FINANCIAL

STATEMENTS
Lecturer : Rofinus Leki, SE, MM
Contact by : 0821 5445 8999
 Financial Statements
Financial statements are the final outputs for applying the accounting cycle
which supply with creditable, relevant, and timely financial information to take
rational economic decision.
The object of a firm is to get profit. It is something of vital importance to all
firms. The profit made by a firm is the difference between the total revenues earned
and the total expenses incurred during a particular period of time. The owner is
also interested to know their financial position. The preparation of Trading and
Profit and Loss Account and Balance Sheet is known as the preparation of final
accounts.
 Basic Of Analysis
Financial Statements (meaning)

• Financial Statement is a statement prepared for evaluating past

performance and predicting future performance.
• Financial Statements are regarded as indices of business enterprises
performance and position.
• The term 'Financial statement' as used in modern accounting refers to
two statements, the position statement reflecting the assets, liabilities
and capital of a business entity on a particular date called the balance
sheet, and the other called the profit and loss account showing the
results of the business operations during a given period.
 Important Definitions Of
Financial Statements
(a) ―The financial statements provide a summary of the accounts
of a business enterprise, the balance sheet reflecting the assets,
liabilities and capital as on a certain data and the income statements
showing the results of operations during a certain period. (John N.
Meyer 2009)
(b) ―The end product of financial accounting is a set of financial
statements prepared by the accountant of a business enterprise that
purport to reveal the financial position of the enterprise the result of
its recent activities, and an analysis of what has been done with
earnings. (Smith and Ashburn 2017)
 Important Definitions Of
Financial Statements
According to (John N. Meyer-2009), ―The financial
statements are composed of data which are the results of a
combination of the following:
• Recorded facts concerning the business transactions .
• Conventions adopted to facilitate the accounting
techniques .
• Postulates or assumptions made to , and
• Personal judgments used in the application of the
conventions and postulates .
 • To communicate to their interested users, quantitative and
objective information, this information is useful in making
economic decisions.
• To meet the specialized needs of conscious creditors and
investors.
• To provide reliable information about the earnings of business
enterprise and its ability to operate at a profit in the future.
• To provide financialbase for tax assessments.
• To provide valuable information for predicting the future
earning power of the enterprise.
Objectives Of • To provide reliable information about the changes in economic
resources .

Financial • To provide information about the changes in net resources of

the organization
• To provide reliable information about the changes in net

Statements economic resources.

• To provide information about the changes in net resources of
the organization that result from profit directed activities.
• To play a very important role in accounting and corporate
reporting.
• To regulate equity and debenture issues by companies
 Importance of Financial Statements
• The financial statements are mirror which reflect the financial position of operating strength or
weakness of the business concern .
• These statements are useful to management , investors , creditors, bankers, workers, government and
public at large .
• Financial statements are the indicators of two significant factors namely, the profitability and financial
soundness of a business enterprise.
• The following major uses of financial statements which shows its importance :
• As a report of stewardship .
• As a basis of fiscal policy .
• To determine the legality of dividends.
• As a guide to dividendpolicy.
• As a basis for granting the credit.
• As informative for prospective investors in an enterprise.
• As guide to the value of investment already made.
• As an aid to government supervision.
• As a basis for price or rate regulation.
• As a basis for taxation.
 Importance of Financial Statements
• The financial statements are mirror which reflect the financial position of operating strength or
weakness of the business concern .
• These statements are useful to management , investors , creditors, bankers, workers, government and
public at large .
• Financial statements are the indicators of two significant factors namely, the profitability and financial
soundness of a business enterprise.
• The following major uses of financial statements which shows its importance :
• As a report of stewardship .
• As a basis of fiscal policy .
• To determine the legality of dividends.
• As a guide to dividendpolicy.
• As a basis for granting the credit.
• As informative for prospective investors in an enterprise.
• As guide to the value of investment already made.
• As an aid to government supervision.
• As a basis for price or rate regulation.
• As a basis for taxation.
 Business Activities
Business activity is the process of transforming inputs into outputs by addition
value. An accounting is a system that collects, records, stores, and processes data to
produce information for decision makers into several firms. The type of a business
depends on size of activity which is performed by the business .Thus the accounting
must be carefully addressed because of the tax, managerial, legal and liability
impacts that business formation has.
From Commercial and Legal angles, a business may be organized in many ways.
There are a number of different forms of Business firms. However, the
commonforms of organizing are: Sole proprietorship, Partnership, Limited Company
and Corporations.

1. Sole proprietorship
The Sole proprietorship is carried on by single individual. All the profits of the
business earn go to him. The sole proprietors‘ liability is unlimited, and he is
personally liable for paying of the debts.
 Business Activities
2. A partnership
A partnership comprises a minimum of two and a maximum of (20) persons trading
together as one firm and sharing in the profits. In addition to sharing the profits, each
partner shares unlimited Liability for all the debts and obligations of the firm and is
responsible for the Liabilities in the firm of his fellow partners as well as his own.

3. A limited company
A limited company is a Legal entity and is treated by the law like a natural person; it
must be run according to the rules set out by the company law. Among other provisions,
it is laid down that financial statement must be prepared and audited every year and be
made available for inspection on a public register.

4. Corporation
The Corporation structure consists of the shareholders and the board of directors. The
shareholders a point the board of directors to manage the company. The capital of a
company is divided into units of ownership called shares .The shares of a public
company are freely transferable from one individual to another.
 Advantages of Analysis of Financial Statements
(a) Knowing The Exact Position
• Everybody who is interested in knowing the exact financial position of the concern is benefited by the
'analysis' of financial statement.
• Interested party gets the valuable information about the exact facts and figures of the concern by
analyzing the financial statements by various methods.

(b) Decision-making
• Every interested party is in a positionto assess the exact financial position of the concern when it
analyses financial statements of that concern by reliable methods.
• Thus, such an analysis ultimately helps that party in taking various types of decisions such as
investment, sale, purchase etc.

(c) Forecasting
After analyzing the financial statements, one is in a position to forecastwhether it would be profitable or not
to invest in or to deal with the business concern.
Making Financial Decisions on the Basis of
Financial Statements
1. The major advantage of financial statement analysis is to provide decision makers information
about our a business enterprise decision-making.
2. Financial statements are used by financial institutions, loaning agencies, banks and others to make
sound loan or credit decisions.
3. Financial statements helps in predicting the earning prospects and growth rate in earnings which
are used by investors while comparing investment alternatives and other users interested in judging
the earning potential of business enterprises.
4. Analysis of financial statements is a significant tool in predicting the bankruptcy and failure
probability of business enterprises.
5. Financial statement analysis is defined as the process of identifying financial strengths and
weaknesses of the firm - by properly establishing relationship between the items of the balance sheet
and the profit and loss account.
Disadvantages Of Financial Statements Analysis

• Completely Ignore Current Costs

• Financial analysisis always based on financial statements which are generally prepared on the basis
of historical costs. Thus, it may reflect distorted results.
• The financial analysis based on such financial statements would not portray the effects of price level
changes over a period of time.
• Financial Statements are Essentially Interim Reports
• The amount of profit or loss as shown by the Profit and Loss account or the financial position as
shown by the Balance Sheet of any unit is always based on certain accounting concepts and
conventions. Therefore, these figures may not reflect the exact position.
• Further, the existence of contingent liabilities, deferred revenue expenditure.
 Disadvantages Of Financial Statements Analysis
3. Financial Analysis is Only a Means Not an End
• The financial analysis should not be considered as the ultimate objective test but it may be carried further based on the outcome
and revelations about the causes of variations. It is the part of the larger information processing system.
• In other words, it is a means to an end and not the end in itself and therefore, it should be used only as a starting point and
conclusion should be drawn keeping in view the overall picture and the prevailing economic and political situation.
4. Completely Ignores Non-monetary Facts
• Financial statements reveal only those facts which can be expressed in terms of money.
• For example,the financial statements will show only the amount paid to workers and staff as wages, salaries and other perks.
• But these will not reveal how loyal they are to their organization or how trained and efficient are they in the work assigned to them.
• These matters are also of considerable importance for the business and play a crucial role in efficientworking of an organization.
• However, these are completely ignored in financial statementas these cannot be measured in terms of money.
 Elements Of Financial Statements
The elements of financial statements are the general groupings of line items contained within the
statements. These elements are as follows:
• Assets : These are items of economic benefit that are expected to yield benefits in future
periods.Examples are accounts receivable, inventory, and fixed assets.
• Liabilities : These are legally binding obligations payable to another entity or individual.
Examples are accounts payable, taxes payable, and wages payable.
• Equity : This is the amount invested in a business by its owners, plus any remaining retained earnings
.
• Revenue : This is an increase in assets or decrease in liabilities caused by the provision of services or
products to customers. It is a quantification of the gross activity generated by a business. Examples
are product sales and service sales.
• Expense : This is the reduction in value of an asset as it is used to generate revenue. Examples are
interest expense, compensation expense, and utilities expense.
 Elements Of Financial Statements
The elements of, assets, liabilities, and equity are included in the balance sheet. Revenues and expenses are included in the
income statement. Changes in these elements are noted in the statement of cash flows.
♦ Assets
♦ Fixed Assets
♦ Current Assets
♦ Inventories
Inventories include those items of tangible property that are:
(1) Held for sale in the ordinary course of business,
(2)Used in process of production for such sale.
♦ Accounts Receivables
♦ Marketable Securities
‫ا‬ ♦ Cash
♦ Liabilities
♦ Owner's Equity
Owner's Equity is sum of funds owned by the proprietors of firm for financing its activities .The
difference between total of Assets and Liabilities is Owner‘s Equity. They can also be called capital, or
net worth.
 Chart Of Accounts
A complete listing of these numbers along with the respective account titles is known as a chart of
accounts. The chart of accounts is shown in the following chart.
 Basic Financial Statements
The accounting process (also called the accounting cycle)consists of the following groups of functions :
• Accounting observes many events and identify and measure in financial terms those events considered evidence of
economic activity.
• The evidence events are recorded, classified into meaningful groups and summarized for conciseness.
• Accountants report a businessactivity by preparing financial statements and special reports.

The purpose of financial accounting statements is mainly to show the financial position of a business at a particular point in
time and to show how that business has performed over a specific period. The three basic financial accounting statements
that help achieve this functionare:
• The trading account and the profit and loss account for the reporting period: an analysis of revenue and expenses of a
business, exactly at the end of the year.
• A balance sheet for the business at the end of the reporting period: a statement showing the assets, liabilities and
capital of abusiness.
• A cash flow statement for the reporting period: a statement showing how cash is generated and how it has been spent
by the business. Final statements consistof trading accountand profit & loss account and balance sheet. All the amounts
from trial balance are taken to prepare these statements.
 Preparation of Final Accounts of Sole
Proprietary Firm
(a) Journal
• 'Journal' is derived from the French Word "Jour" which means a
day. Journal therefore, means a daily record.
• A Journal is a book of "Original Entry" or "Primary Entry".
• First of all the business transactions are recorded in the 'Journal'
and subsequently they are posted in the ledger.
• To study "Book-Keeping", one must learn first how to journalise
the business transactions.
• To journalize the transaction means to record the two-fold
effects of a transaction in terms of debit and credit. This has to
be done by observing the rules of debit and credit.
 Preparation of Final Accounts of Sole
Proprietary Firm
Definition of Journal

"A Journal is a book of original entry in which the transactions are recorded
in a particular way by followingthe rules of debit and credit." (Dictionary for
Accountants written by E.L. Kohler 1983).
 Preparation of Final Accounts of Sole
Proprietary Firm
(b) Ledger
• A ledger is the principle book of accounts.
• All the entries made in the journal must be posted into the
ledger.
• The ledger is a book containing many ledger accounts. It is a
group or set of accounts.
• In other words, ledger is a book in which various accounts
(personal, real and nominal) are opened.
• Its source of information are the books of original entry called
journals.
• Usually, only one account is placed on each page of the ledger.
• A businessman cannot get the information about the transactions
from the Journal.
 Preparation of Final Accounts of Sole
Proprietary Firm
(b) Ledger

8. While transferring the transactions from the journal to the ledger,

the transactions are classified.
9. For each person, head of income, head of expenditure, asset, etc.,
separate accounts are opened in the ledger book.
 Preparation of Final Accounts of Sole
Proprietary Firm
(c) Trial Balance
• Trial Balance is a schedule or list of those debit and credit balances which are expected from various
accounts in the ledger and balances of cash inhand and at bank as shown by the cash book are also included
in it.
• "Trial Balance is a list or abstract of the balances or of total debits and total credits of the accounts in a
ledger,the purpose being to determine the equality of the posted debits and credits and to establish a basic
summary for financial statements.
• "The final list of balances totaled and combined is called Trial Balance".
 Preparation of Final Accounts of Sole
Proprietary Firm
(d) Trial Balance
• After preparing a Trial Balance at the end of an accounting period,the
next step is to prepare the Trading Account‘.
• Trading Account is one of the financial statement which shows the
result of buying and selling of goods and or services during
anaccounting period.
• Trading Account is a flow statementand not a static statement. It is
prepared for a particular accounting period and not at a particular point
of time.
• Trading Account is prepared to know the gross profit or gross loss
during the accounting period.
• The basis for the preparation of Trading account is the matching of
selling prices of goods and services with the cost of the goods sold and
services rendered
 Preparation of Final Accounts of Sole
Proprietary Firm
(d) Trial Balance
 Preparation of Final Accounts of Sole
Proprietary Firm
(e) Profit and Loss Account

• Profit and Loss Account is an account in the books of an organization to

which incomes and gains are credited and expenses and losses are
debited, so as to show the net profit or loss over a given period.
• The Profit and Loss Account has the unique characteristic feature of
enabling the organization to judge the performance of the factors of
production as well as enablingit to take note of the expenses for future
of the organization.
• The Profit and Loss Account enables the organization to make
provision for expenses such as bad debts etc.
 Preparation of Final Accounts of Sole
Proprietary Firm
(e) Profit and Loss Account
 Preparation of Final Accounts of Sole
Proprietary Firm
(f) Balance Sheet

• A Balance Sheet isone important financial statement.

• A Balance Sheet is a statement of assets and liabilities of an enterprise at a
given date.
• It is called as Balance Sheet because it is a sheet of balances of those ledger
accounts which have not been closed till the preparation of the Trading and
Profit and Loss Account.
• A Balance Sheet is a list of assets and claims of a business at some specific
point oftime and is prepared from an adjusted Trial Balance.
• A Balance Sheet shows the financial position of a business by detailing the
sources of funds and the utilization of these funds.
• A Balance Sheet shows the assets and liabilities grouped, properly classified
and arranged in a specific manner.
 Preparation of Final Accounts of Sole
Proprietary Firm
(f) Balance Sheet
Thank you