The statement of changes in owners' equity connects which two financial statements?

• A. Income statement and balance sheet
• B. Income statement and cash flows
• C. Statement of cash flows and balance sheet
• D. Balance sheet and statement of retained earnings

Answer: (A)

The statement of changes in owners' equity shows how profitability and owner transactions affect the owners' equity over the period, linking the income statement to the balance sheet. Net income from the income statement increases owners' equity by boosting retained earnings, while withdrawals or distributions by owners decrease it. Contributions by owners increase contributed capital. By starting with beginning equity, incorporating net income, add-ons from owner actions, and subtractions for withdrawals, it ends with ending equity that appears on the balance sheet. This is why it best connects the income statement and the balance sheet—the income statement feeds into retained earnings, which are a key part of equity on the balance sheet.