Relationships Among the Financial Statements

The information on the financial statements all comes from the same accounting system, and the four basic financial statements are all related to one another. Recall that the income statement calculates net income for the accounting period (usually a month, quarter, or year). The same net income is shown on the statement of stockholders’ equity, in the calculation of retained earnings for the period. Robyn's Retail's September net income of $1,292 is added to retained earnings in the September statement of stockholders’ equity. Total retained earnings and total owners’ equity are then shown on the balance sheet.

Figure 1.3 shows the relationship among financial statements for Robyn's Retail. Net income was calculated first because that carries over to the next statement, which is the statement of changes in stockholder's equity. On the statement of changes in stockholders' equity, retained earnings is calculated using the formula presented in Figure 1.2 (Beginning Retained Earnings + Net Income - Dividends = Ending Retained Earning). The retained earning amount can be seen on the balance sheet in the stockholders' equity section. Furthermore, the cash account on the balance sheet shows a balance of $28,150, which matches the bottom line of the statement of cash flows.

The Income, Stockholders' Equity, and the Balance Sheet

The relationships among the income statement, stockholders’ equity statement, and the balance sheet are summarized in Figure 1.3.

Details of operating revenues and expenses are shown on the income statement and summarized in net income. Net income carries over to the statement of stockholders' equity in the calculation of retained earnings. The final balance in retained earnings then carries over to the balance sheet, along with the balances of other equity accounts.

In addition, the reconciliation of cash in the statement of cash flows agrees with the balance in the cash account on the balance sheet. The four financial statements will always tie together in this manner. Another illustration of the financial statement relationships is shown on page 13 of your textbook.

The financial statements alone don't present enough information to enable investors and creditors to make informed decisions because they're presented in a summary format. They don't contain any information about the characteristics of the company, its choices of accounting methods, or details of complex transactions. For this reason, companies also present notes to the financial statements to provide a more complete communication of financial data. FASB guidelines strive to ensure that companies provide transparency in their financial statements, meaning that they do not hide or disguise information, which might mislead the users of the financial statements. In this course, we will sometimes refer to the financial statement notes and their contents when covering certain topics.