Which financial statement is most affected by adjusting entries?

The income statement is most affected by adjusting entries because these entries are made to record revenues and expenses in the period they are earned or incurred, rather than when cash is received or paid. Adjusting entries are necessary to ensure that the financial statements reflect the true financial position and performance of a business, adhering to the accrual basis of accounting.

For example, if a company has incurred expenses that have not yet been recorded, an adjusting entry would be required to reflect those expenses on the income statement, thereby reducing net income. Similarly, if revenues have been earned but not yet billed to customers, an adjusting entry would need to be made to record that revenue, impacting total income.

While the balance sheet is also affected by adjusting entries, particularly through the changes in asset and liability accounts, the direct impact of these entries is most pronounced on the income statement, which summarizes profitability over a specific period. The cash flow statement primarily reflects cash movements and would not typically show non-cash adjustments that adjusting entries entail. Similarly, the statement of changes in equity is influenced by the net income reported in the income statement but is not where the direct effect of adjusting entries is seen.