Question

Identify the order in which the four financial statements are prepared, and explain how the first three statements are interrelated.

a) Order: Income statement, balance sheet, statement of cash flows, statement of retained earnings; Interrelation: Net income affects retained earnings.
b) Order: Balance sheet, income statement, statement of cash flows, statement of retained earnings; Interrelation: Ending cash balance impacts retained earnings.
c) Order: Statement of cash flows, balance sheet, income statement, statement of retained earnings; Interrelation: Dividends declared affect net income.
d) Order: Income statement, statement of retained earnings, balance sheet, statement of cash flows; Interrelation: Changes in equity impact cash flows.

Answer 1

The financial statements are prepared in the following order: income statement, statement of retained earnings, balance sheet, and statement of cash flows. Their interrelation is critical as each statement's outcomes impact the next, starting with net income affecting retained earnings, which in turn affects the shareholders' equity on the balance sheet, culminating in the statement of cash flows that shows cash activity based on prior statements.

Step-by-step explanation:

The correct order in which the four primary financial statements are prepared is: income statement, statement of retained earnings, balance sheet, and statement of cash flows. The reason for this order is due to their interrelation:

1. The income statement is prepared first to determine the net income or loss for a period.
2. Net income from the income statement is then used to prepare the statement of retained earnings, which shows how the period's profit or loss affects the company's retained earnings.
3. The updated retained earnings figure is incorporated into the balance sheet under shareholders' equity.
4. Finally, the statement of cash flows is prepared, which reconciles the beginning and ending cash balances, showing the cash effects of the company's activities. The balance sheet's ending cash balance should align with the statement of cash flows.

This sequence ensures the accuracy of the financial information, as each statement carries forward information to the next.