How do adjusting entries affect the final financial statements?

Adjusting entries play a crucial role in ensuring that revenue and expenses are properly matched within a specified accounting period, following the accrual basis of accounting. This principle is fundamental for producing accurate financial statements, as it mandates that revenues should be recognized in the period they are earned, and expenses should be recognized in the period they are incurred, regardless of when cash is exchanged.

When adjusting entries are made, they align the accounting records with the underlying economic reality of transactions, thereby ensuring that the financial statements reflect true performance. This matching principle directly affects the income statement by impacting net income and, through the net income, it ultimately influences the equity section of the balance sheet.

This adjustment is vital for providing stakeholders—like management, investors, and creditors—with a clear and accurate understanding of the entity's financial health over a specified period. Thus, adjusting entries significantly contribute to the reliability and relevance of the final financial statements.