Here we detail about the three basic steps taken for preparing financial statement.
Step-1: To Understand The Meaning of Debit and Credit Balances:
The first step in preparation of financial statements is to understand the meaning of debit and credit balances appearing in the trial balance.
(i) Debit Balances in the Trial Balance:
The debit balances appearing in the trial balance either represents balances of
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(a) Assets and Deferred Revenue Expenditure or
(b) Losses and Expenses.
(ii) Credit Balances in the Trial Balance:
The credit balances appearing in the trial balance either represents balances of
(a) Capital, Liabilities, Provision and Reserves or
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(b) Revenue and Gains.
Step-2: Analyse the Debit and Credit Balances:
The next step is to examine and arrive at a conclusion as to which debit balance is an asset and which balance is an expenditure or loss? Similarly, which credit balance is liability and which balance is a gain or income?
(i) Analysis of Debit Balances:
If the business enterprise can recover any amount of debit balance, it should be treated as an asset and when business cannot recover anything of debit balance; it should be treated as losses and expenses.
(ii) Analysis of Credit Balances:
If the business has to pay any amount of credit balance to either owner or outsider, it should be treated as liability (internal or external) and when the business is not liable to pay any amount of credit balance to either owner or outsider, it should be treated as gain or income.
Step-3: Treatment of Debit and Credit Balances:
The next step in preparing financial statements is to treat the debit and credit balances appearing in the trial balance.
(i) Treatment of Debit Balances:
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The balances of assets and deferred revenue expenditure are directly shown on the assets side of the balance sheet. The balances of losses and expenses, depending upon their nature, being direct or indirect, are transferred to the debit side of either Trading Account or Profit & Loss Account as the case may be.
(ii) Treatment of Credit Balances:
The balances of capital, liabilities, provisions and reserves are directly shown on the liabilities side of the balance sheet. The balances of revenue and gains, depending upon their nature, being direct or indirect, are transferred to the credit side of either Trading Account or Profit & Loss Account as the case may be.
Illustration (Final Accounts):
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The following is the Trial Balance of Rishi Trading Co. on 31st March, 2011):
