Future Business Leaders of America (FBLA) Accounting Practice Test

What happens to owner's equity when there is an increase in revenue?

1. It decreases

2. It remains the same

3. It increases

4. It fluctuates

The correct answer is: It increases

An increase in revenue contributes directly to the overall profitability of a business. When a company generates more revenue, it typically leads to higher net income, assuming that expenses do not increase at a rate that outpaces the revenue. In accounting, net income is a key component of owner's equity, which reflects the residual interest in the assets of the business after deducting liabilities. As net income increases due to higher revenue, owner's equity also rises because net income is added to retained earnings, a component of owner's equity. This relationship underscores the fundamental accounting equation: Assets = Liabilities + Owner's Equity. When assets grow (through increased revenue), and assuming liabilities remain constant, owner’s equity must increase as a result. In summary, an increase in revenue leads to a corresponding increase in net income, which ultimately boosts owner's equity. This illustrates how successful revenue generation affects the financial health of a business, enhancing the stake that owners have in the company.