Definition of Balance Sheet and Income Statement
The balance sheet reflects the accounting equation: Assets = Liabilities + Owner’s (Stockholders’) Equity
When a company earns revenues by performing services for cash, its assets increase and its owner’s equity increases. When the company pays cash for an advertisement expense, its assets decrease and its owner’s equity decreases.
In accounting and bookkeeping there is a separate financial statement known as the income statement that reports the revenues, expenses, gains, and losses that are recorded in income statement accounts.
This allows the balance sheet account Owner’s Capital (or Retained Earnings) to avoid having all of the thousands or millions of revenue and expense transactions from appearing. Instead, only the bottom line of the income statement, net income, needs to appear in the the owner’s equity account.
Example of the Connection Between the Balance Sheet and Income Statement
Our Explanation of Accounting Equation contains a series of transactions to illustrate the connection between the income statement and the balance sheet for both a sole proprietorship and a corporation.
