Bookkeeping with Basic Accounting – Training for Non-Accountants

NEED FOR ACCOUNTING

Introduction

Human beings have limitations, Everyday transactions cannot be

retained in the human brain for quite a period of time without confusions and
complications. To avoid these, transactions and other important events
should be recorded. Such written records serve as reference for future recall.
In business, several parties are interested to its records to seek answers
to their questions and bases for their decisions. These parties can be classified
into direct users or those who have direct interest to business records and
indirect users or those who are indirectly interested to the accounting
information of the business. Among the direct users are the following:
1. Owner. He is interested to know whether the business should be
maintained, increased, decreased or disposed completely.
Further, he is interested to know whether he is getting a fair
return of his investment.
2. Management. To management, financial information serves as a
measure for making future financial decisions and measure of its
effectiveness.
3. Investor. An investor is interested in the financial statement for
making future financial decisions and a measure of its
effectiveness.
4. Creditors. Creditors are interested in the financial statement to
determine the company’s ability to pay.
5. Employees. Employees are interested in information to enable
then to assess the ability of the firm to provide remuneration and
other benefits.
6. Government. The government needs accounting information to
regulate the firm’s activities and determine the basis for taxation
policies.

Why study Accounting?

In order to appreciate and understand the financial reports of the

business, one should have an understanding of how the data are gathered
and recorded. All these understanding are gained in the study of Accounting.
Accounting could also be one’s profession – a work which interesting and
highly rewarding.

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Definition of Accounting

The Committee on Terminology, American Institute of

Accountants defined Accounting as the art of recording, classifying and
summarizing in a significant manner and in terms of money, transactions and
events which are in part at least, of a financial character, and interpreting the
results thereof.

Role and purpose of Accounting

The role and purpose of accounting is to provide useful and timely

information about the financial activities of an individual, business, or other
organization. In addition, accounting provides information to other
stakeholders to use in assessing the economic performance and condition of
the business. Without realizing it, you may have participated in an
accounting transaction today.

Four Phases of Accounting

Based on the definition, Accounting has four phases namely, recording,

classifying, summarizing, and interpreting.

Recording. This is technically called bookkeeping. Some people

confuse bookkeeping and accounting as one and same. However, bookkeeping
is only part of Accounting – the record phase. In this phase, transactions are
recorded systematically and chronologically in the proper accounting books.
There are two kinds of bookkeeping: the single entry bookkeeping and the
double entry bookkeeping. The single entry bookkeeping does not show the
two-fold effects of business transactions. It show only the debit or credit of
each transaction. The double entry bookkeeping however reflects the two-fold
effects of business transactions. It has a debit and credit.

Classifying. In this phase, items are sorted and grouped. Similar items
are classified under the same name. They may classified as asset accounts,
liability accounts, capital accounts, revenue accounts and expense accounts.
This classification is useful to the needs of the management.

Summarizing. After each accounting period, data are recorded and

summarized through financial statements. These reports are submitted to the
management at the end of each accounting period or as the need arises.

Interpreting. Usually, due to technicality of accounting reports, the

accountant’s interpretation on the financial statement is needed. In this case,
analysis reports are submitted together with the financial statements.

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Bookkeeping

A mechanical task involving the collection of basic financial data. The

bookkeeping procedures usually end when the basic data have been entered
in the books of account and the accuracy of each entry has been tested. At
that stage the accounting function takes over. Accounting tends to be used
as a generic term covering almost anything to do with the collection and use
of basic financial data. It should, however, be more properly applied to the
use to which the data are put once they have been extracted from the books
of account. Bookkeeping is a routine operating, while accounting requires the
ability to examine a problem using financial and non – financial data.

Source: Arganda, A.M. Accounting Principles 1 Textbook/Workbook;

National Bookstore, 2007

FORMS OF BUSINESS ORGANIZATIONS

There are three major legal forms of business entity: the single
proprietorship, the partnership, and the corporation. While the accounting
process for all three types of business entity is generally the same, differences
in their structures and in the laws that apply to these structures require some
differences in the way certain aspect of their financial affairs are recorded.
These specific differences in accounting procedures are presented in detail in
advanced accounting subjects. However, for now you should understand the
basic differences in the three types of business entities.

Single Proprietorship. The business organization has a single owner called

the proprietor who generally is also the manager. Single proprietorship tend
to be small service – type (e.g. physicians, lawyers and accountants)
businesses and retail establishments. The owner may operate alone or may
employ others.

The owner receives all profits, absorbs all losses and is solely responsible for
all debts of business. From the accounting viewpoint, the single
proprietorship is distinct from its proprietor. Thus, the accounting records of
the single proprietorship do not include the proprietor’s personal financial
records.

Partnership. A partnership is a business owned and operated by two or more

persons who bind themselves to contribute money, property or industry to a
common fund, with the intention of dividing the profits among themselves. A
partnership is a form of business in which two or more people operate for the

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common goal of making profit. They may receive different shares of the profits,
depending on their investment or contribution. Accounting considers the
partnership as a separate organization, distinct from the personal affairs of
each partner.

Corporation. A corporation is a business owned by its stockholders. It is an

artificial being created by operation of law, having the rights of succession
and the powers, attributes and properties expressly authorized by law or
incident to its existence. The stockholders are not personally liable for the
corporation’s debts. The corporation is a separate legal entity.

Source: Arganda, A.M. Accounting Principles 1 Textbook/Workbook;

National Bookstore, 2007

Types of Business Activities

The forms of business organization above are classified according to the

ownership structure of the business entity. Entities, however, can also be
group by the type of business activities they perform. Any of these types of
activities may be performed by a business organization be it a sole or single
proprietorship, a partnership or a corporation.

1. Service. Service businesses offer intangible goods or services and

typically generate a profit by charging for their labor. Income is
produced by the rendering of personal service. Service businesses can
include home repair, education, dentistry, accounting, and plumbing
businesses.

2. Merchandising/ Trading or Retailing. Retailers and distributors act

as middlemen in making goods produced by manufacturers available to
the intended consumer, generating a profit as a result of providing sales
or distribution services. Or these companies purchase goods that are
ready for sale and then sell these to customers. Most consumer-
oriented stores, including chain stores, department stores, as well
as mail-order businesses are distributors or merchandising concern.

3. Manufacturing. Manufacturers produce products, from raw materials

or component parts, which they then sell at a profit. Companies that
make physical goods, such as cars, computers, or clothing, are
considered manufacturers or businesses engaged in manufacturing.
Source: Arganda, A.M. Accounting Principles 1
Textbook/Workbook;
National Bookstore, 2007

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The Account

The basic summary device of accounting is the account. A separate

account is maintained for each element that appears in the balance sheet
(assets, liabilities and equity) and in the income statement (income and
expenses). Thus, an account may be defined as a detailed record of the
increase, decrease and balance of each element that appears in an entity’s
financial statements. The simplest form of the account is known as the “T”
account because of its similarity to the letter “T”. The account has three parts
as shown below:

Account Title

Left side or Right side or

Debit side Credit side

THE ACCOUNTING EQUATION

Financial statements tell us how a business is performing. They are
final products of the accounting process. But how do we arrive at the items
and amounts that make up the financial statements? The most basic tool of
accounting is the accounting equation. This equation presents the resources
controlled by the enterprise, the present obligations of the enterprise and the
residual interest in the assets. It states that assets must always equal to
liabilities and owner’s equity. The basic accounting model is:
Assets = Liabilities + Owner’s Equity
Note that the assets are on the left side of the equation opposite the
liabilities and owner’s equity. This explains why increases and decreases in
assets are recorded in the opposite manner (“mirror image”) as liabilities and
owner’s equity are recorded. The equation also explains why liabilities and
owner’s equity follow the same rules of debit and credit.
The logic of debiting and crediting is related to the accounting equation.
Transactions may require additions to both sides (left and right sides),
subtractions from both sides (left and right sides), or an addition and
subtraction on the same side (left and right side), but in all cases the equality
must be maintained.

DEBITS AND CREDIT – THE DOUBLE – ENTRY SYSTEM

Accounting is based on a double – entry system which means that the dual
effects of a business transaction are recorded. A debit side entry must have

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a corresponding credit side entry. For every transaction, there must be one
or more accounts debited and one or more accounts credited. Each
transaction affects at least two accounts. The total debits for a transaction
must always equal the total credits.

An account is debited when an amount is entered on the left side of the

account and credited when an amount is entered on the right side. The
abbreviations for debit and credit are Dr. and Cr., respectively.

The account type determines how increases or decreases in it are recorded.

Increases in assets are recorded as debits (on the left side of the account)
while decreases in assets are recorded as credit (on the right side).
Conversely, increases in liabilities and owner’s equity are recorded by credits
and decreases are entered as debits.

The rules of debit and credit for income and expense accounts are based on
the relationship of these accounts to owner’s equity. Income increases
owner’s equity and expense decreases owner’s equity. Hence, increases in
income are recorded as credits and decreases as debits. Increases in expenses
are recorded as debits and decreases as credits. These are the rules of debit
and credit.

The following summarizes the rules:

Balance Sheet Accounts

Assets Liabilities and Owner’s equity

Debit Credit Debit Credit

(+) (-) (-) (+)
Increases Decreases Decreases Increases

Income Statement Accounts

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 Debit for Credit for
Decreases in owner’s equity Increases in owner’s equity
Expenses Income

Debit Credit Debit Credit

(+) (-) (-) (+)
Increases Decreases Decreases Increases

ACCOUNTING EVENTS AND TRANSACTIONS

An accounting event is an economic occurrence that causes
changes in an enterprise’s assets, liabilities, and or equity. Events may be
internal actions, such as the use of equipment for the production of goods
and services. It can also be an external event, such as the purchase of raw
materials from a supplier.

A transaction is a particular kind of event that involves the transfer

of something of value between two entities. Examples of transactions include
acquiring assets from owner (s), borrowing funds from creditors, and
purchasing or selling goods and services.

TYPES AND EFFECTS OF TRANSACTIONS

It will be beneficial in the long – term to be able to understand a
classification approach that emphasizes the effects of accounting events
rather than the recording procedures involved. This approach is quite
pioneering.
Although business entities engage in numerous transactions, all
transactions can be classified into one of four types, namely:
1. Source of Assets (SA). An asset account increases and a
corresponding claims (liabilities or owner’s equity) account increases.
Examples: (1) Purchase of supplies on account; (2) Sold goods on cash
on delivery basis.
2. Exchange of Assets (EA). One asset account increases and another
asset account decreases. Example; Acquired equipment for cash.
3. Use of Assets (UA). An asset account decreases and a corresponding
claims (liabilities or equity) account decrease. Example: (1) settled
accounts payable; (2) paid salaries of employees.
4. Exchange of Claims (EC). One claims (liabilities or owner’s equity)
account increases and another claims (liabilities or owner’s equity)
account decreases. Example: Received utilities bill but did not pay.

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 Every accountable event has a dual but self – balancing effect on
the accounting equation. Recognizing these events will not in any manner
affect the equality of the basic accounting model.
The four types of transaction above may be further expanded into nine types
of effects as follows:
1. Increase in Assets = increase in liabilities (SA)
2. Increase in Assets = increase in owner’s equity (SA)
3. Increase in one Asset = decrease in another Asset (EA)
4. Decrease in Assets = decrease in liabilities (UA)
5. Decrease in Assets = decrease in owner’s equity (UA)
6. Increase in liabilities = decrease in owner’s equity (EC)
7. Increase in owner’s equity = decrease in liabilities (EC)
8. Increase in one liability = decrease in another liability (EC)
9. Increase in one Owner’s Equity = decrease in another Owner’s Equity
(EC)

TYPICAL ACCOUNT TITLE USED

BALANCE SHEET

ASSETS
Assets are should be classified only into two: current assets and non – current
assets. Per Philippine Accounting Standards (PAS) No. 1, assets are classified
as current assets when it:
a. Is expected to be realized in, or is held for sale or consumption in, the
normal course of the enterprise’s operating cycle; or
b. Is held primarily for trading purpose or for the short – term and
expected to be realized within twelve months of the balance sheet date;
or
c. Is cash or a cash equivalent asset which is not restricted in its use

All other assets should be classified as non – current assets. Operating cycle
is the time between the acquisition of materials entering into a process and
its realization in cash or an instrument that is readily convertible to cash.

Current Assets
Cash. Cash is any medium of exchange that a bank will accept for deposit at
face value. It includes coins, currency, checks, money orders, bank deposits
and drafts.

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Cash Equivalents. Per PAS No. 7, these are short – term, highly liquid
investments that are readily convertible to known amount of cash and which
are subject to an insignificant risk of changes in value.
Notes Receivable. A note receivable is a written pledge that the customer
will pay the business a fixed amount on a certain date.
Accounts Receivable. These are claims against customers arising from sale
of services or goods on credit. This type of receivable offers less security than
a promissory note.
Inventories. Per PAS No. 2, these are assets which are (a) held for sale in the
ordinary course of business; (b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in the production
process or in the rendering of services
Prepaid Expenses. These are expenses paid for by the business in advance.
It is an asset because the business avoids having to pay cash in the future for
a specific expense. These include insurance and rent. These prepaid items
represent future economic benefits – assets – until the time these start to
contribute to the earning process; these then, become expenses.

Non – Current Assets

Property, Plant and Equipment. Per PAS No. 16, these are tangible assets
that are held by an enterprise for use in the production or supply of goods or
services, or for rental to others, or for administrative purposes and which are
expected to be used during more than one period. Included are such items
as land, building, machinery and equipment, furniture and fixtures, motor
vehicles and equipment.
Accumulated Depreciation. It is a contra account that contains the sum of
the periodic depreciation charges. The balance in this account is deducted
from the cost of the related asset – equipment or building – to obtain book
value.
Intangible Assets. Per PAS No. 38, these are identifiable, non-monetary
assets without physical substance held for use in the production or supply of
goods or services, for rental to others, or for administrative purposes. These
include goodwill, patents, copyrights, licenses, franchises, trademarks, brand
names, secret processes, subscription lists and non- competition agreements.

LIABILITIES
Per PAS No. 1, a liability should be classified as a current liability when it:
a. Is expected to be settled in the normal course of the enterprise’s
operating cycle; or

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 b. Is due to be settled within twelve months of the balance sheet date.

All other liabilities should be classified as non – current liabilities

Current Liabilities
Accounts Payable. This amount represents the reverse relationship of the
accounts receivable. By accepting the goods or services, the buyer agrees to
pay for them in the near future.
Notes Payable. A note payable is like a note receivable but in a reverse sense.
In the case of a note payable, the business entity is the maker of note; that is,
the business entity is the party who promises to pay the other party a specified
amount of money on a specified future date.
Accrued liabilities. Amounts owed to others for unpaid expenses. This
account includes salaries payable, utilities payable, interest payable and
taxes payable.
Unearned Revenues. When the business entity receives payment before
providing its customers with goods or services, the amounts received are
recorded in the unearned revenue account (liability method). When the goods
or services are provided to the customer, the unearned revenue is reduced
and income is recognized.
Current Portion of Long – term Debt. These are portions of mortgage notes,
bonds and other long – term indebtedness which are to be paid within one
year from the balance sheet date.

Non – Current Liabilities

Mortgage Payable. This account records long – term debt of the business
entity for which the business entity has pledged certain assets as security to
the creditor. In the event that the debt payments are not made, the creditor
can foreclose or cause the mortgaged asset to be sold to enable the entity to
settle the claims.

Bonds Payable. Business organizations often obtain substantial sums of

money from lenders to finance the acquisition of equipment and other needed
assets. They obtain these funds by issuing bonds. The bonds is a contract
between the issuer and the lender specifying the terms of repayment and the
interest to be charged.

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OWNER’S EQUITY

Capital. This account is used to record the original and additional

investments of the owner of the business entity. It is increased by the amount
of profit earned during the year or is decreased by a loss. Cash or other assets
that the owner may withdraw from the business ultimately reduce it. This
account title bears the name of the owner.
Withdrawals. When the owner of a business entity withdraws cash or other
assets, such as are recorded in the drawing account rather than directly
reducing the owner’s equity account.
Income Summary. It is temporary account used at the end of the accounting
period to close income and expenses. This account shows the profit or loss
for the period before closing to the capital account.

INCOME STATEMENT
INCOME
Service Income. Revenues earned by performing services for a customer or
client; for example, accounting services by a CPA firm, laundry services by a
laundry shop.
Sales. Revenues earned as a result of sale of merchandise; for example, sale
of building materials by a construction supplies firm.

EXPENSES
Cost of sales. The cost incurred to purchase or to produce the product sold
to customers during the period; also called cost of goods sold.
Salaries and Wages Expense. Includes all payments as a result of an
employer – employee relationship such as salaries or wages, 13th month pay,
cost of living allowances and other related benefits.
Telecommunications, Electricity, Fuel and Water Expenses. Expenses
related to use of telecommunications facilities, consumption of electricity, fuel
and water.
Rent Expense. Expense for space, equipment or other asset rentals.
Supplies expense. Expense of using supplies (e.g. office supplies) in the
conduct of daily business.
Insurance Expense. Portion of premiums paid on insurance coverage (e.g.
on motor vehicle, health, life, fire, typhoon or flood) which has expired.

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Depreciation Expense. The portion of the cost of a tangible asset (e.g.
buildings and equipment) allocated or charged as expense during an
accounting period.
Uncollectible Accounts Expense. The amount of receivables estimated to
be doubtful of collection and charged as expense during an accounting period.
Interest Expense. An expense related to use of borrowed funds.

Preparation of the chart of accounts:

Sure Repair Shop

Chart of Accounts

Account No. Account Title

111 Cash
112 Account Receivable-R. Gil
113 Account Receivable- M. Soriano
114 Repair Tools
115 Repair Supplies
116 Furniture’s and Fixtures
117 Service Truck
211 Accounts Payable- Cruz Furniture
212 Notes Payable
311 G. Alajar, Capital
312 G. Alajar, Personal
411 Service Income
511 Advertising Expense
512 Salaries and Wages
513 Utilities Expense
514 Rent Expense

Chart of Accounts – these are the listing of the account title use by a
particular entity in the course of their business operation.

Account No. – The Number assigned for each account for easy reference. The
business entity may assign their Account No. based on the company
practices. Account titles are listed based on their normal or kinds of business
operation.

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Financial Statements

Financial statements are the means by which the information

accumulated and processed in financial accounting is periodically
communicated to the users of the financial information.

COMPLETE SET OF FINANCIAL STATEMENTS

INCOME STATEMENT
A formal statement showing the performance of the enterprise for a
given period of time. Summarizes the revenues earned and expenses incurred
for that period of time
Proforma Income Statement:

SURE REPAIR SHOP

Income Statement
For the month ended December 31,2014

Service Income xx
Less: Advertising xx
Salaries and Wages xx
Utilities Expense xx
Rent Expense xx
Repair Supplies Used xx
Depreciation-Repair Tools xx
Depreciation- Furniture and Fixtures xx
Depreciation-Service Truck xx
Interest Expense xx xx
Net Profit Pxx

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Statement of Changes in Owner’s Equity
- summarizes the changes that occurred in owner’s equity. This
statement is now a required statement (per Philippine Accounting Standards
(PAS) No. 1)

Proforma Statement of Changes in Equity

SURE REPAIR SHOP

Statement of Changes in Owner's Equity
For the month ended December 31,2014

G. Alajar, Capital xx
Add: Additional Investment xx
Net Profit xx xx
Total xx
Less: Personal (xx)
G. Alajar, Capital as of 12/31/2014 Pxx

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Balance Sheet is a statement that shows the financial position or condition
of an entity by listing the assets, liabilities and owner’s equity as at specific
dates.

Proforma Balance Sheet

SURE REPAIR SHOP
Balance Sheet
As of December 31, 2014

Asset
Current:
Cash xx
Accounts Receivable xx
Repair Supplies xx
Prepaid Advertising xx
Total Current Assets xx

Non-Current:
Repair Tools xx
Less: Accumulated Depreciation xx xx
Furniture’s and Fixtures xx
Less: Accumulated Depreciation xx xx
Service Truck xx
Less: Accumulated Depreciation xx xx
Total Non-Current Assets xx
Total Assets xx

Liabilities
Notes Payable xx
Accrued Interest Payable xx
Accrued Salaries and Wages xx
Accrued Rent Expense xx
Unearned Service Income xx
Total Liabilities xx

Owner's Equity
G. Alajar, Capital xx
Less: G. Alajar, Personal xx
Net Capital xx
Add: Net Profit xx xx
Total Liabilities and Owner's Equity xx

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Statement of Cash Flows
Provides information about the cash receipts and cash payments of
an entity during a period. This statement shows the net increase or decrease
in cash during the period and the cash balance during the period.

Proforma Statement of Cash Flows

SURE REPAIR SHOP

Statement of Cash Flows
For the month ended December 31,2014

Cash Inflows
Cash from Cash Sales xx
Collections of Receivables xx
Cash from Bank Loans xx
Total Cash Inflows xx

Cash Outflows
Payment of Liabilities xx
Purchases xx
Payment of Expenses xx
Total Cash Outflows (xx)
Net Cash Inflows/Cash Outflows xx
Add: Cash Balance Beginning xx
Cash Balance as of 12/31/2015 Pxx

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Debit and Credit

The T-Account

Business transactions cause increases and decreases in the accounting values. To record these
changes; a business firm make use of accounts. An accounts is an accounting device use to summarize
the increases and decreases in the assets, liabilities, and owner’s equity of the business.

A simple form of accounts look like a big letter “T”, thus it is called a “T-account”. It has a
left side and a right side. It appears as follows:

Name of the firm

Left side right side

The left side of a T-account is the debit (abbreviated Dr.) side and the right side is a credit
(abbreviated Cr.) side.

“To debit” is to enter the amount on the left side of a T-account and “to credit” is to enter
on the right side of a T-account. The amount entered in the left side of a T-account are “debits” and
those on the right side are “credits”.

“To debit” and “to credit”, however, should not be confused with “to increase” and “to
decrease”. To debit and to credit may mean either a decrease or an increase depending on the accounts
affected. Thus, the rule of debit and credit is as follows:

Debit to: Credit to:

1. Increase asset 1. Decrease asset

2. Decrease Liabilities 2. Increase Liabilities
3. Decrease in owners’ equity due to: 3. Increase in owners’ equity due to:
a. Withdrawal of assets by the owner a. investment by the owner
b. Increase in expenses and losses b. decrease in expenses and losses
c. Decrease in income c. increase in income

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Illustrations:

Transaction 1

Nov.1 – M. Rogers opened a catering service he called “McRogers”. He invested P32,000 cash and
equipment, P85,000.

Debit Credit

Cash P32,000 M. Capital P117,000

Equipment 85,000

Analysis:

1. The assets and the equity are affected.

2. The owner put in the business cash and equipment, thus increasing the assets and
increasing the equity.

Transaction 2

Nov.3 – He purchased kitchen utensils, tools and additional equipment from Kent Trading on credit,
P20,000.

Debit Credit

Tools and equipment P20,000 Accounts Payable - P20,000

Kent Trading

Analysis:

1. The assets and liabilities are affected

2. Assets, tools, and equipment, are bought by the owner on credit basis, thus increasing
the assets and liabilities of the business.

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Transaction 3

Nov. 7 – Paid for advertisement announcing the opening of his business, P1,500.

Debit Credit

Advertising expense P1,500 Cash P1,500

Analysis:

1. The asset and equity are affected.

2. The equity is decreased due to the advertising expense incurred and the asset, cash, is
decreased for payment of the said expense.

Transaction 4

Nov. 9 – Paid one-half of the account due to Kent trading.

Debit Credit

Accounts payable P10,000 Cash P10,000

Analysis:

1. Assets and liabilities are affected.

2. There is a decrease in liability due to the partial payment of the account to Kent
Trading and also a decrease in asset, cash, for the amount paid for this liability.

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Transaction 5

Nov. 11 – Rendered a catering service to N. San Juan for his son’s wedding and received cash
P52,000.

Debit Credit

Cash P52,000 Service Income P52,000

Analysis:

1. The assets and equity are affected.

2. Cash is received from customer, thus increasing the asset of the business and the
proprietorship is increased due to the revenue derived from rendering of services.

Transaction 6

Nov. 13 – Paid for the food supplies used in San Juan’s wedding party, P25,000.

Debit Credit

Food Supplies P25,000 Cash P25,000

Analysis:

1. The asset and the equity are affected.

2. The equity is decreased due to the cost of food supplies and the asset, cash is also
decreased for payment of the supplies.

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Transaction 7

Nov. 17 – billed J. Estrada, P25,000 for catering service rendered in his birthday party.

Debit Credit

Accounts Receivable - P25,000 Service Income P25,000

Estrada

Analysis:

1. The asset and equity are affected.

2. Equity is increased due to the revenue from services rendered and asset is increased
for the claims from the customer for this service.

Transaction 8

Nov. 20 – Paid the salary of the assistant cook, P5,000.

Debit Credit

Salary P5,000 Cash P5,000

Analysis:

1. The asset and equity are affected.

2. The equity is decreased due to the salary expense incurred by the business and the
assets, cash, is decreased for payment of such expense.

Transaction 9

Nov. 22 – Received from J. Estrada the amount of P10,000 as partial payment of the account due from
him.

Debit Credit

Cash P10,000 Accounts Receivable

P10,000

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Analysis:

1. Only assets are affected. Liabilities and equity are not affected.
2. Cash is received from a customer to apply to his account, thus increasing the assets,
cash, and decreasing the receivable from the said customer.

Transaction 10

Nov. 25 – Withdrew P5,000 for his personal use.

Debit Credit

M. Rogers, Personal P5,000 Cash P5,000

Analysis:

1. The asset and equity are affected.

2. The equity is decreased due to the drawings made by the owner. The asset, cash, is
decreased for such drawing made.

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JOURNALIZING

Chart of Accounts

A chart of accounts is a list of account titles used by business. It serves as a guide to the bookkeeper.
Such accounts are divided into sections and each title has a given code number.

Illustration:

ABC Trading
Chart of Accounts

Assets Cost

111 Cash on Hand 511 Purchases

112 Cash in Bank 511a Purchase Return and Allowances
113 Notes Receivable 511b Purchase Discounts
114 Interest Receivable 412 Freight In
115 Accounts Receivable
115a Allowance for Bad Dedts Expenses
116 Merchandise Inventory
117 Supplies Unused 611 Salary Expense
118 Prepaid Insurance 611 Supply Expense
119 Furnitures and Fixtures 611 Rent Expense
119a Accumulated Depreciation- 611 Advertising Expense
Furnitures and Fixtures 611 Freight Out
120 Equipment 611 Bad Debts
120a Accumulated Depreciation- 611 Depreciation
Equipment 611 Light, Water, And Telephone
121 Land 611 Taxes and Licenses
122 Building 611 Miscellaneous Expense
122a Accumulated Depreciation-
Building Other Income

Liabilities 711 Interest Income

712 Commission Income
211 Notes Payable
212 Accounts Payable Other Expenses
213 Interest Payable 811 Interest Expense
214 Taxes Payable
215 Salaries Payable

Capital

311 Virgil, Capital

312 Virgil, Drawing

23
 313 Revenue and Expense Summary

Income

411 Sales
411a Sales Return and Allowances
411b Sales Discounts

Assets, Liability, and capita accounts are also called real accounts, balance sheet accounts, or
permanent accounts. Income and expense accounts are sometimes called nominal accounts, profit and
loss accounts, or temporary accounts.

Accounting Period and Accounting Cycle

Accounting period or fiscal period is each segment of time, usually a year, in which statements are
prepared in order to know the results of the business operation during that particular period of time.
The length of each accounting period depends on the nature of the business. An accounting period
may be annual, semi-annual, quarterly, or monthly. Usually, most firms use such period of time when
the business is slow as the end of their accounting period and the beginning of the next period.

Accounting cycle consists of successive steps starting with the recording of transactions in the books
of accounts and ending with post-closing trial balance. The following successive steps consist one
accounting cycle which will be discussed in the subsequent chapters.

1. Journalizing
2. Posting
3. Preparation of Trial Balance
4. Adjusting Entries
5. Preparation of the worksheet
6. Preparation of the financial statements
7. Closing the Entries
8. Post-Closing Trial Balance

Journalizing

Journalizing is the first step in the accounting cycle. It is the process of recording business
transactions in a journal.

A journal is a book of accounts wherein business transactions are recorded for the first time. It is also
called the book of original entry. There are two kinds of journal – the general journal and the special
journals. Cash receipts journals, cash payments journals, sales journals, purchase journals, and some
other forms of combination journals are special journals. The type of journal to be used depends on
the size and need of the business. In our lesson, we will only be using general journal.

General journal is the simplest form of journal wherein the two-column form may be used.

24
Illustration:

General Journal
Date Account Titles and Explanation F Debit Credit

A general journal contains the following columns:

Date – the date of the transaction is entered in this column; transactions are recorded ia a systematic
manner and in chronological order.

Account Titles and Explanation – this column contains the debit and credit accounts and a brief
explanation of the entries

Folio – this contains the post reference number or the ledger page in which the accounts are
transferred.

Debit – contains the amounts debited.

Credit – contains the amounts credited

Procedures in Journalizing

A. Under the date column

1. The year is written in small figures at the top of the first column.
2. The month of the transaction is written on the first line of the column. The
year and the month are not repeated except at the top of a new page or when
there is a change in the month.
3. The day of each transaction is written in the right sub-column of the date
column. The date of the transaction occurring on the same day is repeated.
B. Under the account titles and explanation
1. The name of the account debited is written first at the left margin of the
account titles and explanation column
2. The name of the account credited is written on the following line, indented
about one-half inch from the left margin.
3. The explanation is placed on the next line, indented about one inch from the
left margin. The explanation should be short but sufficient enough to explain
the entry.

25
 C. Under the debit column
1. The debit amount is written on the debit column opposite the debit account
D. Under the credit column
1. The credit amount is written on the credit column opposite the credit account.
E. Under the folio column
1. The folio or reference column is used to indicate the page number of the
ledger in which the entry is transferred. There is no entry yet in the folio
column when transactions are recorded in the general journal. However, when
the entries are copied from the journal to the ledger, the account number of the
ledger accounts in which the debits and credits are copied are entered in the
folio column.
2. A single-space should be left blank after each entry.
A journal entry is a record of business transaction in the journal. There are two types of journal entry:
Simple journal entry which contains only one debit and one credit accounts, and the compound
journal entry which contains either one debit and two or more credits; or two or more debits and one
credit; or two or more debits and two or more credits.

Illustration:

Transaction

On January 1 of the current year, Mr. P. Rodriguez opened a tailoring shop which he named “PR
Tailoring’. He invested cash, P25,000 and sewing equipment, P100,000 in the business.

Simple Journal

Date Account Titles and Explanation F Debit Credit

2015 1 Cash 25,000

Jan P. Rodriguez, Capital 25,000

To record the initial investment of P. Rodriguez

1 Sewing Equipment 100,000

P. Rodriguez, Capital 100,000

To record the initial investment of P. Rodriguez

26
Compound Journal Entry

Date Account Titles and Explanation F Debit Credit

2015 1 Cash 25,000

Jan Sewing Equipment 100,000

P. Rodriguez, Capital 125,000

To record the initial investment of P. Rodriguez

Need for Journal

1. To provide in one place a complete record of each transaction. Such will link together
the debits and credits of the transactions.
2. The records make it possible to trace the debits and credits of the accounts when
errors are committed.

Bookkeeping Techniques

When recording transactions in the journal or ledger, commas and periods are no longer written
because the ruled lines in the forms accomplished this purpose. Each column in the journal and ledger
represents a digits.

However, when reports are prepared in unruled paper, commas and periods are necessary.

Dash instead of zeros may be used in writing centavos because it is easier to write than two zeros.
This, however, is optional on the part of the bookkeeper. When preparing reports, however, two zeros
are preferred because they are neater in appearance.

27
POSTING AND TRIAL BALANCE

Posting

Posting is the process of transferring the records from the journal to the ledger. A ledger
constitutes a group of accounts. It is also called the book of final entry. The simpler form of a
ledger is the “T-account”.

Illustration:

General Ledger

Name of the item Account No.

Date Explanation F Debit Date Explanation F Credit

The illustration shown above is the most commonly used form of a ledger. The two vertical
lines in the middle divide the left side or the debit side and right side or the credit side of the
form. Each side has column for date, explanation, cross-reference number or folio, and
amounts.

Need for a ledger

1. Items of similar nature are grouped together.

2. It is easier to locate the item if an information about it is needed.
Procedure of posting

1. Locate the corresponding account title in the ledger.

2. Transfer to the ledger the following information from the journal
a. Date
b. Explanation
c. Amount
Debit accounts from the journal are posted on the debit side of the ledger and credit accounts
are posted on the credit side of the ledger.

3. Place the page number of the journal in which the information was taken to the folio
column of the ledger.

28
 4. Place in the folio column of the journal of the page number of the ledger in which the
information was posted.
Inserting the account number in the journal folio column serves two purposes:

a. It serves as a cross-reference when it is desired to trace the amount from one record to
another.
b. Writing the account number in the journal indicates that posting is completed.
Footing the accounts

Before the preparation of trial balance, the accounts should be footed first. The following
procedure is followed:

1. Foot or add the debit side of the account using pencil.

2. Foot or add the credit side of the account using pencil.
3. Take the difference between the totals of the debits and credits. If the debit total is
more than the credit total, the difference is placed on the explanation column of the
debit side. If the difference is a credit, the amount is written on the explanation
column of the credit side.
Trial Balance

A trial balance is a list of account with open balances in the general ledger. It proves the
equality of the debits and the credits in the general ledger.

There are two types of trial balance: the trial balance of balances and the trial balance of
totals. The trial balance of balances contains accounts with open balances. Accounts with
open balances either have a debit balance or credit balance. An account is said to have a debit
balance if the debit total is more than the credit total and is said to have a credit balance if the
credit total is more than the debit total. If the debit side and credit side are equal, the account
is a zero balance or closed account.

The other form of trial balance is the trial balance of totals. In this form, the total of the debits
and the total of the credits of each accounts are listed.

Procedure in trial balance preparation

1. Write the heading of the trial balance. The heading of the trial balance includes the
following:
a. The name of the business or the owner
b. Title of the list of trial balance
c. Date of the trial balance
2. Provide a column for the accounts and two money columns-----a debit and a credit.
3. The accounts should be written in just one column arranged in the following
sequence;
a. Assets
b. Liabilities
c. Capital

29
 d. Income
e. Expenses
4. Write the amounts opposite the corresponding accounts under the debit money
column if the account is a debit balance and under the credit money column if the
account is a credit balance.
5. Foot the money columns. Double rule the totals.
Errors in Trial Balance

If the total of the debit and credit sides of a trial balance are not equal, an existence of error or
more is possible. The causes of errors are the following:

1. Posting an item twice.

2. Posting to the wrong side of the account
3. Omission of posting
4. Wrong footing of the ledger
5. Wrong transferring of account from the ledger t the trial balance.
The following procedure may be followed to locate errors:

1. Re-add the debits and credits of the trial balance.

2. Get the difference between the two totals.
a. If the difference is a digit of one, i.e., P10, P100, P1,000, etc. the error may be
in the addition or subtraction. Check the footings of the debit and credit in that
case. If the error is not located, the posting in the ledger should be verified.
b. If the difference is an even number, divide the number by 2. The quotient
arrived at may be omitted in the trial balance or an account may be
erroneously transferred on the wrong side of the trial balance. For this type of
trial balance, scan the posting in the general ledger. If the amount is found,
verify if the posting is correct or not.
c. If the difference is multiple by 9, the error may be due to transposition, that is,
the order of the figure is reversed. Such as 57 is written 75, or 119 as 191.
d. If the difference is divisible by 9, this indicates misplacements. For example
P100 is written as P10 or P2,500 as P250.
Correction of Errors

Erasures in the records are not advisable because they destroy the neatness of work. Instead
the following ways may be applied to correct errors committed:

1. Using correcting journal entries; or

Drawing a single straight line through the wrong item or amount and writing immediately
above the cancelled item or amount the correct one.

30
Adjusting Entries, Adjusted Trial Balance, Preparation of Worksheet

Introduction

Accounting period is any length of time which the life of the business is divided. Such time
may either be a monthly period, quarterly period, or a year.

At the end of each accounting period, financial reports are prepared to show the results of the
business operations. Such reports which always include the income statement and balance sheet
should reflect the revenues realized and expenses incurred, and a fairly measure of the assets,
liabilities, and owner’s equity.

Normally, at the end of each accounting period, there are several accounts that need to be
adjusted.

Need for adjustment

1. To reflect the proper amounts revenues realized and expenses incurred during a
period.
2. To show a fair a fairly measure of the assets, liabilities, and owner’s equity.
Accounts that need to be adjusted

1. Adjustment for the expiration of prepayments of expenses.

2. Adjustment for the realization of income collected in advance.
3. Adjustment for the accrual of expenses.
4. Adjustment for the accrual of income.
5. Provision for bad debts.
6. Provision for depreciation.
Adjustment for the Expiration of Prepayments of Expenses

Prepaid expenses are expenses paid in advance. At the time of payment, the account is an
asset and as it is used it becomes an expense. The adjusting entry for this account depends on the
original entries made when it was paid.

There are two methods to be used:

1. Asset Method. Under this method, the original entry made is charged to an asset.
Example:

On November 1 of the current year, C Santos paid ₱30,000 for a three-month rental of the
office space.

Original Entry Adjusting Entry

Nov. 1 Prepaid Rent ₱30,000 Dec. 31 Rent Expense ₱20,000

Cash Prepaid Rent ₱20,000

₱30,000

31
 Prapid Rent Rent Expense
Nov.1 ₱30,000 Dec. 31 ₱20,000 Dec. 31 ₱20,000

Analysis

The ₱30,000 which was paid in November 1 is for a three-month rental of the space i.e., for
November, December, and January. As of December 31, the end of the accounting period, only
₱20,000 or rental for two months have been incurred, so that portion is an expense and the remaining
₱10,000 is still prepaid until January 31 of the following accounting period.

2. Expense Method. Under this method, expense account is charged when payment is
made. Using the same example, the following are the entries made:

Original Entry Adjusting Entry

Nov. 1 Rent Expense ₱30,000 Dec. 31 Prepaid Rent ₱10,000

Cash Rent Expense ₱10,000

₱30,000

Rent Expense Prepaid Rent

Nov.1 ₱30,000 Dec. 31 ₱10,000 Dec. 31 ₱10,000

Analysis:

The rental payment of ₱30,000 is paid for the months of November, December, and January.
As of December 31, only ₱20,000 or for two months rental have been incurred. The remaining
₱10,000 is still prepaid until January 31 of the next accounting period.

Adjustment for the realization of Income Collected in Advance or Unearned Income

Unearned income arises when payment is received before goods are delivered or before
services are rendered.

There are two methods to be used: The income method and the liability method.

Again, the method to be used depends on the original entries made.

1. Income Method. Under this method, income account is credited when cash is
received.

32
Example:

On November 1 of the current year, the business received ₱30,000 cash from the tenant of the
vacant space of the store.

Original Entry Adjusting Entry

Nov. 1 Cash ₱30,000 Dec. 31 Rent Income ₱10,000

Rent Income Unearned Rent

₱30,000 ₱10,000

Rent Income Unearned Rent

Dec.31 ₱10,000 Nov. 1 ₱30,000 Dec. 31 ₱10,000

Analysis:

The business received from a tenant a ₱30,000 cash advance rentals for the months of
November, December, and January. As of December 31, only two months rental or ₱20,000 are
already earned. The remaining ₱10,000 is still unearned until January 31 of the following accounting
period.

2. Liability Method. Under this method, a liability account is credited upon receipt of
cash.
Original Entry Adjusting Entry

Nov. 1 Cash ₱30,000 Dec. 31 Unearned Rent ₱20,000

Unearned Rent Rent Income ₱20,000

₱30,000

Unearned Rent Rent Income

Dec.31 ₱20,000 Nov. 1 ₱30,000 Dec. 31 ₱20,000

Analysis:

As of December 31, the two-month rentals or ₱20,000 are already earned. Only ₱10,000 or
the rental for the month of January is still unearned.

33
Accrual of Expenses

Accrued expenses are those expenses already incurred during the period but are not yet paid
or recorded.

At the end of the accounting period, the income statement should reflect such expense and the
balance sheet should reflect a liability account. The adjusting entry to record accrual of expenses is
debit the expense account and credit the liability account.

Example:

Office employees are prepaid every two weeks. On December 31, five days’ salaries of an
office employee for ₱300 per day have accrued.

Adjusting Entry:

Date Account Titles and Explanation F Debit Credit

Dec.31 Salaries ₱1,500

Accrued Salaries ₱1,500

To record five-day accrued salaries of an employee

for

₱20/day.

Accrual of Income

Accrued income arises when goods have been delivered or services have been rendered but
no amount of payment have been collected or if there is payment, such collection is not yet recorded.

In order to avoid understatement of income and asset, an adjusting entry is needed at the end
of the period.

The entry to adjust accrual of income is to debit the assets account and credit the income
account.

Example:

A tenant who occupies the right side of the shop space, is two months in debts as of the
balance sheet date. His monthly rental is ₱2,500 per month.

Adjusting Entry:

Date Account Titles and Explanation F Debit Credit

Dec.31 Accrued Rent Income ₱5,000

Rent Income ₱5,000

34
Provision for Bad Debts

Usually most business firms extend credits to attract more customers and sell more goods.
However, not all credits extended are good or collectible. For a reason or another, a certain percentage
of these collectibles are not collected. For this reason, the business should provide for such losses for
non-collection of credits. This loss from uncollectible accounts is called bad debts. Bad debts is a
nominal account which must be shown in the income statement at the end of the accounting period.

The entry to adjust bad debts is as follows:

Date Account Titles and Explanation F Debit Credit

Dec.31 Bad Debts ₱xxx

Allowance for bad debts ₱xxx

Bad debts or loss for bad debts is debited to show a decrease in proprietorship account due to
estimated loss.

Estimated Uncollectible Accounts or Allowance for bad debts which is a valuation account is
credited because it is a deduction from an asset account, Account Receivable. In the balance sheet
presentation, Estimated Uncollectible Account is deducted from Accounts Receivable to show the net
book value or the net realizable value of the accounts receivable.

Illustration:

Accounts Receivable ₱xxx

Less: Allowance for bad debts ₱xxx

Net Realizable Value ₱xxx

There are several methods of estimating the probable losses from bad debts.

1. Increasing the accumulated allowance for bad debts by a certain percentage of the
accounts receivable.
2. Increasing the accumulated allowance for bad debts to a certain percentage of
accounts receivable.
Illustration:

Debit Credit

Accounts Receivable ₱7,000

Allowance for Bad Debts ₱500

35
1. Increasing the allowance for bad debts by a certain percentage of the accounts receivable.
What is the adjusting entry to increase the allowance for bad debts by 10% of accounts
receivable?

Computation:

Bad debts estimate = ₱7,000 x.10 = ₱700

Adjusting Entry:

Debit Credit

Bad Debts ₱700

Allowance for Bad Debts ₱700

To record increase of allowance for bad

debts by 10% of accounts receivable

Balance Sheet presentation:

Accounts Receivable ₱7,000

Less: Allowance for bad debts ₱1,200

Net Realizable Value ₱5,800

2. Increasing the allowance for bad debts to a certain percentage of accounts receivable.
Using the same information in the pre-adjusted trial balance, what is the adjusting entry to
increase the allowance for bad debts to 10% of the accounts receivable?

Computation:
Bad debt estimate = ₱7,000 x .10 = ₱700
₱700 – 500 = ₱200

Adjusting Entry:

Debit Credit

Bad Debts ₱200

Allowance for Bad Debts ₱200

To record increase of allowance for bad

debts by 10% of accounts receivable

36
Balance Sheet presentation:

Accounts Receivable ₱7,000

Less: Allowance for bad debts ₱700

Net Realizable Value ₱6,300

Provision for Depreciation

Assets which are relatively permanent in nature are fixed assets. They are used by the business in
its operation and are not intended for sale. The value of these assets, except land decrease as times
passes by due to the following reasons:

1. Wear and tear from operation

2. Inadequacy and obsolescence

An asset is said to be inadequate for the business if there is business expansion and the asset can
no longer fulfill the needs of the business.

It is said to be obsolete in the introduction of new models or inventions and the business desires to
replace the old asset with the new one.

The cost of the fixed asset is allocated to the number of its useful life. Depreciation is the portion
of the cost of the asset which is already used or consumed.

The following formula is used to compute for depreciation:

C – SV
D=
n

Where: D = is the depreciation

C = is the original cost which includes the invoice price less discount plus other costs incurred

before the use of the asset such as freight and installation.

S = is the salvage or scrap value. This is the amount wherein the asset can be sold after its

useful life.

n = is the number of estimated useful life

Example:

A delivery truck was purchased for ₱250,000. It is estimated to last 10 years after which it
shall have a value of ₱50,000. Compute for the depreciation.

37
 C – SV
D=
n

= ₱250,000 - ₱50,000

10 years

= ₱20,000/year

Adjusting Entry:

Debit Credit

Depreciation, delivery truck ₱20,000

Accumulated Depreciation, delivery truck ₱20,000

Depreciation is an expense account. Accumulated depreciation is a contra asset account. A

contra asset account is an account the balance of which is deducted from a related asset to show the
proper amount of such asset. The asset account is not credited to preserve the historical cost of the asset.
Instead, a contra asset account is credited because depreciation is merely an estimate and to preserve
the original cost of the asset.

Depreciation for a Fractional Period

If the purchase date of the asset does not coincide with the beginning of the accounting period,
such asset should be depreciated on a fraction of a period. Suppose the accounting starts at January 1
and ends on December 31. On May 1 of the current year, some pieces of furniture were purchased for
₱4,800. The asset is estimated to have 10 years of useful life. To compute for the depreciation on
December 31 is:

C – SV
D=
n
= ₱4,800 – 0

10 years

= ₱480/year

The annual depreciation of the furniture is ₱480. To compute for the depreciation from May 1
to December 31, divide ₱480 by 12months to get the monthly depreciation. Then multiply the monthly
depreciation by 8 months, i.e., from May to December.

₱480 / 12 mos = ₱40/mo.

₱40 x 8 mos = ₱320

38
Adjusting Entry on the year of purchase:

Date Account Titles and Explanation F Debit Credit

Dec.31 Depreciation, Furniture ₱320

Accumulated Depreciation, Furniture ₱320

In the following years the depreciation of the asset will be on a one whole year that is ₱480/year.

Posting the Adjusting Entries

After the adjusting entries have been recorded in the general journal, they should be posted to
the ledger to adjust the accounts. After accounts have been posted, an adjusted trial balance should be
prepared to prove the accuracy of the posting to the ledger.

The Worksheet

A worksheet is prepared to facilitate the preparation of adjusting entries, financial statements,

and closing entries. It is prepared before the construction of financial statements and before the adjusting
entries are entered in the journal and posted.

The following steps are taken in preparing a worksheet:

1. Write the heading of the worksheet at the top of the paper with the following
information
Name of the business

Worksheet

For the Period of __________,20__

2. Provide the following column in the worksheet:

Adjusted Income Balance

Trial Balance Adjustments
Trial Balance Statement Sheet
Account Debi Credi Debi Credi Debi Credi Debi
Title t t t t t t Debit Credit t Credit

39
 3. Copy the trial balance on the first two money columns.
4. Enter in the adjustments columns the adjusting entries. Before each corresponding
debit and credit amounts, write in parenthesis the same index number or letter. Those
accounts which are not found in the trial balance should be written below the pre-
adjusted trial balance.
5. Total the adjustment columns.
6. The adjusted trail balance columns is the total of the pre-adjusted trial balance and the
adjustment columns. If the amount are both debit, add. Then extend the amount to the
debit column. Same procedure will be followed if the amounts are both credits, only it
will be extended to the credit column. If the amount is on debit and one credit,
subtract the smaller amount from the bigger amount, then extend on the column of the
bigger amount.
7. Add the adjusted trial balance columns to prove the equality of the debits and credits.
8. The adjusted trial balances are extended to the balance sheet at income statement
columns. Assets, liabilities, and capital to the balance sheet columns and income and
expense to the income statement columns. Add these last four columns. Get the
difference of the debit and credit sides of the income statement and the difference of
the debit and credit sides of the balance sheet. The difference of both should be equal,
otherwise, an error or errors are committed.
If the credit total of the income statement is more than the debit total, the difference is a net income. If
the debit side is more than credit side, the difference is a net loss. Write the difference below the
smaller sides.

9. Write in the column for account titles “Net Income” if the difference is a net income
or “Net Loss” if the difference is net loss.
10. Write the final total and double rule.

40
 SURE REPAIR SHOP

Trial Balance

December 31, 2014

Accounts Debit Credit

Cash 900
Accounts Receivable-M. Soraino 1,200
Repair Supplies 1,500
Repair Tools 1,200
Furniture and Fixtures 6,500
Service Truck 20,000
Notes Payable 3,250
G. Alajar, Capital 25,200
G. Alajar, Personal 750
Service Income 5,900
Advertising 250
Salaries and Wages 900
Utility Expense 150
Rent Expense 1,000
Total 34,350 34,350

On December 31, the end of the accounting period, the following data were taken.

1. An actual count of repair supplies showed a balance of ₱850. ________

2. Repair tools are depreciated at 10% per annum. ________
3. Furniture and fixture are estimated to have a useful life of 5 years while service truck
has a useful life of 10 year. Both assets were bought on September of the current year.
________
4. A 10% interest has accrued on the payable. _________
5. Of the income received. ₱900 is applicable to the next accounting period.
6. Accrual of expenses: Salaries and wages ₱250; Rent ₱500 __________
7. The balance of the advertising expense account represents payment for five months.
Paid on September 1 of the current year. ________________.

41
Financial Statements are report prepared by businesses. Business owners keep records of
expenses and income and the overall status of their businesses. They do this for a number of
reasons, to name a few:

1. To help them manage a business

2. To inform other owners of current operations
3. To provide required information to lenders from whom they wish to borrow
money
4. For tax purposes
Two most commonly prepared financial statements are:

1. The Income Statement

2. The Balance Sheet
1. The Income Statement
The Income Statement provides a financial summary of the firm’s operating results
during a specific period. Most common are statements covering one-year period of
operations, ordinarily December 31.

Usually, an income statement has the following items:

a. Sales Revenue – the total peso amount of sales during the period
b. Sales Return and Allowances – goods returned by the buyers are called sales
return while reduction in selling price are sales allowances
c. Cost of goods sold – the amount paid by the business for the items sold to
customers
d. Gross profits – profits earned from producing and selling the goods
e. Operating expenses – amount paid by the firm in selling its goods
f. Net income – income after taxes

Note: Be sure to check the results of your income statement by adding the cost of goods sold,
expenses, net income, and income taxes. They should be equal to net sales

42
2. The Balance Sheet
The Balance Sheet describes the financial condition of a firm at one point in time. It shows
the worth of a business at a particular time by listing its assets, liabilities, and owner’s
equity.

Assets:

Current Assets:----cash or items that can be converted into cash within a short period of time

Cash – in checking and savings accounts

Accounts Receivable – funds owed by customers of the firm

Notes Receivable – value of all notes owed to the firm

Inventory – cost of merchandise that the firm has for sale

Fixed Assets------assets that are expected to be used for more than a year

Land – book value of any land owned by the firm

Buildings – book value of any building

Equipment – book value of any equipment

Furniture & Fixture – book value of any fixture, furniture owned

Liabilities:

Current Liabilities----items that must be paid by the firm within a short period of time,
usually one year

Accounts Payable – amount that must be paid to other firms

Notes Payable – value of all notes owed by the firm

Long-term Liabilities----- items that will be paid after a year

Loans Payable – total due on all loans, mortgages

Long-term notes payable – total of all other debts of the firm

Owner’s Equity---- The difference between the total of all assets and of all liabilities. Also
referred to as capital, net worth or in case of corporation, stockholder’s equity

The relationship between assets, liabilities and owner’s equity expressed by the following:

Asset = Liabilities + Owner’s Equity

43
CLOSING ENTRIES AND POST-CLOSING TRIAL BALANCE
Introduction

After the income statement has been prepared, the nominal accounts have served its purpose, that
is, they have been used to measure and show the nature and causes of changes in the financial
condition of the business. They have provided the source of income and nature of expenses and
losses. These expense accounts are not accumulated. They are computed for each accounting
period. Therefore these accounts should be closed.

To close the nominal accounts:

1. Debit the income account and credit the Revenue and Expense Summary account.
2. Credit the expense accounts and debit the Revenue and Expense Summary account.
3. Get the difference of the Revenue and Expense Summary account. The difference
should be closed to the capital account. If there is a drawing account, the difference of
the Revenue and Expense Summary should be closed to this account. The drawing
account then is closed to the capital account.

Illustration

1. Service Income ₱5,900

Revenue and Expense Summary ₱5,900
To close the income account to the
Revenue and expense summary

2. Revenue and Expense Summary ₱5,195

Advertising ₱200
Salaries and Wages 1,150
Utility Expense 150
Rent Expense 1,500
Repair Supplies Used 650
Depreciation – repair tools 120
Depreciation – furniture and fixtures 433.33
Depreciation – Service Truck 666.67
Interest Expense 325
To close the expense accounts to the
revenue and expense summary accounts

3. Revenue and Expense Summary ₱706

G. Alajar, Personal 706
To close the Revenue and Expense
Summary account to the drawing account
4. G. Alajar, Capital ₱44
G. Alajar, Personal ₱44
To close the drawing account
to the capital account

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Ruling the Closed Nominal Accounts

After the closing entries have been posted to the ledger, the debit and credit sides of
nominal accounts are already in balance. They are therefore, double ruled.

Illustration:

Service Income Advertising Salaries and Wages

CJE (1)
5,900 BAL. 5,900 BAL. 250 AJE (7) 50 BAL. 900 CJE (2) 1,150
CJE (2) 200 AJE (6a) 250

250 250 1,150 1,150

Utilities Expense Rent Expense Repair Supplies Used

CJE (2)
BAL. 150 150 BAL. 1,000 CJE (2) 1,500 AJE (1) 650 CJE (2) 650
AJE (6a) 500

1,500 1,500

Depreciation- Repair tools Depreciation- Furniture and Fixtures Depreciation- Service Truck
AJE (3b) CJE (2)
AJE (2) 120 CJE (2) 120 AJE (3a) 433.33 CJE (2) 433.33 666.67 666.67

Interest Expense Revenue and Expense Summary G. Alajar, Personal

AJE (4) CJE (2)
325 325 CJE (2) 5,194 CJE (1) 5,900 BAL. 750 CJE (3) 706
CJE (3) 706 CJE (4) 44

5,900 5,900 750 750

G. Alajar, Capital
CJE (4) 44 BAL. beg. 25,000
BAL. ending 25,156

25,200 25,200

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Post-closing Trial Balance

To test that the general ledger accounts are in balance before the transactions of the next
accounting period are posted, a post-closing trial balance should be prepared.

Summary of Accounting Cycle

The life of the business is divided into accounting periods. In each accounting period, there is
one recurring accounting cycle which consists of the following successive steps:

1. Journalizing – the process of recording business transactions in a journal.

2. Posting – copying the information recorded in the journal to the ledger.
3. Preparing a trial balance – summarizing the ledger accounts and testing the
correctness of the debits and credits
4. Adjusting the entries – adjusting the accounts that need to be adjusted at the end of
the period to bring the accounts up to date.
5. Preparing worksheets – sorting out the accounts as to nominal and real accounts and
grouping them in their respective columns and then taking the results of the business
operations.
6. Preparing the financial statements – preparing the income statement and balance
sheet from the information in the worksheet.
7. Closing the nominal accounts – preparing and posting the entries to revenue and
expense summary account and closing this account to capital account.
8. Preparing the post-closing trial balance – checking the accuracy of the adjusting and
closing entries made.

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