Courses > Accounting Basics > Preparing Financial Statements
✓ Checked for updates, April 2022. Accountingverse.com
Step 1: Gather the necessary information
In an accounting system, the best tool to take information from would be the "adjusted trial balance". This is the most updated trial balance (i.e. prepared after considering any adjustments to the accounts). In any case, any report that shows a complete listing of company accounts can be used.
Let's take the adjusted trial balance of Gray Electronic Repair Services.
| Gray Electronic Repair Services | ||||
| Adjusted Trial Balance | ||||
| December 31, 2021 | ||||
| Account Title | Debit | Credit | ||
| Cash | $ 7,480.00 | |||
| Accounts Receivable | 3,700.00 | |||
| Service Supplies | 600.00 | |||
| Furniture and Fixtures | 3,000.00 | |||
| Service Equipment | 16,000.00 | |||
| Accumulated Depreciation | $ 720.00 | |||
| Accounts Payable | 9,000.00 | |||
| Utilities Payable | 1,800.00 | |||
| Loans Payable | 12,000.00 | |||
| Mr. Gray, Capital | 13,200.00 | |||
| Mr. Gray, Drawing | 7,000.00 | |||
| Service Revenue | 9,850.00 | |||
| Rent Expense | 1,500.00 | |||
| Salaries Expense | 3,500.00 | |||
| Taxes and Licenses | 370.00 | |||
| Utilities Expense | 1,800.00 | |||
| Service Supplies Expense | 900.00 | |||
| Depreciation Expense | 720.00 | |||
| Totals | $ 46,570.00 | $ 46,570.00 | ||
Step 2: Start with the heading
The heading of a financial statement is often made up of three lines. The first line contains the name of the company (Gray Electronic Repair Services). The second line shows the title of the report (Income Statement). And the third line indicates the period reported.
For income statements, we use For the Year Ended..., For the Quarter Ended..., For the Month Ended..., etc., depending on the period covered in the report. Nonetheless, some annual income statements just omit the "For the Year Ended" phrase.
| Gray Electronic Repair Services | |||
| Income Statement | |||
| For the Year Ended December 31, 2021 | |||
Step 3: Report all revenue accounts
From the trial balance, we will look for and report all income or revenue accounts. You will need to be familiar with different income accounts such as Service Revenue, Sales, Professional Fees, Interest Income, etc. If you need a review on that topic, you may visit this lesson: Elements of Accounting.
In the adjusted trial balance above, there is only one revenue account - Service Revenue.
| Gray Electronic Repair Services | ||||
| Income Statement | ||||
| For the Year Ended December 31, 2021 | ||||
| Service Revenue | $ 9,850 | |||
Note: If there are multiple revenue accounts, you need to list them down and take the sum total of all revenues.
Step 4: Report all expense accounts
From the adjusted trial balance again, we will take all expenses and include them in the report. Once they are all listed, we will get the sum of all the expenses.
| Gray Electronic Repair Services | ||||
| Income Statement | ||||
| For the Year Ended December 31, 2021 | ||||
| Service Revenue | $ 9,850 | |||
| Less: Operating Expenses | ||||
| Salaries Expense | $ 3,500 | |||
| Utilities Expense | 1,800 | |||
| Rent Expense | 1,500 | |||
| Service Supplies Expense | 900 | |||
| Depreciation Expense | 720 | |||
| Taxes and Licences | 370 | 8,790 | ||
It is a good practice to list the expenses from highest to lowest whenever possible. This allows better analysis of company expenses.
Drawing a horizontal line means that a mathematical operation has been performed. The line below 370 means that we took the sum of all expenses which amounts to 8,790. The total amount of expenses is aligned with the total amount of revenues.
Step 5: Compute for the net income
Net income is equal to total revenues minus total expenses.
| Gray Electronic Repair Services | ||||
| Income Statement | ||||
| For the Year Ended December 31, 2021 | ||||
| Service Revenue | $ 9,850 | |||
| Less: Operating Expenses | ||||
| Salaries Expense | $ 3,500 | |||
| Utilities Expense | 1,800 | |||
| Rent Expense | 1,500 | |||
| Service Supplies Expense | 900 | |||
| Depreciation Expense | 720 | |||
| Taxes and Licences | 370 | 8,790 | ||
| Net Income | $ 1,060 | |||
Again, we drew a single line under 8,790 to indicate that a mathematical operation was made. Two horizontal lines are drawn under the final amount (1,060 net income). This is known as "double-rule" and is similar to enclosing the final answers in a box or circle in a math test.
So there you go. The preparation is somewhat easy – you just need to be familiar with the different revenue and expense accounts.
Some Important Notes
This is a simplified illustration of preparing an income statement. Income tax expense was not considered in the above example. The treatment of income taxes depends upon the applicable laws of the state or country. Nonetheless, if the company is subject to income tax, the income tax expense should be deducted to get the net income. Since income tax expense is based on income, we need to get the income before tax first.
Total Revenues - Total Operating Expenses = Income Before Tax
Income Before Tax - Income Tax Expense = Net Income
Also, the income statements of a merchandising or a manufacturing business will look a little different from the above example. Typically, gross profit is computed before deducting the operating expenses. Gross profit is equal to sales minus cost of sales.
Key Takeaways
This lesson presented how an income statement is prepared. An income statement shows information about a company's profitability by summarizing its total revenues and total expenses, and calculating the resulting net income.
Like and share!
Web link
How to prepare an income statement
APA format
How to prepare an income statement (2022). Accountingverse.
https://www.accountingverse.com/accounting-basics/how-to-prepare-an-income-statement.html
Next Lesson
→
How to Prepare a Statement of Changes in Equity
Chapter Outline
≡
How to Prepare Financial Statements
More under How to Prepare Financial Statements
1
How to Prepare an Income Statement2
How to Prepare a Statement of Changes in Equity3
How to Prepare a Balance Sheet
