Preparing Basic Financial Statements
From trial balance to statements
The statement of profit or loss reports performance for a period: revenue − cost of sales = gross profit; less distribution and administrative expenses; plus other income; less finance costs; less tax = profit for the year. Cost of sales = opening inventory + purchases + carriage inwards − closing inventory.
The statement of financial position reports position at a date: non-current assets at carrying amount, current assets, equity (share capital, share premium, retained earnings, revaluation surplus), non-current liabilities and current liabilities.
The statement of changes in equity reconciles opening and closing equity: opening balance + shares issued (including premium) + profit for the year − dividends paid ± other comprehensive income.
Frequently tested adjustments: accruals and prepayments, depreciation and disposals, inventory, tax payable, interest payable, allowances for receivables, and shares issued at a premium. A basic statement of cash flows splits cash movements into operating, investing and financing activities.
Traps: dividends paid are not an expense - they reduce retained earnings; finance costs and tax sit below operating profit; closing inventory is a current asset and reduces cost of sales; share premium is not profit; drawings reduce capital, not expenses.
Worked example: opening retained earnings $40,000, profit for the year $25,000, dividends paid $8,000, and a $5,000 bonus issue capitalised from reserves. Closing retained earnings = 40,000 + 25,000 − 8,000 − 5,000 = $52,000.
Rule of thumb: build the statements in the order revenue, cost of sales, expenses, finance and tax, then equity - and confirm the statement of financial position balances before moving on.