Preparing Company Final Accounts from a Trial Balance

Understand Preparation of Financial Statements from Trial Balance

Key rules to remember

Change in inventories

Opening inventory − Closing inventory

A positive figure is an expense item; a negative figure (closing is higher) reduces expenses. Show it as its own line.

Total expenses

Cost of materials + Purchases of stock-in-trade + Changes in inventories + Employee benefit expense + Finance costs + Depreciation + Other expenses

Use the adjusted figure for each line, after outstanding and prepaid amounts.

Profit before tax (PBT)

Total revenue (revenue from operations + other income) − Total expenses

Exceptional or extraordinary items, if any, are shown separately before arriving at PBT.

Profit after tax (PAT)

PBT − Tax expense

Tax is usually given as a rate on PBT. The unpaid tax is a short-term provision in the Balance Sheet.

Closing surplus

Opening surplus + PAT − Transfers to reserves − Dividend paid or declared

Shown under Reserves and Surplus. A negative balance is shown in brackets.

Adjusted expense

Expense per trial balance + Outstanding − Prepaid

The outstanding amount is a current liability; the prepaid amount is a current asset.

Net carrying amount of asset

Cost − Accumulated depreciation

Depreciation for the year is added to any accumulated depreciation already in the trial balance.

Balance Sheet check

Equity + Non-current liabilities + Current liabilities = Non-current assets + Current assets

If this fails, recheck adjustments posted only once, or the surplus working.

How to solve Preparation of Financial Statements from Trial Balance questions

1. 1Read the adjustments first. Tick each trial balance item they touch and note whether it affects the profit statement, the Balance Sheet, or both.
2. 2Tag every trial balance item with its Schedule III head. For example: purchases is purchases of stock-in-trade, wages and salaries are employee benefit expense, debenture interest is finance cost, bad debts is other expenses.
3. 3Draft the Statement of Profit and Loss in Schedule III order. Revenue first, then expenses line by line with adjusted figures. Compute PBT.
4. 4Compute tax on PBT at the rate given. Deduct it to get PAT. If the question gives dividend or reserve transfers, work out the surplus: opening surplus + PAT − transfers − dividend.
5. 5Draft the Balance Sheet. Equity: share capital, then Reserves and Surplus. Then non-current liabilities, current liabilities. On the asset side: non-current assets (net of depreciation), then current assets.
6. 6Add each side and check that the totals agree. If they do not, find the difference and look for a missed adjustment.
7. 7Add short notes or working notes: depreciation workings, surplus working, and any proposed dividend disclosure.

Quickest way: One-pass adjustment table

Common mistakes in Preparation of Financial Statements from Trial Balance

• Posting an adjustment only in the profit statement or only in the Balance Sheet.

  Students treat adjustments as one-sided corrections.

  Fix: Every adjustment has two effects. Closing inventory, depreciation, outstanding and prepaid items and tax must each appear in both statements.

• Showing closing inventory as a credit in the profit statement and also adding opening inventory with purchases, then showing it again in a different way.

  Old trading account habits clash with the Schedule III format.

  Fix: Show only one line, changes in inventories = opening − closing. Then show closing inventory as a current asset.

• Treating proposed dividend as a liability and deducting it from surplus.

  Older books showed a provision for proposed dividend.

  Fix: A dividend proposed after the year end is only disclosed in the notes. Deduct only interim dividend or a dividend that the question says was declared in the year.

• Showing tax payable inside Reserves and Surplus or ignoring it in the Balance Sheet.

  Students deduct tax from profit and then forget the liability.

  Fix: Deduct tax in the profit statement, and show the unpaid amount under short-term provisions in current liabilities, unless the trial balance shows tax already paid.

• Showing assets at gross cost after charging depreciation.

  Depreciation is posted to the profit statement and the asset is left untouched.

  Fix: Reduce the asset by depreciation for the year and any accumulated depreciation, and present it at net carrying amount.

• Putting items under the wrong head, such as debenture interest in other expenses or provision for doubtful debts as a liability.

  Students do not memorise the Schedule III heads.

  Fix: Finance costs include interest on borrowings. Provision for doubtful debts is deducted from trade receivables, and its charge goes to other expenses.

Worked examples