Preparing Financial Statements using International Accounting Standard 1

This page is available as a PDF file: link at the bottom of the page. Also at the end of this page there is a link to a web page based spreadsheet that contains two questions with fully worked solutions for you to consider.

The preparation of financial statements using International Accounting Standard 1: preparation of financial statements IAS 1) is really the same as preparing financial statements for a small business when we might not even think about using formal accounting standards.

The following diagram sets out which financial statements we need to consider when applying IAS 1:

Classification of Items

The key to the successful presentation of financial statements, whether using IAS 1 or not, is the classification of the items that go into each of the above statements.

The diagram above, Components of Financial Statements shows the foundations of the classification of accounting items.

Income: in the case of the classification of income, all we need to do is to decide if an item in a ledger account of trial balance is income or not. One big clue here is to look at the trial balance and see whether the item you are worried about is in the debit or credit column.

Debit	Income Ledger Account		Credit
Decrease		Increase

That means that if a company sells something or provides a service in return for money, we should CREDIT the Income Account in the Ledger. Similarly, take a look at the following ledger accounts:

Debit	Expense Ledger Account		Credit
Increase		Decrease

Debit	Asset Ledger Account		Credit
Increase		Decrease

Debit	Liability Ledger Account		Credit
Decrease		Increase

Debit	Capital Ledger Account		Credit
Decrease		Increase

Those template ledger accounts show the golden rules of double entry bookkeeping that help all accountants and students of accounting. Golden Rules are rules that will never change.

The trial balance is also a great source of help for accountants and students because it uses the same golden rules as the ledger account. For example, all income accounts will appear in the credit column:

DW plc Trial Balance as at xx/xxxx	Debit	Credit
Sales		100,000
Rent received		24,000
Commission received		11,000
…

In addition to income or revenue items ALWAYS being in the credit column (ie credit balances), expenses are always debit balances … as you can see in the next trial balance:

DW plc Trial Balance as at xx/xxxx	Debit	Credit
Income		XXX
Expenses	XXX
Assets	XXX
Liabilities		XXX
Capital or Equity		XXX
...
...

Summary: you need to know these golden rules and what they mean. Once you have mastered them, your life becomes much easier.

Application of the Rules of Double Entry Bookkeeping: classification for financial statements

You know from the diagram at the beginning of this page that there are four main financial statements, plus the notes. We assume that you already know a little bit about these statements, so now you can use that knowledge to say, for example, into which statement you would put the account items in the following table:

Account Item	Financial Statement
Sales
Non current assets
Long term liabilities
Administration expenses
Cash and cash equivalents

The solution is here

For you to try 1: they are a little more difficult than the example above: which of the financial statement, including the notes to the accounts, should the following account items be placed into?

Account Item	Financial Statement
contingent liabilities
the effect on retained earnings of the correction of a prior period error
cash and cash equivalents
capital contributed during the year
revaluation gain on land (not reversing any previous revaluation)
judgements that management has made in classifying financial assets
income tax expense
Provisions
loss on revaluation of available-for-sale investments
finance expenses
aggregate dividends declared and paid during the year
revaluation loss on building (not reversing any previous revaluation)
allowance for doubtful debts
transfer from retained earnings to general reserve
contractual commitments under an operating lease
deferred tax liability

The solution is here

Checklist

Here’s a checklist for you now: the following list is very useful BUT it is just a beginning for you. As you study more and more you should add to this checklist.

Income Statement		Balance Sheet
Trading Account	Profit and Loss Account
Sales/revenue/Turnover	Expenses	Non Current Assets
Sales Returns	Wages	Land
Opening Stocks	Insurance	Buildings
Purchases	Rent	Premises
Purchase Returns	Telephone	Fixtures and Fittings
Carriage Inwards	Stationery	Machinery
Closing Stock	Carriage Outwards	Vehicles
	Light and Heat	Computers
	Motor Expenses
	General Expenses
	Sundry Expenses
	Marketing Expenses
	Advertising Expenses	Current Assets
	Administration Expenses	Stocks
	Discount Allowed	Debtors
	Bad Debts written off	Prepayments
		Cash at Bank
		Cash in Hand
		Current Liabilities
		Creditors
		Accrued Expenses
		Non Current Liabilities
		Bank Loan
		Mortgage
	Revenues/Income
	Discount Received
	Rent Received
	Commission Received	Equity
		Net Profit from the P&L a/c
		Drawings

For you to try 2: Having mastered all of the above, use your skills and knowledge to complete the following exercise

Now you should write against every Trial Balance Account entry the letters

T P B

You should do this with every exercise or trial balance you come across now: ALWAYS begin by classifying all items in the trial balance and in the additional information. Then you know whether the item is to be put into the Trial Balance (T) the Profit and Loss Account (P) or the Balance Sheet (B).

We have done three of the classifications for you …

DW Trial Balance as at 30th November 2010
	Account	Dr	Cr
T	Stocks as at 1 December 2009
	Purchases
	Returns Outwards
	Sales
	Carriage Inwards
	Returns Inwards
	Carriage Outwards
	Bad Debts
	Provision for Depreciation, Machinery
	Wages
P	Insurance
	Rent
	Telephone
	Premises
	Machinery
	Debtors
	Creditors
	Cash at Bank
	Cash in Hand
B	Loan repayable in 2012
	Loan repayable by 30th November 2010
	Capital
	Drawings

The solution is here

Conclusions

The classification of accounting transactions is the key both to double entry bookkeeping and to the preparation of financial statements. The purpose of this page has been to introduce the concept of classification to you and to encourage you to work with it. If you use this method you should find it will help you throughout your career.

© Duncan Williamson
16th November 2010

PDF version of this page

Fully worked solutions: two questions answered in an Excel Spreadsheet on a web page!