Connection between Balance Sheet and Income Statement PDF

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Summary

The practical showing how to connect or the linkages between the two financial statements used in used by the copanies...

Description

Connect i onbet weenBal anceSheetandI ncomeSt at ement

The connection between the balance sheet and the income statement results from:  The use of double-entry accounting or bookkeeping, and  The accounting equation Assets = Liabilities + Owner's Equity Basically, the income statement components have the following effects on owner's equity:  Revenues and gains cause owner's (or stockholders') equity to increase  Expenses and losses cause owner's (or stockholders') equity to decrease Exampl eofHow t heBal anceSheetandI ncomeSt at ementAr eConnect ed

To illustrate the connection between the balance sheet and income statement, let's assume that a company's owner's equity was $40,000 at the beginning of the year, and it was $65,000 at the end of the year. Let's also assume that the owner did not invest or withdraw business assets during the year. Therefore, the $25,000 increase in owner's equity is likely the company's net income earned for the year. The details for the $25,000 (revenues, expenses, gains, losses) will be reported on the company's income statement for the year. Accountants refer to the income statement accounts (revenues, expenses, gains, losses) as temporary accounts because their balances will be closed and transferred to the owner's capital account at the end of the year.

Fr eeFinancial Statements

Financial Statement The financial statement summarizes the effect of events on a business. Its components are the income statement, retained earnings statement, balance sheet and statement of cash flows. Each statement serves specific functions. The income statement summarizes revenue and expenses. The retained earnings statement summarizes the retained earnings, which are the net income retained by a company. The statement of cash flows summarizes cash receipts and cash payments. The balance sheet lists a business's assets, liabilities and equity.

More on the Balance Sheet Unlike the cash flow, retained earnings and income statements, the balance sheet reports the financial condition of the company at a point in time. The financial condition of a company is represented by the accounting equation, assets = liabilities + stockholders’ equity. Assets have to equal liabilities plus stockholders’ equity. The balance sheet lists the components from left to right. The balance sheet first lists assets in order to arrive at total assets. It then lists liabilities to arrive at total liabilities. Stockholders’ equity is then listed. Total assets must equal total liabilities and stockholders' equity. Assets are the things that a company owns that have value, including property, trademarks and cash. Liabilities are the amount of money a company owes to others. Shareholders’ equity, which takes into account net income, is the money a company would have if it sold all of its assets and paid all of its liabilities.

Income Statement and Net Income The income statement begins by listing the revenues. It then lists the expenses, which can include cost of sales, selling and administrative, and income taxes. Expenses are matched against revenues. The matching concept requires expenses of a period be matched with revenues of the same period. A company has a net income when revenues exceed expenses. This means a company has increased its assets and that revenues have exceeded the assets used to generate the revenues. A company has a net loss and a decrease in assets when expenses have exceeded revenues. Net income is shown on the statement of cash flows as cash from operating activities. It also is placed at the top of the retained earnings statement and matched against any dividends that had been distributed. This results in the stockholders’ equity, which is accounted for as retained earnings on the balance sheet.

How it all Relates An integrated financial statement further shows how the income statement affects the balance sheet. In this example, the company has $10,000 in cash and $5,000 in capital stock on hand. The cash would be listed under assets and the capital stock under stockholders’ equity. The company spends $3,000 to buy land. This is recorded as a negative $3,000 on the cash flow statement because it is an outflow of cash to make an investment. The land is recorded on the balance sheet as negative cash but as a positive asset. The company, which provides accounting services, earns $10,000 in fees. The $10,000 from operations is recorded on the cash flow statement. It is recorded on the integrated financial statement as a positive cash inflow. It is listed on the balance sheet as retained earnings under stockholders’ equity, which makes the puzzle more complete....