By K.A. Francis Updated January 31, 2019
Preparing a financial statement is the last step in the accounting cycle before the cycle starts over in a new period. After the accounts have been adjusted and closed, the financial statements are compiled. There is a logical order to preparing the financial statements because they build on one another. The first step in the process is the trial balance.
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Financial statements are compiled in a specific order because information from one statement carries over to the next statement. The trial balance is the first step in the process, followed by the adjusted trial balance, the income statement, the balance sheet and the statement of owner's equity.
The Trial Balance
The trial balance is the balance of all the accounts at the end of the accounting period. For example, if the business's accounting cycle for May runs from May 1 through May 31, the balances at the end of business on the 31st become the entries for the trial balance.
The Adjusted Trial Balance
After the trial balance is complete, adjusting entries are made. Examples of accounts that often require an adjustment include wages payable, accumulated depreciation and prepaid office supplies. After the needed adjusting entries are completed, all the accounts are included in the adjusted trial balance. These totals are used to compile the financial statements.
The Income Statement
The first financial statement that is compiled from the adjusted trial balance is the income statement. Its name is self-explanatory. It's the statement that lists the revenues and expenses for the business for a specific period. Revenues are listed first, and then the company's expenses are listed and subtracted.
At the bottom is of the income statement is the total. If revenues were higher than expenses, the business had net income for the period. If expenditures were greater than the revenues, the business experienced a net loss for the period.
The Balance Sheet
One way of explaining the balance sheet is that it includes everything that doesn't go on the income statement. The balance sheet lists all the assets and liabilities of the business. For example, assets include cash, accounts receivable, property, equipment, office supplies and prepaid rent. Liabilities include accounts payable, notes payable, any long-term debt the business has and taxes payable.
Owner's equity is also included on the balance sheet. This statement should prove that the accounting formula "Assets = Liabilities +Owner's Equity" is in check because the asset side should equal the combined totals of liabilities and owner's equity.
Statement of Owner's Equity
The statement of owner's equity is a summary of the business owner's investment in the business. It shows any capital the owner put into the business, any withdrawals made as a salary, and the net income or net loss from the current period. This is one reason the income statement has to be prepared first because the calculations from that statement are needed to complete the owner's equity statement.
