The balance sheet and income statement are connected: the income statement reports a period’s financial performance, and its net income or loss contributes to retained earnings on the balance sheet. Transactions can also affect an income statement expense and a balance sheet payable at the same time.
The income statement summarizes revenues and expenses for a period. Revenues greater than expenses produce net income; expenses greater than revenues produce a net loss. During the period-close process, revenue and expense accounts—called temporary accounts—are closed to the income summary account. The income summary balance is then closed to retained earnings.
All flashcards
What is retained earnings?
The accumulated earnings a company has kept after accounting for dividends distributed to shareholders.
What happens to temporary accounts during closing?
Revenue and expense accounts close to income summary; the income summary balance then closes to retained earnings.
How does an expense differ from a payable?
An expense is a cost recognized for a period; a payable is an unpaid obligation reported as a liability.
How is an unpaid utility invoice recorded when paid later?
When incurred on account, debit Utilities Expense and credit Accounts Payable. When paid, debit Accounts Payable and credit Cash.
Quiz questions
Which relationship calculates ending retained earnings?Answer: Beginning retained earnings plus net income minus dividends.
A company begins with $12,000 in retained earnings, earns $18,000 in net income, and pays $5,000 in dividends. What is its ending retained earnings?Answer: $25,000
How does a net loss affect retained earnings?Answer: It decreases retained earnings through the closing process.
What does the statement of retained earnings explain?Answer: How retained earnings changed from the beginning to the end of a period.
A company incurs a utility cost on account and has not yet paid the vendor. Where are the cost and unpaid obligation reported?Answer: The cost is reported on the income statement, and the obligation is reported as a balance-sheet liability.
Based on Principles of Finance by Julie Dahlquist, Rainford Knight (OpenStax), licensed CC BY 4.0. Adapted into a summary, flashcards and quizzes.