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Lesson details
- Estimated study time
- 25 min
- Reading context
- Chapter 3
Statement walkthroughUse this lesson when you need to carry net income and owner distributions into ending retained earnings and total equity.
Learning objectives (7)
The income statement measures performance during a period. The statement of changes in equity explains how that result and owner transactions change equity. Use this lesson when you can calculate income but are unsure which amount belongs in the next statement.
Identify the period and beginning balances
Maple Studio is a corporation that provides design services. Its reporting year runs from January 1 through December 31, 2026. Beginning Common Stock is $20,000 and beginning Retained Earnings is $8,000. No shares are issued or retired during the year. Maple declares $2,000 of dividends.
There are no income taxes, gains, losses, or other equity changes in this simplified example. The following revenue and expense amounts are adjusted balances: all the period's required adjustments have already been included.
Calculate the year's income
An income statement reports the revenue and expenses included in net income for a stated period. Maple's expenses include wages, rent, and depreciation, which allocates equipment cost to the periods using that equipment.
| Maple Studio | US dollars |
|---|---|
| Income statement | |
| Year ended December 31, 2026 | |
| Service revenue | $46,000 |
| Wages expense | (18,000) |
| Rent expense | (6,000) |
| Depreciation expense | (4,000) |
| Total expenses | (28,000) |
| Net income | $18,000 |
Expenses total $18,000 + $6,000 + $4,000 = $28,000. Subtracting those expenses from $46,000 of revenue gives $18,000 of net income. Parentheses indicate amounts subtracted in the statement.
The $2,000 dividend is excluded. Dividends distribute equity to shareholders; they are not expenses incurred in earning the year's revenue. Subtracting them here would report $16,000 of income instead of $18,000.
Explain both equity accounts
Retained earnings accumulates net income and losses, reduced by dividends and other changes charged to that account. Common Stock is a separate equity account associated with share investment, so retained earnings is only one component of total equity.
A statement of changes in equity explains the movement from beginning to ending balances for each component. Maple's net income enters the Retained Earnings column, while its unchanged Common Stock carries through:
| Maple Studio: year ended December 31, 2026, US dollars | Common stock | Retained earnings | Total equity |
|---|---|---|---|
| Beginning balance | $20,000 | $8,000 | $28,000 |
| Net income | 18,000 | 18,000 | |
| Dividends | (2,000) | (2,000) | |
| Ending balance | $20,000 | $24,000 | $44,000 |
Retained earnings ends at $8,000 + $18,000 - $2,000 = $24,000. Adding $20,000 of Common Stock gives $44,000 of ending equity. A statement of retained earnings would explain only one of those accounts, not both components.
Do not copy the beginning account balance
The $8,000 Retained Earnings balance on Maple's adjusted trial balance does not yet include the current year's closing transfers. Calculate the $24,000 ending amount for the statements instead of copying $8,000 to the balance sheet.
Closing later transfers the revenue, expense, and dividend balances into the ledger account. It must produce the same ending retained earnings. Closing does not create the $18,000 of income; the year's transactions and adjustments already determined it.
Connect equity to the balance sheet
Maple's adjusted assets total $53,000 and liabilities total $9,000. The balance sheet therefore reports the same $44,000 of equity: $53,000 - $9,000 = $44,000. The income statement and equity statement cover the year; the balance sheet reports the ending position at December 31.
Net income and ending equity are not Cash balances. A sale on credit can increase income before cash collection. Buying equipment can reduce Cash without reducing equity by the purchase price.
Check your reasoning
Suppose a draft reports the dividend as an expense and shows $16,000 of net income. It then adds that income to $8,000 of beginning retained earnings, without a separate dividend line, and reaches $24,000. Is the draft correct?
Check the answer
No. The ending retained earnings happens to agree, but net income is understated. The income statement must show $18,000, and the equity statement must show the $2,000 dividend separately. Equal ending totals cannot establish that the changes were classified correctly.