Financial Statement Questions and Answers [With PDF]
Financial statements are the final product of the whole accounting process. They turn thousands of entries into a few pages that owners, lenders and tax authorities can read. This is the biggest chapter in the course, so we have grouped the 45 important questions by statement, with ready-to-use formats and worked examples whose totals are checked.
This is Chapter 11 of our Accounting course. It builds on Accounting Principles and Trial Balance.
Financial Statements: The Basics
Q1. What is a financial statement?
A financial statement is a structured report that shows the financial results and the financial position of an organization, prepared from its accounting records at the end of a period.
Q2. What does a complete set of financial statements contain?
- The Statement of Comprehensive Income (income statement)
- The Statement of Changes in Equity
- The Statement of Financial Position (balance sheet)
- The Statement of Cash Flows
- Notes, including a summary of significant accounting policies and other explanations
Q3. What are the objectives of financial statements?
- To provide information that helps users make decisions.
- To help estimate future cash flows.
- To show profit and the performance of the business.
- To show how funds were raised and how they were used.
Q4. What is the importance of financial statements?
- They help in preparing budgets and plans.
- They show the ability to pay short-term and long-term liabilities.
- They help lenders decide whether to lend.
- They help in calculating tax.
- They help in deciding dividends.
- They help governments frame policies on industry and trade.
Q5. What are the limitations of financial statements?
- They are based on historical cost, so they may not show current values.
- They include estimates and judgement, such as depreciation, so they are not perfectly exact.
- They leave out qualitative factors, such as staff skills and reputation, that cannot be measured in money.
- They report the past and do not predict the future.
- Comparison between firms can be difficult if they use different accounting methods.
Q6. Who are the users of financial statements?
| Internal users | External users |
|---|---|
| Owners | Investors and potential investors |
| Management | Creditors and loan providers |
| Internal auditors | Government and the tax authority |
| External auditors and trade unions |
Q7. How do financial statements help their users?
They give information on results, financial position and cash flows, so users can make economic decisions such as investing, lending, buying shares or fixing prices.
Statement of Comprehensive Income
Q8. What is the statement of comprehensive income?
The statement prepared to find the profit or loss of a business for a period, by comparing income with expenses.
Q9. What was its earlier name?
The income statement (also called the profit and loss account).
Q10. What kinds of accounts are used to prepare it?
Nominal accounts: revenue-type incomes and revenue-type expenses.
Q11. What are its objectives?
- To find the net profit or loss for the period.
- To study incomes and expenses so that profit can be improved in future by raising income or controlling expenses.
Q12. In how many ways can it be prepared?
- Single-step income statement
- Multiple-step income statement
Q13. What is a single-step income statement?
It finds net profit in one step: total income minus total expenses for the period.
Q14. What is a multiple-step income statement?
It separates income and expenses into groups and finds profit in stages: gross profit, operating profit and net profit.
Q15. What are the stages of preparing it?
- Gross profit = Sales revenue – Cost of goods sold.
- Operating profit = Gross profit + Operating income – Operating expenses.
- Net profit = Operating profit + Non-operating income – Non-operating expenses.
Q16. What is the format of the statement of comprehensive income?
| Name of business | ||
|---|---|---|
| Statement of Comprehensive Income for the year ended …. | ||
| Sales revenue | xxx | |
| Less: Sales returns | (xxx) | |
| Net sales | xxx | |
| Less: Cost of goods sold | (xxx) | |
| Gross profit | xxx | |
| Add: Operating income (discount received, commission received) | xxx | |
| Less: Operating expenses (salaries, rent, advertising, depreciation, bad debts) | (xxx) | |
| Operating profit | xxx | |
| Add: Non-operating income (interest and dividends received, profit on sale of assets) | xxx | |
| Less: Non-operating expenses (interest on loans, loss on sale of assets) | (xxx) | |
| Net profit | xxx | |
Q17. What are examples of operating income?
- Sales of goods and services
- Discount received
- Commission received
Q18. What are examples of non-operating income?
- Profit on the sale of fixed assets
- Interest on investments
- Interest charged on the owner’s drawings
- Interest on loans given
- Interest received from the bank
- Rent received from sub-letting
- Dividends received
Q19. What are examples of operating expenses?
Items connected to making the goods saleable, such as purchases, carriage inward, wages, import duty and freight, go into the cost of goods sold. The true operating expenses are:
- Salaries, office rent and electricity
- Carriage outward
- Discount allowed
- Repairs, postage and telephone, stationery
- Advertisement, packing, insurance and travelling
- Bad debts and provision for doubtful debts
- Depreciation on assets
- Writing off of goodwill
Q20. What are examples of non-operating expenses?
- Loss on the sale of fixed assets
- Interest on capital
- Interest on bank loans and overdrafts
- Bank charges
- Losses from theft or accidents
Q21. Can you show a worked example?
Prepare the statement of comprehensive income of ABC Advertising for the year ended 31 March 2026: service income 24,000; interest received 800; discount received 1,000; dividend received 2,000; advertising 7,000; office rent 3,000; electricity and telephone 1,500; insurance 2,000; conveyance 700; manager’s salary 3,000; stationery 500.
Single-step method
| Particulars | Amount | Total |
|---|---|---|
| Income from services | 24,000 | |
| Interest received | 800 | |
| Discount received | 1,000 | |
| Dividend received | 2,000 | |
| Total income | 27,800 | |
| Advertising | 7,000 | |
| Office rent | 3,000 | |
| Electricity and telephone | 1,500 | |
| Insurance | 2,000 | |
| Conveyance | 700 | |
| Manager’s salary | 3,000 | |
| Stationery | 500 | |
| Total expenses | 17,700 | |
| Net profit | 10,100 |
Multiple-step method (same profit, shown in stages)
| Particulars | Amount |
|---|---|
| Operating income (24,000 services + 1,000 discount received) | 25,000 |
| Less: Operating expenses | (17,700) |
| Operating profit | 7,300 |
| Add: Non-operating income (800 interest + 2,000 dividend) | 2,800 |
| Net profit | 10,100 |
Q22. What is the cost of goods sold?
The cost of the goods that were sold during the period, including the costs of bringing them to a saleable condition.
Cost of goods sold = Opening stock + Net purchases + Expenses on purchases (carriage inward, wages, import duty) – Closing stock. Example: 3,000 + 4,000 + 500 – 1,500 = 6,000.
Q23. What is a provision for doubtful debts?
An estimate of the part of debtors’ balances that may not be collected. It is charged as an operating expense in the period, even though the loss has not yet happened.
Statement of Financial Position
Q24. What is the statement of financial position?
A statement prepared to show the assets, liabilities and equity of a business on a particular date.
Q25. What was its earlier name?
The balance sheet.
Q26. What are its features?
- It lists assets, liabilities and owner’s equity.
- It shows the position on one particular date, not over a period.
- Total assets always equal total liabilities plus equity.
- It is prepared after the statement of comprehensive income.
Q27. What is the purpose of preparing it?
To show the financial position of the business at the end of the year: what it owns, what it owes and what belongs to the owner.
Q28. What are the benefits of this statement?
- It shows the amounts of fixed and current assets, short and long-term liabilities, and capital.
- It lets users judge solvency and liquidity, for example whether current assets are enough to pay current liabilities.
- It supports ratios such as return on capital employed.
Q29. How is it prepared?
- List assets first, split into fixed assets (land, buildings) and current assets (stock, debtors, cash).
- List the owner’s equity: opening capital plus profit and any capital introduced, less drawings.
- List liabilities, split into long-term (bank loans) and current (creditors, outstanding expenses).
- Check that total assets equal equity plus total liabilities.
Q30. How can balances be arranged in this statement?
- Liquidity preference method
- Permanence preference method
Q31. What is the liquidity preference method?
Items are shown in the order of how quickly they can be turned into cash or paid. Current assets come first, then fixed assets. Current liabilities come first, then long-term liabilities.
Q32. What is the permanence preference method?
The opposite order. The most permanent items come first: fixed assets before current assets, and equity and long-term liabilities before current liabilities.
Q33. What are classified financial statements?
General-purpose external financial statements in which items are grouped into useful categories, such as current and non-current assets.
Q34. What are the categories of assets?
- Current assets
- Investments
- Property, plant and equipment
- Intangible assets
- Other assets (for items that do not fit elsewhere)
Q35. What are the categories of liabilities?
- Current liabilities
- Long-term (non-current) liabilities
Q36. Why is the classification of assets and liabilities important?
Assets differ in purpose and in how fast they turn into cash, and liabilities differ in when they must be paid. Classification lets managers and lenders see whether the business can meet its short-term obligations and manage its assets efficiently.
Q37. What are current assets?
Assets expected to be converted into cash, or used up, within one accounting period. Examples: stock, debtors, cash in hand and cash at bank.
Q38. What are fixed assets?
Assets used in the business for a long time and not bought for resale. Examples: land, buildings, plant and machinery, furniture.
Q39. What are current liabilities?
Obligations due within one accounting period. Examples: creditors, bills payable, outstanding expenses and a bank overdraft.
Q40. What are long-term liabilities?
Obligations that fall due after more than one year, such as bank loans, mortgages and debentures.
Q41. What is the format of the statement of financial position?
Below is a filled-in example in the permanence order, for a business with a net profit of 10,000 and drawings of 4,000 for the year.
| Statement of Financial Position as at 31 December | |
|---|---|
| Assets | |
| Fixed assets: Land | 50,000 |
| Fixed assets: Furniture | 10,000 |
| Current assets: Stock | 8,000 |
| Current assets: Debtors | 5,000 |
| Current assets: Cash | 7,000 |
| Total assets | 80,000 |
| Equity and liabilities | |
| Capital (60,000 + 10,000 profit – 4,000 drawings) | 66,000 |
| Long-term liability: Bank loan | 8,000 |
| Current liability: Creditors | 6,000 |
| Total equity and liabilities | 80,000 |
The two totals agree: 50,000 + 10,000 + 8,000 + 5,000 + 7,000 = 80,000, and 66,000 + 8,000 + 6,000 = 80,000.
Statement of Changes in Equity
Q42. What is the statement of changes in equity?
A statement that summarizes the increases and decreases in the owner’s equity during the period, such as capital introduced, profit earned and drawings taken.
Q43. What is its format?
| Statement of Changes in Equity for the year ended 31 December | |
|---|---|
| Opening capital | 60,000 |
| Add: Additional capital introduced | 0 |
| Add: Net profit for the year | 10,000 |
| Less: Drawings | (4,000) |
| Closing capital | 66,000 |
Retained Earnings Statement
Q44. What is a retained earnings statement?
A statement prepared by a company to show how its retained earnings changed during the year. Part of the year’s profit is paid to shareholders as dividends, and the remainder is retained in the business.
Q45. What is its format?
| Retained Earnings Statement for the year ended 31 December | |
|---|---|
| Retained earnings at the beginning of the year | 20,000 |
| Add: Net profit for the year | 10,000 |
| Less: Dividends declared | (4,000) |
| Retained earnings at the end of the year | 26,000 |
Quick Revision Points
- The statement of comprehensive income shows profit for a period. The statement of financial position shows position on a date.
- Gross profit = Sales – Cost of goods sold. Net profit = Operating profit + non-operating income – non-operating expenses.
- Cost of goods sold = Opening stock + Purchases + Purchase expenses – Closing stock.
- Assets = Liabilities + Equity, always.
- Closing capital = Opening capital + Profit – Drawings.
Take the chapter quiz below, then read the last chapter in the course, Bank Reconciliation Statement.
