An introduction

In Module 1, we defined financial reporting as the process of recording, classifying, summarising, reporting, and analysing financial information. By this point, you should be able to:

• explain how business transactions occur
• record transactions in the relevant general ledger accounts
• balance off ledger accounts
• extract a trial balance after correcting errors

These skills cover the recording, classifying, and summarising stages of financial reporting. This module focuses on the next stage: reporting the summarised information by preparing financial statements.

This chapter is designed to help you revise and recall earlier topics that are essential for preparing financial statements.

Relevant previous knowledge

Refer to Module 1: The financial statement and its elements and revise the chapter before you proceed.

Recap questions

Provide answers to the following questions to refresh the key ideas.

1. List the components of the financial statements.

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2. Explain the purpose of the statement of financial position

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3. Explain the purpose of the statement of profit or loss and other comprehensive income

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4. Explain the purpose of the statement of changes in equity

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5. Explain the purpose of the statement of cashflow

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6. Explain the purpose of the notes to the financial statements

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7. List the elements of the financial statements

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8. Which of the elements of the financial statements are used for the preparation of the statement of profit or loss and other comprehensive income?

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9. Which of the elements of the financial statements are used for the preparation of the statement of financial position?

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The two statements are linked: profit for the year from the statement of profit or loss is added to retained earnings, and other comprehensive income (for example, a revaluation gain) is added to the revaluation surplus. Both sit within equity in the statement of financial position.

IFRS accounting standards

The preparation of financial statements is governed by IFRS 18, which replaces the previous standard IAS 1. However, the statement of cash flows is guided by a separate standard, IAS 7. IFRS 18 sets requirements for the presentation and disclosure of information in general-purpose financial statements, helping users compare financial statements across different entities and across time.

The chapters in this module follow the requirements of IFRS 18. Under IFRS 18, the statement of profit or loss includes the subtotals operating profit and profit before financing and income taxes, and the study guide also asks for profit before income taxes; you’ll see these in the formats chapter.

Note that not all IFRS requirements are examinable within the FA exams. Refer to ACCA technical write-up by a member of the FA examination team on IFRS 18.

Adjustments to the financial statements

Year-end adjustments are entries made after the trial balance is extracted, before the final financial statements are prepared. They aren’t corrections of errors, which are a separate topic. Their purpose is to make sure income and expenses are recorded in the correct accounting period, in line with the accrual basis of accounting.

Adjustments are a key link between the trial balance and accurate financial statements. If adjustments are missing or incorrect, the statement of financial position and the statement of profit or loss will also be incorrect.

The major adjustments, and where each one lands in the two statements, are:

Adjustment	Statement of profit or loss	Statement of financial position
Accrued expenses - expenses incurred but not yet paid (e.g., salaries, utilities)	Increases the expense	Current liability
Prepaid expenses - payments made in advance that need allocation across periods	Reduces the expense	Current asset
Accrued income - revenue earned but not yet received	Increases income	Current asset
Deferred income - payments received in advance for services not yet rendered	Reduces income	Current liability
Depreciation - systematic allocation of asset costs over their useful lives	Expense	Reduces the carrying amount of the non-current asset
Irrecoverable debts and allowance for receivables - writing off debts that will not be recovered, and adjusting the allowance for debts that may not be recovered	Irrecoverable debts expense, plus any increase in the allowance (a decrease reduces the expense)	Reduces trade receivables
Closing inventory - counted and valued at the lower of cost and net realisable value (IAS 2), including write-downs for damaged or obsolete inventories	Reduces cost of sales	Current asset
Accrued loan interest - interest incurred on loans for the period but not yet paid	Finance cost	Current liability

Exam tip: Most marks in a financial statements question come from processing the adjustments correctly. Practise each type until you can post it without notes.

Refer to ACCA technical write-up by a member of the FA examination team on adjustments to the financial statements.