Guided Readings for Financial Accounting, Lesson 5.2 – Expert Level
Read the third section of Chapter Five (“Preparation of Financial Statements”). We have looked at transactions, debits, credits, journal entries, T-accounts, a trial balance, and adjusting entries. It is time to put all that together and create financial statements. The income statement, statement of retained earnings, and balance sheet are presented here with the statement of cash flows examined in a later chapter.
Look at the accounts presented in the trial balance in Table 5.7. Trace each number to where it is reported on the financial statements shown in Table 5.8. Make sure you see where each balance is included in the individual financial statements. Where is Cash reported? Where is Accounts Receivable reported? Where is Salary Expense reported? Are all of the balances found within the specific statement that you expected?
Near the section titled “The Purpose of Closing Entries,” you will find a link to a video titled “Understanding Account Balances.” Watch that video to make sure you have understood the information that is conveyed by each of these accounts.
(5Q20) – For the following accounts, indicate on which financial statement each balance should be reported:
- --Gain on sale of land
- --Insurance expense
- --Dividends paid
- --Cost of goods sold
- --Capital stock
- --Note payable
- --Deferred revenue
- --Gain on sale of land – Income statement
- --Insurance expense – Income statement
- --Dividends paid – Statement of retained earnings
- --Inventory – Balance sheet
- --Cost of goods sold – Income statement
- --Capital stock – Balance sheet
- --Note payable – Balance sheet
- --Deferred revenue – Balance sheet
The following statement comes from the end-of-chapter material for the Financial Accounting textbook. The statement is FALSE. Explain why it is false. Only one trial balance is prepared during each separate accounting period.
The previous statement is False. A company can produce a new trial balance (which is simply a list of all current T-account balances) whenever officials want to study those figures. Companies often produce trial balances at regularly scheduled intervals such as each day or each week. A trial balance is normally produced prior to the preparation of adjusting entries and again after they have been made.
(5Q21) – As far as time is concerned, how are the various financial statements dated?
(5A21) – The income statement, the statement of retained earnings, and the statement of cash flows all report activities that cover a period of time. “For the year ended December 31, 2023,” for example, or “From January 1, 2023, to December 31, 2023.” A balance sheet presents a company’s asset and liability amounts at one specific point in time. That day is normally the last day of the period of time reflected in the other statements. In this example, that is December 31, 2023.
(5Q22) – In what order are financial statements produced?
(5A22) – When financial statements are prepared, the income statement is created first. The net income number must be determined so it can be used in the next statement: the statement of retained earnings. The final retained earnings number is then computed and used in the production of a balance sheet. The statement of cash flows is different. It does not report account balances. Instead, it reports all changes in the cash balance during the period -- classified within three categories for ease of understanding.
This entire textbook is primarily a study of financial statements as prepared using U.S. GAAP. Take a few minutes and study the examples presented in Table 5.8. How are revenues and expenses shown? Why is the gain on sale of land reported separately? Why are dividends paid not on the income statement? What accounts are reported as current assets and current liabilities? What do the two figures in stockholders’ equity tell decision makers? There is a lot of important information available here.
(5Q23) – What is the purpose of closing entries?
(5A23) – Closing entries have two purposes. First, certain balances (revenues, gains, expenses, losses, and dividends distributed) only measure the financial effect for the current period. At the end of that time, these balances are reset back to zero. Second, retained earnings includes all revenues, gains, expenses, losses, and dividends distributed since the company first began. After each year, these account balances must be moved into retained earnings. Closing entries are prepared at the end of each year to solve both needs.
Walk through the following: In Table 5.1, a trial balance is presented as of 12/31. All T-account balances are listed with their debit or credit total. In Tables 5.2, 5.3, 5.5, and 5.6, adjusting entries are made so that all accounts are presented fairly according to U.S. GAAP. (Table 5.4 shows an alternative scenario.) Table 5.7 is the trial balance updated for these entries. Financial statements (except for the statement of cash flows) are presented in Table 5.8. This is the accounting system that companies use to ensure that all reported information is presented fairly according to U.S. GAAP.
SUGGESTION: What are the important topics in Chapter Five? What will help you most in the business world as you seek to make wise decisions? Watch the video at the end of the chapter (“The Most Important Elements of Chapter Five”) and see if you agree with the assessment made by one of the authors. The video is not terribly long. It is a good use of your time. Some topics are simply more important than others and you want to be aware of those as you review this chapter.
SUGGESTION: At the end of Chapter Five, you will find two video problems. The second concerns your uncle who holds an ownership interest in an office supply store. He is aware of the need for adjusting entries, but he is not sure which of the accounts might need adjusting. As with many business people, he understands his business well but he is uncertain about accounting. What advice would you provide? Watch the video. These kinds of problems can make the subject more real for you.
SUGGESTION: Go to the end of Chapter Five and work Problem Number 7 (the Marlin Corporation – this was problem 3 in the previous edition). This problem looks at unearned (or deferred) revenue, accrued expenses, prepaid rent, and accrued revenue. See what answers you get. Then, watch the following video. If you arrive at the correct entries, you are ready to move on. Make sure to go back and restudy anything you miss.
“An hour of hard practice is worth five hours of foot-dragging.”
Pancho Segura, tennis legend