4 Revenue and Expenses

Order of Financial Statement Preparation

Great work. Now where does that net income go? Of course—Net Income increases Retained Earnings. And there’s a whole statement that describes how equity accounts, such as Retained Earnings, change during the year. It’s called the Statement of Changes in Equity. Equity is just that important! Let’s take a step back and consider the order of financial statement preparation. We’d better prepare the Income Statement first! Then we’ll prepare the Statement of Changes in Equity which calculates retained earnings. Then, equipped with all our necessary equity section balances, we’ll prepare the Statement of Financial Position. So, the order of financial statement preparation is:

1. Income Statement: where we calculate Net Income
2. Statement of Changes in Equity: where we calculate Retained Earnings
3. Statement of Financial Position: where we list all our account balances—including the ones we calculated in the first two!

Now that we’ve discussed the flow of information from the Income Statement through to the Statement of Financial Position, let’s take a look at logistics. How do we move account balances from the Income Statement to Retained Earnings?