Preparing the trial balance is part of the accounting cycle. This step precedes the preparation of financial statements. Companies record financial transactions in the journal, post these journal entries to the ledger and then transfer the balances of all accounts to the unadjusted trial balance. This allows bookkeepers to verify that they have transferred the ledger balances correctly, make the necessary adjustments for errors and omissions, and compile the financial reports.
Identify the revenue and expense accounts on the unadjusted trial balance. Typically, companies keep a chart of accounts, which is a numbered list of accounts. Asset, liability, shareholders' equity, revenue and expenses are the different types of accounts. Income accounts have a credit balance and expense accounts have a debit balance. Revenue accounts include sales, fee revenue, service revenue and investment income. Expense accounts include marketing expenses, general and administrative expenses, and interest and taxes.
Prepare a separate column under the heading "net income" and divide the column into two sub-columns for debit and credit. Copy the revenue amounts to the credit column and the expense amounts to the debit column. If you are using a software spreadsheet application, this involves adding two new columns to the right of the unadjusted trial balance columns. If you have prepared the trial balance on a paper worksheet, add two new columns or prepare a new worksheet and copy the revenue and expense row contents.
Add the debit and credit balances in the net income column. The total in the debit column represents the total expenses for the period, while the credit total represents the total revenue for the period.
Subtract expenses from revenue to calculate net income. If expenses exceed revenue, you have a net loss for the period. You can also calculate the gross profit and operating income separately. Gross profit is sales minus cost of goods sold, and operating income is gross profit minus operating expenses, such as selling and administrative expenses. Interest expenses and taxes are part of non-operating expenses.
Tip
Debits increase asset and expense accounts, and they decrease revenue, liability and shareholders' equity accounts. Credits decrease asset and expense accounts, and they increase revenue, liability and shareholders' equity accounts.
For a small business, you are probably preparing a single-step income statement with just the revenue and expense items. Therefore, you may not need to calculate the gross profit and operating income amounts separately.
