Preparation of Financial Statements from Trial Balance

A trial balance is a preliminary step in preparing a balance sheet. It summarizes the general ledger account balances. The trial balance taken the first time is called an unadjusted trial balance. Whenever totals of debits and credit side mismatches in the unadjusted trial balance, the major job is to search for and correct the irregularity. Such a corrected statement is known as an ‘adjusted trial balance’.

While preparing the financial statements, a business entity will look at the adjusted trial balance for account information. Based on this information, the business entity will begin constructing each of the statements, starting with the income statement. Income statements will include all revenue and expense accounts.

Once the adjusted trial balance is saved/ printed, the closing balances of revenue-related accounts (like interest received, the commission received, discount received, salary paid, premises rent paid, telephone bill paid, electric bill paid, traveling expenses, stationery expenses, postage expenses, etc.) of the reporting financial year will be journalized and transferred to the ‘Profit and loss account’ (also known as ‘Retain earning account’).

The statement of retained earnings will include beginning retained earnings, any net income (loss) (found on the income statement), and dividends. This statement shows how a company’s retained earnings change over a specific period. It’s also known as a statement of shareholders’ equity, equity statement, or statement of owner’s equity. The statement of retained earnings will include beginning retained earnings, any net income (loss) (found on the income statement), and dividends. The balance sheet is going to include assets, contra assets, liabilities, and stockholder equity accounts, including ending retained earnings and common stock.

Once the balance of the above types of accounts is closed and moved to the profit and loss account, only permanent accounts that have balance in them will continue in the books of accounts and the same will be balanced again under the double entry system. This balanced list of permanent accounts is called the post-closing trial balance. A post-closing trial balance is a listing of all balance sheet accounts containing non-zero balances at the end of a reporting period. As mentioned above, the post-closing trial balance does not show balance in any of the income account or expenses accounts, since these temporary accounts have already been closed and their balances moved into the profit and loss account as part of the closing process.

The post-closing trial balance validates the preparation of financial statements. This is also known as the closing balance sheet.

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