Lessons · Accounting · how the statements tie through equity
How the statements tie together through equity
This period's profit from the income statement flows into equity on the balance sheet: closing equity equals opening equity plus profit, plus what the owner put in, minus what the owner took out.
Hone is a place to practise a career, one idea a day. This is one of its lessons, written out in full and free to read without an account.
What it is for
The auditor's first check on any set of statements is whether they tie. If the balance sheet's equity does not equal last year's equity plus this year's profit and owner movements, something has been left out, and the whole set is suspect until it is found.
How to think about it
Start from last period's closing equity. Add the profit from this period's income statement. Add capital the owner put in. Subtract drawings. The result must be the equity on this period's balance sheet.
Worked example
Opening equity 12,000Last balance sheet's equity.
+ profit 5,000From this period's income statement.
+ owner put in 2,000; − drawings 3,000The owner's own movements, which are not profit.
Closing equity = 12,000 + 5,000 + 2,000 − 3,000 = 16,000What this period's balance sheet must show. If it shows anything else, find out why before anyone reads it.
Your turn
Opening equity 20,000, owner put in 1,000, drawings 4,500, closing equity 23,500. Write the line with the profit filled in.
Closing equity = 20,000 + + 1,000 − 4,500 = 23,500
Solve one, graded on the server
The trap
Forgetting drawings. Equity comes out 3,000 too high, the balance sheet will not balance, and an hour goes on hunting for a posting error that is really a missing line on the equity statement.