Which of the following statements is TRUE regarding the linkage of financial statements?

• A. Cash Flow Statement begins with Accounts Payable
• B. Net Income from Income Statement affects Retained Earnings on Balance Sheet
• C. Balance Sheet does not connect to Cash Flow Statement
• D. Depreciation is excluded from all financial statements

Answer: (B)

The statement that net income from the income statement affects retained earnings on the balance sheet is accurate because retained earnings represent the cumulative amount of income that has been retained in the company rather than distributed as dividends. Each period, the net income calculated on the income statement is added to the beginning retained earnings balance on the balance sheet. This linkage is essential for understanding how profits impact a company’s equity over time.

The movement of net income to retained earnings is a fundamental concept in financial accounting, emphasizing how performance (net income) affects the company's financial position (equity). Each period's net income adjusts retained earnings, providing a clearer picture of a company's financial health and growth.

In contrast, the other statements are inaccurate. For example, the cash flow statement starts with net income, and accounts payable is not the initial figure. The linkage between the balance sheet and cash flow statement is integral, as changes in assets and liabilities illustrated in the balance sheet affect cash flows. Additionally, depreciation is included in the income statement as an expense and impacts both the net income and the cash flow statement through the adjustment to cash flows from operating activities. Therefore, it is incorrect to say depreciation is excluded from all financial statements.