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Chapter 8: Problem 2

What is the difference between a firm's balance sheet and its income statement?

Short Answer

Expert verified
A balance sheet presents a company's financial position at a specific point in time, outlining its assets, liabilities, and equity. An income statement, on the other hand, shows a company's financial activities, such as earnings and expenses, over a certain period.

Step by step solution

01

Define Balance Sheet

A balance sheet, also known as a 'statement of financial position', presents a snapshot of a firm's financial condition at a specific moment in time. It lists out the company's assets, liabilities and shareholders' equity. The assets of a company represent the resources that the firm owns, such as buildings, machinery, etc., which can be used to generate income. The liabilities represent the debts and obligations of the firm. The shareholders' equity represents the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid.
02

Define Income Statement

An income statement, also known as a 'profit and loss statement' or the 'statement of earnings', presents a company's revenues and expenses during a specific period. It shows how revenue is transformed into net income. It displays the revenue recognized for a specific period, and the cost and expenses charged against this revenue, including write-offs and taxes. The purpose of the income statement is to show managers and investors whether the company made or lost money during the period being reported.
03

Identify the Differences

The primary difference between a balance sheet and an income statement is the time frame they cover. A balance sheet shows a company's financial health at a single point in time, while an income statement shows a company's financial performance over an extended period. Besides, the balance sheet indicates the equation 'Assets = Liabilities + Shareholder's Equity', whereas the income statement outlines the equation Revenue - Expenses = Net Income.

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