How do we turn a trial balance into a full set of financial statements, deciding where each balance belongs?
Prepare the income statement and statement of financial position from a trial balance
A focused answer to the O-Level Principles of Accounts outcome on building statements from a trial balance. Deciding where each balance belongs, dealing with closing inventory, and tying the statements together.
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What this dot point is asking
SEAB wants you to prepare the income statement and statement of financial position from a trial balance. The central insight is a simple sorting rule: each balance is either an income/expense (income statement) or an asset/liability/capital (statement of financial position), and a few items, especially closing inventory, appear in both because they come in as adjustments rather than as trial balance balances.
The answer
The sorting rule
Every trial balance balance goes to exactly one statement, decided by its element:
| Element | Goes to |
|---|---|
| Income (sales, discount received, rent received) | Income statement |
| Expense (purchases, rent, wages, carriage) | Income statement |
| Asset (equipment, receivables, bank, inventory) | Statement of financial position |
| Liability (payables, loan) | Statement of financial position |
| Capital and drawings | Statement of financial position (capital section) |
Drawings, although a debit balance, is not an expense; it is deducted in the capital section.
Closing inventory in both statements
Closing inventory is usually given as a note after the trial balance (only opening inventory is a trial balance balance). It appears in both statements:
- Income statement - deducted in the cost of sales (the goods are unsold, so not a cost this year).
- Statement of financial position - a current asset (goods still held at the year end).
The double entry behind this is Debit Inventory (asset), Credit the income statement (reducing cost of sales).
Tying the statements together
The two statements connect through profit: the profit for the year from the income statement is added to capital in the statement of financial position. When the capital section is built and the statement balances, the set is complete and internally consistent.
Examples in context
Example 1. A clean sort under time pressure. Faced with a long trial balance, a student first marks each line "IS" (income statement) or "SOFP". Sales, purchases and expenses are IS; equipment, receivables, payables and capital are SOFP. This quick sort prevents the common slip of dropping an item in the wrong statement when working at speed.
Example 2. The inventory that does double duty. A firm's closing inventory of \8,000$ lowers cost of sales (raising gross profit) and also appears as a current asset. Seeing it in both places reminds the preparer that unsold goods are not yet a cost but are still an asset the business owns, which is exactly what the matching principle requires.
Try this
Q1. State which statement each belongs in: wages, trade payables, sales, drawings. [2 marks]
- Cue. Wages - income statement; trade payables - statement of financial position; sales - income statement; drawings - statement of financial position (capital section).
Q2. Opening inventory \4,000\, closing inventory \5,000$. State the cost of sales. [2 marks]
- Cue. Cost of sales = 4\,000 + 30\,000 - 5\,000 = \29,000$.
Q3. Explain why closing inventory appears in both financial statements. [2 marks]
- Cue. In the income statement it is deducted in cost of sales (unsold, so not a cost this year); in the statement of financial position it is a current asset the business still holds.
Exam-style practice questions
Practice questions written in the style of SEAB exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
Original10 marksThe trial balance at 31 December shows: sales \80\,000\ (Dr); opening inventory \7\,000\ (Dr); wages \10\,000\ (Dr); trade receivables \9\,000\ (Cr); bank \4\,000\ (Cr); drawings \10\,000\. Prepare the income statement and statement of financial position.Show worked answer →
Income statement:
| Income statement for the year | $\
| --- | --- | --- |
| Sales | | 80,000 |
| Opening inventory | 7,000 | |
| Purchases | 45,000 | |
| | 52,000 | |
| Less closing inventory | (9,000) | |
| Cost of sales | | (43,000) |
| Gross profit | | 37,000 |
| Less rent | 6,000 | |
| Less wages | 10,000 | |
| Total expenses | | (16,000) |
| Profit for the year | | 21,000 |
Statement of financial position:
| Statement of financial position at 31 December | $\
| --- | --- | --- |
| Equipment | | 25,000 |
| Inventory (closing) | 9,000 | |
| Trade receivables | 9,000 | |
| Bank | 4,000 | 22,000 |
| Total assets | | 47,000 |
| Capital | | 30,000 |
| Add profit | | 21,000 |
| Less drawings | | (10,000) |
| Closing capital | | 41,000 |
| Trade payables | | 6,000 |
| Total capital and liabilities | | 47,000 |
Markers reward closing inventory used in cost of sales and as a current asset, profit of \21,000\.
Original4 marksExplain how you decide whether a balance in the trial balance belongs in the income statement or the statement of financial position, and why closing inventory appears in both statements.Show worked answer →
A balance belongs in the income statement if it is an income or an expense (sales, purchases, rent, wages). It belongs in the statement of financial position if it is an asset, a liability or capital (equipment, receivables, payables, capital, drawings under capital).
Closing inventory appears in both because it is given as an adjustment, not a trial balance balance. In the income statement it is deducted in cost of sales (it has not been sold, so it is not a cost this year). In the statement of financial position it is a current asset (goods the business still holds at the year end).
Markers reward the income/expense versus asset/liability/capital test, and the dual role of closing inventory (deducted in cost of sales and shown as a current asset).
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