Income Statements and the Owner Equity Statement
In the preceding articles, we looked at the Income Statement and a sample of the single-step format; we discussed how to prepare the Income Statement, how to read the Income Statement, and the difference between the single-step formats versus the multiple-step format. In this article, we're going to explain the relationship between the Income Statement and the Owner Equity Statement. There is a direct correlation and transfer of data from one piece of the financials to the next, and the relationship between the Income Statement and the Owner Equity Statement is an excellent example.
Once the net income has been established and the Income Statement is complete, the next financial statement to be prepared is the Statement of Owner's Equity. If the business is a corporation, this will be known as the Statement of Retained Earnings. On the Statement of Owner's Equity, there is a direct transfer of the Net income figure from the Income Statement to the Owner Equity statement that is labeled "Net Income for ___" (the month referenced is provided in the blank space). The equitable value of the business is a direct result of this computation.
Now, as you progress further into the financials, you will begin to see that the equity value is an important piece of financial information when creditors and investors examine the business financial information. Accurate reporting of this value can aid in determining loan eligibility, investor appeal, and owner net worth.
So much about the perceived health and success of a business are driven by the numbers reported on the Income Statement, and further flowed into the remaining financial statements. There are some pieces of information that cannot be readily assigned a dollar value; items such as brand recognition, goodwill, customer loyalty, and salvage value of assets. These variables are not included in the financial information about a business. Only the very tangible, regulated and marketable items are included when assessing the business financial status.
For this reason, and the fact that financials are building blocks for year after year of operating, financial, and investor information it is absolutely necessary to be accurate, and to verify the information that is included in these statements. An example of this need for accuracy and verifiable information can be found when we purchase equipment. When equipment is purchased, a salvage value must be assigned to the equipment; the salvage value is then deducted from the purchase value, and a method of depreciation chosen. The depreciation expense of equipment is a direct expense deduction on the Income Statement. If the information obtained about the salvage value of the equipment is incorrect, or if the method of depreciation chosen is incorrect, it will directly affect the Income Statement's Net Income Value; this will in turn impact the Owner's Equity Statement, etc.
As we learn more about the individual financial statements, we also learn more about their intricate relationship, and the importance of ethics and accuracy from the accounting profession. Our understanding of accounting, the industry for which we provide services and our individual client's situation can either work to the benefit of our client, or to their financial detriment.
Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.