How Do Accountants Prepare Financial Statements?

Crafting a set of financial statements is how a business translates its daily operations into a clear, understandable story of performance and health. Getting this story right isn't magic; it's a careful, methodical process that turns raw transaction data into strategic business insights. This article breaks down the exact eight steps accountants follow to prepare accurate and reliable financial statements, from gathering source documents to the final review.

Understanding the Foundational Accounting Principles

Before any numbers are entered, accountants operate within a framework of rules to ensure consistency and comparability. In the United States, this framework is known as Generally Accepted Accounting Principles (GAAP). These principles are the bedrock of financial reporting, ensuring that anyone reading the statements can trust the information presented. The two most fundamental concepts to grasp are:

• The Accrual Basis of Accounting: This is the core of GAAP. It dictates that revenue and expenses are recognized when they are earned or incurred, not necessarily when cash changes hands. This provides a more accurate picture of a company’s performance during a specific period. For example, if you complete a service for a client in December but don't get paid until January, the accrual method requires you to record that revenue in December.
• Consistency and Comparability: These ideas mean an accountant uses the same methods year after year. This allows stakeholders to compare financial results from one period to the next and identify real trends, rather than changes caused by switching accounting methods. It’s what allows an investor to see if revenue is actually growing or if profitability is truly improving over time.

Without these guiding principles, financial statements would be a chaotic mix of subjective information, useless for making sound business decisions.

Step 1: Gathering and Organizing Source Documents

Every number on a financial statement starts as a real-world event, documented by a piece of paper or a digital record. The first step in the accounting cycle is to collect and organize these source documents. This is the evidence backing up every transaction.

These documents include:

• Invoices sent to customers
• Bills and receipts from suppliers
• Bank and credit card statements
• Payroll records and timesheets
• Checks, both sent and received
• Loan agreements and contracts

Using modern accounting software like QuickBooks, Xero, or Wave is indispensable at this stage. These tools help centralize data by linking directly to bank accounts, capturing receipts digitally, and automating repetitive entries. This organization is vital; clean, well-documented source information is the foundation for accurate financial reporting. If the input is wrong, the final report will be wrong, no matter how skilled the accountant is.

Step 2: Recording Transactions in the General Journal

With organized source documents in hand, the next step is to record each transaction in the company’s general journal. Think of the journal as the official, chronological diary of the business. Each entry, known as a journal entry, captures a single transaction.

Every journal entry follows the rules of double-entry bookkeeping, where for every transaction, there are at least two accounts affected. An entry is made up of debits and credits, which must always equal each other. For example, if a business buys $500 of office supplies with cash:

• The Office Supplies account (an asset) is debited for $500, increasing its balance.
• The Cash account (also an asset) is credited for $500, decreasing its balance.

Accountants include a date, a description of the transaction, and the affected accounts in each entry. This creates a detailed and permanent record that serves as a clear audit trail.

Step 3: Posting Journal Entries to the General Ledger

While the general journal is a chronological list, it’s not very useful for seeing how much money is in the bank or how much is owed to suppliers. That’s the job of the general ledger (GL). The general ledger is a collection of all the company's accounts, organized by type: assets, liabilities, equity, revenues, and expenses.

The process of "posting" is simply transferring the debits and credits from the journal entries to their respective accounts in the ledger. After posting the office supply purchase from the previous step, the Cash ledger account would show a $500 decrease, and the Office Supplies ledger account would show a $500 increase. This step organizes all the transactional data, letting you see the total balance of any given account at any time.

Step 4: Preparing the Unadjusted Trial Balance

After a full period's worth of transactions have been journalized and posted, it's time for a crucial check-in: the unadjusted trial balance. This is an internal report, not a public financial statement. Its purpose is to verify that the total of all debit balances in the general ledger equals the total of all credit balances.

To prepare it, the accountant lists all the GL accounts and their balances in two columns—one for debits and one for credits. If the totals match, it confirms the mathematical accuracy of the ledger. If they don't, it signals an error somewhere in the journalizing or posting process that must be found and corrected before moving on. This step is a fundamental quality control check that prevents bigger problems down the line.

Step 5: Making Adjusting Entries

The unadjusted trial balance isn’t the final word because it doesn't yet reflect accrual accounting principles. Some financial events happen over time and aren't tied to a single daily transaction. Adjusting entries are journal entries made at the end of the accounting period to record these items.

These entries are critical for creating an accurate picture of the company's financial status. Most fall into one of these categories:

• Accrued Expenses: Costs that were incurred in one period but won't be paid until the next period. For example, if employees earn wages in the last week of December but payroll isn’t processed until January, an adjusting entry records wage expense and wages payable.
• Accrued Revenues: Income that was earned over a certain period but not yet received or noted. Imagine a consulting company that completes a project in December but won’t bill for it until January. An adjusting entry records the revenue and creates an account receivable.
• Prepaid Expenses: Expenses paid in advance and initially recorded as an asset. As they are used, they must be reported as expenses. The most common example is an insurance premium paid for the entire year. Each month, an adjusting entry moves a portion of that asset to an expense.
• Unearned Revenue: Money received before services are performed. Think of a magazine subscription or a retainer fee for legal services. When the service is provided, the liability is reduced, and revenue is recognized.
• Depreciation: The systematic allocation of the cost of a tangible asset over its useful life. Depreciation accounts for the wearing out or usage of an asset and spreads its cost over the periods it is used.

These entries are where a skilled accountant adds immense value, ensuring the financial statements truly reflect the business’s performance for the period.

Step 6: Preparing the Adjusted Trial Balance

Once all the adjusting entries have been journalized and posted to the general ledger, the accountant prepares another trial balance: the adjusted trial balance. Like the first one, it lists all accounts with their balances to ensure that total debits still equal total credits.

This adjusted report is the definitive, correct source of data from which the formal financial statements will be created. It reflects all financial activity for the period, fully aligned with accrual accounting principles. It's the final proof before the main statements are built.

Step 7: Creating the Core Financial Statements

With an accurate adjusted trial balance, the accountant now has all the figures needed to assemble the three core financial statements and a fourth statement, the statement of cash flows. The accounts from the adjusted trial balance are categorized in the following ways and in this specific order, starting with the income statement and following in a sequence.

1. The Income Statement: Often called the Profit & Loss (P&L) statement, this report shows the company’s financial performance over a specific period (like a month or a year). It's calculated as Revenues - Expenses = Net Income. All the revenue and expense accounts from the adjusted trial balance are transferred to the income statement.
2. The Statement of Retained Earnings: This statement acts as a bridge between the income statement and the balance sheet. It starts with the beginning retained earnings balance, adds the net income (from the income statement), and subtracts any dividends paid to shareholders. The result is the ending retained earnings balance for the period.
3. The Balance Sheet: This statement provides a snapshot of the company’s financial position at a single moment in time. It follows the fundamental accounting equation: Assets = Liabilities + Owner’s Equity. The asset, liability, and updated equity accounts (including the new retained earnings balance) are pulled from the adjusted trial balance.
4. The Statement of Cash Flows: Unlike the income statement, it tracks the actual cash that came in and went out of the business over the period. It reconciles the net income to net cash provided by activities in operating, investing, and financing sections.

Step 8: Closing the Books and Post-Closing Review

The final step in the cycle is to close the books. This means an accountant makes "closing entries." Temporary accounts (consisting of revenue and expenses) are reset to zero to prepare for the next accounting period. Their balances are transferred to permanent accounts as part of retained earnings in the equity section of the balance sheet.

After closing entries are made, a post-closing trial balance is prepared to ensure the ledger is still in balance. This final check ensures all temporary accounts have been properly reset, and the ledger is ready to begin a new accounting cycle.

Final Thoughts

Preparing financial statements is a dependable, structured process that moves from individual transactions to a cohesive picture of a company’s financial standing. Each step, from recording journal entries to making complex adjusting entries, builds on the last to create reports that are essential for making smart business decisions.

Creating and interpreting these statements often brings up detailed questions about compliance, from revenue recognition rules under state law to the proper depreciation schedules for specific assets according to the tax code. We designed Feather AI to give accountants and financial professionals instant, citation-backed answers to these questions, pulling directly from authoritative sources like the IRC and state guidance. This removes the hours spent on manual research and lets professionals focus on what matters most: strategic analysis and turning sound data into actionable advice.