Page |1

CHAPTER 1
THE ACCOUNTING CYCLE
“Accounting is the language of business.” – Warren Buffett
THE ACCOUNTING SYSTEM
INPUT PROCESS OUTPUT

THE ACCOUNTING PROCESS (ARCRI is a mnemonic to promote long-term retention)

The series of activities of activities that begins with a transaction and ends with the closing of the books.
It is repeated every reporting period.
Analyzing the transactions – Basic Accounting Equation, Source Documents
Recording the transactions – Rules of Debit and Credit, Journals
Classifying the accounts – T-Accounts, Ledgers
Reporting the results – Trial Balance, Financial Statements
Interpreting the results – Financial Statement Analysis
THE ACCOUNTING CYCLE
The accounting cycle refers to a series of sequential steps or procedures performed to accomplish the
accounting process. The steps in the cycle:

Step 1 Identification of Events to be recorded

During the
Step 2 Transactions are recorded in the Journal
Accounting Period
Step 3 Journal entries are posted to the ledger

Step 4 Preparation of a Trial Balance

Step 5 Preparation of Worksheet including adjusting entries
Step 6 Preparation of Financial Statements At the end of the
Step 7 Adjusting journal entries are journalized and posted Accounting Period
Step 8 Closing journal entries are journalized and posted
Step 9 Preparation of a Post-Closing Trial Balance

At the start of the next

Step 10 Reversing journal entries are journalized and posted
Accounting Period

THE FINANCIAL STATEMENTS

The financial statements are the output of the accounting system, by means of an accounting process
which is the accounting cycle. These documents are the means by which the information accumulated and
processed in the accounting cycle is periodically communicated to the users. The objective of financial
statements is to provide information about the financial position, financial performance and cash flows of
an entity that is useful to a wide range of users in making economic decisions.

Frequency of Reporting:
Financial statement shall be presented at least annually. The financial statements shall disclose the period
covered by such financial statements.
 Page |2

The complete set of financial statements include the following:

1. Income Statement
2. Statement of Comprehensive Income
3. Statement of Financial Position (or Balance Sheet)
4. Statement of Changes in Equity
5. Statement of Cash Flows
6. Notes to the Financial Statements

STATEMENT OF COMPREHENSIVE INCOME (SCI)

Comprehensive income is the change in equity during a period resulting from transactions and other
events, other than changes resulting from transactions with owners in their capacity as owners.
Comprehensive income includes components of profit or loss and components of other comprehensive
income.

The term” other comprehensive income” comprises of items of income and expenses including
reclassification that are not recognized in profit or loss as required or permitted by Philippine Financial
Reporting Standards (PFRS). The SCI is prepared to show the result of the firm’s operations for a definite
time period, specifically the revenue and expenses, including gains and losses from incidental activities.
*OCI will not be discussed here, as it is an advanced topic.

THE INCOME STATEMENT

An income statement is a formal statement showing the financial performance of an entity for a
period of time. The financial performance (or sometimes called the results of operations) of an entity is
primarily measured in terms of the level of income earned by the entity through the effective and efficient
utilization of its resources.

Definition of Terms (Conceptual Framework for Financial Reporting)

Income – increase in economic benefit during the accounting period in the form of inflow or increase in
assets or decrease in liability that results in increase in equity, other than contributions from equity
participants.
Revenue – meets the definition of income and arises in the ordinary course activities of an entity.
Gains – represent other items that meet the definition of income and do not arise in the ordinary course of
business of an entity.
Expense – decrease in economic benefit during the accounting period in the form of outflow or decrease
in asset and increase in liability that results in decrease in equity, other than distribution to equity
participants.
Profit or Loss - is the total income less expenses excluding the components of other comprehensive income.
Not present in the Conceptual Framework, author’s own definition .

Presentation of the Income Statement (Philippine Accounting Standard [PAS] 1, par. 99)
1. Natural Presentation – expenses are aggregated according to their nature and not allocated among the
various functions within the entity.
2. Functional Presentation – classifies expenses according to their function as part of cost of sales,
distribution costs, administrative activities and other activities.
*We will use the functional presentation for discussions, as this is the most commonly used.
 Page |3

ARCRI Corporation
Income Statement
For the Year Ended December 31, 2017
Revenue P xx
Less: Cost of Goods Sold/Cost of Services (xx)
Gross Profit P xx
Add: Other Income xx_
Total Income P xx
Expenses:
Distribution Costs P xx
Administrative Expenses xx
Other Expenses (includes losses) xx
Finance Cost (Interest Expense) xx (xx)
Income Before Tax P xx
Income Tax Expense (xx)
Net Income P xx
For a Merchandising Type of Business, the cost of goods sold is computed as follows:
Inventory, Beginning P xx
Gross Purchases P xx
Less: Purchase Discounts (xx)
Purchase Returns & Allowances (xx)
Net Purchases P xx
Add: Freight Cost xx
Net Cost of Purchases xx
Cost of Goods Available for Sale P xx
Less: Inventory, Ending (xx)
Cost of Goods Sold P xx
For a Manufacturing Type of Business, the cost of goods sold is computed as follows:
Raw Materials, Beginning P xx
Add: Raw Materials Purchased xx
Less: Raw Materials, Ending (xx)
Raw Materials Used P xx
Direct Labor xx
Factory Overhead:
Indirect Materials P xx
Indirect Labor xx
Factory-related Expenses xx xx
Total Manufacturing Cost P xx
Add: Work-in-Process, Beginning xx
Cost of Goods Placed into Process P xx
Less: Work-in-Process, Ending (xx)
Cost of Goods Manufactured P xx
Add: Finished Goods, Beginning xx
Cost of Goods Available for Sale P xx
Less: Finished Goods, Ending (xx)
Cost of Goods Sold P xx
 Page |4

STATEMENT OF FINANCIAL POSITION (SFP)

The SFP is a formal statement showing the three elements comprising the financial position, namely
assets, liabilities and equity.

The SFP is done every end of the period as a cut-off date in determining the value of all properties
owned by the company in a given point in time. The SFP also shows the debts still unpaid as of the end of
the period and the residual interest in the company, total assets minus liabilities. The equity is the residual
interest that serves as the margin of safety to the creditors. This means that the assets’ value can decline by
that amount but the company can still pay all of its liabilities.

Investors, creditors and other users analyze the SFP to evaluate such factors as liquidity, solvency
and the need of the entity for additional financing.

Definition of Terms (Conceptual Framework)

Assets - resources controlled by the entity as a result of past transactions and events and from which future
economic benefits are expected to flow to the entity.
Liabilities – present obligations of an entity arising from past transactions or events, the settlement of which
is expected to result in an outflow from the entity of resources embodying economic benefits.
Equity – the residual interest in the assets of the entity after deducting all of its liabilities.

Current Assets Criteria (PAS 1, par. 66)

a. The asset is cash or cash equivalent unless the asset is restricted from being exchanged or used to
settle a liability for at least twelve months after the reporting period.
b. The entity holds the asset primarily for the purpose of trading.
c. The entity expects to realize the asset within twelve months after the reporting period.
d. The entity expects to realize the asset or intends to sell or consume it within the entity’s normal
operating cycle
Noncurrent Assets Criteria (PAS 1, par. 66) – those that are not classified as current. Example includes
Property, Plant and Equipment, Long-term Investments and Intangible Assets.

Presentation of Current Assets (PAS 1, par, 54) – minimum items under current assets.
a. Cash and Cash Equivalents
b. Financial Assets at fair value
c. Trade and other receivables
d. Inventories
e. Prepaid Expenses

Current Liability Criteria (PAS 1, par. 69)

a. The entity expects to settle the liability within the entity’s normal operating cycle.
b. The entity holds the liability primarily for the purpose of trading.
c. The liability is due to be settled within twelve months after the reporting period.
d. The entity does not have an unconditional right to defer settlement of the liability for at least twelve
months after the reporting period.

Noncurrent Liability Criteria (PAS 1, par. 69) – those that are not classified as current. Example includes
Noncurrent portion of a long-term debt, finance lease liability and deferred tax liability.
 Page |5

Presentation of Current Liabilities (PAS 1, par. 54) - minimum items under current liabilities.
a. Trade and other payables
b. Current Provisions
c. Short-Term Borrowing
d. Current Portion of long-term debt
e. Current Tax Liability

Selected explanations in the above criteria:

Cash Equivalents (PAS 7) – short-term, highly liquid investments that are readily convertible into known
amount of cash and which are subject to an insignificant risk of changes in value. Short maturity means
three months or less from the date of acquisition.
Operating Cycle – the time between the acquisition of assets for processing and their realization in cash or
cash equivalents.
Long-term debt currently maturing – I as per PAS 1, par. 72, a liability which is due to be settled within
twelve months after the end of the reporting period is classified as current, even if the original term was
for a period longer than twelve months.

Shareholders’ Equity / Stockholders’ Equity – the residual interest of owners in the net assets of a
corporation measured by the excess of assets over liabilities.

Definition of Terms
Share Capital – the portion of the paid in capital representing the total par or stated value of the shares
issued.
Share Premium – the capital contributed by the shareholders in excess of the par or stated value of the
shares subscribed and issued.
Subscribed Share Capital – the portion of the authorized share capital that has been subscribed but not yet
fully paid and therefore still unissued.
Subscription Receivable – reflected as a deduction from the related subscribed share capital. If collectible,
it shall be presented as a current asset.
Retained Earnings – represent the cumulative balance of periodic net income or loss, dividend
distributions, prior period errors, changes in accounting policy and other capital adjustments. The
Unappropriated portion represent the free portion and can be declared as dividends. The appropriated
portion is restricted and is not available for distribution.
Deficit – a debit balance in retained earnings. Also called Negative Retained Earnings.
Treasury Shares – entity’s own shares that have been issued and then reacquired but not cancelled. It is
reported as a reduction from the shareholders’ equity. Under the Corporation Code, retained earnings must
be appropriated to the extent of the cost of the treasury shares.

Presentation of the Statement of Financial Position

1. Account Form – a presentation that follows an account, meaning assets on the left side and the liabilities
and equity on the right side.
2. Report Form – sets forth the three major sections in a downward sequence of assets, liabilities and
equity.
*The Report form will be used throughout the discussion.
 Page |6

Example: Using the Report Form

ARCRI CORPORATION
Statement of Financial Position
As of the Year Ended December 31, 2017
ASSETS
Current Assets:
Cash and Cash Equivalents P xx
Financial Assets xx
Trade and Other Receivables xx
Inventory xx
Prepaid Expenses xx
Total Current Assets P xx
Noncurrent Assets:
Property, Plant and Equipment P xx
Less: Accumulated Depreciation (xx) P xx
Biological Assets xx
Total Noncurrent Assets xx
Total Assets P xx
LIABILITIES AND EQUITY
Current Liabilities:
Trade and Other Payables P xx
Notes Payable xx
Total Current Liabilities P xx
Noncurrent Liabilities:
Mortgage Payable P xx
Bonds Payable xx
Total Noncurrent Liabilities xx
Shareholder’s Equity:
Share Capital P xx
Share Premium xx
Retained Earnings xx
Total Shareholder’s Equity xx
Total Liabilities and Equity P xx

STATEMENT OF CHANGES IN EQUITY (SCE)

The SCE is prepared to show the result of items, transactions and events affecting the equity account
balance (owner’s equity for sole proprietorship, partner’s equity for partnerships, and shareholder’s equity
for corporation).

This provides a reconciliation between the carrying amount at the beginning and at the end of the
period, separately showing the changes from profit or loss, other comprehensive income and transactions
with owners in their capacity as owners, showing separately contributions by and distributions to owners.
 Page |7

Example: Sole Proprietorship

Owner’s Equity, Beginning P xx

Add: Additional Investments xx
Net Income for the period xx
Less: Withdrawals (xx)
Net Loss for the period (xx)
Owner’s Equity, Ending P xx

Example: Partnership
Partner A Partner B
Partner’s Equity, Beginning P xx P xx
Add: Additional Investments xx xx
Share in the Net Income for the period xx xx
Less: Withdrawals (xx) (xx)
Share in the Net Loss for the period (xx) (xx)
Owner’s Equity, Ending P xx P xx

Example: Corporation
Share Capital Reserves Retained Earnings Treasury Shares Total
Beginning Balance P xx P xx P xx P (xx) P xx
Issuance of Shares xx xx --- --- xx
Net Income (Loss) --- --- x(x) --- xx
Dividend Declaration --- --- (xx) --- xx
Reacquisition of Shares --- --- --- (xx) (xx)
Ending Balance P xx P xx P xx P (xx) P xx

The SCE for a sole proprietorships and for partnerships are identical in their format and
presentation. The only difference is that in a sole proprietorship, the sole owner absorbs all the net income
and losses of his business. In a partnership, net income and losses are split according to the partner’s
agreement on how to divide the profits or losses.

For a corporation, the equity is divided into three major categories (this is presented in the OLD
accounting standard and is not required for presentation according to current standards): (1) Share Capital
(or Paid-in Capital) – which represents the par value or stated value of the shares issued. This also
represents the minimum issue price of the shares; (2) Reserves – this represents all other additions to the
equity except for the income and share issuances. An example is the excess of price paid over the par value
or stated value of the shares issued (known as Share Premium or Additional Paid-in Capital), etc.; (3)
Retained Earnings (or Accumulated Profits) – is the total of net income and net losses from the beginning
of the business minus dividends paid to the shareholders.
*Other items affecting the retained earnings will be discussed in higher accounting subjects.

STATEMENT OF CASH FLOWS (SCF)

This is prepared due to the importance of cash flows in evaluating the viability and stability of an
organization and its ability to take advantage of economic opportunities. The cash flows are classified as
follows:
 Page |8

Cash Flows from Operating Activities – these are brought about by the day-to-day operating activities
such as collections on sales and other income and payments for operating expenses, other expenses and
income taxes. This part is sometimes called the “Cash Basis Income Statement.”

Cash Flows from Investing Activities – these arises from the acquisition and disposal of noncurrent assets
such as land, building, equipment, machinery, etc.

Cash Flows from Financing Activities – these are brought about by transactions affecting the long-term
debt and the equity section.
*For better retention, the author recommends to relate the classification with the balance sheet.

CURRENT LIABILITIES
CURRENT ASSETS

NONCURRENT LIABILITIES

NONCURRENT ASSETS
EQUITY

Imagine a big T-account of the classifications of the balance sheet items. Cash flows from Current
Assets and Liabilities are classified as Operating Activities (Green above). Cash flows from Noncurrent
Assets are classified as Investing Activities (Yellow above). Cash flows from Noncurrent Liabilities and
Equity are classified as Financing Activities (Blue above).
The Operating Activities of SCF is prepared using two methods: (1) Direct Method and (2) Indirect
Method. The investing and financing activities is presented using the Direct Method only. Regardless of
the method used, the resulting cash flows would be the same.

The operating cash flows using indirect method starts with the Net Income, the one appearing in
the SCI (or income statement). Then the non-operating Gains are deducted, non-operating losses are added
back to the net income because they increased or decreased the net income but they are not related to the
operations or main line of business of the organization. After the items above, the non-cash expenses are
added back to net income because these are expenses that reduced the net income but as the name implies,
they did not decreased the cash. Example of which is the depreciation of noncurrent assets and the
amortization of intangible assets.

After the two items above, the changes in working capital shall be considered. Working capital is
the difference of current assets and current liabilities, it is the amount made to revolve in conducting the
operations of the organization and serves as the lifeblood of the organization.

Increases in current assets, except cash, are a deduction to net income to arrive at the cash flow
because it is presumed that cash was used to acquire other current assets. It follows then that decreases in
 Page |9

current assets, except cash, are added back to net income because it is presumed that the current assets were
sold, thus receiving cash. Therefore, the relationship of current assets and cash flows is inverse.

Increases in current liabilities are an addition to net income to arrive at the cash flows because the
expenses incurred are not yet paid by the organization, will become liabilities, thus the cash the ‘should be’
the payment for the expenses is retained by the organization. It then follows that decreases in current
liabilities are deducted to net income because the liabilities are finally been paid therefore an outflow of
cash. Therefore, the relationship of current liabilities and cash flows is direct.

In preparing the SCF using the direct method, the cash flows are properly labeled as to the source
of the cash receipts or the nature of the payments or disbursements made.

Example: Using the Indirect Method for Operating Cash Flows

ABM Manufacturing Company
Partial Statement of Cash Flows
For the Year Ended December 31, 2016
Cash Flows from Operating Activities:
Net Income P xx
Non-operating Gains (xx)
Non-operating Losses xx
Non-cash Expenses xx
Increases in Current Assets (xx)
Decreases in Current Assets xx
Increases in Current Liabilities xx
Decreases in Current Liabilities (xx)
Net Cash flow provided by (used in) Operating Activities P xx

Example: Using the Direct Method for all cash flows

ABM Manufacturing Company

Statement of Cash Flows
For the Year Ended December 31, 2016
Cash Flows from Operating Activities:
Cash sales P xx
Collection on credit sales xx
Payments for purchases (xx)
Payments for direct labor (xx)
Payments for factory overhead (xx)
Payments for operating expenses (xx)
Payments for Income taxes (xx)
Net Cash Flow provided by (used in) Operating Activities P x(x)

Cash Flows from Investing Activities:

Acquisition of investments P (xx)
Acquisition of plant, property and equipment (xx)
Proceeds from sale of noncurrent assets xx
Net Cash Flow provided by (used in) Investing Activities x(x)
 P a g e | 10

Cash Flows from Financing Activities:

Proceeds of loans and other long term debts P xx
Proceeds from issuance of shares xx
Payment of debts (xx)
Dividends paid (xx)
Net Cash Flow provided by (used in) Financing Activities x(x)
Net Change in Cash and Cash Equivalents, 2016 P x(x)
Add: Cash and Cash Equivalents, January 1 xx
Cash and Cash Equivalents, December 31 P xx

NOTES TO THE FINANCIAL STATEMENTS

These provide explanations to items that are not shown in the face of the four financial statements
discussed above. Notes shows the name of the business, its principal place of business group of companies
where the business is under. The Notes also show the statement of compliance with the PFRS, accounting
policies and measurement basis, supporting computations not directly shown in the financial statements
and other required disclosures. Computations in the notes may also be used to compress the presentation
of the financial statements.

Working Problem (Review of the Accounting Process)

Listed below are the June 1, 2017 account balances of the Bob Uy’s business
110 Cash P 33,000
120 Accounts Receivable 192,000
130 Merchandise Inventory 413,000
140 Supplies 51,000
150 Prepaid Insurance 48,000
160 Land 460,000
170 Building 1,750,000
175 Accumulated Depreciation – Building P 350,000
180 Equipment 2,310,000
185 Accumulated Depreciation – Equipment 630,000
210 Accounts Payable 108,000
220 Salaries Payable ---
230 Mortgage Payable 2,600,000
310 Uy, Capital 1,569,000
320 Uy, Withdrawals
330 Income Summary
410 Sales
420 Sales Returns and Allowances
430 Sales Discounts
510 Purchases
520 Purchase Returns and Allowances
530 Purchase Discounts
540 Transportation In
610 Salaries Expense
620 Supplies Expense
630 Insurance Expense
640 Depreciation Expense – Building
650 Depreciation Expense – Equipment
 P a g e | 11

660 Transportation Out

670 Advertising Expense
680 Interest Expense
690 Miscellaneous Expense
Total P 5,257,000 P 5,257,000

(STEP 1) During the month of June 2017, the following transactions occurred:
June 1 Collected P 113,000 from customers on account.
2 Paid P 64,000 of accounts due less discounts of 3%.
4 Purchased merchandise, P 170,000. Terms: FOB Shipping Point, 3/10, n/30.
5 Sold merchandise on account to Power Company, P 270,000. Terms: FOB Shipping
Point, 2/10, n/30.
7 Paid for advertising for the month of June, P 6,000.
7 Sold merchandise for cash, P 250,000.
8 Paid the amount due from the June 4 transaction.
9 Paid Hatid Freight Co. P 4,000 for delivering merchandise last June 4.
10 Received returns from the Power Company, P 70,000.
12 Received payment from the Power Company less returns and discounts.
14 Paid P 26,000 interest on the mortgage payable.
15 Paid salaries, P 51,000.
16 Sold merchandise on account to Mate Company, P 392,000. Terms: FOB
Destination, 2/10, n.30.
18 Paid P 4,000 freight charges on the sale of June 16.
19 Acquired supplies for cash, P 21,000.
20 Purchased P 125,000 of merchandise from Lazada Corp. on account. Terms: FOB
Destination, 3/10, n/30.
22 Paid P 7,000 miscellaneous expense.
23 Received payment from Mate Company less discounts.
24 Purchased P 373,000 of merchandise on account from Liberty Co. Terms: FOB
Shipping Point, 3/10, n/30.
24 Paid CPA Express P 9,000 freight for delivering merchandise acquired from
Liberty Co.
25 Sold merchandise to Mate Company on account, P 420,000. Terms: FOB Shipping
Point, 2/10, n/30.
26 Received returns from Mate Company, P 71,000.
28 Uy withdrew P 28,000 from the business.
28 Returned merchandise purchased from Liberty Co. on June 24, P 25,000.
Additional Information:
a. Salaries in the amount of P 51,000 have accrued on June 30.
b. Insurance coverage with premiums of P 2,000 has expired at month-end.
c. Depreciation on the building and on the equipment for the month amounted to P 9,000 and P 12,000,
respectively.
d. Supplies on hand at month end amounted to P 14,000.
e. A count of the merchandise inventory on June 30 amounted to P 397,000.
STEP 2: The journal entries for all the transactions above are as follows:
June 1 Cash 113,000
Accounts Receivable 113,000
2 Accounts Payable 64,000
Cash 62,080
Purchase Discounts (64000 x3%) 1,920
 P a g e | 12

4 Purchases 170,000
Accounts Payable 170,000
5 Accounts Receivable 270,000
Sales 270,000
7 Advertising Expense 6,000
Cash 6,000
7 Cash 250,000
Sales 250,000
8 Accounts Payable 170,000
Cash 164,900
Purchase Discounts (170,000 x 3%) 5,100
9 Transportation In 4,000
Cash 4,000
10 Sales Returns and Allowances 70,000
Accounts Receivable 70,000
12 Cash 196,000
Sales Discount (200,000 x 2%) 4,000
Accounts Receivable 200,000
14 Interest Expense 26,000
Cash 26,000
15 Salaries Expense 51,000
Cash 51,000
16 Accounts Receivable 392,000
Sales 392,000
18 Transportation Out 4,000
Cash 4,000
19 Supplies 21,000
Cash 21,000
20 Purchases 125,000
Accounts Payable 125,000
22 Miscellaneous expense 7,000
Cash 7,000
23 Cash 384,160
Sales Discounts 7,840
Accounts Receivable 392,000
24 Purchases 373,000
Accounts Payable 373,000
24 Transportation In 9,000
Cash 9,000
25 Accounts Receivable 420,000
Sales 420,000
26 Sales Returns and Allowances 71,000
Accounts Receivable 71,000
28 Uy, Withdrawals 28,000
Cash 28,000
28 Accounts Payable 25,000
Purchase Returns and Allowances 25,000
 P a g e | 13

STEP 3: The T-Accounts of Each Account Balances before adjusting journal entries:
P a g e | 14
 P a g e | 15

STEP 4: Trial Balance as of June 30, 2017, using the unadjusted balances:
110 Cash P 593,180
120 Accounts Receivable 428,000
130 Merchandise Inventory 413,000
140 Supplies 72,000
150 Prepaid Insurance 48,000
160 Land 460,000
170 Building 1,750,000
175 Accumulated Depreciation – Building P 350,000
180 Equipment 2,310,000
185 Accumulated Depreciation – Equipment 630,000
210 Accounts Payable 517,000
220 Salaries Payable
230 Mortgage Payable 2,600,000
310 Uy, Capital 1,569,000
320 Uy, Withdrawals 28,000
330 Income Summary
410 Sales 1,332,000
420 Sales Returns and Allowances 141,000
430 Sales Discounts 11,840
510 Purchases 668,000
520 Purchase Returns and Allowances 25,000
530 Purchase Discounts 7,020
540 Transportation In 13,000
610 Salaries Expense 51,000
620 Supplies Expense
630 Insurance Expense
640 Depreciation Expense – Building
650 Depreciation Expense – Equipment
660 Transportation Out 4,000
670 Advertising Expense 6,000
680 Interest Expense 26,000
690 Miscellaneous Expense 7,000
Total P 7,030,020 P 7,030,020
STEP 5: The Worksheet
P a g e | 16
 P a g e | 17

STEP 6: Bob Uy
Statement of Comprehensive Income
For the month ended June 30, 2017

Gross Sales P 1,332,000

Less: Sales Returns and Allowances ( 141,000)
Sales Discounts ( 11,840)
Net Sales P 1,179,160
Less: Cost of Goods Sold
Inventory, June 1 P 413,000
Purchases P 668,000
Less: Purchase Returns & A. ( 25,000)
Purchase Discounts ( 7,020)
Net Purchases 635,980
Add: Transportation In 13,000
Net Cost of Purchases 648,980
Cost of Goods Available for Sale P 1,061,980
Less: Inventory, June 30 ( 397,000)
Cost of Goods Sold ( 664,980)
Gross Profit P 514,180
Less: Operating Expenses
Salaries Expense P 102,000
Supplies Expense 58,000
Insurance Expense 2,000
Depreciation – Building 9,000
Depreciation – Equipment 12,000
Transportation Out 4,000
Advertising Expense 6,000
Interest Expense 26,000
Miscellaneous Expense 7,000 ( 226,000)
Net Income P 288,180

Bob Uy
Statement of Changes in Equity
For the month ended June 30, 2017

Uy, June 1, 2017 P 1,569,000

Add: Net Income for the period 288,180
Total P 1,857,180
Less: Withdrawals ( 28,000)
Uy, June 30, 2017 P 1,829,180

The amount shown as the ending balance of the owner’s equity in the above statement of changes in
equity will be carried over to the statement of financial position.
 P a g e | 18

Bob Uy
Statement of Financial Position
As of June 30, 2017

ASSETS
Current Assets:
Cash P 593,180
Accounts Receivables 428,000
Merchandise Inventory 397,000
Supplies 14,000
Prepaid Insurance 46,000
Total Current Assets P 1,478,180
Noncurrent Assets:
Land P 460,000
Building P 1,750,000
Less: Accumulated Depreciation ( 359,000) 1,391,000
Equipment 2,310,000
Less: Accumulated Depreciation ( 642,000) 1,668,000
Total Noncurrent Assets 3,519,000
Total Assets P 4,997,180
LIABILITIES AND EQUITY
Current Liabilities:
Accounts Payables P 517,000
Salaries Payable 51,000
Total Current Liabilities P 568,000
Noncurrent Liabilities:
Mortgage Payable 2,600,000
Total Liabilities P 3,168,000
Uy, June 30, 2017 1,829,180
Total Liabilities and Equity P 4,997,180

Bob Uy
Partial Statement of Cash Flows
For the month ended June 30, 2017

Cash Flows From Operating Activities (Using Indirect Method)

Net Income P 288,180
Non-cash Expenses (Depreciation) 21,000
Increase in Accounts Receivable ( 236,000)
Decrease in Merchandise Inventory 16,000
Decrease in Supplies 37,000
Decrease in Prepaid Insurance 2,000
Increase in Accounts Payable 409,000
Increase in Salaries Payable 51,000
Net Cash flow provided by (used in) Operating Activities P 588,180
 P a g e | 19

Bob Uy
Statement of Cash Flows
For the month ended June 30, 2017

Cash Flows from Operating Activities (Using Direct Method)

Collection from Customers P 943,160
Payment to Suppliers ( 226,980)
Payment of Advertising ( 6,000)
Payment for Freight Charges ( 17,000)
Payment of Interest ( 26,000)
Payment of Salaries ( 51,000)
Purchase of Supplies ( 21,000)
Payment of Miscellaneous Expense ( 7,000)
Net Cash Flow provided by (used in) Operating Activities P 588,180

Cash Flows from Investing Activities 0

Cash Flows from Financing Activities
Withdrawal of Cash P ( 28,000)
Net Cash Flow provided by (used in) Financing Activities ( 28,000)
Net Increase (Decrease) in Cash P 560,180
Add: Cash, June 1, 2017 33,000
Cash, June 30, 2017 P 593,180

The amount shown as the ending balance of cash should be the same as the one appearing in the statement
of financial position. The statement of cash flows provides a link between the statement of comprehensive
income and the statement of financial position.

STEP 7:.
30 Salaries Expense 51,000
Salaries Payable 51,000
30 Insurance Expense 2,000 STEP 7:
Prepaid Insurance 2,000 Adjusting
30 Depreciation Expense – Building 9,000
Journal
Depreciation Expense – Equipment 12,000
Accumulated Depreciation – Building 9,000 Entries
Accumulated Depreciation – Equipment 12,000
30 Supplies Expense 58,000
Supplies (51,000 + 21,000 – 14,000) 58,000

The Updated ledgers of accounts affected by the adjustments made.

 P a g e | 20

STEP 8:
30 Sales 1,332,000
Purchase Returns and Allowances 25,000
Purchase Discounts 7,020
Purchases 668,000
Sales Returns and Allowances 141,000
Sales Discounts 11,840
Transportation In 13,000
Salaries Expense 102,000
Supplies Expense 58,000
Insurance Expense 2,000 STEP 8:
Depreciation Expense – Building 9,000
Closing
Depreciation Expense – Equipment 12,000
Transportation Out 4,000 Journal
Advertising Expense 6,000 Entries
Interest Expense 26,000
Miscellaneous Expense 7,000
Income Summary (Balancing figure) 304,180
30 Inventory, June 30 397,000
Income Summary (Balancing figure) 16,000
Inventory, June 1 413,000
30 Income Summary 288,180
Uy, Capital 288,180
30 Uy, Capital 28,000
Uy, Withdrawals 28,000

The Updated ledgers of accounts affected by the closing journal entries.

 P a g e | 21

Observe that the nominal (temporary) accounts are the ones used for the closing entries. This is because
the net income from operations should now be transferred to the equity account. Capital Accounts
(Revenue, Expense, Withdrawals) will now have a Zero balance after the closing entries. The Income
Summary account serves as the bridge of the capital accounts going to the equity account. Take note now,
that the Merchandise Inventory is a Real (permanent) account but it is still closed, ONLY under the Periodic
Inventory System, which was used in the example. No closing entry including the inventory account will
be seen if the company is under the Perpetual Inventory System.
 P a g e | 22

STEP 9 Bob Uy
Post-Closing Trial Balance
June 30, 2017

110 Cash P 593,180

120 Accounts Receivable 428,000
130 Merchandise Inventory 397,000
140 Supplies 14,000
150 Prepaid Insurance 46,000
160 Land 460,000
170 Building 1,750,000
175 Accumulated Depreciation – Building P 359,000
180 Equipment 2,310,000
185 Accumulated Depreciation – Equipment 642,000
210 Accounts Payable 517,000
220 Salaries Payable 51,000
230 Mortgage Payable 2,600,000
310 Uy, Capital 1,829,180
Total P 5,998,180 P 5,998,180

STEP 10
A reversing entry is a journal entry which is the exact opposite of a related adjusting entry made at the end
of the period. It is an optional step in the accounting cycle because it only simplifies the recording of regular
transactions in the next accounting period. Take note that ALL accruals and ONLY deferrals recorded
using the income statement approach can be reversed. To facilitate long-term retention, adjusting that will
make an asset or liability INCREASE can be reversed.

In the above example only the adjusting entry in the salaries (it is an Accrual) can be reverse.
Salaries Payable 51,000
Salaries Expense 51,000

When the employees are paid on July 1, the entry would be:
Salaries Expense 51,000
Cash 51,000

If the reversing entry is not prepared, the entry on July 1 would be:
Salaries Payable 51,000
Cash 51,000

Working Problem 1 - Service Type of Business

On December 1 of the current year Chris Yan opened the “C.Y. Men’s Wear Shop”, and during
the month, the following transactions were completed:

Dec. 1 – Chris Yan invested P 8,000 cash in the business.

1 – He bought two sewing machines worth P 3,000 each from Ringo Star Merchandising.
Gave P 1,500 down and the balance is payable within 60 days.
1 – Paid a three-month rental of the shop, P 3,000. This was charged to Prepaid Rent.
1 – Paid a one-year insurance policy, P 570. (Use expense method).
 P a g e | 23

3 – Bought sewing tools P590 and sewing supplies P270 from Eduardz Trading on credit.
5 – Received P120 from a customer for a terno delivered.
7 – Billed Flor Valdez, P500 for a two-pair of pants and polo barong delivered.
10 – Purchased clothing materials from Divisoria Market and paid P1, 500 cash.
13 – Received P1, 250 from various customers for pants and barong made and delivered.
14 – Gave Ringo Star Merchandising P1, 500 and issued a 60-day, 6% note for the balance.
15 – Paid the wages of the shop helper, P250.
17 – Chris Yan withdrew P500 from the business for personal use.
18 – F. Valdez gave P200 as partial payment of her account.
20 – Received P1, 475 from various customers for pants and shirts delivered.
22 – Paid the wages of the shop helper, P250.
23 – Billed Julius Lelot P400 for barong and pants delivered to him.
27 – Paid the following monthly expenses: utility bills, P150; telephone bill, P250.

At the end of the month, the following data were gathered:

a. The sewing machines are estimated to have a 5-year useful life.
b. The actual count of the sewing supplies revealed a balance of P 170.
c. The business is conservative to estimate a 5 % of the receivables to be uncollectible.
d. Balance of the clothing materials account is P700.

Chart of Accounts
Assets Owner’s Equity
110 Cash 311 C. Yan, Capital
120 Accounts Receivable 312 C. Yan, Drawings
125 Allowance for Uncollectible Accounts 313 Income Summary
130 Sewing Supplies
140 Clothing Materials Income
150 Prepaid Rent 411 Service Income
160 Prepaid Insurance
170 Sewing Tools Expenses
180 Sewing Equipment 511 Wages Expense
185 Accumulated Depreciation – Sewing 512 Utilities Expense
Equipment 513 Insurance Expense
514 Telephone and Communication Expense
Liabilities 515 Sewing Supplies Expense
211 Accounts Payable 516 Clothing Materials Expense
212 Notes Payable 517 Rent Expense
213 Accrued Interest Expense 518 Interest Expense
519 Depreciation – Sewing Machines
520 Uncollectible Accounts Expense
Requirements: Prepare the following
1. The journal entries
2. Post journal entries to the ledger
3. Trial Balance
4. Ten-column worksheet with adjustments
5. Income Statement, Balance Sheet Statement of Changes in Equity and Statement of Cash Flows
6. Journalize and post the adjusting entries
7. Journalize and post the closing entries
8. Post-closing Trial Balance
9. Journalize and post the reversing entries
 P a g e | 24

Exercise Problems:
1. The accounts for the balance sheet, statement of changes in equity and income statement of S.V. Pam,
CPA, are as follows:

Accounts Payable P 63,500

Accounts Receivable 198,000
Accumulated Depreciation – Building 110,000
Accumulated Depreciation – Equipment 120,000
Auditing Revenue 1,361,500
Building 750,000
Cash 118,500
Depreciation Expense – Building 55,000
Depreciation Expense – Equipment 60,000
Pam, Capital, 1/1/2017 1,193,500
Pam, Withdrawals 165,000
Land 75,000
Notes Receivable 60,000
Office Equipment 362,500
Office Supplies Expense 96,000
Office Supplies 28,000
Professional Development Expense 86,500
Rent Expense 52,500
Salaries Expense 735,000
Salaries Payable 30,500
Travel Expense 41,000
Utilities Expense 18,000

During the year, S.V. Pam invested additional P 22,000 in the business.

Requirements:
a. Prepare the Income Statement.
b. Prepare the Statement of Changes in Equity.
c. Prepare the Statement of Financial Position.

2. Casio Business Solutions had a profit of P 330,000 in 2017. During the year, the entity had
depreciation expense of P 70,000. Accounts receivable increased by P 110,000 and accounts payable
increased by P 50,000. The entity started operations in 2017 and the foregoing are the entity’s only
current assets and current liabilities.

Prepare the net cash flows from operating activities using the indirect method.

FINANCIAL STATEMENT ANALYSIS

In analyzing and interpreting financial statements of a particular entity, the analyst must somehow have
standards with which he may compare the contents of said statements. These standards may be figures,
ratios, percentages or changes indicated in budgets, industry averages, competitor’s financial statements
and the company’s own financial statements for prior periods.
 P a g e | 25

1. HORIZONTAL ANALYSIS (or INDEX ANALYSIS) – the financial statements of the current period
is compared to the financial statements of the prior periods. The difference and percentage change of
the amounts are calculated using the earlier period as the base period. It may be accomplished by using
(1) Comparative Statements, (2) Trend Ratio.

A. Comparative Statements – show the increases or decreases in account balances and their
corresponding percentages.
Example:
ABM Hotel
Comparative Statement of Comprehensive Income
For the Year Ended December 31, 2016 and 2017

2017 2016 Amount Change % Change

Sales P 480,000 P 320,000 P160,000 50%
Less: Cost of Sales 200,000 160,000 40,000 25%
Gross Profit P 280,000 P 160,000 P 120,000 75%
Less: Operating Expenses 169,950 167,500 2,450 1.5%
Operating Income P 110,050 P (7,500) P 117,550 ---
Less: Non-operating Loss 39,000 ------------ 39,000 ---
Net Income P 71,050 P (7,500) P 78,550

B. Trend Ratio – using trend ratios or percentages showing the behavior of financial data for
successive periods.

ABM Hotel
Comparative Statement of Comprehensive Income
For the Years Ended December 31, 2016 and 2017
2017 2016 2017 2016
Sales P 480,000 P 320,000 150% 100%
Less: Cost of Sales 200,000 160,000 125% 100%
Gross Profit P 280,000 P 160,000 175% 100%
Less: Operating Expenses 169,950 167,500 101% 100%
Operating Income P 110,050 P (7,500) N/A 100%
Less: Non-operating Loss 39,000 ------------ N/A N/A
Net Income P 71,050 P (7,500) N/A 100%

Notice in the example above, you can observe the weakness of using trend ratio. When there is a
negative amount in any part of the comparatives, you cannot compute for a representative percentage
change.

2. VERTICAL ANALYSIS (or COMMON SIZE STATEMENTS) - the financial statements are
converted into percentages to enable comparability with the industry averages, competitors or
companies with difference in sizes. In converting the SCI, the Net Sales shall be used as the bas
number (100%) and the other items in the SCI will be converted into percentages with the Net Sales
as the common denominator. For the SFP, the Total Assets will be the common denominator.
 P a g e | 26

Example: Comparison Between two Corporations

ABC Corp. XYZ Corp.
Sales P 1,200,000 100% P 32,000 100%
Less: Cost of Sales 680,000 56.67% 14,000 43.75%
Gross Profit 520,000 43.33% 18,000 56.25%
Less: Operating Expenses 175,000 14.58% 6,000 18.75%
Net Income P 345,000 28.75% P 12,000 37.50%

Example: Statement of Financial Position as a Common Size Statement

ABC Corp.

Current Assets P 324,485 44.45%

Investments 196,005 26.85%
Property, Plant and Equipment 209,510 28.70%
Total Assets P 730,000 100%
LIABILITIES AND EQUITY
Current Liabilities P 131,400 18.00%
Long-Term Debt 328,500 45.00%
Capital Stock 219,000 30.00%
Retained Earnings 51,100 7.00%
Total Liabilities and Stockholder’s Equity P 730,000 100%

3. FINANCIAL RATIOS
Financial ratios are the significant relationships between items in the financial statements expressed
in mathematical form (Mejorada, 2006). In the analysis and interpretation of financial statements,
indications should not be considered conclusive. Instead, they should be used more as a guide for the
analyst in determining the possible areas of weaknesses in a company and the order of priority in making
further inquiry regarding details of operations.

Financial Ratios may be classified into those that are used in measuring (a) liquidity, (b)
profitability, (c) activity and (d) stability.

As a general rule, in computing ratios, if the numerator is an income statement account and the
denominator is a balance sheet account, the average figure for the balance sheet items should be used.
There are exceptions to this rule when not using an average will give a more reliable data. Also in
computing ratios, a 360-day year is used unless otherwise specified that another number of days is to be
used.

LIQUIDITY (SHORT-TERM SOLVENCY) RATIOS – shows the ability of the firm to pay its currently
maturing debts.

Current (Working Capital) _Current Assets_ Indicates the ability to pay

Ratio Current Liabilities current obligations.
Indicates the ability to pay
__Quick Assets__
Quick (Acid-Test) Ratio current obligations with more
Current Liabilities
liquid assets.
 P a g e | 27

PROFITABILITY RATIOS – shows how effectively a firm uses its resources to generate profits.

Indicates the adequacy of

Gross Profit gross margin to cover
Gross Profit Ratio
Net Sales operating expenses and
provide desired profit.
Indicates the amount of
Return on Sales or Net Income
net income per peso of
Income Margin Net Sales
sales.
Net Sales_____ Indicates the efficiency in
Asset Turnover
Average Total Assets the use of total resources.
Return on Sales x Asset Turnover Indicates the profitability
OR in the use of the total
Return on Assets
Net Income_____ assets, borrowed and
Average Total Assets invested.
_Net Income__ Indicates profitability in
Return on Equity
Average Equity the use if invested capital.
Net Income – Preferred Stock Dividends Indicates the ability to pay
Earnings Per Share
Ave. No. of Common Outstanding Shares dividends.
Indicates the number of
Market Price per Share
Price-Earnings Ratio pesos required to buy P1
Earnings Per Share
of earnings.
Measures the rate of
Dividends per share return in the investor’s
Dividend Yield
Market Price per share common stock
investment.
Indicates the percentage
Dividends per share of distributed earnings
Payout Ratio
Earnings per share based on earnings per
share.

ACTIVITY RATIOS – shows the efficiency with which assets are converted to sales or cash.

Indicates the number of times

____Net Credit Sales____
Receivable Turnover the receivable is collected
Ave. Accounts Receivables
during the period.
Average Collection Period or ___360 days___ Indicates the number of days
Average Age of Receivables Receivable Turnover to collect the receivables.
Indicates the number of times
Cost of Goods Sold
Inventory Turnover inventory was sold during the
Ave. Inventory
period.
Inventory Conversion Period Indicates the number of days
__360 days__
or Average Age of to sell or consume the
Inventory Turnover
Inventories inventory.
Net Credit Purchases Indicates the number of times
Payable Turnover
Ave. Accounts Payable the payable is being paid.
Payment Deferral Period or _360 days_ Indicates the number of days
Average Age of Payables Payable Turnover before paying the payables.
 P a g e | 28

Indicates the days from

investing the cash to buy or
Average Age of Receivables
Operating Cycle produce the inventory, selling
+ Average Age of Inventory
the inventory and finally
collecting the cash.
Indicates the length of time
that elapses from the point
Operating Cycle – Average
Cash Conversion Cycle cash payment is made for
Age of Payables
purchases to the point of
collection from customers.

STABILITY (LONG-TERM SOLVENCY) RATIOS – measures the ability of the firm to pay its liabilities.

Measures the proportion of

Total Liabilities
Debt-Equity Ratio borrowed capital to invested
Total Equity
capital.
_Total Equity_ Indicates the margin of safety
Equity-Debt Ratio
Total Liabilities to creditors.
Indicates what portion of total
Total Liabilities
Debt Ratio assets is provided by
Total Assets
creditors.
Total Equity Indicates what portion of total
Equity Ratio
Total Assets assets is provided by owners.
Common Stock Equity Measures recoverable amount
Book Value per share Number of Common Stocks by common stockholders in
Outstanding case of liquidation.

END OF CHAPTER 2
 P a g e | 29

EXERCISE PROBLEMS:
ABM MANUFACTURING CORPORATION
Comparative Income Statements
For the Years Ended December 31, 2016 and 2017
2017 2016
Sales P 300,000 P 200,000
Less: Cost of Goods Sold (See Note 1) 120,000 100,000
Gross Profit 180,000 100,000
Less: Operating Expenses (includes
P 6,000 depreciation) 125,000 60,000
Income before income tax P 55,000 P 40,000
Less: Income tax 19,250 14,000
Net Income P 37,750 P 26,000

Note 1: Schedule of Cost of Goods Sold

Direct Materials Cost:
Inventory, January 1 P 8,000 P 13,040
Purchases 54,000 47,560
Inventory, December 31 (12,000) (8,000)
Direct Material Cost P 50,000 P 52,600
Direct Labor 40,500 32,000
Factory Overhead (including P5,000 and
P3,000 depreciation for 2017 and 2016) 30,000 24,000
Total Manufacturing Cost P 120,500 P 108,600
Work in process, January 1 13,500 6,900
Work in process December 31 (16,000) (13,500)
Cost of Goods Manufactured P 118,000 P 102,000
Finished Goods, January 1 26,000 24,000
Finished Goods, December 31 (24,000) (26,000)
Cost of Goods Sold P 120,000 P 100,000

ABM MANUFACTURING CORPORATION

Comparative Balance Sheet
As of the Years Ended December 31, 2016 and 2017

ASSETS 2017 2016

Current Assets:
Cash P 15,500 P 12,200
Marketable Securities 5,000 16,000
Accounts Receivable 25,000 15,000
Finished Goods 24,000 26,000
Work in Process 16,000 13,500
Raw Materials 12,000 8,000
Factory Supplies 1,200 2,000
Prepaid Expenses 1,800 2,300
Total Current Assets P 100,500 P 95,000
Noncurrent Assets:
Investments 25,000 20,000
Property, Plant and Equipment, net 75,000 60,000
Total Assets P 200,500 P 175,000
 P a g e | 30

LIABILITIES AND STOCKHOLDER’S EQUITY

Current Liabilities:
Accounts Payable P 15,000 P 22,000
Income Taxes Payable 19,250 14,000
Accrued Expenses 5,000 9,000
Total Current Liabilities P 39,250 P 45,000
Noncurrent Liabilities:
Mortgage Payable 60,000 50,000
Total Liabilities P 99,250 P 95,000
Stockholder’s Equity:
12% Preferred Stock, par P10 P 20,000 P 20,000
Common Stock, par P10 30,000 25,000
Premium on Preferred Stock 5,000 5,000
Premium on Common Stock 10,000 8,000
Total Paid-in Capital P 65,000 P 58,000
Retained Earnings 36,250 22,000
Total Stockholder’s Equity P101,250 P 80,000
Total Liabilities and Stockholder’s Equity P200,500 P175,000

Additional Information:
Market Value per share of common stock P 65 P 60
Net Credit Sales 200,000 180,000
Net Credit Purchases 40,000 30,000
Dividends on Preferred Stock 2,400 2,400
Dividends on Common Stock 19,100 15,200
December 31, 2015 figures:
Accounts Receivable P 12,000 Operating Expenses P 60,000
Total Current Assets 80,000 Total Assets 160,000
Total Current Liabilities 50,000 Stockholder’s Equity 60,000
Common Stock 25,000
The marketable securities qualify as cash equivalents.

In analyzing the financial statements, the officers of the corporation have requested you to compute the
following ratios for both 2016 and 2017:

1. Return on Sales 11. Inventory (Finished Goods) Turnover

2. Return on Assets 12. Average Age of Inventory
3. Gross Profit Rate 13. Receivable Turnover
4. Return on Equity 14. Average Age of Receivables
5. Earnings Per share 15. Current Ratio
6. Price-Earnings Ratio 16. Quick Ratio
7. Payout Ratio 17. Operating Cycle
8. Payable Turnover 18. Cash Conversion Cycle
9. Average Age of Payables. 18. Debt Ratio
10. Book Value Per Share 20. Equity-Deb Ratio
 P a g e | 31

CHAPTER 2
BANK RECONCILIATION
“Do not study hard, study smart.”
Bank Deposits
There are three kinds of bank deposits, namely:
Demand Deposit – this is the current account or checking account where deposits are covered by deposit
slips and where funds are withdrawable on demand by drawing checks against the bank. It is noninterest
bearing.
Saving Deposit – the depositor is given a passbook upon the initial deposit. The passbook is required when
making deposits and withdrawals. It is interest bearing.
Time Deposit – it is evidenced by a formal agreement in an instrument called certificate of deposit. It may
be withdrawn on demand or after a certain period of time agreed upon. It is interest bearing.

Bank reconciliation - is a statement which brings into agreement the cash balance per book cash balance
per bank. It is usually prepared monthly because the bank provides the depositor with the bank statement
at the end of every month.

The bank statement is an exact copy of the depositor’s ledger in the records of the bank.

Reconciling Items
At the end of every month, comparison between the cash records of the depositor and the bank statement
received from the bank will yield the following reconciling items:
1. Book Reconciling Items 2. Bank Reconciling Items
a. Credit Memos a. Deposits in Transit
b. Debit Memos b. Outstanding Checks
c. Errors c. Errors

Credit Memos- refer to items not representing deposits credited by the bank to the account of the depositor
but not yet recorded by the depositor as cash receipts. Common examples are notes receivable collected by
the bank, loan proceeds credited to the bank account of the depositor and customers directly depositing their
payment to the bank account of the depositor.

Debit Memos - refer to items not representing checks paid by the bank which are debited by the bank to the
account of the depositor but not yet recorder by the depositor as cash disbursements. Common examples are
bank service charges for various reasons, loan repayment automatically deducted to the depositor’s account
or No Sufficient Fund (NSF) Checks which are checks deposited but returned by the bank because of
insufficiency of fund.

Deposits in Transit – are collections already recorded by the depositor as cash receipts but not yet reflected
on the bank statement. Common examples are collections already forwarded to the bank but late to appear
in the bank statement and cash still on hand awaiting deposit.

Outstanding Checks – are checks already recorded by the depositor as cash disbursements but not yet
reflected on the bank statement. An example is a check drawn and already given to payee but not yet
presented for payment. Any certified checks included are deducted to outstanding checks. Because a
certified check is already deducted to the bank balance even if not yet actually paid by the bank.

The book and bank balance are adjusted to equal the correct cash balance, which will be shown in the
balance sheet.
 P a g e | 32

Proforma Reconciliation

Book Balance P xx Bank Balance P xx

Add: Credit Memos xx Add: Deposit In Transit xx
Less: Debit Memos ( xx) Less: Outstanding Checks ( xx)
Adjusted Book Balance P xx Adjusted Bank Balance P xx

Working Problem 1:
The cash records of Valix Company show the following for the month of June.
CASH IN BANK

CASH RECEIPTS CASH DISBURSMENTS

June 5 60,000 June 6 Check No. 721 5,000
13 20,000 7 Check No. 722 10,000
25 30,000 10 Check No. 723 18,000
30 40,000 14 Check No. 724 2,000
150,000 28 Check No. 725 37,000
31 Check No. 726 28,000
100,000

The bank statement for the month of June received from Philippine National Bank

In account with No. 123

Valix Company Philippines National Bank
Angeles City Angeles City, Philippines
Date Check No. Withdrawals Deposits Balance
June 6 60,000 60,000
8 721 5,000 55,000
11 722 10,000 45,000
12 723 18,000 27,000
14 20,000 47,000
17 724 2,000 45,000
26 30,000 75,000
26 15,000 CM 90,000
30 5,000 RT 85,000
30 1,000 SC 84,000
Code: CM –Credit Memo, DM – Debit Memo, RT – Returned Check, SC – Service Charge

Additional Information:
a. The CM of P 15,000 on Jun 26 represents proceeds of note collected by the bank in favor of the
company.
b. The RT of P 5,000 represents check of customer deposited previously but returned by the bank
because of “no sufficient fund.”

After preparing the bank reconciliation statement, adjusting journal entries on the book of the depositor will
be necessary. This is make the cash per book equal to the correct cash balance and it will be forwarded to
the Statement of Financial Position.
 P a g e | 33

Valix Company
Bank Reconciliation
June 30, 2017
Book Balance P 50,000
Add: Note Collected 15,000
Less: Debit Memos
NSF Check 5,000
Service Charge 1,000 ( 6,000)
Adjusted Book Balance P 59,000

Bank Balance P 84,000

Add: Deposit in Transit 40,000
Less: Outstanding Checks
Check No. 725 37,000
Check No. 726 28,000 ( 65,000)
Adjusted Bank Balance P 59,000

The adjusting journal entries are:

Cash in Bank 15,000
Notes Receivable 15,000
Accounts Receivable 5,000
Cash in Bank 5,000
Bank Service Charge 1,000
Cash in Bank 1,000

Working Problem 2:
A newly hired staff of Error Company prepared the bank reconciliation on March 31, 2017.
Book Balance P 1,405,000
Add: March 31 deposit P 750,000
Collection of Note Receivable 2,500,000
Interest on Note 150,000 3,400,000
Less: Mirror Company’s deposit
To our account 1,100,000
Bank Service Charge 5,000 ( 1,105,000)
Adjusted Book Balance P 3,700,000
Bank Balance P 5,630,000
Add: Error on check no. 175 45,000
Less: Preauthorized payment for
Light and water 245,000
NSF Check 220,000
Outstanding Checks 1,650,000 ( 2,115,000)
Adjusted Bank Balance P 3,560,000
 Check no. 175 was made for the proper amount of P 249,000 in payment of account. However it was
entered in the cash disbursements journal as P294,000.
 Error Company authorized the bank to automatically pay the light and water bills as submitted directly
to the bank.
Excerpt: Financial Accounting Volume 1 by Conrado Valix
END OF CHAPTER 2
 P a g e | 34

EXERCISE PROBLEMS
1. The following data are gathered from the records of Expert Company for the month of December of the
current year.
Balance per book 5,000,000
Balance per bank 4,450,000
Deposit in Transit 3,000,000
Outstanding check 850,000
Bank service charge for December 50,000
Customer’s check returned by the bank marked “NSF” 500,000
Customer’s note collected by the bank:
Face Value, P 2,000,000; Interest, P 200,000;
Collection Fee, P 50,000 2,150,000
Prepare the Bank Reconciliation and Adjusting journal entries to correct the cash balance.

2. Seth Corp. keeps all its cash in a checking account. An examination of the entity’s accounting records
and bank statement for the month of December 2017 revealed a bank statement balance of P 18,969,000
and book balance of P 19,210,000.

A deposit of P 1,450,000 placed in the bank’s night depository on December 31, 2017 does not appear
on the bank statement. Checks outstanding on December 31, 2017 amount to P 770,000 of which P
70,000 had been certified.

The bank statement shows that on December 26, 2017, the bank collected a note for Cain Company and
credited the proceeds of P 1,936,000 to the entity’s account which includes interest of P 36,000.

Seth Corp. discovered that check number 1000759 written in December 2017 for P 1,930,000 in payment
of an account had been recorded in the entity’s records as P 1,390,000. Included with the December 31,
2017 bank statement was an NSF check for P 840,000 that Seth Corp. had received from a customer on
December 20, 2017. Seth Corp. has not yet recorded the returned check. The bank statement shows a P
47,000 service charge for December.

Prepare the Bank Reconciliation and adjusting entries on December 31, 2017.
 P a g e | 35

CHAPTER 3
PRINCIPLES OF TAXATION
“This is too difficult for a mathematician. It takes a philosopher. The hardest
thing in the world to understand is the income tax.”

“Study the concepts of taxation, you will laugh at Einstein in terms of taxation.”

THE INHERENT POWERS OF THE STATE

By way of analogy, a newly born child has three basic needs: clothing, shelter and food, even without
showing a birth certificate. The government, upon its creation, also has basic needs and right even without
a Constitution. These are the inherent powers of the government; Power of Eminent Domain, Police Power
and Taxation Power. These are natural, inseparable and innate to every government. These powers are
exercisable by the government even without constitutional grant, though the Philippine Constitution sets up
limits for these powers.

Power of Eminent Domain – the inherent power of the sovereign State, exercised by the legislature, to take
private property for public purpose after paying just compensation.

Police Power – the inherent power of the sovereign State, exercised by the legislature, to enact laws for the
protection of the health, general welfare, safety and morals of the public.

Taxation Power - the inherent power of the sovereign State, exercised by the legislature, to impose
proportional burden upon its subjects and objects within its jurisdiction, to raise revenues for the
expenditures of the government.

Point of Difference Eminent Domain Police Power Taxation Power

Exercising Government and Public
Government Government
Authority utilities
Protect the general Support of the
Purpose For Public purpose
welfare of the people. government.
Persons Affected Owner of the property Community Community
No amount imposed.
Amount of Limited (Cover cost Unlimited (Based on
(The government pays
Imposition of regulation) government needs.)
just compensation.)
Public purpose and just Public interest and Constitutional and
Limitation
compensation Due Process Inherent limitations.
(Excerpt from: Income Taxation by Rex B. Banggawan)
.
WHAT IS TAXATION?
Taxation is the process by which the sovereign, through its lawmaking body, raises income to defray the
necessary expenses of the government.

The Principle of Necessity (Theory of Taxation)

The existence of a government is absolutely necessary for the improvement of the quality of life of
a society. With the help of the government, services are provided for the benefit of the people. However,
services provided by the government entails financial support. Thus, the Government’s necessity for funding
is due from the Principle of Necessity which is also the theory of taxation.
 P a g e | 36

The Benefit Received Theory (Basis of Taxation)

The government provides services to the public and the public shall provide for the funds needed for
those goods and services. This mutual interest between the government and the people is referred to as the
basis of taxation.
Public Services

Taxes

Receipt of benefits is conclusively presumed

Most public services are received indirectly, their achievement by the citizen and resident is cannot
be disputed or denied. Benefits include daily free usage of public infrastructures, access to public health,
education services, protection and security of person and property. Because of these reason, the taxpayers
cannot avoid payment of tax the defense of absence of benefit received.

LIFEBLOOD DOCTRINE
Taxes are essential and indispensable to the continued subsistence of the government, without taxes,
the government would be paralyzed for lack of motive power to activate or operate it. (CIR vs. Algue)

Taxes are the lifeblood of the government, and their prompt and certain availability are an imperious
need. Upon taxation depends the government’s ability to serve the people for whose benefit taxes are
collected (Vera vs. Fernandez).

This is the most important and the very basis of the whole taxation power. This simple doctrine can
explain a thousand rules and regulations of taxation. Examples include: tax is imposed even in the absence
of Constitutional grant, claims for tax exemptions are construed against the taxpayers or providing limits
for deductions and exemptions.

SCOPE OF THE TAXATION POWER

The scope of Taxation is Comprehensive (includes substantially all objects), Plenary (complete in
every aspect), Unlimited (based on government needs) and Supreme (superior to others). However, with
the seemingly the most superior power also have limitations that are inherent and imposed by the
Constitution.

INHERENT LIMITATIONS OF THE TAXATION POWER

1. Territoriality of Taxation – public service are provided only within the boundaries of the State,
therefore, tax can be imposed only within the territories of the State. Exceptions to this limitation
includes the resident citizens and domestic corporations which are taxable in their income within and
without* the Philippines, another is the taxes on the transfers of citizens or resident of their properties
within and without* the Philippines.
*These are the words used in our National Internal Revenue Code (NIRC) of 1997, as amended (RA 8424).

2. International Comity – the basic principle of international law that all states are equally sovereign.
When the State enters into treaties with other states, it is bound to honor the terms as a matter of mutual
courtesy. In case the local tax law and a treaty is in conflict, the treaty will prevail and shall be followed.

3. Public Purpose – taxation power must be exercised absolutely for public purpose. It cannot further any
private interest. Though it may give a direct benefit to a private individuals (e.g. donation to persons
devastated by calamity.
 P a g e | 37

4. Exemption of the Government – the taxation power can be exercise upon anything including itself.
However, taxing the government will not add revenue to the government but will only increase
unnecessary expenses. These exemption only extends to Government agencies and instrumentalities to
the exclusion of government-owned/or controlled corporation, which are commercial in nature.
However, SSS, GSIS, PHIC, PCSO, PDIC and Local Water utilities are also exempted from income
taxation.

5. Non-delegation of the Taxing Power – the taxation power is vested exclusively in Congress and non-
delegable in relation to the doctrine of separation of the branches of the government. However, there are
exceptions in which the taxation power can be delegated. These are the power of local government units
to exercise the power to tax to enable them their fiscal autonomy and the president is allowed to fix the
tariffs to align in trading conditions.

CONSTITUTIONAL LIMITATIONS (Under the 1987 Constitution)

1. No person shall be deprived of life, liberty or property without due process of law, nor shall any person
denied the equal protection of the laws (Art. III, Sec. 1).
2. The rule of taxation shall be uniform and equitable. The Congress shall evolve a progressive system of
taxation (Art. VI. Sec. 28)
a. Progressive Tax System – as the tax base increases, the rate increases.
b. Uniformity Rule – persons or properties under the same class should be taxed the same kind
and rate of tax.
c. Equality Rule – the same means and methods be applied impartially to all the members of
each class. Simply, taxation should consider the taxpayer’s ability to pay.
3. No law impairing the obligation of contracts shall be passed (Art III, Sec. 10).
4. Non-imprisonment for non-payment of debt or poll tax (Art III, Sec. 20).
5. No law shall be made respecting an establishment of religion or prohibiting the free exercise thereof
(Art III, Sec. 5).
6. Charitable institutions, churches and parsonages or convents appurtenant thereto, mosques, no-profit
cemeteries, and all lands, buildings and improvements, actually, directly, exclusively used for religious,
charitable or educational purposes shall be exempt from taxation (Art. VI, Sec. 10).
7. Non-appropriation of public funds or property to the benefit of any church, sect or religion (Art VI, Sec.
29).
8. All revenues and assets of non-stock, non-profit educational institutions used actually, directly and
exclusively for educational purposes shall be exempt from taxes and duties (Art. XIV, Sec. 4)
9. All appropriation, revenue or tariff bills ….... shall originate exclusively in the House of Representatives,
but the Senate may propose or concur with amendments (Art. VI, Sec. 24)
10. No law granting tax exemption shall be passed without the concurrence of a majority of all the members
of Congress (Art. VI, Sec. 28).
11. The Supreme Court shall have the power to review, revise, reverse, modify or affirm on appeal or
certiorari as the law or the Rules of Court may provide, final judgments and orders of lower courts in
……. All cases involving the legality of any tax, impost, assessment, or toll or any penalty imposed in
relation thereto (Art. III, Sec. 5).
12. The Congress may, authorize the President to fix tariff rates, import and export quotas, tonnage,
wharfage dues and other duties and impost (Art. VI, Sec 28).
13. Each local government unit shall have the power to create its own sources of revenues and to levy taxes,
fees and charges subject to such guidelines and limitations as the Congress may provide, consistent with
the basic policy of local autonomy. Such taxes, fees and charges shall accrue exclusively to the local
governments (Art. X, Sec. 5).
 P a g e | 38

OTHER DOCTRINES IN TAXATION

1. Benefit Received Theory – The more benefit one receives from the government, the more taxes he
should pay.
2. Ability to Pay Theory – taxation should consider the taxpayer’s ability to pay. Contribution should be
based on the relative capacity to sacrifice for the support of the government.
3. Marshall Doctrine – The power to tax involves the power to destroy.
4. Holme’s Doctrine – Taxation power is the power to build.
5. Prospectivity of tax laws – affects only the current and future period unless intended to affect previous
periods.
6. Non-compensation or set-off, except for obvious overpayment of taxes or appropriation already made
for a refund.
7. Non-assignment of taxes – the government will only collect from the taxpayer. An individual cannot
transfer his liability for taxes to another entity by contract.
8. Imprescriptibility in taxation – the government’s right to collect taxes does not prescribe unless the law
itself provides for such prescription. Prescription is the lapsing of a right due to passage of time.
9. Doctrine of Estoppel – any misrepresentation made by one toward another who relied therein in good
faith will be held true and binding against that person who made the representation. The government is
NOT subject to estoppel.
10. Judicial Non-interference – courts are generally not allowed to interfere with tax collection.
11. Strictissimi Juris – Taxation is the rule, exemption is the exception.

PRINCIPLES OF A SOUND TAX SYSTEM (by Adam Smith)

1. Fiscal Adequacy – requires that the sources of government funds must be sufficient to cover
government costs. The government must not incur a deficit.
2. Administrative Feasibility – tax laws should be capable of efficient and effective administration to
encourage compliance.
3. Theoretical Justice – taxation should consider the taxpayer’s ability to pay. Exercise of taxation power
should not be oppressive, unjust or confiscatory.

TAX – is an enforced proportional contribution levied by the lawmaking body of the State to raise revenue
for public purpose.
Elements of a Valid Tax
1. Tax is an enforce contribution.
2. Tax must be levied by the taxing power having jurisdiction over the object of taxation.
3. Tax must not violate inherent and constitutional limitations.
4. Tax must be uniform and equitable.
5. Tax must be for public purpose.
6. Tax is generally payable in money.

ASPECTS OF TAXATION
Taxation cover three separate areas or aspects of government activity, namely:
1. Levy or Imposition of Tax – this involves the passage of tax laws which is generally a legislative act.
In the Philippines, the taxing power is exercised by the Congress.
2. Assessment – the process of determining the correct amount of tax due.
3. Collection and payment – the act of compliance with the tax law by the taxpayer.
*Assessment and Collection and payment is executive or administrative in nature. It is done by the Bureau
of Internal Revenue (BIR).

ESCAPES FROM TAXATION

1. Shifting – the tax burden is transferred by the one on whom tax is imposed or assessed to another.
 P a g e | 39

2. Capitalization – there is a reduction in the price of the taxed object equal to the capitalized value of
future taxes which the taxpayer expects to be called upon to pay.
3. Transformation – the producer or manufacturer upon the tax has been imposed, fearing the loss of his
market if he should add the tax to the price, pays the tax. He then endeavors to recoup the tax paid by
making his production more efficient and lowering his cost of production.
4. Tax Exemption or Tax Holiday – freedom from the burden of paying tax.
5. Tax Avoidance or Tax Minimization – occurs when the means to minimize taxes are legal and not
prohibited by law.
6. Tax Evasion or Tax Dodging – connotes fraud through the use of pretenses and forbidden devices to
lessen or defeat taxes.

BUREAU OF INTERNAL REVENUE (BIR) FORMS

BIR FORM 0605 – Payment Form – every taxpayer shall use this form to pay taxes which do not require
the use of a tax form such as registration fees, delinquency and deficiency taxes, advance payments etc.

BIR FORM 1700 – Annual Income Tax Return – every purely compensation earning individual taxpayer
whose income is subjected to Regular Income Taxation (Sec. 24 A of the Tax Code). It is paid quarterly
(April 15, August 15, November 15 of the same year for the first 3 quarters), and annually (April 15 of the
following year).

BIR FORM 1701 – Annual Income Tax Return – every self-employed or deriving mixed income
individual taxpayer whose income is subjected to Regular Income Taxation (Sec. 24 A of the Tax Code). It
is paid quarterly (April 15, August 15, November 15 of the same year for the first 3 quarters), and annually
(April 15 of the following year).

BIR FORM 1702 – Annual Income Tax Return – every corporation and partnership whose income is
subject to Regular Income Tax Rate of 30%. It is paid quarterly (60 days after the end of the taxable quarter)
and annually (on the 15th day of the fourth month after the end of the taxable year. Corporations are also
subject to a Minimum Income Tax Rate of 2% of all income subject to the regular rate, starting from the
fourth year following the commencement of business (X + 4).

BIR FORM 2550 – Value-Added Tax Form – every business who is VAT-registered or VAT-registrable
(those whose sales/receipts exceeded P 1,919,500 for any 12-month period). It is paid monthly (20 days
after the end of the month) and quarterly (25 days after the end of the quarter). Generally, businesses and
individuals in the practice of their professions are subject to 12% VAT of their sales/revenue and any Input
VAT can be deducted to get the VAT payable.
Illustration:
During a month, an entity sold goods to customers on accounts for P 5,000,000 VAT-exclusive.
Accounts Receivable 5,600,000
Sales 5,000,000
Output VAT (12% x 5,000,000) 600,000
In the same month, the entity purchased goods on account for P 2,240,000 VAT-inclusive.
Purchases (2,240,000/112%) 2,000,000
Input VAT (2,000,000 x 12%) 240,000
Accounts Payable 2,240,000
At the end of every month, the Input VAT is offset against the Output VAT in order to determine the net
liability of the entity.
Output VAT 600,000
Input VAT 240,000
 P a g e | 40

VAT Payable 360,000

Subsequently, when the net liability is paid in the succeeding month.
VAT Payable 360,000
Cash 360,000

BIR FORM 2551 – Percentage Tax Return – every business who is not VAT-registered, those who are
not required to register and those specifically subject to percentage tax. It is generally payable monthly (20
days after the end of the month), but some are required to pay taxes quarterly (20 days after the end of
quarter). Generally, businesses and individuals in the practice of their profession are subject to a tax rate of
3% of the Receipts for Service providers and Sales for manufacturing and merchandising businesses.

Illustration:
During a month, an entity sold goods to customers on accounts for P 5,000,000.
Accounts Receivable 5,000,000
Sales 5,000,000
In the same month, the entity purchased goods on account for P 2,240,000.
Purchases 2,240,000
Accounts Payable 2,240,000
At the end of every month, the percentage tax is computed
Percentage Tax Expense (5,000,000 x 3%) 150,000
Percentage Tax Payable 150,000
Subsequently, when the net liability is paid in the succeeding month.
Percentage Tax Payable 150,000
Cash 150,000

FILING AND PAYMENT OF TAXES (in order of priority)

1. Any authorized agent banks (AAB) located within the jurisdiction of the Revenue District Officer
(RDO) where the taxpayer is registered.
2. Revenue Collection Officer under the jurisdiction of the RDO where the taxpayer is registered, if there
is no AAB
3. In case of no payment returns, file with the RDO where the taxpayer is registered or his legal residence
or place of business in the Philippines.
4. For non-resident taxpayers, it shall be filed with the Office of the Commissioner or Revenue District
Office No. 39, South Quezon City.

END OF CHAPTER 3
 P a g e | 41

EXERCISE PROBLEMS:
1. The principal purpose of taxation is
a. To encourage growth of home industries. c. To reduce excessive inequalities of wealth.
b. To implement the police power of the state. d. To raise revenue for government needs.
2. Which statement is incorrect?
a. Every person must contribute his share in government costs.
b. The existence of a government is expected to improve the lives of people.
c. The government provides protection and other benefits while the people provide support.
d. Only those who are able to pay tax can enjoy the privileges and protection of the government.
3. Which is the most incorrect statement regarding taxes?
a. Taxes are necessary for the continued existence of the government.
b. The obligation to pay tax does not rest upon the privilege enjoyed.
c. There should be personal benefit enjoyed from the government before one is required to pay tax.
d. Taxes should be collected without unnecessary delay.
4. The provisions in the Constitution regarding taxation are
a. Grants of the power to tax
b. Limitations of the power to tax
c. Grants and limitation of the power to tax
d. None of the choices
5. Persons or thing belonging to the same class shall be taxed at the same rate.
a. Simplicity in Taxation c. Equality in Taxation
b. Reciprocity in Taxation d. Uniformity in Taxation
6. The tax should be proportional to the relative value of the property to be taxed.
a. Simplicity in Taxation c. Equality in Taxation
b. Reciprocity in Taxation d. Uniformity in Taxation
7. Which of the following is a violation of the principle of non-delegation?
a. Requiring that legislative enactment must exclusively pertain to Congress.
b. Authorizing the President to fix the amount of custom duties on imported commodities.
c. Authorizing certain private corporation to collect taxes.
d. Allowing the Department of Finance and Bureau of Internal Revenue to issue regulations which go
beyond the scope of a tax law.
8. This is an inherent limitation on the power of taxation
a. Tax laws must be applied within the territorial jurisdiction of the state.
b. Exemption of government agencies and instrumentalities from taxation
c. No appropriation of public money for religious purposes.
d. Power to tax cannot be delegated to private persons or entities.
9. Concerned with increasing unemployment rate in the country, the President encouraged the Philippine
Senators to pass a law granting tax privileges to foreign investors who will establish businesses in the
country. The Senate drafted the bill and passed it to Congress for approval. Is the exercise of taxation
power valid?
a. Yes, it is the discretion of the President to adopt any measures he deemed necessary to alleviate poor
conditions in the country.
b. Yes, any means beneficial to the public interest should be given optimum priority.
c. No, the President’s proposal will have to be finally approved and passed by the legislature.
d. No, tax bills shall originate exclusively from the House of Representatives.
10. Which of the following entities will pay real property tax?
a. Bantay Bata, a non-profit charitable institution.
b. Jesus Crusade Movement, a religious institution
c. University of Pampanga, a private proprietary educational institution.
d. CV Property Holdings, a property development company.
 P a g e | 42

11. Which principle demands that tax should be just, reasonable and fair?
a. Theoretical Justice c. Administrative feasibility
b. Fiscal Adequacy d. Economic consistency
12. Which of the following has no power to impose taxes?
a. Provinces c. Barangays
b. Cities d. Barrios
13. It is the privilege of not being imposed a financial obligation to which other are subject.
a. Tax Dodging c. Tax Amnesty
b. Tax Holiday d. Tax Avoidance
14. Violation of this principle will make a tax law invalid.
a. Theoretical Justice c. Administrative feasibility
b. Fiscal Adequacy d. Economic consistency
15. Which of the Inherent powers cannot be solely exercised by the government?
a. Police Power c. Taxation Power
b. Power of Eminent Domain d. None of the choices
16. Which of the following is not a public purpose?
a. National Defense c. Improvement of the solar power industry
b. Public Education d. Improvement of a subdivision road.
17. Which of the following may not raise money for the government?
a. People Power c. Power of Taxation
b. Power of Eminent Domain d. Police Power
18. Although the power of taxation is basically legislative in character, it is not the function of Congress to?
a. Fix with certainty the amount of taxes.
b. Collect the tax levied under the law
c. Identify who should collect the tax
d. Determine who should be subject to the tax.
19. The strongest of all inherent powers of the state because without it, the government can neither survive
nor dispense any of its other powers and functions effectively.
a. People Power c. Power of Taxation
b. Power of Eminent Domain d. Police Power
20. In exercising taxation, the government do not need to consider
a. Inherent limitations c. Due process of law
b. Constitutional limitations d. Just compensation
 P a g e | 43

ACCOUNTING PRACTICE SET – Project for Finals

On October 1, 2017, Ms. Anne Yare, a recent medical board topnotcher, started her medical practice with a
name of Dr. Anne Yare Medical Clinic. Her accountant prepared the trial balance as of October 30, 2017.
During the month of October, the following transactions were completed:
October
1 Yare invested P 400,000 personal funds in Valix Bank, in a new bank account in the name of
Anne Yare, M.D. She registered her business with the Bureau of Internal Revenue as a VAT-
Taxpayer. Filing BIR Form 0605 and paying P 500, by encashing check no. 340.

2 Bought a piece of land with a constructed building from Landers, Inc. for a total of P 1,250,000. The
land has a value of P 250,000 and the rest goes to the building. Dr. Yare gave P 50,000 cash through
check no. 341 and issued a note payable with an interest of 20% per year payable after two years.

2 Hired Mr. Kevin Peralta, medical technologist and Ms. Olive Suba, receptionist.

4 Acquired a fire insurance for P 20,000 cash through check no. 342 from Tolentino
Insurance Agency.

5 Bought supplies on account from Rex Medical Supply, P 28,000, VAT-inclusive.

6 Bought a medical equipment from Chris Gardner worth P 465,000 by paying P 65,000 cash through
check 343 and issuing a note payable with 24% interest per year for the balance payable after 2
years.

7 Paid association dues, P 15,000 cash through check no. 344.

8 Billed Mr. Chris Tamayo P 51,700 for services rendered, VAT-exclusive.

12 Received P 90,000 from the International Medical Research Institute to conduct a

3-day seminar about her specialization.

15 Paid the salaries of her two employees, P 36,500 though checks no. 345 and 346 for equal amount.

16 Paid P 7,000 to Rex Medical Supply by issuing check no. 347.

18 Billed Mr. Mark Espenilla P 229,400 for the services rendered, VAT-exclusive.

19 Collected the whole amount due patients from Mr. Tamayo.

20 Bought medical supplies from Rey Medical Supply, P 34,720 on account, VAT-inclusive.

22 Hired Mr. Joseph Chua, nurse and Mr. Matthew Dizon, radiologic technician.

24 Billed Ms. Vivian Alcantara 152,900 for services rendered, VAT-exclusive.

28 Paid to Mr. Vincent Geronimo the repair of the medical equipment by giving check no. 348, P
23,000, VAT-exclusive.

30 Paid utilities, P 3,360 cash to Electronix Corp. through check no. 349, VAT-inclusive.
 P a g e | 44

31 Paid the salaries of Mr. Peralta and Ms. Suba, P 36,500 by issuing checks no. 350
and 351.

31 Withdrew P 200,000 cash from the business for personal use by writing a check payable to
herself. The check was numbered 352.

Additional Information:
 All cash receipts and collections are immediately deposited to the bank account. All cash disbursements
are made through issuance of checks.

 The prepaid insurance amount of P 20,000 is for one year insurance.

 Medical supplies on hand at month-end amounted to P 17,000.

 The Building has an estimated useful life of ten years with residual value of P 100,000 at the end of its
life. The equipment has five years life that will be worthless at the end of its life.

 Unearned Seminar revenue in the amount of P 40,000 have been still unearned at month-end.

 Salaries of P 46,000 have accrued at month-end for Mr. Chua and Mr. Dizon’s salaries.

Chart of Accounts
110 Cash 320 Yare, Withdrawals
120 Accounts Receivable 330 Income Summary
130 Medical Supplies 410 Medical Revenue
140 Prepaid Insurance 420 Seminar Revenue
150 Land 430 Output VAT
160 Building 510 Salaries Expense
165 Accumulated Depreciation – Bldg. 520 Insurance Expense
170 Medical Equipment 530 Repairs Expense
175 Accumulated Depreciation – Equip. 540 Supplies Expense
210 Accounts Payable 550 Association Dues Expense
220 Salaries Payable 560 Utilities Expense
230 Interest Payable 570 Depreciation Expense – Bldg.
240 VAT Payable 580 Depreciation Expense - Equip
250 20% Notes Payable 590 Interest Expense
260 24% Notes Payable 600 Input VAT
270 Unearned Seminar Revenue 610 Bank Service Charge
310 Yare, Capital 620 Licensing Expense
 P a g e | 45

The bank statement was sent by the bank:

VALIX BANK
Ms. Anne Yare For the period October 1 – 31, 2017
Date Check no. Withdrawals Deposits Balance
October 1 400,000 400,000
1 340 500 399,500
2 341 50,000 349,500
4 342 20,000 329,500
7 343 65,000 264,500
9 344 15,000 249,500
12 90,000 339,500
15 345 18,250 321,250
15 346 18,250 303,000
19 57,904 360,904
21 Deposit from Mark Espenilla 178,300 539,204
31 352 200,000 339,204
31 351 18,250 320,954
31 350 18,250 302,704
31 Service Charge 500 302,204

Requirements: Round off to the nearest centavo.

1. Accomplish the basic business forms: Official receipts (for the services rendered), checks (issued for
disbursements). * Refer to attachments at the next pages.
2. Prepare the journal entries, post them to the ledger, and prepare the bank reconciliation statement, the
trial balance (BEFORE bank reconciling items and VAT items) and the ten-column worksheet showing
all adjustments including the bank reconciling and VAT items.
3. Prepare the financial statements; SCI, SCE, SFP, SCF (Direct Method).
4. Prepare the adjusting journal entries and closing entries and post them to the ledger, then prepare the
post-closing trial balance. Also, prepare all necessary reversing journal entries.
5. Perform a Financial Statement Vertical Analysis and Ratio Analysis: Current Ratio, Quick-Acid Ratio,
Return on Sales, Asset Turnover, Return on Assets, Return on Equity, Receivable Turnover, Average
Age of Receivable, Inventory Turnover, Average Age of Inventory, Payable Turnover, Average Age of
Payables, Operating Cycle, Cash Conversion Cycle, Debt-Equity Ratio, Debt Ratio, Equity Ratio. Hint:
Beginning balances are all zero (0) for ratio purposes.
P a g e | 46
P a g e | 47