Chapter
Preparing
Financial Statements
3
For Single Company
1
3.1 Dealing with exam questions
Tutor note: Objective test questions and integrated case study will not require you to
complete a whole set of financial statements. However it is imperative that you practice
questions preparing financial statements in order to understand the whole process. This will
then help with the answering shorter questions in objective tests and integrated case study.
You will normally be given the trial balance of a company, from which you will need to produce
the statement of comprehensive income (income statement), statement of financial position
(balance sheet) and statement of changes in equity in accordance with current regulations.
You will also be given a list of additional information. Some of this information will need to be
incorporated into the financial statements and some will be for note purposes.
Journal entries
required
Additional
Trial balance
+
information
Disclosure in
notes
Statement of Statement of
Statement of
comprehensive financial position
changes to
income (balance sheet)
equity
(income
statement)
Statement of
Cash flows
Notes to the above
financial statements
Financial statements
2
Technique for preparing financial statements
Step 1 Layout pro-forma s
For the statement of comprehensive income (income statement) and statement of
financial position (balance sheet), allow for 2 whole A4 sides for each statement.
For the statement of changes in equity allow 1 whole A4 side. For the statement of
cash flows all 2 whole A4 sides.
Step 2 Work through the notes
Go through the additional information provided note by note. This will involve:
(i) Identifying any relevant accounting standards / accounting principles,
describing the accounting standards and explaining the treatment of the
transaction.
(ii) Doing journal entries
(iii) Doing further calculations
(iv) Detailing the destination of transactions (i.e. income statement / statement of
financial position / statement of changes in equity)
Step 3 Additional calculations
After the notes have been dealt with, do the following calculations before completing
the financial statements:
(i) Depreciation
(ii) Cost of sales
(iii) Carrying value of tangible and intangible assets
(iv) Taxation charge
Step 4 Complete the financial statements
Pick the figures from the trial balance and insert into the pro-forma financial
statements (ensuring you tick and bash the trial balance and also incorporate the
workings done during step 2 and step 3). Ensure the workings are cross referenced.
Order of completion:
1 Statement of comprehensive income (income statement)
2 Statement of changes in equity
3 Statement of financial position (balance sheet)
Tutor note: it s important to practice preparing financial statements as part of your revision
to ensure that you fully understand the whole process. This will help with answering shorter
questions set in the exam.
3
Under international accounting standards, the IASB have issued the formats for the financial
statements. However these can be adapted for individual companies needs if it allows users a
greater understanding of the financial statements.
Other useful tips for preparing financial statements
1 Finance cost
Always watch out for interest (finance cost) accruing on long-term borrowings. If the trial balance
shows the full amount of interest for the year paid for, there are no further workings required.
However if the full amount has not be paid during the year, the remaining finance cost will need to
be accrued:
Debit Finance cost (statement of comprehensive income / income statement)
Credit Interest payable (statement of financial position /balance sheet)
2 Taxation
The taxation charge to the income statement consists of:
Tax estimate for the year X
Under / (over) provision X / (X)
Increase / (decrease) in deferred taxation X / (X)
Tax charge to the income statement X
The actual taxation paid to the tax authorities is normally calculated after the financial statements
have been finalised. The actual tax paid will either be more or less than what was accrued. This
therefore results in either an over provision or under provision.
Under provision from last year will result in a higher charge to the income statement  bad news!
In the trial balance this would be a  debit balance.
Over provision from last year will result in a lower tax charge to the income statement  good
news! In the trial balance this would be a  credit balance
4
2 Taxation cont& .
Journal entries for the tax are as follows:
Note: IS = statement of comprehensive income / income statement
BS = statement of financial position / balance sheet
Tax estimate for the year Dr Tax expense IS Cr Tax payable BS
Under provision Dr Tax expense IS Cr Tax payable BS
Over provision Dr Tax payable BS Cr Tax expense IS
Deferred tax increase Dr Tax expense IS Cr Defer tax BS
Deferred tax decrease Dr Defer tax BS Cr Tax expense IS
The tax estimate for the year will appear under  current liability in the statement of financial
position / balance sheet. The under / over provision s are removed from the statement of financial
position and transferred to the income statement.
The journal above will increase or decrease the deferred taxation in the balance sheet. Deferred
taxation in the statement of financial position appears under  non current liabilities
Taxation account in statement of financial position (current liability)
Bal b/f (under provision) X Bal b/f (over provision) X
Transfer over provision to tax X Transfer under provision to tax X
expense in IS expense in IS
Tax estimate for the year X
Bal c/f = tax estimate X
Total X Total X
5
3 Other manual journals
Note: IS = statement of comprehensive income / income statement
BS = statement of financial position / balance sheet
SOCE = statement of changes in equity
Accruals for expenses Dr Expense IS Cr Current liability BS
Prepayments of expenses Dr Current asset BS Cr Expense IS
Dividends proposed Dr SOCE Cr Current liability BS
Depreciation Dr Expense IS Cr Provision for depreciation BS
Amortisation Dr Expense IS Cr Provision for amortisation BS
Impairment of assets Dr Expense IS Cr Provision for amortisation BS
Revision on double entry rules
Event Financial statement Debit or Credit
Increase in assets Balance sheet Debit
Decrease in assets Balance sheet Credit
Increase in liability Balance sheet Credit
Decrease in liability Balance sheet Debit
Increase in capital Balance sheet Credit
Decrease in capital Balance sheet Debit
Increase in revenue Income statement Credit
Decrease in revenue Income statement Debit
Increase in expense Income statement Debit
Decrease in expense Income statement Credit
6
Lecture Example 3.1 - Dot Cotton Ltd
The following trial balance has been prepared by Dot Cotton Ltd, plastics manufacturers, on 31
May 20X4, which is the end of the company s accounting period.
Ł Ł
Share capital Ł1 ordinary shares 400,000
Share premium account 100,000
Revaluation reserve 100,000
Accumulated profit  31 May 20X3 275,500
Tax liability 6,000
Provision for deferred taxation 8,000
Dividends paid 20,000
Intangible assets 215,500
Freehold land at cost 250,000
Leasehold property
Cost 75,000
Amortisation  31 May 20X3 15,000
Factory plant and machinery
Cost 150,000
Accumulated depreciation  31 May 20X3 68,500
Fixtures and fittings
Cost 50,000
Accumulated depreciation - 31 May 20X3 15,750
Motor vehicles
Cost 75,000
Accumulated depreciation - 31 May 20X3 25,000
10% debentures (20X2  20X8) 100,000
Trade receivables 177,630
Trade payables 97,500
Bank overdraft 65,250
Opening inventories as at 31 May 20X3
Raw materials 108,400
Work in progress 32,750
Finished goods 184,500
Purchases  raw materials 750,600
Carriage inwards  raw materials 10,500
Manufacturing wages 250,000
Manufacturing overheads 125,000
Cash 10,120
Sales 1,526,750
Administrative expenses 153,100
Selling and distributable expenses 116,800
Financial, legal and professional expenses 54,100
Provisions for doubtful trade receivables 5,750
2,809,000 2,809,000
7
Additional information:
a) Inventories at 31 May 20X4 were:
Ł
Raw materials 112,600
Finished goods 275,350
Work in progress 37,800
b) Depreciation for the year for the non-current assets is to be charged as follows:
Plant and machinery 8% on cost  charged to production
Fixtures and fittings 10% on cost  charged to admin.
Motor vehicles 20% on reducing value  25% admin
- 75% selling and distribution
The leasehold land and buildings are held on a 50-year lease, acquired ten years ago.
c) Financial, legal and professional expenses include Ł5,000, which relates to the solicitor s
fees for purchase of freehold land during the year.
d) Provision is to be made for a full year s interest on the debentures.
e) The corporation tax charge on the profits of the year is estimated at Ł40,000 and is due for
payment on 28 February 20X5. This has not yet been provided. The balance on the
corporation tax liability account relates to the balance of last years estimate after payment.
The provision for deferred taxation is to be increased by Ł5,000.
f) In addition to the interim dividends paid during the year, the directors propose that a final
dividend of 1 pence per share to be paid on the ordinary share capital. This announcement
was made before 31st May 20X4.
g) The freehold land had a professional valuation done at the year end. The freehold land was
valued at Ł300,000. This has not yet been accounted for (ignore note c for the revaluation
gain or loss calculation).
Requirement
Prepare Dot Cotton Ltd s statement of comprehensive income (income statement), the statement of
changes in equity for the year ended 31 May 20X4 and statement of financial position (balance
sheet) at that date.
The financial statements should be in the form suitable for international accounting standards.
Notes are not required. The statement of comprehensive income should be one statement.
8
For lecture example 3.1, the 2 part income statement would appear as follows:
Dot Cotton Ltd: Income statement for year ended 31 May 20X4
Ł Ł
Revenue 1,526,750
Cost of sales (1,048,000)
Gross profit 478,750
Distribution costs (124,300)
Administrative expenses (211,200)
Finance costs (10,000)
Profit before tax 133,250
Income tax expense (39,000)
Profit for the year 94,250
Dot Cotton Ltd: Other comprehensive income for the year ended 31 May 20X4
Ł
Profit for the year 94,250
Other comprehensive income
Gain on revaluation of land 50,000
Total comprehensive income for the year 144,250
Homework
Get hold of annual accounts of your company or order some from financial times. Review
these to give you a better understanding of how companies produce and present financial
statements.
9
Key summary of chapter   Preparing financial statements for single company
Tutor note: Objective test questions and integrated case study will not require you
to complete a whole set of financial statements. However it is imperative that you
practice questions preparing financial statements in order to understand the whole
process. This will then help with the answering shorter questions in objective tests
and integrated case study.
Step 1 Layout pro-forma s
For the statement of comprehensive income (income statement) and statement of
financial position (balance sheet), allow for 2 whole A4 sides for each statement. For
the statement of changes in equity allow 1 whole A4 side. For the statement of cash
flows all 2 whole A4 sides.
Step 2 Work through the notes
Go through the additional information provided note by note. This will involve:
(i) Identifying any relevant accounting standards / accounting principles,
describing the accounting standards and explaining the treatment of the
transaction.
(ii) Doing journal entries
(iii) Doing further calculations
(iv) Detailing the destination of transactions (i.e. income statement / statement of
financial position / statement of changes in equity)
Step 3 Additional calculations
After the notes have been dealt with, do the following calculations before completing
the financial statements:
(i) Depreciation
(ii) Cost of sales
(iii) Carrying value of tangible and intangible assets
(iv) Taxation charge
Step 4 Complete the financial statements
Pick the figures from the trial balance and insert into the pro-forma financial statements
(ensuring you tick and bash the trial balance and also incorporate the workings done
during step 2 and step 3). Ensure the workings are cross referenced.
Order of completion:
1 Statement of comprehensive income (income statement)
2 Statement of changes in equity
3 Statement of financial position (balance sheet)
10
Manual journals
Accruals for expenses Dr Expense IS Cr Current liability BS
Prepayments of expenses Dr Current asset BS Cr Expense IS
Dividends proposed Dr SOCE Cr Current liability BS
Depreciation Dr Expense IS Cr Provision for depreciation BS
Amortisation Dr Expense IS Cr Provision for amortisation BS
Impairment of assets Dr Expense IS Cr Provision for amortisation BS
11
12
Solutions to Lecture Examples
Solution to Lecture Example 3.1 - Dot Cotton Ltd
Step 1 Layout the pro forma s
Step 2 Work through the notes systematically
Step 3 Additional calculations
Step 4 Complete the financial statements
Dot Cotton Ltd: Statement of comprehensive income for year ended 31 May 20X4
Ł Ł
Revenue 1,526,750
Cost of sales (W1) (1,048,000)
Gross profit 478,750
Distribution costs (W2) (124,300)
Administrative expenses (W3) (211,200)
Finance costs (note d) (10,000)
Profit before tax 133,250
Income tax expense (note e) (39,000)
Profit for the year 94,250
Other comprehensive income
Gain on revaluation of land (note g) 50,000
Total comprehensive income for the year 144,250
Dot Cotton Ltd: Statement of changes in equity for year ending 31 May 20X4
Ł Equity share Share Revaluation Retained Total
capital premium Reserve earnings
Balances b/f 400,000 100,000 100,000 275,500 875,500
Total comprehensive 50,000 94,250 144,250
income for the year
Dividends (24,000) (24,000)
Balances c/f 400,000 100,000 150,000 345,750 995,750
13
Dot Cotton Ltd: statement of financial position at 31 May 20X4
Ł Ł
Assets
Non-current assets
Property, plant and equipment (W4) 502,250
Intangible assets 215,500
717,750
Current assets
Inventories (W1) 425,750
Trade receivables (W5) 171,880
Cash in hand 10,120
607,750
Total assets 1,325,500
Equity and liabilities
Share capital Ł1 ordinary shares 400,000
Share premium account 100,000
Revaluation reserve (note g) 150,000
Retained profit 345,750
Total equity 995,750
Non- current liabilities
Long term borrowings 10% Debentures (20X2-20X8) 100,000
Deferred tax (note e) 13,000
113,000
Current liabilities
Trade payable 97,500
Short term borrowings bank overdraft 65,250
Interest payable (note d) 10,000
Income tax payable (note e) 40,000
Dividends payable (note f) 4,000
Total current liabilities 216,750
Total equity and liabilities 1,325,500
14
Step 2 - Work through the notes systematically
Note a - Closing inventory
The closing inventory will be shown in the SOFP under current assets. The opening inventory
from the trial balance will be taken to the cost of sales.
Note b - Depreciation
Depreciation based on cost = cost x depreciation %
Depreciation based on reducing value = carrying value x depreciation %
Calculation Ł Journal
Dr cost of sale (IS), Cr acc depreciation (BS)
Plant and machinery - 8% x 150,000 12,000
Dr admin (IS), Cr acc depreciation (BS)
Fixtures and fittings - 10% x 50,000 5,000
Dr admin (IS), Cr acc depreciation (BS)
Motor vehicles - ź x 20% x 50,000 2,500
Dr selling & distribution (IS), Cr acc depreciation (BS)
Motor vehicles - � x 20% x 50,000 7,500
Dr admin (IS), Cr acc amortisation (BS)
Leasehold - 1/50 x Ł75,000 1,500
(For the leasehold, the amortisation is assumed to go to administration expense)
Note c  Freehold land fees
The financial, legal and professional fees of Ł5,000 will be capitalised in the balance sheet as these
costs directly relate to the acquisition of a non current asset (freehold land).
Journal for Ł5,000
Debit Freehold land cost (statement of financial position / balance sheet)
Credit Financial, legal and professional expenses (statement of comprehensive income)
Note d  Interest payable
From the trial balance it can be seen that interest (finance cost) has not been paid on the 10%
debentures.
Interest charge calculation = coupon interest rate x nominal value of debt
= 10% x Ł100,000
= Ł10,000
Journal for Ł10,000
Debit Finance cost (statement of comprehensive income)
Credit Interest payable (statement of financial position / balance sheet)
15
Note e  Taxation
Ł
Dr tax expense (IS), Cr tax liability (BS)
Tax estimate for the year 40,000
Dr tax liability (BS), Cr tax expense (IS)
Over provision (6,000)
Dr tax expense (IS), Cr deferred tax (BS)
Increase in deferred taxation 5,000
Tax charge to the income statement 39,000
The balance on the deferred tax account in the balance sheet is now (Ł8,000 + Ł5,000) Ł13,000
Note f  Dividends
Dividends were proposed before the year end, which under IAS 10 post balance sheet events,
requires accruing in the financial statements.
0.01p x 400,000 shares = Ł4,000
Journal for Ł4,000
Debit Dividends (statement of changes in equity)
Credit Dividends payable (statement of financial position / balance sheet)
Note g  Revaluation of land
Carrying value of land before revaluation = Ł250,000
Revaluation = Ł300,000
Revaluation surplus = Ł 50,000
Before IAS 1 was revised in September 2007, the revaluation surplus would have been shown in
the reserves in the statement of changes in equity.
Now under the new revised IAS 1, the revaluation surplus represents non-owner changes in equity
and will therefore be presented in the comprehensive income statement. Non-owner movements in
equity may not be presented as separate items in the statement of changes in equity. This revision
has been made so as to clearly segregate changes in equity arising from transactions with owners in
their capacity as owners from non-owner changes in equity.
Journal for revaluation gain of Ł50,000
Debit Freehold land cost (statement of financial position / balance sheet)
Credit Revaluation gain (statement of comprehensive income)
The revaluation reserve account balance will be (Ł100,000 + Ł50,000) Ł150,000.
16
Step 3 Additional calculations
The expenses in the income statement will be analysed by function. Therefore it is important to
group the expenses into cost of sales, administrative expenses, selling and distribution costs.
Working 1 Calculation of cost of sales
As this is a manufacturing company, the cost of goods sold will have 3 elements to the inventory:
Ł Ł
1 Opening inventories
Raw materials 108,400
WIP 32,750
Finished goods 184,500
325,650
Plus
2 Costs incurred during the year
Purchases  raw materials 750,600
Carriage inwards 10,500
Manufacturing wages 250,000
Manufacturing overheads 125,000
Depreciation of plant and machinery (note b) 12,000
1,148,100
Less
3 Closing inventories
Raw materials 112,600
WIP 275,350
Finished goods 37,800
425,750
Closing inventory for balance sheet
Cost of goods sold 1,048,000
Working 2 Selling and distributions costs
Ł
Per trial balance 116,800
Depreciation (note b) 7,500
124,300
Working 3 Administrative expenses
Ł Ł
Administrative expenses as per trial balance 153,100
Financial expenses 54,100
Less: solicitors fees capitalised (5,000)
49,100
Depreciation (note b) 7,500
Amortisation of lease (note b) 1,500
Total administrative expenses 211,200
17
Working 4 Property, plant and equipment note
Exam questions may specifically ask for property, plant and equipment note. If this is case the
following needs to be done:
Freehold Leasehold Factory Motor Fixtures Total
land property plant and vehicles and
machinery fittings
Ł Ł Ł Ł Ł Ł
Cost
Bal b/f 75,000 150,000 75,000 50,000 350,000
Additions *255,000 255,000
Revaluations 50,000 50,000
Disposals - - - - -
Bal c/f 305,000 75,000 150,000 75,000 50,000 655,000
Depreciation
Bal b/f 15,000 68,500 25,000 15,750 124,250
Revaluations - - - - -
Disposals - - - - -
Charge of year 1,500 12,000 10,000 5,000 28,500
Bal c/f 16,500 80,500 35,000 20,750 152,750
Carrying value
At end of year 305,000 58,500 69,500 40,000 29,250 502,250
At 1 June 20X3 60,000 81,500 50,000 34,250 225,750
* Cost of land Ł250,000 + capitalised professional fees Ł5,000
If a property, plant and equipment note is not specifically requested in the exam, then it would be
quicker to find the carrying values of the assets in a much simpler working such as:
Freehold land {250,000 + 5,000+50,000} = Ł305,000
Motor vehicles {75,000  25,000  10,000} = Ł40,000
Working 5 Trade receivables
The provision for doubtful debts needs to be offset against the trade receivables
Ł
Trade receivables 177,630
Less provision for doubtful debts (5,750)
171,880
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