Skip main navigation

Towards Financial Statements: Income Statement and Balance Sheet

This video will guide you through a meaningful step: how we assess balance sheet and income statement at the end of the year.
Hi and welcome back to the introduction to financial accounting course. We are still in week 3 and if you recall we finished off the last video by talking about deferred revenues and deferred expenses. We will continue to add release to the estimation so that required at the end of the year in order for any company - in our case food on the go - to estimate periodic income. Let’s get started adjustment. Number five relates to the deferred expenses into either the 25 percent of the office supplies are still available. Adjustment 6 relates to accrued expenses in transaction twelve and we know that interest on loan I’ve accrued for 450.
If you remember food on the go made a deal with the bank and obtain financial resources in terms of loan (debt) that will be repaid in the future. We know that any debt relationship carries an interest. We also know that by the nature of the contract signed with the bank that
repayment and repayments of interest will occur later: It will be postponed. Vis a vis the time of the initial transaction. This urges us to estimate the amount of interest that they have accrued as an expense for the estimation of the kingdom adjustment number seven. Accrued expenses salaries have accrued in the last month but have not been paid yet. The amount is three thousand six hundred. This is standing us said the company has already relied on the work of its own employees. Yet the salaries have not been financially paid out yet. However we have to take these salaries into account in the estimation of periodic income. Adjustment number eight relates to accrued revenues.
Several customers have fully used the promotional sale and exceeded the free cap. Therefore revenues have accrued for 2,200. This is fairly common when we use apps and there is a cap. And if we exceed the cap then we commit to pay for the services or products that we have used. And this is the case here. Adjustment number 9 relates to provisions which is the first time we actually meet in our journey.
One of the employees sued the company for an injury: food the go provisions 4300. So this is a precautionary estimation of a potential future loss that the company may incur. Let’s see how we account for all these adjustments.
Adjustment number five: deferred expenses. On September 10th according to transaction eleven food on the go buys office supplies for 2000. Payment is in six months at the end of the year. We estimate that 25 percent of these office supplies are still available meaning that they are still usable. So they represent an asset. If you want to draw the line, we know that not all the office supplies are being used but there is one tiny part - 25 percent - that is still unused. Therefore from the initial amount of the purchase which is 2000 we can tell that one thousand five hundred are an expense whereas 500 can be considered as an asset. This is the main logic.
Let’s see how we transferred the logic into journal entries and T-account. We use the journal entry and we know the date well that we don’t indicate the date because it would be fiscal year end school year end. And here we have two account. First we have material expense which is an expense account an increase in an expense account is a debit and correspondingly we reduce the value of the raw material which is office supply - by the same amount. Therefore we credit for 500. If you recall this is a reduction in the value of asset. In terms of the accounts. We have them down here. Material expenses. This is an expense account.
And we know that when expenses go up we have to debit there for you right here. On the other hand the accounting title to raw materials was initially established for two thousand at the time of the purchase. But now we have to deduct part of the value. Therefore we credit for five hundred. Here we are with the adjustment number six. This is an accrued expenses in relation to the loan and the interest on the loan that have accrued as a result of time passing by. If you remember transaction 12 on October the 1st for the new go obtains a five year loans four of sixty thousand.
And there is an interest on the loan that equals one thousand eight hundred per year. We also know that interest on the loan have accrued for four hundred and fifty. Where does these 450 come from these four hundred and fifteen. If you take the time line here are in essence the interest that have accrued between October the 1st and December 31. So these are three months that will be eventually paid on April 1st in the next year where the whole six months will be paid. So the cash disbursement will be equal to nine hundred.
However for the accrual principle we have to take into account that some of the cost connected to the fee related to interest belong to this year. How do we journalise this transaction? We use the same date which is fiscal year end and we use an expense account which is interest on loan. This is an expense account and we know that expense account when they go up are debited. At the same time. We have two credit something and we credit an account called liability versus bank, which is a liability account. And we know that when liabilities go up we have to credit one hundred and fifty. This is exactly what we have also in the ticket.
And in fact we have an interest on loan account. We increase it by 4 15 and by the same token we increase the liability by 4 and we are done with this transaction.
Adjustment 7: these are again an accrued expense salaries have accrued in the last month but they have not been paid out yet and the amount of the salaries to be paid is 3,600. This is an interesting case and I would like again to use the timeline. If we are sitting here on a December 31 we know that the work of the employees has been used but the payment will occur at some point X day in January. So this is the time of the financial transaction which is a cash disbursement; however the economic phenomenon has already occurred and this is valued Three thousand six hundred. How do we journalise these transaction?
We know that we always use fiscal year end and we use an expense account which we call salaries. We know that an expense account go up we debit with three thousand six hundred and one. We have a liability which is a debt versus employees. This is a liability account and we know that when liabilities go up. We created and this is exactly what we have tended to account. So let’s add to the debit side 3600 and then we credit liabilities for 3,600. Adjustment number eight. We’re facing accrued revenues. Several customers have fully used the promotional s. And exceeded the free cap. Therefore revenues for two thousand two hundred have accrued.
If we use again the timeline to make this concept quite simple we know that actually for them the goal has already delivered services or food prior to December 31. The cash inflow will only occur at some point in time In January. We know that one of the underlying principles of accounting is that we we disentangle the cash dynamic from the income dynamic. Therefore we recognize on December 31 accrued revenues for 2,200 how do we account for this. We go to journal entries. Here we have the fiscal year and this is the date. And here we have accrued revenues. You can name this account in whatever way you like.
The important thing is that you remember that this is an asset account because we know that as a result of the past transactions our customers owe us something. It is an asset account that goes up before we get back to What happens in the credit side? Now we have to book revenues or Sales and you know that this is a revenue account therefore in order to increase the revenue account we credit 2000; this is the same thing that we do.
Also in relation to the T account therefore we have accrued the revenues of two thousand two hundred and we have Sales they’re credited for the same amount adjustment number nine is an accrued expense even though it is of a different kind from what we have seen before, because is the company now is facing a litigation risk. So there is a risk that in the future a court will rule out against the company that will have to pay one of its employees for precautionary purposes. The company provisions. And how do we do this from an accounting point of view. This is a bit tricky.
You have to be careful now in the fiscal year end is the date in which is the expense account. We call it provision expense and it is an expense account now we know that when there is an increase in an expense account we have to be
the corresponding account is a liability account which we call again provision but without expense. And this is a liability an increasing liability means credit. Four thousand three hundred added is exactly what we are doing. So in the dickens provisions go up by 4300. And liability provisions will go up by the same amount. There is a substantial difference here. This is a provision expense account which with debit. What has this one isa provision liability account. Which we credit instead we are now getting very close to being able to assess the performance of the year in the income statement as well as measuring the value of assets liabilities and equity in the balance sheet.
But before doing this we have to go through the ledgers in this slide here. We have the ledger for the asset account. So if you have noticed we have used a bunch of accounts in relation to assets liabilities. Revenues Expenses and equity of course. In this slide we summarize all the accounts in relation to assets and we have bank, accounts receivables, receivables, raw materials, license and then we have a series of accounting adjustments account so to speak the company both the license for 12000. But we know that we amortize the license for one third. Therefore this is an adjustment account. Same thing with prepaid rent, property and equipment.
The equipment account is quite similar to the license account because the company both scooters for 8,000 but only half of the value is gone because of the amortization. When we move to the liabilities account. We have a lower number of accounts. Here we are including the liabilities in equity namely the right hand side of the balance sheet and in fact we start with payables. We have unearned revenues. We’ve got debits, towards employees. We have liabilities, provisions, loans and equity. This is much simpler than all the assets account because in general the liabilities account are much less. The last set of accounts relate to income statement accounts.
So here we have a summary of all the expenses and all the revenues or sales or gangs that the company has incurred throughout the year. Therefore we have provisions for future cost interest on loans, material expenses amortization of scooters. We have amortization license builders office rent salaries and then St.. And as you remember next to each of them the amount we’ve got the transaction to which they referred to. In principle what we hope is that you are able to build up the general ledger yourself prior to getting to the financial statement. Here we are with the financial statements. They represent The main document for disclosing
financially related information: we have the balance sheet and the income statement the balance sheet is split between asset and liabilities or equity; and the income statement starts with the revenues and then it lists a series of expenses. A crucial thing for you to remember is that the net income or loss that we retrieve from the income statement is actually the connection with the balance sheet. In fact, we have the value of income that represents the increase or decrease in wealth belonging to the shareholders.
If you carefully have a look at the balance sheet: on the asset side you will notice that we start from assets that are more liquid to the least liquid and the same thing happens with liabilities. The first line is the equity which is the resources that are connected to the life of the enterprise for a long period. And then we move down by listing all the debits. Another key principle that we would like to highlight here is that the total value of assets equals the total value of liabilities but only when we have taken into account the income. We have hit the end of the session and it is your turn to practice again.
I would like to thank our colleagues from the Department of Mathematics for letting us use the lightboard. See you at the next video.

This video is the last leg of activity 3 in week 3. It is fairly lengthy and you may want to consider pausing towards min 10, after all the adjustments are over and before the ledger accounts pop in. The purpose of the video is analysing how we deal with investments whose lives will go beyond the current year and how we can correctly attribute costs and revenues to the periodic income. Furthermore, we will finally abandon the use of Trial Balance to work with balance sheet and the income statement. Finally, we landed to the Financial Statements!

This article is from the free online

Introduction to Financial Accounting

Created by
FutureLearn - Learning For Life

Reach your personal and professional goals

Unlock access to hundreds of expert online courses and degrees from top universities and educators to gain accredited qualifications and professional CV-building certificates.

Join over 18 million learners to launch, switch or build upon your career, all at your own pace, across a wide range of topic areas.

Start Learning now