An Introduction to Financial Statements

We had detailed discussion of trial balance and also learnt that how it is being prepared with the help of ledger account balances. We had also detailed discussion about the preparation of balance sheet with the help of accounting equation or from balances of ledger account for assets, liabilities and capital. Likewise calculations of profits were made with the help of incomes, expenses and inventory accounts.

In examinations, financial statements (income statement and balance sheet) are usually prepared with the help of trial balance with separate debit and credit sides. However, sometimes it might show a single column for balances without pointing out debit and credit items separately. Occasionally, a list of balances is given in the exams without a figure for capital which in that case may be calculated as a balancing item when total of credit items are subtracted from total of debit items.

Most of the students should by now be in a position to recognize the items shown in an income statement and the items reported in a balance sheet.

Need for Income Statement:

The balance sheet shows total profit for the year but accounting users need more detailed information. They need to know that how profit was earned. Profit/loss is the difference between total revenue or incomes earned and the total expenses incurred. The income statement is prepared to show performance of the business. Did the firm perform well (by making a profit) or do badly (by incurring a loss)?

Income statement are therefore prepared to set out the financial results of operational activities for a particular period.

Uses of Income Statement:

Income statement helps a business to:

(1) Assess its financial position.

(2) Identify weak and strength areas.

(3) Have a comparison with other businesses or for the previous years for the same business.

Relationship between Income statement and Balance Sheet:

Income statement and balance sheet both are financial statements prepared by a business on regular basis. At this stage of study, this is worth emphasizing that income statement is prepared for a period of time and balance sheet is related to a particular point in time. So we can say that if income statement provides a movie of financial performance for the whole period whereas a balance sheet gives a snapshot of the financial position of the business at year end. The relationship between income statement and balance sheet may be illustrated as follows:

relationship of income statement and balance sheet