Financial statements are useful indicators of a business’s health. Preparation of financial Statements is a significant task in Accounting. That means making official records of the company’s financial activities. These records describe how much the business made, spent and owned. Small-medium business or large corporation, every company needs these statements for understanding its financial position. Investors, banks and government bodies also use them.
Well, what is the process of preparation of financial statements? It involves maintaining all monetary transactions, correcting any discrepancies, and presenting the data in appropriate formats such as balance sheet, profit and loss account, and cash flow statement. Financial statements (also known as financial reports)
What Are Financial Statements?
Financial statements are recorded financial information of a business. These kinds of reports provide visibility into a business’s financial health. Every business needs them. Financial statements help you track money that goes in and out of your shop or company.
Five main types of financial statements are:
- Balance Sheet
- Profit and Loss Account (Income Statement)
- Cash Flow Statement
Other Financial Statements are as follow
Balance Sheet
The balance sheet shows the business’ assets (what it owns) and its liabilities (what it owes). It also shows the owner’s equity. It offers a picture of a business’s financial position at a specific time.
Profit and Loss Statement
This statement indicates revenue and expense. Which reports whether the company made a profit or a loss over a period of time.
Cash Flow Statement
This report shows the cash coming in and going out. It looks at the flow of money, not just accounting entries.
Shareholders Equity Statement of Changes
It shows the owner’s investment in the business for the year.
Notes to Accounts
The others are notes that add to the funded numbers in the primary statements.
Many use these financial reports for their work. But you know what business owners need? Investors are interested in whether they should invest in the company. Banks look at these, before lending out money.”
How do Financial Statements Work?
How financial statements work and its respective accounting rules. You learn these statements are based upon the records maintained throughout the entire year. If a business keeps daily records of sales, expenses, and assets, it becomes easier to prepare financial reports at the end of the year.
Here is how it works:
- The Next is Book of accounts — All the transactions of the business are recorded in the books of accounts.
- They make a trial balance at year end to ensure the balance of all accounts.
- They perform modification in the financial statement preparation. Like other things such as accrued expenses, prepaid lease, depreciation and so on.
- They Make the Final Statements after these changes
This whole process helps in:
- Sentiment Analysis of News Articles to Understand Business Performance
- Making future plans
- Getting loans or funds
- Filing taxes
Understanding how financial statements work will additionally assist investigation of blunders. It reconciles cash in hand with cash written down. It also indicates whether the business can meet its debts in due time.
The financial statements take a company in the right direction if it wishes to see an increase in a business. They assist in progress monitoring, minimising wastage, and increasing profit.
How to Prepare Financial Statements?
You follow a sequential process for preparation of financial statement. This process makes sure that the numbers displayed are correct and meaningful.
Step 1: Record Transactions
Begin entering daily transactions such as sales, purchases, payments, and receipts in the appropriate books.
Step 2: Develop a Trial Balance
Prepare a trial balance to verify that the totals of both the debits and credits are equal to each other. If not, discover and fix mistakes.
Step 3: Make Adjustments
Adjustments in preparation of financial statements can make the real picture of financial affairs.
Some common changes include:
- Accrued incomes and expenses
- Prepaid expenses
- Depreciation
- Bad debts
- Provision for doubtful debts
Example. Consider prepaid rent of ₹5,000. This is a prepaid expense. You’re doing this subtracting from rent and showing it as an asset. These modifications assist with obtaining accurate numbers.
Adjustments in preparation of financial statements practical problem solutions are modified through examples that result in practical utility by means of journal entries by means of journal entries.
Step 4: Preparation of Final Accounts
Once you have everything adjusted, prepare the below:
- Trading and Profit & Les Account
- Balance Sheet
- Cash Flow Statement
Step 5 — Insert Notes and Disclosures
There are some items based on the law that you need to get notes or explanations. This may cover depreciation methods or any ongoing lawsuits.
Adjustment in Preparation of Financial Statement
The adjustment in the preparation of the financial statement is made to correct errors or add an entry that is not booked but pertains to the current period. These changes reflect the actual financial status of the company.
Why is the adjustment important?
- They pair outgoings with incomings
- They are free of exaggeration or understatement
- They make reports reliable
Examples of adjustments in preparation financial statements include:
| Adjustment Type | What to Do | Where to Show |
| Outstanding Expenses | Add as expense and shown as liability | P&L and Balance Sheet |
| Prepaid Expenses | Shown as asset & deduct from expense | P&L and Balance Sheet |
| Accrued Income | Added to income & shown as asset | P&L and Balance Sheet |
| Depreciation | Charge to P & L and asset value is reduced | P&L and Balance Sheet |
Practicable examples of adjustments in preparation of financial accounts must be learned. This promotes clarity and enhances accuracy in the final reports.
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What are the Objectives of Preparing Financial Statements?
Now, let us understand what is the purpose of preparing financial statements.
Understand Business Performance
This report helps determine if a company is in profit or loss.
Assess Financial Position
They indicate what the business owns and owes.
Address Legal Obligations
Companies have to create these to comply with regulations and settle taxes.
Decisions
They help the owner, managers to take correct decisions.
Attract Investors
Well-prepared financial statements are the light for attracting new investors.
Lending
Banks look at these before providing financial assistance.
Hence, the objectives of financial statements preparation are advising relevant, comprehensive, forecasting and control, and reporting information.
The Framework for the Preparation and Presentation of Financial Statements
The basis of preparation and presentation of financial statements is a kind of a rulebook. This is given by accounting organizations such as the International Accounting Standards Board (IASB), which in India is adhered to as Indian Accounting Standards (Ind AS).
This framework tells:
- What to include in statements
- When to record an item
- How to display assets, liabilities, income and expenses
Key points in this framework:
- Accrual Basis: Account for when the transaction occurs, not when cash is received or disbursed.
- Going Concern — The business will keep on operating.
- Consistency: Implement the same practices year after year.
- Be cautious: Don’t inflate assets or income.
Using this framework helps to keep reports consistent, which enables comparison. It acts to ensure that readers trust the data presented in financial statements.
How to Prepare Consolidation of Financial Statements with Examples
The more the parent company owns the subsidiaries, the more substantial the consolidation of financial statements.
It makes a consolidated report if for example: a parent has subsidiaries. This process is known as consolidation of financial statements.
Steps for Consolidation:
- Include aggregate of parent and subsidiary assets and liabilities.
- Eliminate inter-company transactions
- Make necessary adjustment for minority interest (if any).
Example:
80% of Company B is owned by Company A.
The companies prepare their balance sheet on their own.
Company A will consider Company B’s assets and liabilities when preparing the consolidated balance sheet.
If Company B has to pay ₹50,000 to Company A, then that amount would be eliminated in the consolidation process.
Understanding how to prepare consolidation of financial statements with examples is essential. This should be followed by most big companies to be able to provide a complete picture of their group performance.
How to Prepare Financial Statements of Company?
Step by Step guide to Prepare Financial Statements of a Company includes:
Gather Financial Data
Data from journals, ledgers and other documents.
Adjustments
Add or subtract amounts for unpaid bills, advance incomes, etc.
Prepare Final Accounts
Profit and Loss Account and Balance Sheet.
Prepare Cash Flow Statement
It is mandated by law for big companies.
Make Notes and Disclosures
Describe accounting policies and any other required information.
The Companies Act, 2013, and Accounting Standards govern the companies. They must also have their reports audited.
Relevance to ACCA Syllabus
Financial statements are a core component of the ACCA FA, FR and SBR exams. Candidates will be required to apply IFRS, for purposes of the preparation and interpretation of financial reports. Knowing accruals, presentation structure, and fair representation in brief, is key.
Preparation of Financial Statements ACCA Questions
Q1: The complete set of financial statements include all following except under IFRS?
A. Balance Sheet
B. Financial Statements Notes
C. Director’s Report
D. Changes in equity statement
Answer: C.
Q2 : Which Financial statements as per IAS 1 represent the company’s Performance during the time period?
A. Balance Sheet
B. Cash flow details
C. Profit and other comprehensive income
D. Change in equity statement
Answer: c.
Q3: Half-markers facilitate much better quality financial information, therefore is which financial information is ultimately free from bias and complete?
A. Relevance
B. Timeliness
C. Faithful Representation
D. Understandability
Answer: C.
Q4: With accrual accounting you are required to:
A. Cash sales only
B. Transactions are recorded when they happen
C- year end revenue realization
D. Only expenses are deferred
Answer: B.
Q5: The notes to the financial statements serve one of its primary purposes of:
A. To summarize movements in equities
B. To provide audit opinions
C. To provide additional clarification regarding the numbers contained in the statements
D. To report taxes computed
Answer: C.
Relevance to US CMA Syllabus
US CMA (Certified Management Accountant) Part 1 Financial Reporting Having CMAs that should be able to prepare financial statements in accordance with US GAAP (i.e. US generally accepted accounting principles), analyze financial results and tie that information into the decisions being made.
Preparation of Financial Statements CMA Questions
Q1 — Which items are recognised in the Statement of Changes in Equity?
A. Operating cash flows
B. Inventory turnover
C. Dividends paid
D. Revenue by product line
Answer: C.
Q2: TRUE or FALSE: According to GAAP, revenue must be recognized in the same period as the associated cost of goods sold.
A. Cash basis — record revenue when you actually receive cash
C. Product is delivered and title passes, revenue is recognized
C. Recognize revenue before expenses are incurred
D. R — Recognition of revenue as book (up to period end).
Answer: B.
Q3: Which figure in the financial overview depicts the concise liquidity position of this business?
A. Income Details
B equity details
C. Balance sheet
D. Budgetary income details
Answer: c. Balance sheet
Q4: Specific pang, income details — the one pang to learn.
A. put the profit distribution
B. Prepare a statement of financial position Statements
C. To make the Hichepers advantages or disadvantages of the company over decades
D. Aggregate investment activity
Answer: c.To make the Hichepers advantages or disadvantages of the company over decades
Q5: Does the principle ensure that revenue is not recognised until, rather when the revenue is earned?
A. Rules for recognizing revenue
B full disclosure syntax and semantics
C. Matching theory
D. Cost principle
Answer: c. Matching theory
Relevance to CFA Syllabus
In fact, FRA is the most important component of the CFA Program itself, covering a large portion of Levels I and II, with candidates being tested on FRA. The course also covers reading financial statements (IFRS and US GAAP), income recognition as well as analyzing financial performance to enable better investment decisions.
Financial Statements Preparation CFA Questions
Q1: Which is the financial reporting objective?
A. Maximizing profits
B. Complying with tax laws
C. Communications with Current and Prospective Investors
D. Reducing expenses
Answer: C.Communications with Current and Prospective Investors
Q2: What does a solveny measure and which financial statement is used by analysts to assess a company’s solvency?
A. Income Statement
B. Financial Status Statement
C. Statement of Updated Retrieved Income
D. statement of changes in equity
Answer: B.Financial Status Statement
Q3: Which of the financial statements answers how the company performed during a period?
A. Balance Sheet
B. Income Statement
C. Trial Balance
D. General Ledger
Answer: B.
Q4: How is the discontinued operations accounted under IFRS?
A. In the notes only
B. From continuing operations
Q. Line separates in income statement from revenue
D. Not reported
Answer: C.
Q5: Select one that is a non-current asset?
A. Inventory
B. Accounts Receivable
C. Equipment
D. Cash
Answer: C.
Relevance to US CPA Syllabus
In USA CPA Exam, FAR that is, Financial Accounting & Reporting has a depth which includes preparation of financial statements according to US GAAP, financial statement types and indicators. The keys are quite pertinent in the context of audit, tax and reporting obligations.
Preparation of Financial Statements US CPA Questions
Q1: What goes into other comprehensive income under US GAAP?
A. Revenue from Sales
B. Depreciation expenditure
C. Converting currency to a foreign currency
D. interest income
Answer c.
Q2: Which of the following is NOT a requirement for classified balance sheet under US GAAP?
A. Long term liabilities above current assets
B. Current and non-current classification of assets and liabilities
C. A list of accounts in alphabetical order
D. Liabilities appearing in reverse order
Answer: B.
Q3: When are expenses recognized according to the matching principle?
A. When paid
B. When incurred
In parallel with revenueC.
D. End of the fiscal year
Answer: C.
Q4 Which one is included in cash flow statement – financing activities?
A. Interest paid
B. Sale of inventory
C. Payment of dividends
D. Purchase of equipment
Answer: C.
Question 5 What is the order of creation of financial statements under US GAAP?
A. Profit & Loss → Balance Sheet → Cash Flow
B) Cash Flow Statement → (2) Statement of Equity → (3) Income Statement
C. Income Statement⇒Statement of Equity and Balance Sheet ⇒ Cash Flows
D Cash Flows to P&L to Statement of Financial position
Answer: C. Income Statement⇒Statement of Equity and Balance Sheet ⇒ Cash Flows
