SOKOINE UNIVERSITY OF AGRICULTURE

For BAIB And AEA

BMAF 100: PRINCIPLES OF ACCOUNTING
LECTURE NOTES – PREPARATION OF FINANCIAL STATEMENTS
Introduction
A trial balance is the summary of all the ledger account balances at a
particular point in time. It tends to check the arithmetic accuracy of the
accounts. Under the double entry system of accounting, every debit has a
corresponding credit and vice-versa. This means that the total of the debit
balances of all accounts in the ledger must equal the total of all credit
balances.
The trial balance is simply a list of all the ledger accounts and their
respective balances as at a specified point of time e.g., as at 31
December 20X3.
Pro forma/format of trial balance
Trial balance as at…………
Debit Credit
Tshs Tshs
Cash XX
Inventory XX
Payables XX
Share capital XX
Retained earnings XX
Other accounts XX
etc. XX XX
Total

Purpose of a trial balance

To check the arithmetic accuracy of accounting. After preparing all
required ledgers, a trial balance is prepared, to list out at one place, the
balances of all the ledger accounts. This helps in checking the arithmetic
accuracy of the ledger accounts.
Identifying, detecting and rectify errors which affects the trial
balance. Trial balance is used to detect if there are errors made during
the preparation of the accounts or during posting. The errors which can be
detected during preparation of trial balance are errors which affects the
trial balance.
Assisting in the preparation of financial statements. The financial
statements must be prepared at the end of each accounting year. The
balances of all the ledgers accounts used to prepare financial statements
are already available in the trial balance. Hence, trial balance makes it
easier to prepare and analyze the financial statements.
Assist in adjustments. Adjustments accounts like prepaid and accruals
need to be prepared during the preparation of the trial balance. This assist
in making adjustments only relevant to the current accounting year.
Assist in comparative analysis. Preparation of trial balance helps to
compare balances of the current year with the past years and peer
analysis. This helps the business to make important decisions regarding
income, expenses, production cost etc. It helps to recognize the trend in
the business and take action whenever necessary.
Limitations of a trial balance
The fact that the trial balance balances is a preliminary assurance that the
accounts are free from any mathematical / arithmetic errors. However, it
is not conclusive proof of the absence of errors. It only shows arithmetical
accuracy i.e., every debit has been provided a corresponding credit.
Therefore, even if the totals of the debit column and the credit column
agree, certain errors may remain unnoticed. Such errors may include:
 Errors of omission: these are errors caused by failure to record a
transaction.
 Errors of commission: these are errors caused due to incorrect
recording of a transaction in the day book, from day books to
ledger, inaccurate totalling/ balancing etc.
 Errors of principle: these include the types of errors which result
from the violation of fundamental principles of accountancy e.g.,
capital expenditure treated as revenue expenditure and vice-versa.
 Compensating errors: when two or more errors are committed in
such a way that the net effect of these errors on the debit and credit
of accounts is nil.
Relationship of the trial balance with the accounting cycle
The entire accounting exercise is summarised below:
 Transactions are identified and recorded in day books (journal, sales
book, purchase book, cash book, etc.).
 Transactions are recorded from day books to ledger accounts.
 A trial balance is prepared from the ledger accounts. It is a list of the
balances of all ledger accounts where total debits = total credits.
A trial balance contains:
 ledger balances that affect the statement of profit or loss: balance
of expense accounts and income accounts.
ledger balances that affect the statement of financial position:
balance of asset accounts and liability accounts.
Balances that affect the statement of profit or loss are recorded in it

and profit earned or loss incurred during the period is determined.
 Balances that affect the statement of financial position along with
the profit or loss determined by the statement of profit or loss are
recorded in it.
 The asset and liability side of the statement of financial position is
totalled. The total of the assets side should be equal to the total of
the liabilities side.
Steps involved in the preparation of a trial balance
I. Balance all the ledger accounts in the general ledger.
II. Calculate the totals of the balances in the accounts payable and
accounts receivable ledger accounts. (A single consolidated figure
will be taken for total receivables/payables in the trial balance - not
all individual ledger accounts).
III. Prepare a trial balance.
 Write the names of all accounts one after the other.
 All credit balances are written in the credit column of the trial
balance – against the name of the respective accounts.
 All debit balances are written in the debit column of the trial
balance – against the name of the respective accounts.
 Total both the columns.
 The two totals should be equal.
Example
The ledger balances of BBG Inc as on 31 December 20X3 are as follows.
Prepare a trial balance.
LEDGER ACCOUNTS TZS
Sales 1,000,000
Purchases 700,000
Salaries 25,000
Power and fuel 40,000
Auditor’s fees 10,000
Bad debts 2,000
Depreciation 35,000
Miscellaneous income 20,000
Rent received 60,000
Dividends 50,000
Plant & machinery 600,000
Intangible assets 200,000
inventory (opening) 100,000
Cash 18,000
Share capital 500,000
Retained earnings 200,000

Extract a trial balance at a particular date from a given set of

ledger accounts
Preparing extracts of an opening trial balance:
There are two types of accounts involved here.
I. Accounts that are transferred to the statement of profit or loss and
closed at the year end. These are the incomes and expenses
accounts.
II. Accounts that are taken to the statement of financial position and
carried over to the next accounting year. These are the assets and
liabilities accounts.
Example:
Trial balance as at 31 December 20X2
Debit Credit Nature of Disclosed
Tshs’000 Tshs’000 item in
Sales 10,000 Income SOPL
Purchases 6,000 Expense SOPL
Salaries and 2,000 Expense SOPL
wages
Cash 11,000 Asset SOFP
Receivables 6,000 Asset SOFP
Payables 3,000 Liability SOFP
Share capital 12,000 Liability SOFP
Answer:
Step 1: Close all accounts and identify if they should be transferred to the
statement of profit or loss or carried over to next year. (We have already
done it above).
Step 2: Transfer all expenses and income to the statement of profit or
loss.
Step 3: Carry over all assets and liabilities to the next year. Don’t forget
to include profit or loss incurred during the previous year.
Statement of profit or loss
TZS’000
Sales 10,000
Purchases (6,000)
Salaries and wages (2,000)
Profit 2,000
Note: The above profit of Tshs2 million is payable to the owners and
hence is a liability on the opening statement of financial position.
Trial balance as at 1 January 20X3
Debit Credit
Tshs’00 Tshs’00
0 0
Cash 11,000
Receivables 6,000
Payables 3,000
Share capital 12,000
Profit retained 2,000
Total 17,000 17,000

Conclusion:
A trial balance is not a financial statement. It does not reflect the financial
position of a company. A trial balance does not explain the financial
position and performance of the entity.
To enable us to understand and interpret the financial data, other financial
statements e.g., the statement of profit or loss and the statement of
financial position are prepared using the trial balance as their source of
information.
FINANCIAL STATEMENTS
Elements of financial statements and their nature
Financial statements portray the financial effects of transactions and other
events by grouping them into broad classes according to their economic
characteristics. These broad classes are what are termed as elements of
financial statements.
Elements related to financial position
Assets
An asset is a resource owned and controlled by an entity as a result of
past events and from which future economic benefits are expected to flow
to the entity.
Conditions
 They represent potential future benefits
 They belong to the business
 They are measurable in monetary terms
 Are a result of past transactions
Asset recognition
An asset is recognized in the statement of financial position when it is
probable that future economic benefits will flow to the entity and when
that asset has a cost or value that can be measured reliably.
Nature
All assets are debit in nature when they increase and credit in nature
when decrease.
Liabilities
A liability is a present obligation of the entity arising from past events, the
settlement of which is expected to result in an outflow from the entity’s
resources embodying economic benefits.
Condition
 Must involve a future sacrifice of resources
 Measurable in monetary terms
 The sacrifice must be an obligation of the business
 The obligation must have arisen from a past transaction
Recognition of liability
Liability is recognized when it is probable that an outflow of resources
embodying economic benefits will result from the settlement of a present
obligation and the amount at which the settlement will take place can be
measured reliably.
Nature
All liabilities are credit in nature when increase and debit when decrease.
Equity
Equity- is the residual interest in the assets of the entity after deducting
all its liabilities.
Nature
Equity is always credit in nature when increase.
Elements related to financial performance
Incomes
Is an increase in economic benefits during accounting period in the form
of inflow or enhancement of assets or decrease in liabilities that results in
the increase of equity, other than those relating to contributions from
equity participants.
This definition encompasses both revenue and gains.
Recognition of incomes
Incomes are recognized in the income statement when an increase in the
future economic benefit related to an increase in an asset or decrease in
liability has arisen and that can be measured reliably.
Nature
All incomes are credit in nature when increase and debit when decrease
Expenses
Is a decrease in economic benefits during accounting period in the form of
outflow or depletion of assets or increase in liabilities that results in the
decrease of equity, other than those relating to distributions to equity
participants.
Recognition of expenses
Expenses are recognized in the income statement when a decrease in the
future economic benefit related to a decrease in asset or increase in
liability has arisen and that can be measured reliably.
Nature
All expenses are debit in nature when increase and credit when decrease
Preparing statement of financial position and statement of profit
or loss
Format:
NAME OF BUSINESS
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED …
TZS TZS TZS
Sales XX
Less: return inwards (XX) XXX
Less: cost of sales
Opening stock XX
Add: purchases XX
Carriage inwards XX
XXX
Less: return outwards (XX) XXX
XX
Less: closing stock (XX) (XXX)
Gross profit XXX
Add: other incomes
Eg. Rent received XX
XXX
Less: operating expenses
Carriage outwards XX
Wages and salaries XX
Rent XX
Rates and insurance XX
Heating & lightning XX
Motor expenses XX
Depreciation XX
Increase PDD XX (XXX)
Net profit XXX

NAME OF BUSINESS
STATEMENT OF FINANCIAL POSITION AS AT …
TZS TZS
NON-CURRENT ASSETS
Motor vehicle XX
Fixtures and fitting XX XXX

CURRENT ASSETS
Closing stock XX
Debtors XX
Prepaid rates XX XXX
XXX
CAPITAL & LIABILITIES
Capital XX
Add: net profit/net loss XX
XX
Less: drawings (XX) XXX

SHORT TERM LIABILITIES

Bank overdraft XX
Creditors XX
Rent owing XX XX
XXX

Examples:
1. From the following trial balance of B Cork, extracted after one year’s
trading, prepare income statement for the year ended 31 Dec 2012
and a statement of financial position.
Trial balance as at 31 Dec 2012
DR CR
TZS TZS
Sales 200,500
Purchases 120,800
Salaries 58,600
 Motor expenses 2,400
Rent 1,900
Insurance 300
General expenses 170
Premises 95,600
Motor vehicles 17,200
Accounts receivable 26,800
Account payables 17,600
Cash at bank 16,400
Cash in hand 600
Drawings 8,400
Capital 131,070
349,170 349,170
Inventory at 31 Dec 2012 was TZS 15,600.
2. From the following trial balance of G. Foot after his first year’s
trading, you are required to draw up an income statement for the
year ending 31 June 2012 and a statement of financial position.
Trial balance as at 31 June 2012
DR CR
TZS TZS
Sales 266,000
Purchases 154,000
Rent 3,800
Light and heating expenses 700
Salaries and wages 52,000
Insurance 3,000
Buildings 84,800
Fixtures 2,000
Accounts receivable 31,200
Sundry expenses 300
Account payables 16,000
Cash at bank 15,000
Drawings 28,600
Vans 16,000
Motor running expenses 4,600
Capital 114,000
396,000 396,000
Inventory at 30 June 2012 was TZS 18,000
3. From the following trial balance of G Still, draw up a trading and
profit and loss account for the year ended 30 September 20X9, and
a balance sheet as at that date.
Trial balance as at 30th september,20x9
DR CR
Stock 1 October 20X8 41,600
Carriage outwards 2,100
 Carriage inwards 3,700
Returns inwards 1,540
Returns outwards 3,410
Purchases 188,43
0
Sales 380,400
Salaries and wages 61,400
Warehouse rent 3,700
Insurance 1,356
Motor expenses 1,910
Office expenses 412
Lighting and heating 894
expenses
General expenses 245
Premises 92,000
Motor vehicles 13,400
Fixtures and fittings 1,900
Debtors 42,560
Creditors 31,600
Cash at bank 5,106
Drawings 22,000
Capital 68,843
484,25 484,253
3
Stock at 30 September 20X9 was TZS44,780.