowings X X
Long-term provisions X X
X X
Current liabilities
Trade and other payables X X
Short-term borrowings,…. X X
X X
Total equity and liabilities X X

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• Non-current assets
Non-current assets includes tangible, intangible operating and
financial assets of a long-term nature.
• Current liabilities
A liability should be classified as a current liability when it is:
- Expected to be settled in the entity’s normal operating cycle
- Due to be settled within 12 months of the reporting date
- Held primarily for the purpose of being traded.
All other liabilities should be classified as non-current liabilities.

• Equity
Share capital and profit have to be disclosed separately, because
profit is distributable as a dividend but share capital cannot be
distributed
Therefore, any retained profits are kept in the retained earnings
reserve.

1.2 Structure X COMPANY

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED …….
20X2 20X1
$ $
Revenue X X Cost of sales
(X) (X) Gross profit X
X Other income X X Distribution
costs (X) (X) Administrative expenses
(X) (X) Other expenses (X)
(X) Finance cost (X) (X) Profit before
tax X X Income tax expense
(X) (X) Profit for the year X
X Other comprehensive income
Gains on property revaluation X X
Total comprehensive income for the year X X

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• Revenue:
- The sale of goods
- The rendering of services
• Cost of sales:
Cost of sales = Opening balance + Purchase – Closing balance
• Expenses
- Expenses are gathered under a number of headings
- Any detail needed will be given in the notes to the financial
statements.
• Finance cost: This is interest payable during the period. Remember
that this may include accruals for interest payable on loan stock.
• Income tax expense: This will include accruals for the tax due on the
current year’s profit.

EXAMPLE 2

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The following additional information is relevant.

(a)Inventory at 31 December 20X9 was valued at $1,600,000.
(b) Depreciation is to be provided as follows.
- Buildings at 5% straight line, charged to administrative expenses
- Plant and equipment at 20% on cost, charged to cost of sales
- Motor vehicles at 25% on cost, charged to distribution costs
(c) No final dividend is being proposed.
(d) A customer has gone bankrupt owing $ 76,000. This debt is not expect to
be recovered and an adjustment should be made. An allowance for
receivables of 5% is to be set up.
(e) Taxation was valued at $ 500
Required: Prepare the following:
(a)Statement of profit or loss for the year ended 31 December 20X9
(b)Statement of financial position as at 31 December 20X9

USB
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED
31 DECEMBER 20X9
$
Revenue Cost of
sales Gross profit
Distribution costs
Administrative expenses
Profit before tax
Income tax expense
Profit for the year

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$’000
Non-current assets
Property, plant and equipment
Current assets
Inventory
Trade receivables
Cash
Total assets
Equity and liabilities
Equity
Share capital Share
premium Retained
earnings Current
liabilities Sales tax
payable Trade
payables
Total equity and liabilities

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1.2 Structure

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