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.
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.
FAQs
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.
What is the order to prepare financial statements? ›
Financial statements are prepared in the following order:
- Income Statement.
- Statement of Retained Earnings - also called Statement of Owners' Equity.
- The Balance Sheet.
- The Statement of Cash Flows.
The correct answer is c) Income Statement, Statement of Retained Earnings, Balance Sheet, Statement of Cash Flows.
What are the order in which you must create the financial statements? ›
Which financial statement is prepared first?
- Income statement. The financial statement prepared first is your income statement. ...
- Statement of retained earnings. Your statement of retained earnings is the second financial statement you prepare in your accounting cycle. ...
- Balance sheet. ...
- Cash flow statement.
The steps in the accounting cycle are identifying transactions, recording transactions in a journal, posting the transactions, preparing the unadjusted trial balance, analyzing the worksheet, adjusting journal entry discrepancies, preparing a financial statement, and closing the books.
Which financial statements go first? ›
The income statement is often prepared before other financial statements because it provides a summary of a company's revenues and expenses over a specific period. This information can then be used to calculate net income, which is an essential metric for understanding a company's profitability.
What is the order of the three financial statements? ›
The income statement, balance sheet, and statement of cash flows are required financial statements. These three statements are informative tools that traders can use to analyze a company's financial strength and provide a quick picture of a company's financial health and underlying value.
Which financial statement is typically prepared first? ›
The income statement, which is sometimes called the statement of earnings or statement of operations, is prepared first. It lists revenues and expenses and calculates the company's net income or net loss for a period of time.
What is the order of notes to the financial statements? ›
There is a paragraph setting out the order in which notes to the financial statements are normally presented: this begins with a statement of compliance, then a summary of significant accounting policies, supporting information for individual line items following their sequence in the primary statements, and finally ' ...
What is the correct order of an income statement? ›
(1) Revenue, (2) expenses, (3) gains, and (4) losses. An income statement is not a balance sheet or a cash flow statement.
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.
What is the correct sequence of accounting process? ›
The correct sequence of the accounting process is "Identifying -- recording -- communicating".
What is step 5 in the preparation of financial statements? ›
Step 5: Make adjusting journal entries
Your next step is to make any adjusting journal entries necessary so your financial statements include relevant information for your working period. There are three types of adjusting entries: Accruals, tax adjustments, and missing transaction adjustments.
Which of the 3 financial statement should be prepared first? ›
Income statement: This is the first financial statement prepared. The income statement is prepared to look at a company's revenues and expenses over a certain period, such as a month, a quarter, or a year.
What is the order of the statement of financial position? ›
A statement of financial position is often formatted as a table with three columns. The first column lists the asset accounts, the second column lists liability or equity accounts and the final column contains totals for each section that are used to calculate net worth.
