✍🏻 Posted by Lee Ingram on 9/14/23. ⏱️ Total Reading Time: ~15 minutes
⚠️ Warning! Don't Get Caught Off-Guard!
Imagine walking into your first accounting exam, confident that you've memorized all the formulas and key terms, only to discover that you're required to write out financial statements by hand on a blank sheet of paper. No prompts, no templates, just you and the blank space staring back at you. This is a reality in many introductory accounting courses, and it can be a disastrous curveball if you're unprepared.
Why is this a big deal?
Writing financial statements by hand involves not just knowing what goes where, but also understanding the logical flow between different financial statements. It's one thing to pick the correct answer in a multiple-choice question about what constitutes revenue on an income statement; it's another entirely to create the whole statement from scratch.
What to do?
The first step to conquering this challenge is simple: practice. Take a blank sheet of paper and write out each financial statement by memory, then compare it to a template to see where you went wrong and right. If needed, use an example homework problem from your textbook.
Most exams are time-bound, and writing by hand generally takes longer than students anticipate. Get used to writing out these statements under time constraints to build your speed and efficiency.
So don't let your first accounting exam be the first time you've written out financial statements by hand. Use our practice resources to prepare for this inevitable challenge and get a leg up on your classmates who didn't see it coming.
Remember, accounting is as much about execution as it is about knowledge. Being prepared for every scenario is the key to acing exams!
Introduction
Accounting is often considered the "language of business," and financial statements are its poetry. But how well can you recite their verses? In this blog post, I'll break down the core financial statements every intro accounting student must understand: the Income Statement, Statement of Retained Earnings, and the Balance Sheet. Plus, I've got some exam tips that could mean the difference between a pass and a fail!
🚀 Let’s get started!
Table of Contents
- Where Do Financial Statements Come From?
- The Income Statement: Your Financial Report Card for a Specific Period
- The Statement of Retained Earnings: Tracking Changes to R/E Over Time
- The Balance Sheet: A “Snapshot” of Financial Information
- What about the Cash Flow Statement?
Where Do Financial Statements Come From?
Before we dive into each statement, it's essential to understand their origins. Financial statements are derived from an adjusted trial balance, which is essentially a listing of all account balances in your accounting system at a given point in time. This trial balance serves as the basis for preparing all your financial statements.
Not sure what an adjusted trial balance is?
#1 — The Income Statement: Your Financial Report Card for a Specific Period
Key Takeaways:
- Summarizes a company’s financial performance over a specified period.
👇🏻 Income Statement Formula
[Company Name] Income Statement For Period Ended on [Date]
- [Revenue 1]
- [Revenue 2, etc]
Total Your Revenues
- [Expense 1]
- [Expense 2]
- [Expense 3, etc]
Total Your Expenses
Net Income (or Net Loss) = Total Revenues - Total Expenses
Note: Typically, you may encounter 1 or 2 revenue accounts, but multiple expense accounts. This varies depending on the problem at hand, so be ready for anything!
To solidify your understanding even further… check out an example below.
Looking for an example to follow?
🚀 Stay tuned as we explore the Statement of Retained Earnings and the Balance Sheet in subsequent sections!
#2 — The Statement of Retained Earnings: Tracking Changes to R/E Over Time
Key Takeaways:
- Reveals how much profits (or losses) the company has chosen to keep in the business as opposed to distributing as dividends to owners and investors.
- Remember, if a net loss is recorded, this will reduce the retained earnings for the period.
Statement of Retained Earnings Formula (with Net Income)
[Company Name] Statement of Retained Earnings For Period Ended on [Date]Beginning Retained Earnings
Plus Net Income
Minus Dividends
= Ending Retained Earnings
Statement of Retained Earnings Formula (with Net Loss)
[Company Name] Statement of Retained Earnings For Period Ended on [Date]Beginning Retained Earnings
Minus Net Loss
Minus Dividends
= Ending Retained Earnings
💡 Special Scenario: Brand-New Companies
If you're dealing with a brand-new company in your exam questions, remember: the Beginning Retained Earnings would be zero! No Retained Earnings from a previous period would be carried forward. This tricks on exams constantly, so be careful!
💡 Why Ending Retained Earnings Matters
Your final Retained Earnings figure is essential as it flows into the Balance Sheet. For insight into how financial statements interconnect, check out my quick guide below.
#1 Income Statement
Revenues - Expenses = Net Income
Always start with the Income Statement!
#2 Statement of R/E
Beginning R/E + Net Income - Dividends = Ending R/E
Net Income flows into the Statement of Retained Earnings!
#3 Balance Sheet
Assets = Liabilites + Equity
Ending R/E flows into the Equity section of the Balance Sheet!
To solidify your understanding even further… check out an example below.
Looking for an example to follow?
🚀 On to the Balance Sheet next… Just one more statement to go!
#3 — The Balance Sheet: A “Snapshot” of Financial Information
Key Takeaways:
- Captures a company's financial position at a specific moment, usually the end of a fiscal period. Unlike the Income Statement, it doesn't show performance over a time period. Grasping this distinction is crucial for exam success.
👇🏻 Balance Sheet Formula
[Company Name] Balance Sheet As of [Date]Assets
- [Asset 1]
- [Asset 2]
- [Asset 3], etc.
- (Subtract Contra Assets like Accumulated Depreciation)
Total Assets
Liabilities
- [Liability 1]
- [Liability 2]
- [Liability 3], etc.
Total Liabilities
Equity
- [Equity Account 1]
- [Equity Account 2]
- [Equity Account 3], etc.
- (See Note Below on Contra Equity Accounts like Dividends)
Total Equity
Total Your Equity
Total your Liability and Equity
💡Additional Instructions & Tips
- Focus on Ending Balances Only: Exercise caution in ensuring that your Balance Sheet reflects only the ending balances for Assets, Liabilities, and Equity.
- For example, a common mistakes students make when preparing Balance Sheets is listing the "Beginning Period Retained Earnings" instead of the "Ending Period Retained Earnings." Stay vigilant to avoid such mistakes!
- Confused? See this visual aid below:
- Contra Assets: These accounts, such as Accumulated Depreciation, should be subtracted from the asset section to arrive at the Total Assets.
#1 Income Statement
Revenues - Expenses = Net Income
Always start with the Income Statement!
#2 Statement of R/E
Beginning R/E + Net Income - Dividends = Ending R/E
Net Income flows into the Statement of Retained Earnings!
#3 Balance Sheet
Assets = Liabilites + Equity
Ending R/E flows into the Equity section of the Balance Sheet!
- Contra Liabilities: Introductory accounting exams rarely cover this, but it's beneficial to know they exist for future reference.
- Contra Equity and Dividends: Do not include Dividends in the Balance Sheet; they're already accounted for in the Statement of Retained Earnings.
- Stuck on Contra Accounts?
- The Balancing Act: Your Balance Sheet is accurate when Total Assets equal the combined sum of Total Liabilities and Equity (aka A = L + E!). When you discover your finished Balance Sheet is "in balance," it's a huge confidence booster—especially if its during your exam!
By adhering to these guidelines, you're well on your way to mastering the Balance Sheet and acing your accounting exams.
To solidify your understanding even further… check out an example below.
Looking for an example to follow?
⚠️ What About the Cash Flow Statement?
If you’re taking your first introductory accounting course, the focus is often only on the Income Statement, Statement of Retained Earnings, and the Balance Sheet. The Cash Flow Statement is usually covered in managerial accounting courses. Regardless, please always consult your professor to understand what is expected for your exams.
Want to get ahead?
Summary and Takeaways
Acing your accounting exams hinges significantly on mastering financial statements, from income statements to balance sheets. This guide has given you actionable strategies and resources like quizzes, videos, and pro tips to sharpen your skills. Remember, exam success isn't just about knowing the material, but being able to execute it under pressure. Utilize these resources and strategies for optimal preparation. You’ve got this!
🤯 Stressed About Your Upcoming Accounting Exam?
Don't worry, you're not alone. Remember, the goal of this blog post was to clear up the maze of financial statements, especially Income Statements, Statements of Retained Earnings, and Balance Sheets. With consistent practice, these core topics will become instinctive for you. For a deeper dive, make sure to check out my Chapter 1 Cheat Sheet. (It’s free!)
Looking for the ultimate study toolkit? At SurviveAccounting.com, you’ll find an arsenal of videos, quizzes, practice exams, flashcards, and pro exam tips to help you ace exams, impress your professors, and transform yourself into a financial statement guru. Try out my Chapter 1 Exam Prep resources for free and experience the difference for yourself.
And there you have it—your roadmap to mastering financial statements and beyond. Master these principles, and you're not just passing that introductory accounting exam—you're acing it. Best of luck, and happy studying!
Your partner in exam domination, Lee
lee@surviveaccounting.com
About the Author
✍🏻 Lee Ingram is the founder of SurviveAccounting.com, your trusted guide to acing your accounting exams. With two accounting degrees and 8+ years of experience, Lee has helped nearly 1,500 students conquer their fears and pass their exams.
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