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Financial Statement Analysis

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Financial Statement Analysis-FIN621
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Lesson-8
ACCOUNTING CYCLE/PROCESS
(Continued)
Pre-paid costs e.g. Pre-paid rent, will be recorded as follows:
Date
Description
L/F
Dr.
Cr.
Prepaid Rent
12,000
Cash Account
12,000
Rent paid in advance
Pre-paid costs e.g. Pre-paid rent, will be recorded as follows:
Date
Description
L/F
Dr.
Cr.
Rent Expense
1,000
Prepaid Rent
1,000
Recording rent expense
Pre-paid costs e.g. Pre-paid Insurance will be recorded as follows:
Date
Description
L/F
Dr.
Cr.
Prepaid Insurance
12,000
Cash Account
12,000
Insurance paid in advance
Pre-paid costs e.g. Pre-paid Insurance will be recorded as follows:
Date
Description
L/F
Dr.
Cr.
Insurance Expense
1,000
Prepaid Insurance
1,000
Recording Insurance expense
g) Preparing Financial Statements
Now we come to the all-important step of preparing Financial Statements from
Accounting Records. Income Statement is prepared from Adjusted Trial Balance, first. Then Statement
of Owner's equity between Income Statement and Balance Sheet is prepared. For this, Net profit/loss in
Income Statement is added to/ subtracted from owner's equity in "Owner's equity Statement", and the
total/net is then transferred to Balance Sheet. After the preparation of Balance Sheet, the fourth
Financial Statement i.e. Cash flow Statement is prepared separately.
As a practical illustration, let us prepare these Financial Statements.
Income Statement
For the period ending August 31, 2006
Particulars
Rs.
Rs.
Revenues
Sales Commission earned.
10,640
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Financial Statement Analysis-FIN621
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Expenses
Advertising expenses.
645
Salaries expenses.
7,400
Telephone expenses.
400
Depreciation expense: building
150
Depreciation expense: office equipment
45
8,640
Net Income.
2,000
The revenue and expenses shown in the income statement are taken directly from the company's
adjusted trial balance. Our measurement of net income is not absolutely accurate or precise, because of
the assumptions and estimates in the accounting process. An income statement has certain limitations.
Remember that the amount shown for depreciation expense or based on estimates of the useful lives of
the company's building and office equipment. Also the income statement includes only those events that
have been evidence by business transactions. Alternative titles for the income statement include
earnings statement, statement of operations, and profit and loss statement. However, income statement
is by far the most popular term for this important financial statement. In summary, we can say that an
income statement is used to summaries the operating results of business by matching the revenue
earned during a given time period with the expenses incurred in obtaining that revenue.
Note: This is case of service business, and sole proprietorship. In the case of Merchandise
& Manufacturing business:
Net Income=Sales­Cost of Goods sold­Other expenses.
ii) Owner's equity Statement
Owner's equity which was Rs.180, 000 on July 31, 2006 increases by Rs.2000 due to
profitable operations during the month of August, 2006. Net income is transferred to owner's equity
statement, which is further transferred to Balance Sheet. Correspondingly, there would be either
increase in Assets (Left) side of the Accounting Equation (or Balance Sheet), or decrease in Liabilities
(Right) side, to maintain balance.
Statement of Owner's equity summarizes increase/decrease in owner's equity during
accounting period. It is increased due to profit and additional investment by the owner. It is decreased
due to loss and withdrawal/drawing by the owner.
Statement of Owner's equity for the month of August, 2006
Particulars
Rs.
Khizr, capital July 31, 2006
180,000
Add: Net income for August, 2006
2,000
Additional investment by owner
4,000
Sub total
186,000
Less withdrawal/drawing by owner
3,000
Owner's equity August 31, 2006
183,000
III. Balance Sheet
The balance sheet lists the amounts of the company's assets, liabilities, and owner's equity at
the end of accounting period. The balances of the assets and liability accounts are taken directly
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Financial Statement Analysis-FIN621
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from the adjusted trial balance. Cash is listed first among the assets. It is often followed by such
asset as marketable securities, short-term notes receivable, accounts receivable, inventories, and
supplies. These are the most common examples of current assets. The term "current assets"
includes cash and those assets that will be quickly converted to cash or used up in operations
.
Khizr Property Dealer
Balance Sheet
As on August 31,2006
Assets
Rs.
Rs.
Liabilities & Equity
Rs.
Cash
16,105
Accounts Payable
23,814
Accounts Receivables
19,504
Owner's equity
183,000
Land
130,000
Building
36,000
Less Accumulated Dep:
150
35,850
Office Equipment
5,400
Less Accumulated Dep:
45
5,355
TOTAL
206,814
TOTAL
206,814
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Owner's equity obtained from Owner's equity statement
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