Tutorial

Table of Contents

 

1 Learning Objectives 8 Normal Balances and Trial Balance: Corporations  
2 Overview

9

Financial Statements for Corporations: Income Statement  
3 Normal Balances

10

Financial Statements for Corporations: Statement of Retained Earnings  
4 Normal Balances and Trial Balance: Sole-Proprietorships

11

Financial Statements for Corporations: Balance Sheet  
5 Financial Statements for Sole-proprietorships: Income Statement

12

Review Question 1  
6 Financial Statements for Sole-proprietorships: Statement of Changes in Owner's Equity

13

Summary  

7

Financial Statements for Sole-proprietorships: Balance Sheet

14

Key Terms  


Learning Objectives
After completing this tutorial you should be able to:

Prepare a trial balance.

Prepare an income statement.

Prepare a balance sheet.

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Overview

The accounting cycle includes all the steps from the occurrence of various transactions to the preparation of the financial statements. Previous tutorials described the following two steps:
Analyze and record transactions in journal.
Post transactions to ledger.

This tutorial describes two steps which are completed after posting transactions to the ledger:
Prepare trial balance.
Prepare financial statements.

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Normal Balances

Assets

Assets are increased by debits. Therefore, the normal balance in asset accounts is a debit balance. Cash is debited when cash is received. Cash is credited when cash is paid. A credit balance would imply that the organization has a negative amount of Cash. Thus usually we would expect a debit balance in the Cash account. In the example shown below the Cash account has been debited by $10,500 for receipts and credited by $2,500 for payments resulting in a debit balance of $8,000.

Cash

Debit

 

Credit


|


Liabilities
Liabilities are increased by credits. When amounts owed to creditors or suppliers increase, a liability account is credited. When a payment is made to creditors (suppliers) the liability is debited. Thus the normal balance in a liability account is a credit balance. In the example shown below the Accounts payable account has been credited by $1,200 for credit purchases and debited by $700 for payments resulting in a credit balance of $500.

Notes Payable

Debit

 

Credit


|


Owners' Equity

Owners' equity is increased by credits. Since the accounts used for recording owner investments and distribution of cash to owners are different for different forms of business organizations, the normal balances for these accounts are described separately for proprietorships and corporations later in the tutorial.

Revenues

Owners' equity increases when a business earns revenue. A revenue account is credited to show this increase in owners' equity. Thus revenue accounts will typically have a credit balance.

Expenses

Owners' equity decreases when a business incurs an expense. An expense account is debited to record this decrease in owners' equity. Thus expense accounts will typically have a debit balance.


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Normal Balances and Trial Balance - Sole-proprietorships


Normal Balances: Owner's Equity Accounts

Owners' equity is increased by credits. The Owner's Capital account is credited to record owner investments in sole-proprietorships. Thus the normal balance in the Capital account is a credit balance.

When a sole proprietor withdraws money, the Drawings account is debited since withdrawals reduce owner's equity. Hence the normal balance in the Drawings account is a debit balance.

Trial Balance

After all the transactions have been posted, a trial balance is prepared. As shown below, a trial balance lists each account in the general ledger and its balance (debit or credit) on a particular date. The total of the amounts in the debits column must equal the total of the amounts in the credit column. If the two amounts do not match there must be an error in the recording. For example, if only the debit part of an entry is posted then the two amounts will not match.

Clean-Rite Service
Trial Balance
March 31, 2000

 

Debit

Credit

Cash

$1,085

 
Supplies

35

 
Equipment

400

 
Truck

1,000

 
Notes Payable  

$1,750

Lisa, Capital  

500

Lisa, Drawings

100

 
Service Revenue  

 450

Supplies Expense

80

 
     
 

$2,700
=====

$2,700
=====
     

After preparing the trial balance, financial statements are prepared. The next few screens will describe three financial statements for proprietorships. These are:

Income Statement
Statement of Changes in Owners' Equity
Balance Sheet

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Financial Statements for Sole-proprietorships: Income Statement

An income statement shows the profitability of a business over a period of time. It shows the revenue and expense account balances. The difference between revenues earned during a period and the expenses for the period represents the net income for the period. The heading of the statement shows the name of the organization, the title of the statement and the period for which the statement is being prepared.

Clean-Rite Service
Income Statement
for the month ended March 31, 2000

Revenues    
Service Revenue  

 $450

     
Expenses    
Supplies Expense

80

 
 

Total Expenses

80

Net Income  

$370
     


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Financial Statements for Sole-proprietorships :
Statement of Changes in Owner's Equity

The statement of changes in owners' equity shows transactions affecting owners' equity during a period. Three types of transactions affected owner's equity for Clean-Rite Service: (1) the original investment of $500, (2) the revenues and expenses resulting in a net income of $370 and (3) the withdrawal of $100 by the owner. The heading of the statement shows the name of the organization, the title of the statement and the period for which the statement is being prepared.

Clean-Rite Service
Statement of Owner's Equity
for the month ended March 31, 2000
Lisa, Capital, March 1, 2000  

 0

     
Plus: Investments  

 $500

       
  Net Income  

 370

       
Less: Drawings:  

 100

Lisa, Capital, March 31, 2000  

$770
====
     
     

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Financial Statements for Sole-proprietorships: Balance Sheet
A balance sheet presents the financial position of an organization on a particular date. It shows the assets, liabilities and owners' equity balances for a company at the end of a fiscal period.

The heading of the statement shows the name of the organization, the title of the statement and the date at which the statement is being prepared.

Clean-Rite Service
Balance Sheet
March 31, 2000

   

Debit

Assets    
Cash  

$1,085

Supplies  

35

Equipment  

400

Truck  

1,000

Total Assets  

$2,520
=====
     
Liabilities    
Notes Payable

$1,750

Total Liabilities  

1,750

     
Owner's Equity    
Lisa, Capital

 770

  
Total Owner's Equity  

 770

 Total Liabilities & Owner's Equity  

$2,520
=====
     

For sole-proprietorships, the balance in the Owner's, Capital account is shown in the owner's equity section of the balance sheet. Note that the balance sheet shows the ending balance in the Owner's Capital account. The ending balance is computed as shown in the statement of changes in owner's equity.


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Normal Balances and Trial Balance: Corporations

Owners' equity is increased by credits. Corporations record direct owner investments using the Capital Stock account. Since direct owner investments increase owners' equity, the Capital Stock account is credited. Thus Capital Stock will have a credit balance. Distributions to owners are recorded in the Dividends account. When dividends are declared owners' equity in the business decreases and the Dividends account is debited. Normally, the Retained Earnings account will have a credit balance. However, if a business has had losses, the Retained Earnings account can have a debit balance.

Trial Balance

After all the transactions have been posted, a trial balance is prepared. As shown below, a trial balance lists each account in the general ledger and its balance (debit or credit) on a particular date. The total of the amounts in the debits column must equal the total of the amounts in the credit column. If the two amounts do not match there must be an error in the recording. For example, if only the debit part of an entry is posted then the two amounts will not match.

Music Stop
Trial Balance
April 30, 2000

 

Debit

Credit

Cash

$36,400

  
Supplies

17,000

  
Equipment

12,000

  
Accounts Payable  

$15,000

Notes Payable  

40,000

Capital Stock  

10,000

Retained Earnings  

 0

Sales Revenue  

4,500

Cost of Goods Sold

3,000

  
Salaries Expense

 1,000

  
Utilities Expense

100

  
 

$69,500
======

$69,500
======
     

After preparing the trial balance, financial statements are prepared. The next few screens will describe three financial statements for corporations. These are:

Income Statement
Statement of Retained Earnings
Balance Sheet

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Financial Statements for Corporations: Income Statement

The income statement for Music Stop for the month of April, 2000 is shown below. An income statement shows the profitability of a business over a period of time. It shows the revenue and expense account balances. The difference between revenues earned during a period and the expenses for the period represents the net income for the period. The heading of the statement shows the name of the organization, the title of the statement and the period for which the statement is being prepared.

Music Stop
Income Statement
for the month ended April 30, 2000

Revenues    
Sales Revenue  

 $4,500

     
Expenses    
Cost of Goods Sold

$3,000

 
Salaries Expense

1,000

 
Utilities Expense

    100

 
Total Expenses  

 4,100

   

$400 
=====

     

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Financial Statements for Corporations: Statement of Retained Earnings

The income statement showed the changes to owners' equity resulting from profitable operations of the business. Retained earnings represents the portion of owners' equity created by earning net income and reinvesting the profits in the business. The net income minus any dividends declared represent the reinvested profits. The reinvested profits are added to the beginning retained earnings balance. This gives the following relationship:

Ending Retained Earnings = Beginning Retained Earnings + Net Income - Dividends

Note that the Retained Earnings balance on the trial balance ($0) corresponds to the balance in the Retained Earnings account at the beginning of the period. This is because revenues, expenses and dividends are recorded in separate accounts during the fiscal period. Thus the amount of reinvested profits are not accumulated in the Retained Earnings account during the period.

The statement of retained earnings for Music Stop for the month of April, 2000 is given below. The heading of the statement shows the name of the organization, the title of the statement and the period for which the statement is being prepared.

Music Stop
Statement of Retained Earnings
for the month ended April 30, 2000

Retained Earnings, April 1, 2000  

 0

     
Plus: Net Income  

 400

     
Less: Dividends  

 0

     
Retained Earnings, April 30, 2000  

$400
====
     



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Financial Statements for Corporations: Balance Sheet

A balance sheet presents the financial position of an organization on a particular date. It shows the assets, liabilities and owners' equity balances for a company at the end of a fiscal period. Note that the Retained Earnings balance is the ending balance shown in the statement of retained earnings. The heading of the statement shows the name of the organization, the title of the statement and the date at which the statement is being prepared.

Music Stop
Balance Sheet
April 30, 2000

   

Debit

Assets    
Cash  

$36,400

Supplies  

17,000

Equipment  

12,000

Total Assets  

$65,400
======
     
Liabilities    
Accounts Payable

$15,000

Notes Payable

40,000

 
Total Liabilities

55,000

     
Owner's Equity    
Capital Stock

10,000

  
Retained Earnings

400

 
Total Owner's Equity  

10,400

 Total Liabilities & Owner's Equity  

$65,400
======
     

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Review Problem 1


Fill in the blanks. Use a term from the list given below.

Terms:

balance sheet

dividends

income statement

net income

normal balance

trial balance

A   lists all the accounts with their ending balances.

  is added to the beginning Retained earnings balance to compute the ending balance.

are subtracted from the beginning Retained earnings balance to compute the ending balance.

Revenues and expenses are shown on the  

Assets and liabilities are shown on the 

 refers to whether an account usually has a debit or a credit balance.

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Summary

The ending balance in an account is the difference between the account's total debits and total credits. Normal balance refers to whether an account usually has a debit or a credit balance.

A trial balance lists each account in the general ledger and its balance (debit or credit) at a particular date. The total of the amounts in the debits column must equal the total in the credits column.

An income statement reports the revenue and expense account balances. The difference between revenues and expenses represents the net income for the period.

The statement of retained earnings summarizes changes to retained earnings resulting from the business operations of a particular period.

A balance sheet reports the assets, liabilities and owners' equity balances for a business at the end of a fiscal period.


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Key Terms
 
Asset Liability
Balance Sheet Owners' Equity
Dividends Revenue
Expense Statement of Changes in Owners' Equity
Income Statement Statement of Retained Earnings

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