3.4 From the Unadjusted Trial Balance to the Financial Statements
Key Takeaways
- The worksheet path is unadjusted trial balance → equal-debit-and-credit adjustments → adjusted trial balance → income statement → equity or retained earnings → balance sheet.
- Temporary accounts (revenues, expenses, drawings or dividends) close to zero; permanent accounts (assets, liabilities, capital or retained earnings) carry forward.
- Closing entries debit revenues into Income Summary, credit expenses out of Income Summary, close Income Summary to capital or retained earnings, and close drawings to capital.
- On a 10-column worksheet, net income is entered as a debit in the income statement columns and as a credit in the balance sheet columns so both pairs total.
- AIPB's adjusting-entries skill includes setting up the trial balance, inputting adjustments, building the adjusted trial balance, and converting those balances to the financial statements.
AIPB's certification pages describe Mastering Adjusting Entries as learning how to make end-of-period adjustments and how to create the trial balance and the adjusted trial balance. The online course language is even more operational: compute and record adjustments, set up the trial balance, input the adjustments, set up the adjusted trial balance, and see how it converts to the financial statements. This independent OpenExamPrep section is that conversion. You will walk a small Harbor Lane worksheet from the unadjusted trial balance through adjustments to the adjusted trial balance, then to the income statement, the statement of retained earnings (or owner's equity), and the balance sheet, and finish with the closing entries that reset temporary accounts.
Why the worksheet exists
The general ledger after December transactions is internally consistent, but it is not yet accrual-complete. Insurance may still sit entirely in Prepaid Insurance, depreciation may not be posted, and wages earned since the last payday may be missing. The unadjusted trial balance (UTB) lists every account's unadjusted debit or credit and proves that the ledger still balances. It does not prove that the balances are the right amounts for the statements. Adjusting entries, including the prepaid, bad-debt, interest, and depreciation items in this chapter, are entered in paired worksheet columns. Extending each line produces the adjusted trial balance (ATB). Only the ATB is ready to sort into financial statements.
A common 10-column worksheet uses five pairs of debit/credit columns:
| Column pair | What it holds | How a line gets there |
|---|---|---|
| Unadjusted trial balance | Ledger balances before adjustments | Copied from the accounts |
| Adjustments | Period-end deferrals, accruals, and estimates | Each adjustment has an equal debit and credit |
| Adjusted trial balance | UTB ± adjustments | Cross-foot each line; totals must equal |
| Income statement | Revenues and expenses | Extended from the ATB |
| Balance sheet | Assets, liabilities, equity, drawings | Extended from the ATB; net income links the last two pairs |
Some worksheets insert extra pairs for the statement of retained earnings or for a 12-column layout. The logic does not change: profit is measured first, equity is updated second, and the balance sheet is last because it needs the updated equity figure.
Harbor Lane unadjusted trial balance
Harbor Lane's December 31 unadjusted balances (both totals $39,500):
| Account | Debit | Credit |
|---|---|---|
| Cash | $8,400 | |
| Accounts Receivable | 6,200 | |
| Prepaid Insurance | 2,400 | |
| Equipment | 15,000 | |
| Accumulated Depreciation—Equipment | $3,000 | |
| Accounts Payable | 2,100 | |
| Unearned Revenue | 1,800 | |
| Owner's Capital | 20,000 | |
| Owner's Drawings | 1,500 | |
| Service Revenue | 12,600 | |
| Salaries Expense | 5,000 | |
| Rent Expense | 1,000 | |
| Totals | $39,500 | $39,500 |
Adjustments entered on the worksheet
Four adjustments (each with a matching debit and credit; combined adjustment-column totals $1,450):
| Key | Adjustment | Debit | Credit |
|---|---|---|---|
| (a) | Insurance expired $200 | Insurance Expense $200 | Prepaid Insurance $200 |
| (b) | Depreciation $250 | Depreciation Expense $250 | Accumulated Depreciation $250 |
| (c) | Accrued salaries $400 | Salaries Expense $400 | Salaries Payable $400 |
| (d) | Revenue earned from unearned $600 | Unearned Revenue $600 | Service Revenue $600 |
After posting those four items, selected adjusted balances include Prepaid Insurance $2,200, Accumulated Depreciation $3,250, Unearned Revenue $1,200, Service Revenue $13,200, Salaries Expense $5,400, Insurance Expense $200, Depreciation Expense $250, and a new liability Salaries Payable $400. The adjusted trial balance totals $40,150 on each side.
Prove a line: Prepaid Insurance unadjusted debit $2,400 minus credit adjustment $200 = $2,200. Service Revenue unadjusted credit $12,600 plus credit adjustment $600 = $13,200. If an adjustment debit and credit are not equal, the ATB will not balance and you must find the broken pair before extending statements.
Sorting the adjusted trial balance into statements
Income statement accounts are revenues and expenses. Harbor Lane's adjusted Service Revenue is $13,200. Expenses are Salaries $5,400 + Rent $1,000 + Insurance $200 + Depreciation $250 = $6,850. Net income = $13,200 − $6,850 = $6,350.
On the worksheet, the income-statement credit column (revenue) exceeds the debit column (expenses) by $6,350. To make those two columns total, you place $6,350 as a debit in the income-statement pair — a balancing figure labeled net income, not an extra expense. You then place $6,350 as a credit in the balance-sheet pair, because profit increases owner's capital (or retained earnings).
A net loss reverses those sides: a credit in the income-statement columns and a debit in the balance-sheet columns (loss reduces equity).
Statement of owner's equity (sole proprietorship) or statement of retained earnings (corporation) comes next. Harbor Lane's capital began at $20,000. Add net income $6,350; subtract drawings $1,500. Ending capital = $24,850. A corporation would start with beginning retained earnings, add net income, subtract dividends, and report ending retained earnings. Do not close drawings into Income Summary; drawings (or dividends) are distributions, not expenses, and they bypass the profit subtotal.
Balance sheet uses remaining ATB amounts plus ending equity. Assets: Cash $8,400 + AR $6,200 + Prepaid Insurance $2,200 + Equipment $15,000 − Accumulated Depreciation $3,250 = $28,550. Liabilities: Accounts Payable $2,100 + Salaries Payable $400 + Unearned Revenue $1,200 = $3,700. Equity $24,850. Liabilities plus equity = $28,550.
Drawings appear in the balance-sheet debit column of a 10-column worksheet (or in the equity statement columns of a wider worksheet). They are not assets; they reduce capital when the equity statement is prepared.
Temporary versus permanent accounts
| Class | Also called | Examples | After closing |
|---|---|---|---|
| Temporary | Nominal | Revenues, expenses, Income Summary, drawings, dividends | Balance zero; next period starts clean |
| Permanent | Real | Assets, liabilities, owner's capital, retained earnings, contra-assets | Balance carries to the next period |
Income Summary exists only during closing. It is not a financial-statement line in the published reports; it is a clearing account in the journal.
Closing entries, in order
- Close revenues: debit each revenue account for its balance; credit Income Summary. Harbor Lane: debit Service Revenue $13,200, credit Income Summary $13,200.
- Close expenses: debit Income Summary for total expenses; credit each expense account. Harbor Lane: debit Income Summary $6,850; credit Salaries Expense $5,400, Rent Expense $1,000, Insurance Expense $200, Depreciation Expense $250.
- Close Income Summary to equity. Income Summary now has a $6,350 credit (net income): debit Income Summary $6,350, credit Owner's Capital $6,350. A corporation credits Retained Earnings. A net loss (debit balance in Income Summary) is closed with a debit to Capital or Retained Earnings and a credit to Income Summary.
- Close drawings: debit Owner's Capital $1,500, credit Owner's Drawings $1,500. A corporation debits Retained Earnings and credits Dividends (or Dividends Declared).
After these four steps, a post-closing trial balance lists only permanent accounts: assets, contra-assets, liabilities, and capital or retained earnings. Revenues, expenses, drawings, and Income Summary are gone. That list should match the ending balance sheet (with capital already net of drawings and plus net income).
Order of work on exam items
Do not prepare the balance sheet from the unadjusted trial balance. Do not extend Service Revenue into the balance-sheet columns. Do not treat drawings as an expense on the income statement. Do not close Cash, Equipment, or Accounts Payable. If the worksheet's income-statement columns will not total after you insert net income, an adjustment was extended to the wrong statement or a debit/credit was flipped. The adjusted trial balance is the control tower: every financial-statement number should trace to it.
Which sequence correctly converts bookkeeping data into financial statements on a 10-column worksheet?
How are revenue accounts closed at year-end?
Harbor Lane's worksheet shows $13,200 of revenue and $6,850 of expenses. How is the $6,350 net income entered so the worksheet columns total?