Module 3
Accounting Adjustments and
Constructing Financial Statements
Learning Objectives – coverage by question
True/False Multiple Choice Exercises Problems Essays
LO1 – Analyze and record
transactions using the
1-6 1-8 1-4 1-4 1
financial statement effects
template.
LO2 – Prepare and explain
accounting adjustments and
7-12 9-16 4-9 1, 2, 5 1, 2
their financial statement
effects.
LO3 – Explain and construct
13 17-19 10 6 1, 3
the trial balance.
LO4 – Construct financial
statements from the trial - 20, 21 11-13 6-8 1, 4
balance.
LO5 – Describe the closing
14, 15 22-25 5, 14 9, 10 1, 5
process
©Cambridge Business Publishers, 2015
Test Bank, Module 3 3-1
,Module 3: Accounting Adjustments and Constructing Financial
Statements
True/False
Topic: Financial Statement Effects Template
LO: 1
1. The financial statement effects template captures the effects of transactions on all four financial
statements.
Answer: True
Rationale: The balance sheet accounts are all on the left side of the template and the income
statement accounts on the right. In addition, the cash column provides the statement of cash flows,
and the two equity columns can be used to construct the statement of shareholders’ equity.
Topic: Journal Entries
LO: 1
2. Assets, expenses and dividends increase with debits.
Answer: True
Rationale: Assets increase with debits and equity decreases with debits. Therefore, expenses and
dividends decrease equity – they are debits.
Topic: Journal Entries
LO: 1
3. Increases are recorded on the left side of asset T-accounts and on the right side of liability T-accounts.
Answer: True
Rationale: Debits increase assets and credits increase liabilities.
Topic: Financial Statement Effects of Transactions
LO: 1
4. When shareholders contribute capital to a company, earned capital increases because the company
has earned the shareholders’ trust and their investments.
Answer: False
Rationale: When shareholders contribute capital to a company, contributed, not earned, capital
increases.
Topic: Financial Statement Effects of Transactions
LO: 1
5. Revenues and expenses affect the income statement but not the balance sheet.
Answer: False
Rationale: Revenue and expense recognition increases retained earnings on the balance sheet.
©Cambridge Business Publishers, 2015
3-2 Financial & Managerial Accounting for MBAs, 4th Edition
,Topic: Financial Statement Effects of Transactions
LO: 1
6. Revenue is typically recorded as earned when cash is received because that is when the company
can measure the revenue objectively.
Answer: False
Rationale: Revenue is recorded when it is earned regardless of when cash is received.
Topic: Financial Statement Effects of Transactions
LO: 2
7. Expenses that are paid in advance are held on the balance sheet until the end of the accounting
period when they are transferred to the income statement with accounting adjustments.
Answer: False
Rationale: Expenses paid in advance include prepaid insurance, inventory and fixed assets. All of
these items end up on the income statement when they are used up, not necessarily at the end of the
accounting period.
Topic: Accrual Accounting
LO: 2
8. Accrual accounting recognizes revenues only when cash is received and expenses only when cash is
paid.
Answer: False
Rationale: Accrual accounting refers to the recognition of revenue when earned and the matching of
expenses when incurred. The recognition of revenues and expenses does not, necessarily, relate to
the receipt or payment of cash.
Topic: Accrual Accounting
LO: 2
9. The journal entry for recording sales revenue that has been earned is to debit accounts receivable if
cash will be received later, or debit unearned revenue if cash was received in advance.
Answer: True
Rationale: If cash is received later, the debit is to accounts receivable. If the cash is received before
revenue is earned then the appropriate debit is to unearned revenue.
Topic: Accounting Adjustments
LO: 2
10. The journal entry for recording cost of sales is to debit cost of sales expense and credit the inventory
account.
Answer: True
Rationale: The journal entry for recording cost of sales is to debit cost of sales expense and credit
inventory. When the cash is paid for the inventory does not affect the expense.
©Cambridge Business Publishers, 2015
Test Bank, Module 3 3-3
, Topic: Accounting Adjustments
LO: 2
11. Accounting scandals can happen when managers abuse the accounting adjustment process.
Answer: True
Rationale: Accounting scandals can result from improperly recorded transactions or with improper
accounting adjustments. However, even if managers abuse the adjustment process, it is not the case
that a scandal always ensues.
Topic: Accounting Adjustments
LO: 2
12. Companies make adjustments to more accurately reflect items on the income statement and the
balance sheet.
Answer: True
Rationale: Adjustments ensure that performance and position are accurately portrayed in the financial
statements.
Topic: Trial Balance
LO: 3
13. Companies typically prepare two trial balances – one after recording all the transactions and one after
recording all the accounting adjustments.
Answer: True
Rationale: An unadjusted and an adjusted trial balance are both part of the accounting cycle.
Topic: Closing Accounts
LO: 5
14. A company closes all of its accounts in order to zero out the balances so that next period starts with a
fresh slate.
Answer: False
Rationale: A company closes its temporary accounts only. Balance sheet accounts are never closed
out – they have cumulative balances.
Topic: Closing Accounts
LO: 5
15. To close revenue accounts, a company must debit Retained Earnings because Revenue has a credit
balance and debits must equal credits.
Answer: False
Rationale: Revenue does have a credit balance. Therefore, to close Revenue, the company debits
Revenue and credits Retained earnings.
©Cambridge Business Publishers, 2015
3-4 Financial & Managerial Accounting for MBAs, 4th Edition
Accounting Adjustments and
Constructing Financial Statements
Learning Objectives – coverage by question
True/False Multiple Choice Exercises Problems Essays
LO1 – Analyze and record
transactions using the
1-6 1-8 1-4 1-4 1
financial statement effects
template.
LO2 – Prepare and explain
accounting adjustments and
7-12 9-16 4-9 1, 2, 5 1, 2
their financial statement
effects.
LO3 – Explain and construct
13 17-19 10 6 1, 3
the trial balance.
LO4 – Construct financial
statements from the trial - 20, 21 11-13 6-8 1, 4
balance.
LO5 – Describe the closing
14, 15 22-25 5, 14 9, 10 1, 5
process
©Cambridge Business Publishers, 2015
Test Bank, Module 3 3-1
,Module 3: Accounting Adjustments and Constructing Financial
Statements
True/False
Topic: Financial Statement Effects Template
LO: 1
1. The financial statement effects template captures the effects of transactions on all four financial
statements.
Answer: True
Rationale: The balance sheet accounts are all on the left side of the template and the income
statement accounts on the right. In addition, the cash column provides the statement of cash flows,
and the two equity columns can be used to construct the statement of shareholders’ equity.
Topic: Journal Entries
LO: 1
2. Assets, expenses and dividends increase with debits.
Answer: True
Rationale: Assets increase with debits and equity decreases with debits. Therefore, expenses and
dividends decrease equity – they are debits.
Topic: Journal Entries
LO: 1
3. Increases are recorded on the left side of asset T-accounts and on the right side of liability T-accounts.
Answer: True
Rationale: Debits increase assets and credits increase liabilities.
Topic: Financial Statement Effects of Transactions
LO: 1
4. When shareholders contribute capital to a company, earned capital increases because the company
has earned the shareholders’ trust and their investments.
Answer: False
Rationale: When shareholders contribute capital to a company, contributed, not earned, capital
increases.
Topic: Financial Statement Effects of Transactions
LO: 1
5. Revenues and expenses affect the income statement but not the balance sheet.
Answer: False
Rationale: Revenue and expense recognition increases retained earnings on the balance sheet.
©Cambridge Business Publishers, 2015
3-2 Financial & Managerial Accounting for MBAs, 4th Edition
,Topic: Financial Statement Effects of Transactions
LO: 1
6. Revenue is typically recorded as earned when cash is received because that is when the company
can measure the revenue objectively.
Answer: False
Rationale: Revenue is recorded when it is earned regardless of when cash is received.
Topic: Financial Statement Effects of Transactions
LO: 2
7. Expenses that are paid in advance are held on the balance sheet until the end of the accounting
period when they are transferred to the income statement with accounting adjustments.
Answer: False
Rationale: Expenses paid in advance include prepaid insurance, inventory and fixed assets. All of
these items end up on the income statement when they are used up, not necessarily at the end of the
accounting period.
Topic: Accrual Accounting
LO: 2
8. Accrual accounting recognizes revenues only when cash is received and expenses only when cash is
paid.
Answer: False
Rationale: Accrual accounting refers to the recognition of revenue when earned and the matching of
expenses when incurred. The recognition of revenues and expenses does not, necessarily, relate to
the receipt or payment of cash.
Topic: Accrual Accounting
LO: 2
9. The journal entry for recording sales revenue that has been earned is to debit accounts receivable if
cash will be received later, or debit unearned revenue if cash was received in advance.
Answer: True
Rationale: If cash is received later, the debit is to accounts receivable. If the cash is received before
revenue is earned then the appropriate debit is to unearned revenue.
Topic: Accounting Adjustments
LO: 2
10. The journal entry for recording cost of sales is to debit cost of sales expense and credit the inventory
account.
Answer: True
Rationale: The journal entry for recording cost of sales is to debit cost of sales expense and credit
inventory. When the cash is paid for the inventory does not affect the expense.
©Cambridge Business Publishers, 2015
Test Bank, Module 3 3-3
, Topic: Accounting Adjustments
LO: 2
11. Accounting scandals can happen when managers abuse the accounting adjustment process.
Answer: True
Rationale: Accounting scandals can result from improperly recorded transactions or with improper
accounting adjustments. However, even if managers abuse the adjustment process, it is not the case
that a scandal always ensues.
Topic: Accounting Adjustments
LO: 2
12. Companies make adjustments to more accurately reflect items on the income statement and the
balance sheet.
Answer: True
Rationale: Adjustments ensure that performance and position are accurately portrayed in the financial
statements.
Topic: Trial Balance
LO: 3
13. Companies typically prepare two trial balances – one after recording all the transactions and one after
recording all the accounting adjustments.
Answer: True
Rationale: An unadjusted and an adjusted trial balance are both part of the accounting cycle.
Topic: Closing Accounts
LO: 5
14. A company closes all of its accounts in order to zero out the balances so that next period starts with a
fresh slate.
Answer: False
Rationale: A company closes its temporary accounts only. Balance sheet accounts are never closed
out – they have cumulative balances.
Topic: Closing Accounts
LO: 5
15. To close revenue accounts, a company must debit Retained Earnings because Revenue has a credit
balance and debits must equal credits.
Answer: False
Rationale: Revenue does have a credit balance. Therefore, to close Revenue, the company debits
Revenue and credits Retained earnings.
©Cambridge Business Publishers, 2015
3-4 Financial & Managerial Accounting for MBAs, 4th Edition
