Florida General Contractor Practice Exam

Which of the following statements directly affects the balance sheet?

1. Statement of retained earnings

2. Statement of cash flows

3. Income statement

4. Adjusting entries

The correct answer is: Income statement

The income statement directly affects the balance sheet because it provides critical information regarding the company's revenues and expenses over a specified period, ultimately leading to the calculation of net income or loss. This net income is then incorporated into the equity section of the balance sheet through retained earnings. When net income increases, it enhances retained earnings, positively affecting the overall equity and financial position of the company. Therefore, changes in profitability reflected on the income statement will have a direct impact on the balance sheet's equity calculation. The other statements and concepts listed, while connected to the overall financial reporting and health of a business, do not have a direct impact on the balance sheet in the same way. For example, the statement of retained earnings provides details on how net income affects retained earnings, but it does not alter the balance sheet itself. The statement of cash flows offers insights into cash movement but does not directly modify the balance sheet items. Adjusting entries, meanwhile, are typically used to correct or update accounting records prior to financial reporting and indirectly affect the balance sheet by adjusting the accounts involved, but they do not stand as a primary source of change like the income statement does.