Acca f3 Financial Accounting (int) Study Text

Part C  The use of double entry and accounting systems

  6:  From trial balance to financial statements

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part of the double entry system, so the basic rule of double entry still applies: every debit must have an 

equal and opposite credit entry. 

This income and expense account contains the same information as the financial statement we are aiming 

for, ie the income statement, and in fact there are very few differences between the two. However, the 

income statement lays the information out differently and it may be much less detailed. 

So what do we do with this new ledger account? The first step is to look through the ledger accounts and 

identify which ones relate to income and expenses. In the case of Ron Knuckle, these accounts consist of 

purchases, rent, sales, bank loan interest, and other expenses. 

The balances on these accounts are transferred to the new income and expense account. For example, the 

balance on the purchases account is $5,000 DR. To balance this to zero, we write in $5,000 CR. But to 

comply with the rule of double entry, there has to be a debit entry somewhere, so we write $5,000 DR in 

the income and expense (I & E) account. Now the balance on the purchases account has been moved to 

the income and expense account. 

If we do the same thing with all the separate accounts of Ron Knuckle dealing with income and expenses, 

the result is as follows. 

PURCHASES

$

$

Trade account payables

5,000 I & E a/c

5,000

RENT

$

$

Cash at bank

3,500 I & E a/c

3,500

SALES

$

$

I & E a/c

12,500

Cash at bank

10,000

Trade accounts receivable

2,500

12,500

12,500

BANK LOAN INTEREST 

$

$

Cash at bank

100 I & E a/c

100

OTHER EXPENSES 

$

$

Cash at bank

1,900 I & E a/c

1,900

INCOME AND EXPENSE ACCOUNT 

$

$

Purchases 5,000 

Sales 

12,500 

Rent 3,500 

 

 

Bank loan interest 

100   

Other expenses 

1,900

(Note that the income and expense account has not yet been balanced off but we will return to that later.) 

If you look at the items we have gathered together in the income and expense account, they should strike 

a chord in your memory. They are the same items that we need to draw up the income statement.

Question

Income statement 

Draw up Ron Knuckle's income statement. 

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6: From trial balance to financial statements   Part C  The use of double entry and accounting systems 

Answer

RON KNUCKLE: INCOME STATEMENT 

$      

$      

Sales

12,500

Trading

Cost of sales (= purchases in this case) 

 

(5,000) account

Gross profit 

 

7,500 

Expenses

 Rent 

3,500 

 

Income 

and 

 

Bank loan interest 

100 

 

expenditure 

 Other 

expenses 

1,900  

account 

(5,500)

Net profit 

 

2,000

3 The statement of financial position

The balances on all remaining ledger accounts (including the income and expense account) can be listed 

and rearranged to form the 

statement of financial position.

Look back at the ledger accounts of Ron Knuckle. Now that we have dealt with those relating to income 

and expenses, which ones are left? The answer is that we still have to find out what to do with the cash, 

capital, bank loan, trade accounts payable, shop fittings, trade accounts receivable and the drawings 

accounts.

Are these the only ledger accounts left? No: don't forget there is still the last one we opened up, called the

income and expense account. The balance on this account represents the profit earned by the business, 

and if you go through the arithmetic, you will find that it has a credit balance – a profit – of $2,000. (Not 

surprisingly, this is the figure that is shown in the income statement.) 

These remaining accounts must also be balanced and ruled off, but since they represent assets and 

liabilities of the business (not income and expenses) their balances are not transferred to the income and 

expense account. Instead they are carried down in the books of the business. This means that they 

become opening balances for the next accounting period and indicate the value of the assets and liabilities 

at the end of one period and the beginning of the next. 

The conventional method of ruling off a ledger account at the end of an accounting period is illustrated by 

the bank loan account in Ron Knuckle's books. 

BANK LOAN ACCOUNT 

$       

$

Balance carried down (c/d)

1,000

Cash (D)

1,000

Balance brought down (b/d)

1,000

Ron Knuckle therefore begins the new accounting period with a credit balance of $1,000 on this account. 

A

credit balance brought down denotes a liability. An asset would be represented by a debit balance 

brought down.

One further point is worth noting before we move on to complete this example. You will remember that a 

proprietor's capital comprises any cash introduced by him, plus any profits made by the business, less 

any drawings made by him. At the stage we have now reached, these three elements are contained in 

different ledger accounts: cash introduced of $7,000 appears in the capital account; drawings of $1,500 

appear in drawings; and the profit made by the business is represented by the $2,000 credit balance on 

the income and expense account. It is convenient to gather together all these amounts into one 

capital

account, in the same way as we earlier gathered together income and expense accounts into one income 

and expense account. 

FAST FORWARD

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