Financial Statement Preparation and Analysis

Financial accounting aims to provide useful information to investors and creditors.
Financial statements serve as the foundation of this information.
These statements are directly prepared from the adjusted trial balance.

The income statement is prepared first among the financial statements because its information is needed for other statements.
It includes a company's revenues and expenses.
Net income is the result of revenues minus expenses.
The heading includes:
- Company name
- Name of the financial statement (Income Statement)
- Date: "Year Ended" followed by the specific date. It can also be "Month Ended" or "Quarter Ended".
The income statement details revenues and expenses over a period of time; the date reflects this time period.
Revenues are listed first, and if there are multiple revenue streams, they are subtotaled, with the total revenue in the far column.
Expenses are listed next, subtotaled, and the total expenses are in the far column.
Net income is the difference between total revenues and total expenses.
Columns are for subtotaling and totaling amounts, not for debits and credits.

Prepared after the income statement because it uses net income.
Net income increases retained earnings.
Constructed from retained earnings and dividends from the adjusted trial balance, plus net income from the income statement.
The heading is similar to the income statement:
- Company name
- Name of the statement (Statement of Retained Earnings)
- Date: "Year Ended" followed by the specific date.
Details changes in retained earnings over a period of time.
Beginning retained earnings (from the adjusted trial balance) is listed first.
Net income is added to increase retained earnings.
Dividends are subtracted to decrease retained earnings.
The result is the ending retained earnings balance, which goes on the balance sheet.

Includes assets, liabilities, and equity accounts.
Ending retained earnings figures are taken from the statement of retained earnings.
Assets and liabilities are listed based on liquidity, which is the quickness of conversion to cash or payment.
Current Assets: Assets expected to be converted to cash, sold, or used within one year or one operating cycle, whichever is longer.
Current Liabilities: Liabilities expected to be paid within one year or one operating cycle, whichever is longer.
Long-Term Assets (Noncurrent Assets): Assets with useful lives exceeding one year.
Long-Term Liabilities (Long-Term Debt): Liabilities due beyond one year.
The balance sheet includes:
- Company name
- Name of the statement (Balance Sheet)
- Date: either just the date or "as of" followed by the date (point in time).
Reports assets, liabilities, and equity at a specific point in time.
Assets are listed in order of liquidity, with current assets listed first, followed by long-term assets.
Long-term assets may be grouped into investments, plant assets, intangible assets, and other noncurrent assets.
Liabilities are presented similarly, with current liabilities listed before long-term liabilities.
Stockholder's equity includes common stock and retained earnings.
Total liabilities plus stockholder's equity should equal total assets.
All figures match the adjusted trial balance except the retained earnings, which is updated after closing entries.

Accounts are categorized as temporary or permanent.
Temporary Accounts: Closed (zeroed out) at the end of the accounting period.
Permanent Accounts: Not closed during the closing process but retained earnings is instead.
Closing journal entries move revenues, expenses, and dividends to retained earnings.
Revenues increase equity, while expenses and dividends decrease equity.
This process prepares the accounts for the next accounting period with zero balances in temporary accounts.
Examples:
- Operating revenues (temporary): Reflect earnings for a specific period.
- Cash (permanent): Represents the amount at the end of the year and carries over to the next year.

Closing entries can be prepared using the adjusted trial balance or financial statements.
Closing Revenues:
- Debit revenue accounts (e.g., Service Revenue) to reduce their balance to zero.
- Credit Retained Earnings.
Closing Expenses:
- Credit expense accounts to reduce their balance to zero.
- Debit Retained Earnings for the total amount of expenses.
Closing Dividends:
- Credit Dividends to reduce its balance to zero.
- Debit Retained Earnings.
The Retained Earnings account is updated by closing revenues, expenses, and dividends.

Optional step prepared after closing entries to verify that the temporary accounts have been closed.
Lists accounts in the order: assets, liabilities, equities.
Only includes balance sheet accounts (assets, liabilities, and equity) since temporary accounts (revenues and expenses) have been closed.

Measures the ability to pay current liabilities with current assets, expressed as a ratio.
Higher ratio generally indicates a better ability to pay debts.
Formula: $Current Ratio = \frac{Current Assets}{Current Liabilities}$
A current ratio greater than 1.5 is generally considered strong.

Indicates the proportion of assets financed with debt.
Formula: $Debt Ratio = \frac{Total Liabilities}{Total Assets}$
A high debt ratio suggests greater pressure to pay interest and principal, while a low ratio might indicate the company isn't using enough leverage.
A debt ratio of less than 30% suggests the company isn't as efficient as it could be, whereas a ratio of more than 75% suggests possible bankruptcy.