Financial

Managerial
&
Accounting
for MBAs Sixth Edition

Peter D. Easton
Robert F. Halsey
Mary Lea McAnally
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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Accounting Cycle Tools

 Financial Statement Effects Template (FSET)

 Provides a convenient way to represent relatively complex financial
accounting transactions and events in a simple, concise manner
 Captures transaction on all four financial statements
 Facilitates analysis and interpretation, especially “What if” scenarios

 T-Accounts
 Expands each account into increases and decreases and can be used to keep
running totals
 Journal entries
 Classic debits and credits

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Financial Statement Effects Template
(FSET)

The FSET captures the transaction on the:

 Balance sheet
 Income statement
 Statement of stockholders’ equity
 Statement of cash flows

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T-Accounts

 T-accounts capture increases and decreases to individual balance

sheet and income statement accounts.
 T-accounts illustrate the effect of each transaction.
 Assets’ normal balance is on the left. Asset T-accounts record increases on
the left and decreases on the right.
 Liabilities’ normal balance is on the right. Liability T-accounts record
increases on the right and decreases on the left.

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Journal Entries

 Journal entries 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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Apple FSET
2017-2018

For each transaction, we ask these three questions:

 What accounts are affected?
 What is the direction of the effect?
 What is the amount of the effect?

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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 accounting adjustments so that financial

statements are accurate and complete.
 For example, employees might have earned wages during an accounting
period but not been paid before the end of the period.
 Failure to recognize the wages owed would understate liabilities
(because wages payable would be too low) and would overstate net
income for the period.
(because wages expense would be too low)
 Both the balance sheet and the income statement
would be inaccurate.
 SO, the company makes an accounting adjustment.

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Four Types
of Accounting Adjustments

 Prepaid expenses―advance cash payments that will ultimately become

expenses
 Unearned revenues―cash received from customers before any services or
goods are provided
 Accrued expenses―expenses incurred and recognized on the income
statement even though cash has not been paid yet
 Accrued revenues―revenues earned and recognized on the income statement
even though cash is not received yet
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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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Four Types
of Accounting Adjustments

 Prepaid expenses―advance cash payments that will ultimately become

expenses
 Unearned revenues―cash received from customers before any services or
goods are provided
 Accrued expenses―expenses incurred and recognized on the income
statement even though cash has not been paid yet
 Accrued revenues―revenues earned and recognized on the income statement
even though cash is not received yet
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Learning Objective 4
Construct financial statements from the
accounting records.

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Constructing
the Financial Statements

 When all transactions and adjustments have been recorded in the

FSET, sum each column to obtain ending balances.
 Prepare financial statements in this order:
1. Income statement
2. Statement of stockholders’ equity―including the retained earnings
reconciliation
3. Balance sheet
4. Statement of cash flows

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Apple’s Income Statement

 Apple’s income statement accounts are in the last three columns

of the FSET.
 We use the data from those columns to prepare the income
statement.
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Apple’s
Retained Earnings Reconciliation

Update the retained earnings balance:

 Add net income
 Subtract dividends
 Subtract any stock repurchased and retired

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Apple’s
Statement of Stockholders’ Equity

We use the information from the contributed capital and earned

capital columns in the FSET to prepare the statement of
stockholders’ equity.

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Apple’s Balance Sheet

 Use the ending balances

from the last row in the
FSET.

 Balance sheet accounts

are called permanent
accounts because their
respective balances carry
over from one period to
the next.

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Learning Objective 5
Explain and apply
the closing process.

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The Closing Process

AKA: Closing the books

 The closing process―“zeroing out” of the temporary accounts

by transferring their ending balances to retained earnings
 Revenues, expenses, and dividends are temporary accounts
because the balance at the start of each accounting period is $0 so
that only the current period’s activities are included in the total
amount.
 Balance sheet accounts are permanent accounts and do NOT
CLOSE each period.

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The Closing Process
FSET vs. Practice
Closing Process: FSET
 The FSET and T-accounts are pedagogical tools that represent transactions’ effects on
financial statements.
 The FSET is highly stylized, but its simplicity is instructive.

 Each transaction and adjustment is automatically transferred to retained earnings―no

additional closing process.

Closing Process: Practice

 Journal entries capture transactions and adjustments.

 Retained earnings are not continuously updated.

 Companies use a formal “closing process” at the end of each reporting period.

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Journal Entries

Debit Credit Debit Credit Debit Credit

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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 Accounts

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Financial
Managerial
&
Accounting
for MBAs Sixth Edition

Cambridge Business Publishers

www.cambridgepub.com