In which order are the basic financial statements usually prepared for a reporting period?

Introduction / Context:
The three core financial statements are the income statement, the statement of retained earnings (or statement of changes in equity), and the balance sheet. These statements are interrelated, and the output from one is used as input into the next. Because of this linkage, there is a logical order in which they are prepared. This question tests whether you understand that sequence.

Given Data / Assumptions:

• The income statement reports revenues and expenses for the period and results in net income or net loss.
• The statement of retained earnings starts with opening retained earnings, adds net income (or subtracts net loss), subtracts dividends, and results in ending retained earnings.
• The balance sheet presents assets, liabilities, and equity at period end, with equity including the updated retained earnings figure.
• We assume a simple structure where retained earnings are a key link between the income statement and balance sheet.

Concept / Approach:
Because net income is needed to update retained earnings, the income statement must be prepared first. Once net income for the period is determined, the statement of retained earnings can be prepared, showing how that net income and any dividends affected retained earnings. Finally, the ending retained earnings balance flows into the equity section of the balance sheet. Preparing the balance sheet last ensures that it reflects updated equity and that the accounting equation balances using current figures.

Step-by-Step Solution:
Step 1: Prepare the income statement to compute net income or net loss from revenues and expenses. Step 2: Take the net income figure from the income statement and plug it into the statement of retained earnings as an addition to opening retained earnings. Step 3: Subtract any dividends from retained earnings to arrive at ending retained earnings. Step 4: Use this ending retained earnings figure, along with share capital and other equity items, in the equity section of the balance sheet. Step 5: Prepare the balance sheet last, ensuring that Assets = Liabilities + Equity with the updated retained earnings. Step 6: From the options, the sequence that matches this logic is: Income statement, then statement of retained earnings, then balance sheet.

Verification / Alternative check:
Consider what would happen if you tried to prepare the balance sheet first. You would not yet know the period's net income or the ending retained earnings, making it impossible to complete the equity section correctly. Similarly, you cannot complete the statement of retained earnings without first knowing net income from the income statement. Accounting textbooks and practice manuals consistently show the preparation sequence as income statement, then statement of retained earnings, then balance sheet, confirming that this is the standard order.

Why Other Options Are Wrong:
Option a suggests preparing the balance sheet before the statement of retained earnings, which is illogical because equity amounts would be incomplete. Option c starts with the balance sheet, which cannot be properly completed without computed net income and updated retained earnings. Option d places the statement of retained earnings first, which is impossible without net income from the income statement. Therefore, only option b reflects the correct order.

Common Pitfalls:
A frequent source of confusion is that, when reading published annual reports, users may see the balance sheet presented first, followed by the income statement and other statements. This presentation order in a printed report is not necessarily the same as the preparation order used by accountants. For exam purposes and for understanding the logical flow of data, always remember that net income flows into retained earnings, and retained earnings flows into equity on the balance sheet, so the income statement must be prepared first, followed by the statement of retained earnings, and then the balance sheet.

Final Answer:
The usual preparation order is income statement, then statement of retained earnings, then balance sheet.