Definition of Balance Sheet and Income Statement
The balance sheet reports the following amounts at the end of an accounting period: Assets = Liabilities + Owner’s (Stockholders’) Equity.
This accounting equation is always in balance because of the double-entry system. This means that every transaction affects at least two accounts (selected from a list of all the balance sheet and income statement accounts).
The income statement reports the company’s revenues it earned and the expenses it incurred during the accounting period (as well as certain gains and losses). The net amount of the income statement items is reported as net income.
A positive amount of net income will cause an increase in the balance sheet’s Owner’s (Stockholders’) Equity. A net loss will cause a decrease.
Examples of the Balance Sheet and Income Statement Connection
Assume that in December, XYZ Co. earned consulting revenues of $8,000 and its clients are expected to pay in January. In December, XYZ’s balance sheet will see an increase in assets (Accounts Receivable) of $8,000 and its net income will increase $8,000 from the revenues earned. Since XYZ’s net income increased by $8,000, its Owner’s Equity also increased by $8,000.
In December, XYZ also incurred interest of $500 that will be paid in January. In December, XYZ’s balance sheet will see an increase in its liabilities (Interest Payable) of $500 and its net income will decrease by $500. Since XYZ’s net income decreased by $500, its Owner’s Equity also decreased by $500.
In both examples the accounting equation (and the balance sheet) will remain in balance.
