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Income Statement

Income Statement

Introduction

The trial balance data for Nybrostrand Company with additional information are used to prepare the list of adjusting and closing entries and to compose income statement for the period ending 31 December 2012 in accordance with US GAAP.

Unadjusted trial balance: past years’ retained earnings

Before composing the income statement, other potential sources of errors in the bookkeeping process should be sought for and corrected. The unbalanced trial balance means there is an error in some of the accounts (“Balancing an Unbalanced Trial Balance”, 2010). The most probable source of error is supposed to be retained earnings account which balance is not included in the trial balance. The missing amount or balancing figure on substracting the amount of all credits from the amount of all debits equals to substraction difference between 982, 850 $ and 851, 000 $, or 131,850 (982, 850 $ - 851, 000 $ = 131,850 $) representing the past years’ retained earnings ledger account (Table 1, Working 1) However this trial balance is unadjusted, as it is created based on the unadjusted information from general ledger accounts and further adjusting entries should be made (“Balancing an Unbalanced Trial Balance”, 2010).

Adjusting and closing entries: current year retained earnings

Adjusting entries should be made to compose income statement in compliance with the accrual principle of accounting, which is the underlying concept of FASB conceptual framework (FASB, 2010). Adjusting entries purpose is 2-fold: to correct the errors of bookkeeping process and to make final entries to income summary account (“Bookkeeping fundamental-2: adjusting & closing entries”, 2009). As the bookkeeper has already corrected the sales account adjusting the revenues for the goods sale which has not taken place within the accounting period, further cost of goods sold adjustment is necessary to eliminate 42, 000$ cost of goods which have not been dispatched during this accounting period.This adjustment is based on the accrual principle of accounting and the matching concept (FASB, 1985).This adjusting entry will have impact on both year-end inventory (increasing its amount by 42,000$) and cost of goods sold decreasing it by 42,000$ (Table 2,Working 2). Afterwards, closing entries (all appropriate debits and credits to income summary account) will be done, with final transfer of the income summary account balance to retained earnings. The excess of revenue over the total expenses equals 161,150$ (586,000 $(revenue account balance) - 424,850$ (income summary account balance as the sum of all related expenses) = 161,150$) (Table 2, Working 3). The balance of 161,150$ should be transferred to retained earnings account as current year retained earnings (“Bookkeeping fundamental-2: adjusting & closing entries”, 2009).

Adjusted trial balance: income and expenses

Income Statement
Income statement prepared on the basis of trial balance shows the amount of net income equal to 161 150 $ (Table 4, Calculation: Table 2, Working 2)

Discussion

The income statement for Nybrostrand Company for the accounting period ending 31 December 2012 has been prepared based on the accrual basis of accounting and matching concept. These are underlying assumptions of FASB Conceptual Framework (FASB, 1985; FASB, 2010). The accrual basis of accounting means that the effects of all transactions, events and circumstances are recognized in the entity financial statements when they occur which can be different from the periods where the cash is received or paid (FASB, 1985, para 139). The matching concept is a logical consequence of the accrual accounting, as it requires recognition of revenue and expenses which arose directly and jointly from the same transactions or events, at the same time, i.e. within the same accounting period (FASB,2010, para 146). In relation to sales, the matching concept means that sale of goods involves both transaction of revenue (sale) and expense (cost of goods) recording treating them as arising jointly from the same event. That serves the basis for the adjusting entry of 42,500$ costs of goods sold decrease for Nybrostrand Company (Table 2), as due to the sales not having occurred in 2012, and the sales account having been decreased for the relevant revenue amount, the related expense (cost of goods part of the event) should also have been taken from the costs of sales account.
The importance of matching concept is clearly illustrated by comparison of Nybrostrand Company income statement with the one which would have been composed if the adjustments entries had not been made (Table 4). The income statement without adjusting entries would have depicted net income for 2012 equal to 118,650$ (161,150$ -42,500$ =118,650$) which would have substantially distorted the gross profit margin and the bottom line for the company, currently being equal 55% and 28% (Table 4, Working 3). If no adjustments had been made, the margins would have been significantly lower, 48% and 20% correspondingly (Table 4, Working 4), which would have distorted the information presented to the stakeholders to enable them to make economic decisions based on company profitability. On the contrary, in the future periods, when the sales would have been recorded without the corresponding expence (cost of goods sold) matching, it would have increased the margins unappropriately, thus misleading the users of financial statements.

Conclusion

The income statement preparation for Nybrostrand Company is based on 3 steps: producing unadjusted trial balance, making adjusting and closing entries and extracting items of revenue and expenses from the adjusted truial balance.The application of the accrual basis of accounting and the matching concept in compliance with US GAAP is essential for Nybrostrand income statement to present true and fair view of the company performance, and for the users of the company financial statements to make well-informed economic decisions.
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References:

1. Balancing an Unbalanced Trial Balance (2010). College-Cram. Retrieved from: http://www.college-cram.com/study/accounting/accounting-cycle/balancing-an-unbalanced-trial-balance/
2. Bookkeeping fundamental-2: adjusting & closing entries (2009). Accounting, Financial & Tax. Retrieved from: http://accounting-financial-tax.com/2009/11/bookkeeping-fundamental-2-adjusting-and-closing-entries/
3. . Financial Accounting Standards Board (FASB) (1985). Financial Accounting Standards Board Concept Statement No 6. Elements of Financial Statements Retrieved from: http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1218220132831&acceptedDisclaimer=true
4. Financial Accounting Standards Board (FASB) (2010). Financial Accounting Standards Board Concept Statement No 8. Conceptual Framework for Financial Reporting Retrieved from: http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1218220132831&acceptedDisclaimer=true