The balance sheet reports a company's assets, liabilities, and owner's equity as of the last instant of an accounting year. Generally, the amount of the owner's equity will have changed from the previous balance sheet amount due to
- the company's net income
- the owner's additional investments in the business
- the owner's withdrawals of business assets
- If the owner did not invest or withdraw, the change in owner's equity is likely to be the amount of net income earned by the business.
- The revenues, expenses, gains, and losses that make up the net income are reported on the company's income statement.
To illustrate, let's assume that a company's balance sheets had reported owner's equity of $40,000 as of December 31, 2012 and $65,000 as of December 31, 2013. If during the year 2013 the owner did not invest or withdraw business assets, the $25,000 increase in owner's equity is likely to be the net income earned by the business. The details for the $25,000 of net income will appear on the company's income statement for the year 2013. (If the owner had withdrawn $12,000 of business assets for personal use, the net income must have been $37,000 since the net increase in owner's equity was $25,000.)
The connection between the balance sheet and the income statement results from the use of double-entry accounting or bookkeeping and the accounting equation Assets = Liabilities + Owner's Equity.