State BPA Fundamental Accounting Practice Exam

What does net income increase in terms of accounting?

1. Liabilities

2. Assets

3. Owner’s Equity

4. Expenses

The correct answer is: Owner’s Equity

Net income is a crucial indicator of a company's financial performance, representing the excess of revenues over expenses during a specific period. When net income increases, it directly contributes to an increase in owner’s equity. This relationship stems from the fact that net income is ultimately added to retained earnings, which is a component of owner’s equity. As net income accumulates, it reflects the business's ability to generate profit, which strengthens the overall equity position of the owners or shareholders. In financial statements, this increase in owner’s equity reflects not only in the balance sheet but also conveys improved financial health and profitability of the business over time. Owner’s equity is a residual interest in the assets of the business after deducting liabilities, so as net income rises and is retained within the firm, it signals reinvestment into the business and enhances its capacity for growth, stability, and increased value for owners or shareholders.