Income statements are commonly prepared in two formats: multiple-step and single-step. In the multiple-step format revenues are often presented in great detail, cost of goods sold is subtracted to show gross profit, operating expenses are separated from other expenses, and operating income is separated from other income. In the single-step format, all expenses are combined in a single section including cost of goods sold.
Retained Earnings Statement
The retained earnings statement is a summary of what has occurred to the retained earnings account. The retained earnings statement always begins with the ending balance of the past period, then presents net income or loss, dividend payments and other elements affecting the retained earnings account. It is not unusual for the retained earnings statement and the income statement to be combined into one statement. This is primarily done for simplicity.
Balance Sheets
Balance sheets can be arranged in two forms: account form and report form. The account form lists all asset accounts on the left hand side of the balance sheet, and all liabilities and equity accounts are listed on the right-hand side. The report form lists all accounts in a downward sequence beginning with assets, liabilities, and ending with equity. Both assets and liabilities should be arranged according to their liquidity or purpose. Assets that are generally liquid and are expected to be held less than a year are listed under current assets. Assets that are permanent in nature or are expected to be used for a long period of time are listed under plant assets. Liabilities are classified into short and long term depending on their maturity.
Adjusting and Closing Entries
The work sheet provides the information needed for the adjusting entries. Adjusting entries involve asset, liability, expense, and revenue accounts. Special adjusting entries are required for inventory:
- debit Income Summary and credit Inventory for the beginning balance, and
- debit Inventory and credit Income Summary for the ending balance.
After all adjusting entries have been performed, closing entries are required for all temporary accounts. Sales, income accounts, purchases returns & allowances, and purchases discounts are debited to close, and the Income Summary account is credited for the total. Expenses, purchases, sales discounts, sales returns & allowances, and transportation in are all credited to close, and the Income Summary account is debited for the total. The Income Summary debit or credit balance is closed to the Owner's Equity or Retained Earnings account. The Dividends account is credited and Retained Earnings debited if any dividends were paid during the year.
Reversing Entries
Since some adjusting entries performed at the end of a financial period disrupt routine transactions, they are simply reversed on the first day of the new period. A reversing entry exact reverses the adjusting entry. An example of an adjusting entry that is commonly reversed is salary or wages payable. Reversing entries are performed because they reduce errors and save time. Reversing entries are optional and some firms do not perform them.
Interim Statements
Financial statements prepared for a period less than a complete accounting year are referred to as interim statements. Data for interim statements is obtained from work sheets. Any adjusting and closing entries performed to prepare interim statements are not recorded in the accounts, (this is only necessary at the end of a fiscal year or accounting period).
Correcting Errors
Depending upon the type of an error and the point in time it is discovered, the correcting procedure differs.
- When a journal entry is incorrect and has not yet been posted, a line should be drawn through the error and the correct title or amount should be entered.
- When a journal entry has been posted incorrectly, it is necessary to journalize and post a correcting entry.
- When a journal entry is correct but has been posted incorrectly, a correcting entry should be posted.
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