4. Preparing the Statement of Financial Position

Question 1

What comprises owner’s capital? (3)

Answer 1

The owner’s capital comprises any cash introduced, plus any profits made by the business, less any drawings.

Question 2

What three accounts would the three elements of owner’s capital be contained in?

Cash introduced
Profits
Drawings

Answer 2

1. Cash introduced appears in the capital account
2. Profits appear in the profit and loss account.
3. Drawings appear in the drawings account.

Question 3

How is the closing capital balance determined?

Answer 3

To determine the closing capital balance, we combine these in the capital account, which is prepared in a similar way to the profit and loss ledger account.

Question 4

Which accounts need to be balanced off to prepare the statement of financial position?

What do these accounts represent?

Answer 4

One the capital account has been prepared by transferring account balances from the capital, drawings and profit and loss accounts, the following accounts need to be balanced off:
1. Cash
2. Capital
3. Bank Loan
4. Trade Payables
5. Non-current Assets
6. Trade Receivables

These accounts represent assets, capital and liabilities of the business so their balances are carried down in the accounting records of the business.
This means that they become opening balances brought down for the next reporting period.

Question 5

What kind of balance brought down represents an asset vs a liability?

Answer 5

A debit balance brought down denotes an asset.

A credit balance brought down denotes a liability.

Question 6

How can the trial balance be used to prepare financial statements?

Answer 6

The trial balance can be used to draw up a statement of profit or loss and a statement of financial position, without the need to create a profit and loss ledger account.

To produce a statement of profit or loss, transfer each income and expense figure from the trial balance to the statement of profit or loss pro forma. Then add down to calculate the profit (or loss) for the year.

To produce a statement of financial position, transfer the balance for each asset, liability and capital account to a statement of financial position pro forma. In the equity section, record the profit of for the year (as per the statement of profit or loss). Finally, add down the asset section and add down the equity and liabilities section of the statement of financial position to show the subtotal and total figures where appropriate.

This is the method that should be used in the exam - there is a full example in Chapter 12.