Which financial statement is prepared first? This is a common question among individuals and professionals alike when it comes to understanding the sequence of financial reporting. The answer to this question lies in the fundamental structure of financial statements and the accounting cycle. In this article, we will explore the order in which financial statements are prepared and why the income statement is typically the first to be completed.
The accounting cycle is a series of steps that businesses follow to record, classify, and summarize their financial transactions. The cycle consists of several phases, including journalizing, posting, adjusting, preparing financial statements, and closing the books. Each phase plays a crucial role in ensuring that the financial statements accurately reflect the company’s financial position and performance.
At the beginning of the accounting cycle, companies start by journalizing transactions. This involves recording all financial transactions in the general journal. Once the journalizing process is complete, the next step is to post these transactions to the respective accounts in the general ledger. This step is essential for maintaining accurate and up-to-date financial records.
After posting, the company must perform adjusting entries. These entries are necessary to ensure that the financial statements reflect the correct financial position and performance for the accounting period. Adjusting entries can include accruals, deferrals, and estimates. For example, if a company has earned revenue but has not yet received payment, an accrual entry is made to recognize the revenue in the current period.
With the adjusting entries complete, the company can now prepare its financial statements. The income statement is typically the first financial statement prepared. It provides a summary of the company’s revenues, expenses, gains, and losses for the accounting period. The income statement helps determine the company’s net income or net loss, which is a critical measure of its financial performance.
Once the income statement is prepared, the next financial statement to be prepared is the statement of changes in equity. This statement shows the changes in the company’s equity accounts, such as retained earnings, during the accounting period. It helps to explain how the net income or net loss from the income statement affects the company’s equity.
After the statement of changes in equity, the balance sheet is prepared. The balance sheet provides a snapshot of the company’s financial position at a specific point in time. It lists the company’s assets, liabilities, and equity, and shows how these elements are interrelated. The balance sheet is essential for understanding the company’s liquidity, solvency, and overall financial health.
Finally, the statement of cash flows is prepared. This statement shows the inflows and outflows of cash during the accounting period, categorized into operating, investing, and financing activities. The statement of cash flows helps investors and creditors assess the company’s ability to generate cash and its cash management practices.
In conclusion, the income statement is generally prepared first in the sequence of financial statements. This is because it provides a summary of the company’s financial performance, which is a fundamental aspect of its financial reporting. By understanding the order in which financial statements are prepared, individuals and professionals can gain a clearer picture of a company’s financial health and performance.
