FINANCIAL & MANAGERIAL

ACCOUNTING for MBAs 5e

Peter D. Robert F. Mary Lea Al L. Wayne J.
EASTON HALSEY McANALLY HARTGRAVES MORSE

MODULE 3
Transactions, Adjustments, and
Financial Statements

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 Learning Objective 1

Explain the accounting cycle, and construct the

financial statement effects template.

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 Accounting Cycle

 Step 1 Record transactions in the accounting records.

 Step 2 Prepare accounting adjustments
 Step 3 Prepare financial statements.
 Step 4 Close the books in anticipation of the start of a
new accounting cycle.
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 Financial Statement Effects Template

 The template captures the transaction and its effects on the four
financial statements:
 Balance sheet
 Income statement
 Statement of stockholders’ equity
 Statement of cash flows
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 T-Accounts

 The T-account is used to reflect increases and

decreases to individual accounts.
 A T-account provides a simple illustration of the
financial effects of each transaction.
 The left side of an asset T-account records increases in the
asset and the right side records decreases.
 The right side of a liability and an equity T-account records
increases and the left side records decreases.

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 Journal Entries

 Journal entries also capture the effects of transactions.

 Journal entries reflect increases and decreases to accounts using the
language of debits and credits.
 Debits and credits simply refer to the left or right side of a T-account,
respectively.

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 Learning Objective 2

Apply the financial statement effects template to

analyze accounting transactions.

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 Financial Statement Effects Template
for Apple 2014–2015 (1)

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 Financial Statement Effects Template
for Apple 2014–2015 (2)

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 Learning Objective 3

Prepare and explain accounting adjustments and

their financial statement effects.

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 Accounting Adjustments

 Companies make adjustments to more accurately

report their financial performance and condition.
 For example, employees might not have been paid for
wages earned at the end of an accounting period.
 Failure to recognize this labor cost would understate the
company’s total liabilities (because wages payable would be
too low) and would overstate net income for the period
(because wages expense would be too low).
 Thus, neither the balance sheet nor the income statement
would be accurate without accounting adjustments.

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 Four Types of Accounting Adjustments

 Prepaid expenses—Reflect advance cash payments that will

ultimately become expenses.
 Unearned revenues—Reflect cash received from customers
before any services or goods are provided.
 Accrued expenses—Expenses incurred and recognized on the
income statement even though they are not yet paid in cash.
 Accrued revenues—Revenues earned and recognized on the
income statement even though cash is not yet received.
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 Prepaid Expenses

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 Unearned Revenues

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 Accrued Expenses

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 Accrued Revenues

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 Learning Objective 4

Construct financial statementsfrom the accounting

records.

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 Preparation of Financial Statements

 Once we enter all of the transactions and adjustments into the

financial statement effects template, we sum each column to
obtain ending balances for the accounts.
 With the accounts totaled, we can prepare the financial
statements.
 There is an order to financial statement preparation.
1. A company prepares its income statement using the income statement
accounts. It then uses the net income number and dividend information
to update the retained earnings account.
2. It prepares the balance sheet using the updated retained earnings
account along with the remaining balance sheet accounts.
3. It prepares the statement of stockholders’ equity.
4. It prepares the statement of cash flows.
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 Income Statement
— Apple —

 Apple’s income statement accounts are in the last three columns of the
financial statement effects template.
 We use the data from those columns to prepare the income statement.

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 Retained Earnings Statement
— Apple —

 Once the income statement is prepared, companies update

the retained earnings balance by adding net income and
subtracting dividends.

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 Balance Sheet
— Apple —
 Balance sheet accounts are called permanent accounts because
their respective balances carry over from one period to the next.
 To prepare the balance sheet, we use the ending balances from
the last row in the financial statement effects spreadsheet.

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 Statement of Stockholder’s Equity
— Apple —

 We use the information from the financial statement effects

template pertaining to contributed capital and earned capital to
prepare the statement of stockholders’ equity.

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 Learning Objective 5

Explain and apply the closing process.

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 The Closing Process

 Closing with the Template. It is important to distinguish our financial

statement effects template from companies’ accounting systems.
 The financial statement effects template and T-accounts are pedagogical tools that
represent transactions’ effects on financial statements.
 The template is highly stylized, but its simplicity is instructive.

 Closing with Journal Entries. In practice, managers use journal entries to

record transactions and adjustments.
 The template captures these in summarized fashion. However, in practice, income
statement transactions are not automatically transferred to retained earnings, and
retained earnings is not continuously updated.
 Instead, companies have a formal “closing process” at the end of each reporting period
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 1. Close Revenue and Gain Accounts

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 2. Close Expense and Loss Accounts

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 3. Close Dividend Account

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The End