How Profit Affects a Balance Sheet — Practice Questions - dummies

How Profit Affects a Balance Sheet — Practice Questions

By Kenneth Boyd, Kate Mooney

An accountant calculates profit by summing up all revenues and subtracting all expenses. When a company’s revenues increase, this affects its assets in a positive way. The following practice questions look at how sales revenues increase the assets of a company.

Practice questions

  1. What is the impact of an increase in sales revenues on the balance sheet?

  2. A company reported net income of $550,000 for the year. If liabilities decreased by $250,000, what was the impact (if any) on the balance of assets?

Answers and explanations

  1. Sales revenues increase assets.

    When a company sells a product to a customer, the customer is expected to either pay for it immediately with cash or pay for it in accordance with the terms of the agreement (accounts receivable). Thus, sales revenues increase either cash or accounts receivable. So an asset is increased when sales revenues are recorded.

  2. Assets increased $300,000.

    This question requires you to look at the basic accounting equation: assets = liabilities + owners’ equity. If net income increased by $550,000, that means equity increased by $550,000. The decrease in liabilities is $250,000. All you need to do is plug in those numbers to the equation and solve for assets. Thus, assets equal the decrease in liabilities of $250,000 plus the increase in equity of $550,000, which equals $300,000 (note that liabilities are negative because they decreased).

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