1 Handout Accounting 1 Partnership Formation Operation Dissolution Liquidation

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1 Handout Accounting 1 - Partnership formation, operation,

dissolution, liquidation
Accountancy (University of the Cordilleras)
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Note to Student:
DISCLAIMER: This handout does not contain all information regarding the topics in Financial
Accounting and Reporting.
This handout contains concepts and some practice problems hence you still need to solve
problems in different study materials.
Study well!
-JDCT

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HO1: OVERVIEW OF ACCOUNTING
DEFINITION OF ACCOUNTING
- ASC Accounting Standards Council (Service); its function is to provide quantitative information,
primarily financial in nature, about economic entities that is intended to be useful in making economic
decisions.
- AICPA American Institute of Certified Public Accountants (Art); 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.
- AAA American Accounting Association (Process); process of identifying, measuring and
communicating.
BUSINESS ORGANIZATIONS
By law all businesses must keep accounting records. Decisions are based on accounting information for profit
and non-profit companies alike.
There are different forms of business organizations:

 Sole Proprietorship—owned by one person, called the Sole-Proprietor
 Partnership—co-owned by two or more persons, in Philippine Law, there is no maximum number of
partners.
 Corporation—owned by investors called stockholders (The business—not the owners—are
responsible for the company’s obligations.). Owned by 5 to 15 persons called shareholders
There are different types of business organizations:

 Service business— renders services e.g. doctors, lawyers, barber shop, etc.
 Merchandising business—purchases goods for resale or buys and sells merchandise to the public
 Manufacturing business—produces a product to sell or buys raw materials and converts them into
finished goods to be sold to the public
BOOKKEEPING v. ACCOUNTING
Bookkeeping focuses on the recording of transactions and in the preparation of financial reports while in
Accounting, it records the transactions, prepare and analyze financial reports, and users make decisions.
BRANCHES OF ACCOUNTING
1. Financial accounting/ Financial Reporting – focuses on general purpose financial statements. It
is primarily concerned with the recording of business transactions and the eventual preparation of
financial statements
2. Management accounting – focuses on special financial reports geared towards the needs of an
entity’s management. It is the preparation of financial reports and management research intended
for management use and interpretation of these reports and researches. Examples of financial
reports are Sales reports, Cost of Production reports, Budgets etc. Example of management
research is evaluation of a business process and management consulting.
3. Cost accounting – the systematic recording and analysis of the costs of materials, labor, and
overhead incident to production. It is primarily concerned with proper accumulation of costs such as
materials, labor and overhead, proper costing of inventories and study of different costing methods.
4. Auditing – a systematic process of objectively obtaining and evaluating evidence regarding
assertions about economic actions and events to ascertain the degree of correspondence between
these assertions and established criteria and communicating the results to interested users. It
basically deals with the examination of the financial statements by an independent party (auditor) to
ascertain whether such financial statements are in conformity with Philippine Accounting Standards.
5. Tax accounting – the preparation of tax returns and rendering of tax advice, such as determination
of tax consequences of certain proposed business endeavors. It deals with the study of provisions
of the law with regard to Philippine taxation system and proper computation of taxes such as income
tax, value-added tax, withholding tax and other taxes.

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6. Government accounting – the accounting for the national government and its instrumentalities,
focusing attention on the custody of public funds and the purpose or purposes to which such funds
are committed.
SECTORS IN THE PRACTICE OF ACCOUNTANCY

1. Practice of Public Accountancy - involves the rendering of audit or accounting related services to
more than one client on a fee basis.
2. Practice in Commerce and Industry - refers to employment in the private sector in a position which
involves decision making requiring professional knowledge in the science of accounting and such
position requires that the holder thereof must be a certified public accountant.
3. Practice in Education/Academe – employment in an educational institution which involves teaching
of accounting, auditing, management advisory services, finance, business law, taxation, and other
technically related subjects.
4. Practice in the Government – employment or appointment to a position in an accounting
professional group in government or in a government–owned and/or controlled corporation, including
those performing proprietary functions, where decision making requires professional knowledge in
the science of accounting, or where a civil service eligibility as a certified public accountant is a
prerequisite.
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)

 The GAAP of the Philippines are represented by the Philippine Financial Reporting Standards
(PFRSs).
 GAAP refers to rules, procedures, practice and standards followed in the preparation and
presentation of financial statements,
 Philippine Financial Reporting Standards (PFRSs)
o These are Standards and Interpretations adopted by the Financial Reporting Standards
Council (FRSC). They comprise of:
 Philippine Financial Reporting Standards (PFRSs);
 Philippine Accounting Standards (PASs); and
 Interpretations
o PFRSs, PASs, and PICs have equal authority.
o PFRSs sets out the recognition, measurement, presentation and disclosure requirements
dealing with accountable events.
o PFRSs apply to all general purpose financial statement and these statements are directed
towards the common information needs of a wide range of users
 FRSC is the council that establishes and improves accounting standards that will be generally
accepted in the Philippines.
o FRSC (Financial Reporting Standards Council)
 Established by the Board of Accountancy through R.A. 9298 to promulgate
accounting standards in the Philippines
 Composed of a chair and 14 members (BOA, COA, SEC, BIR, BSP, FINEX, 8
PICPA)
 FUNCTION: Establishment and Approval of PFRSs and Philippine Interpretations
(GAAP)
Accounting as “Language of Business”

The primary objectives of the business are:
1. To generate profits
2. To properly manage limited and scarce resources
With these objectives, a business must prepare financial reports and interpret these reports as an aid in
decision-making. In making decisions, accounting is used as a tool for communication.
PURPOSE OF ACCOUNTING
The basic purpose of accounting is to provide information about economic activities intended to be useful in
making economic decisions.
TYPES OF INFORMATION PROVIDED BY ACCOUNTING

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 Quantitative information – expressed in numbers, quantities or units

 Qualitative information – expressed in words or descriptive form
 Financial information – expressed in terms of money
TYPES OF INFORMATION CLASSIFIED AS TO USERS’ NEEDS

 General purpose accounting information - designed to meet the common needs of most statement
users. This information governed by the Philippine Financial Reporting Standards (PFRSs).
 Special purpose accounting information - designed to meet the specific needs of particular statement
users. This information is provided by other types of accounting, e.g., managerial accounting, tax
basis accounting, etc.
USERS OF ACCOUNTING INFORMATION

According to the Conceptual Framework:
 Primary Users – Potential and Existing Investors or Owners, and Potential and Existing Lenders or
Creditors
 Other Users – Any other user not a primary user.
As to whether the user is External or Internal:

 Internal Users – Management and Employees
 External Users – Investors, Creditors / Lenders, Suppliers / Vendors, Government, and Public
BASIC ACCOUNTING CONCEPTS

1. Entity Concept
 Separate Entity Concept / Accounting Entity Concept
 Under this concept, the business enterprise is viewed as separate from the owners, managers,
and employees of the business.
2. Time period
 This concept requires that the indefinite life of an enterprise is subdivided into time periods
which are usually of equal length or the life of the business is divided into series of reporting
periods.
o Accounting time periods (a month, a quarter, a year)
 Monthly and Quarterly – Interim Periods
 Year – Annual Periods
 Calendar Year – starts January ends December
 Fiscal Year – 12-month period not starting on January
3. Monetary Unit
 This concept assumes that financial transactions be measured in terms of money or currency
of the Philippines; and changes in purchasing power are ignored.
o Stability of Peso - and changes in purchasing power are ignored
o Quantifiability of Peso - financial transactions be measured in terms of money or
currency of the Philippines
4. Historical Cost
 Cost Principle
 This concept requires that assets should be recorded initially at original acquisition cost
5. Adequate Disclosure
 Full Disclosure Principle
 This concept requires that all significant and relevant information leading to the preparation of
financial statements should be clearly reported
 That financial statements provide sufficient detail to disclose matters that make a difference to
users, yet sufficient condensation to make the information understandable, keeping in mind the
costs of preparing and using it.
6. Materiality

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 This concept relates to the significance of an item to the overall presentation of the financial
statements. Information is material if its omission could influence the economic decision of the
users of the financial statements.
7. Accrual Basis
 The effects of transactions are recognized when they occur (and not as cash or its equivalent
is received or paid) and they are recognized in the accounting periods to which they relate.
8. Consistency
 This concept requires that the accounting methods and practices should be applied on a uniform
basis from one time period to another.
 That financial statements are prepared on the basis of accounting principles which are followed
consistently from one period to the next.
9. Comparability
 There are 2 kinds of comparability: Comparability within an enterprise and Comparability
between enterprises
o Comparability within an enterprise is the quality of information that allows comparisons
within a single enterprise from one time period to the next.
o Comparability between enterprises is the quality of information that allows comparisons
between two or more enterprises engaged in the same industry.
10. Going Concern

 This concept assumes that business will operate indefinitely and there is no intention of
liquidating or closing down the business.
11. Conservatism
 Under this concept, when alternatives exist, the alternative which has the least effect on net
income or owner’s equity should be chosen.
 Conservatism is synonymous with Prudence. Prudence is the desire to exercise care and caution
when dealing with the uncertainties in the measurement process such as assets or income are
not overstated and liabilities or expenses are not understated.
12. Objectivity
 This concept requires that financial transactions that were recorded be supported by business
documents.
13. Matching Principle

 Associating cause and effect
 That costs are recognized as expenses when the related revenue is recognized.
14. Cost Benefit

 That cost is the pervasive constraint in financial reporting and the cost of processing and
communicating information should not exceed the benefits to be derived from it.
THE ACCOUNTING PROCESS (according to the definition of AAA)

- Identifying as the analytical component
o Recognition of Accountable events
 Criteria for Accountable Events / Recognition Criteria: Probable, Measurable, Meets
the definition
 There are 3 types of transactions:
 Business transaction – transactions which are recorded in the financial
books. Example is investment of the owner.
 Personal transaction – transactions which are not recorded in the financial
books. Example is purchase of house and lot of a business owner using his
personal money.

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 Neither business nor personal transaction – Business events that are not
recorded in the financial books. Examples are hiring of employees, death
of the owner, entering into a contract etc.
 NOTE: We only account for transactions that pertain to the business and meets the
definition of the elements.
 Events can be classified as:
 External events – events which involve an entity and an external party.
o Exchange (reciprocal transfer) – reciprocal giving and receiving
o Non-reciprocal transfer – “one way” transaction
o External event other than transfer – an event that involves changes
in the economic resources or obligations of an entity caused by an
external party or external source but does not involve transfers of
resources or obligations.
 Internal events – events which do not involve an external party.
o Production – the process by which resources are transformed into
finished goods.
o Casualty – an unanticipated loss from disasters or other similar
events.
- Measuring as the technical component

o Assigning of peso amounts or numbers to the economic transactions and events
- Communicating as the formal component
o Process of preparing and distributing accounting reports to potential users of accounting
information
END

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HO 2: THE ACCOUNTING CYCLE
ACCOUNTING CYCLE
- A series of well-defined steps leading to the communication of the effects of a business transaction.
- The accounting cycle represents the steps or accounting procedures normally used by entities to record
transactions and prepare financial statements.
STEPS IN ACCOUNTING CYCLE
1. Identifying and Analyzing

 Selecting accountable events and analyzing its impact on the financial statements
2. Journalizing
 Process of recording transactions to the journals.
o Journals are book of original entry.
 Two Kinds of Journals: General Journal and Special journal.
 General Journal –used to record transactions other than those which
are recorded in the special journals.
 Special Journal – used to record transactions of a similar nature.
3. Posting
 Process of transferring data from the journal to the appropriate accounts in the ledger
o Account is used as a storage unit of information in a double entry system.
 Real Account – those reported in the balance sheet, which is the summary of
the assets, liabilities, and owners’ equities of a business. The label real refers
to the continuous, permanent nature of this type of account. Real accounts are
active from the first day of business to the last day.
 Nominal Account – those reported in the income statement, which is the
summary of the revenue and expenses of a business for a period of time.
Balances in nominal accounts are cumulative over a period of time.
o Ledgers are books of final entry. Ledgers are systematic compilation of a group of
accounts.
 Two Kinds of Ledgers: General Ledger and Subsidiary Ledger.
 General ledger – contains all accounts appearing in the financial
statements.
 Subsidiary ledger – supporting ledger for controlling accounts in the
general ledger.
4. Preparing the unadjusted trial balance

 A list of accounts and their balances, prepared for the purpose of proving the mathematical
accuracy of the monetary totals of debits and credits in the ledger.
 Proves mathematical accuracy of accounts posted in the ledger
 Reveals: Transplacement, Transpositions
o Transposition – figures are interchanged
o Transplacement – error in placing the decimal point
 Does not reveal: Wrong Classification, Omissions, Double posting
5. Preparing adjusting entries

 Adjusting entries ensure that the revenue recognition and expense recognition principles are
followed.
 To split mixed accounts into their real and nominal elements (Prepaid Expenses, Unearned or
precollected income, Bad Debts, Inventory, Depreciation)
6. Preparing Adjusted trial balance

 Facilitates gathering of data for adjustment, the preparation of FS and closing entries.

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 After a company has journalized and posted all adjusting entries, it prepares another trial balance
from the ledger accounts. This trial balance is called an adjusted trial balance. It shows the
balances of all accounts, including those adjusted, at the end of the accounting period.
7. Preparing the FS
 Financial statements are the means by which the information accumulated and processed in
financial accounting is periodically communicated to the users.
 A complete set of financial statements comprises the following:
o Statement of financial position
o Statement of profit or loss and other comprehensive income
o Statement of changes in equity
o Statement of cash flows
o Notes
o Additional statement of financial position required in certain cases (PAS 1)
8. Closing the Books

 Is the process of preparing closing entries and ruling and balancing accounts.
 Closing Entries are entries to bring to zero all nominal accounts in the ledger.
9. Preparing the post-closing trial balance

 Contents: Real Accounts only
 After a company has journalized and posted all closing entries, it prepares another trial balance
from the ledger accounts. This trial balance is called post-closing trial balance. It shows the
balances of all real accounts at the end of the accounting period.
10. Preparing Reversing entries

 Entries made on the first day of the next accounting period to reverse certain adjusting entries.
 Accruals, Prepayments recorded using the expense method, unearned income recorded using
the income method
END

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HO 3: ANALYZING BUSINESS TRANSACTIONS
ELEMENTS OF FINANCIAL STATEMENTS

1. Assets
 Resource controlled by the enterprise as a result of past events and from which future economic
benefits are expected to flow to the enterprise.
 Physical form is not essential to the existence of the asset. Right of ownership is not essential. It is
the capacity to control the economic benefits expected.
 In basic accounting, Assets are items with money value that are owned by a business. Some
examples are: cash, accounts receivable (selling goods or services on credit), equipment (office,
store, delivery, etc.), and supplies (office, store, delivery, etc.).
2. Liabilities
 Present obligation arising from past events, the settlement of which is expected to result in an outflow
of economic benefits.
 In basic accounting, Liabilities are debts owed by the business.
3. Equity
 Residual interest of owners is the assets of the enterprise.
 Also called as Capital
 Classification of Transactions:
o Capital Transactions – represents direct contributions or withdrawals
o Income-related Transactions – represent income statement transactions
4. Income
 Increases in economic benefits
 Profit – measure of performance
 Revenue – arises from ordinary course of business
 Gains – represent other items that meet the definition of income and may, or may not, arise in the
course of the ordinary activities of the enterprise.
5. Expense
 Decreases in economic benefits
THE RULE OF DEBIT AND CREDIT

 Debit means left side. (Dr.)
 Credit means right side. (Cr.)
Debit Credit
 The figure above is called a “T” ACCOUNT, it is so named because it looks like a capital T. Use
this form of an account to help you determine whether the amount is placed on the left (debit) or
right (credit) side of the account.
 It is important that you think of debits and credits as only meaning left and right!
 Debits and Credits can either be increases or decreases depending on the type of account.
THE DOUBLE ENTRY SYSTEM

 Under the Double-entry system, each transaction is recorded in two parts – debit and credit. The
double-entry system makes use of the following concepts:
o Duality – this concept views each transaction as having a two-fold effect on values – a
value received and a value parted with, and each transaction is recorded using at least
two accounts.

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o Equilibrium –this concept requires each transaction to be recorded in terms of equal

debits and credits.
 Double-entry accounting means that there will be at least two (2) accounts affected by each
transaction.
THE ACCOUNTING EQUATION

Assets = Liabilities + Equity
This equation must always balance!
The equation states that business assets are financed by two parties. They are the creditors or lenders
(liabilities) and the owner (capital).
If we try to simplify the accounting equation:

Assets = Equity
The assets comprise of the equity of the Owners (Owner’s Equity) and the equity of the Creditors (Liabilities)
If we try to expand the accounting equation:

Assets = Liabilities + Investment – Withdrawal + Revenue – Expense
Notice that we just expanded the equity portion.
Hence to compute for equity:
Equity = Investment/Capital – Withdrawal + Revenue – Expense
NORMAL BALANCES OF ELEMENTS

Using the expanded accounting equation, we may infer the normal balances of the elements. The expanded
accounting equation is:
Assets = Liabilities + Investment – Withdrawal + Revenue – Expense
If we try to make all the elements in the equation normal (meaning positive), we must place Withdrawal and
Expense to the other side thus we can get this equation:
Assets + Withdrawals + Expense = Liabilities + Investment + Revenue
Notice that Assets, Withdrawals, Expense are on the left side and Liabilities, Investment, Revenue are on
the right side. As mentioned earlier, Debit means left side, and Credit means right side. Therefore, the normal
balance of Assets, Withdrawals, Expense is DEBIT and of Liabilities, Investment, Revenue is CREDIT.
Debit Credit
Asset Liabilities
Withdrawals Investment
Expense Revenue
You may ask what is the importance of knowing the normal balances, the purpose of knowing the normal
balance is that: whenever you INCREASE the Element you use the Normal Balance, but when you
DECREASE the Element you use the opposite side of the Normal Balance.
SUMMARY ON THE RULE OF DEBIT AND CREDIT
ASSET W/DRAWALS EXPENSE LIABILITIES INVESTMENT REVENUE

Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
+ - + - + - - + - + - +
BUSINESS TRANSACTIONS AND THE ACCOUNTING EQUATION

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 We are only accounting for accountable business transaction. We say that the transaction is
accountable when it has an effect to the firm’s assets, liabilities, or owner’s equity and that the
transaction pertains to the business.
 The effect of recording a business transaction must always leave the two sides of the accounting
equation in balance.
 Each transaction increases or decreases (or both) the basic elements in the accounting equation.
The following are the basic financial transactions and the effects on the accounting equation:
A W E = L I R
TRANSACTION: Asset Withdrawal Expense Liabilities Investment Revenue
Investment of the owner + +
Withdrawal of the owner - +
Purchase of an asset thru + & -
cash
Purchase of an asset by + +
incurring a liability
Incurring a liability to receive + +
an asset
Paying the liability whether - -
partial or full
Incurring an expense and it is - +
paid immediately
Incurring an expense but it + +
was not yet paid
Prepaid an expense to be + & -
incurred over a period of time
Used or incurred the prepaid - +
expense
Earned a revenue and + +
payment is received at the
time the revenue is earned
Earned a revenue but + +
payment is not yet received
Precollected a revenue which + +
is to be rendered over a
period of time
Rendered the precollected - +
revenue
END

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HO 4: THE RECORDING PROCESS
Practically every business uses three basic steps in the recording process:
1. Analyze each transaction for its effects on the accounts.
2. Enter the transaction information in a journal.
3. Transfer the journal information to the appropriate accounts in the ledger.
JOURNALIZING
Companies initially record transactions in chronological order (the order in which they occur). Thus, the
journal is referred to as the book of original entry. For each transaction the journal shows the debit and credit
effects on specific accounts.
Entering transaction data in the journal is known as journalizing. Companies make separate journal entries
for each transaction. A complete entry consists of (1) the date of the transaction, (2) the accounts and
amounts to be debited and credited, and (3) a brief explanation of the transaction.
DATE ACCOUNT TITLES REF DEBIT CREDIT

(1) (2) (3) (4) (4)
(1) The date of the transaction is entered in the Date column.

(2) The Journal entry is entered in the Account Titles column followed by a brief explanation of the
transaction. The debit account title (that is, the account to be debited) is entered first at the extreme
left margin. The credit account title (that is, the account to be credited) is indented and entered on
the next line. A space or (#) is left between journal entries. The blank space or (#) separates individual
journal entries and makes the entire journal easier to read.
(3) The column titled Ref. (which stands for Reference) is left blank when the journal entry is made. This
column is used later when the journal entries are transferred to the ledger accounts.
(4) The Amounts of the Debit and Credit Account Titles.
NOTE: In making Journal Entries, it is important to use correct and specific account titles. The main criterion
is that each title must appropriately describe the content of the account.
SIMPLE AND COMPOUND ENTRIES

 Simple Entries – involves two accounts, one debit and credit.
 Compound Entries – involves three or more accounts.
CHART OF ACCOUNTS
 This chart lists the accounts and the account numbers that identify their location in the ledger.
The numbering system that identifies the accounts usually starts with the balance sheet accounts
and follows with the income statement accounts.
ACCOUNT TITLES
NOTE: If a chart of accounts is given, use the chart of accounts. If no chart of account is given you may refer
in these account titles:
ASSETS:
 CASH – This includes bills and coins, bank check, bank accounts.
 ACCOUNTS RECEIVABLE – Amount collectible from clients or customers for services rendered
or sale of goods. Normally, if the service rendered or the sale is on account we use this account
title.
 ALLOWANCE FOR DOUBTFUL ACCOUNTS – Is a Contra-asset account that represents
provision for estimated doubtful accounts.
 NOTES RECEIVABLE – Amount collectible from clients or customers for services rendered or
sale of goods but is evidenced by a promissory note.

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 ADVANCES TO EMPLOYEES – Cash advance given to employees.

 PREPAID EXPENSES – These refer to expenses that are paid in advance. E.G. Prepaid Rent,
Prepaid Insurance, Prepaid Advertising etc.
 SUPPLIES / OFFICE SUPPLIES – When the company purchases supplies for business use.
 LAND – When the company acquires or purchases land for business use.
 EQUIPMENT – Can also be Office Equipment, Store Equipment, or Transportation Equipment.
When the company acquires or purchase an equipment.
 BUILDING – When the company acquire, purchase, or contract, building for business use.
 ACCUMULATED DEPRECIATION – Is a Contra-asset account that represents cumulative
depreciation for depreciable fixed assets.
LIABILITIES:
 ACCOUNTS PAYABLE – Amount payable to supplier, creditor or vendor for money, supplies,
goods or property loaned.
 NOTES PAYABLE – Same with Accounts Payable but is evidenced by a promissory note.
 INTEREST PAYABLE – Incurred interest but not yet paid. Unpaid interest.
 TAXES AND LICENSES PAYABLE – Unpaid taxes and licenses to be remitted / paid to the
government.
 UTILITIES PAYABLE – Unpaid communication, light and water bills.
 SALARIES AND WAGES PAYABLE – Unpaid Salaries and Wages of Employees.
 UNEARNED INCOME – This refers to cash received in advance but not yet earned. E.G.
Unearned Rent, Unearned Advertising etc.
 MORTGAGE PAYABLE – This refers to bank loan with assets such as house and lot or vehicle
as collaterals. Loan with collateral.
 BONDS PAYABLE – This refers to loan that is evidenced by a bond certificate or indenture.
EQUITY:
 OWNERS, CAPITAL – This refer to claim or interest of the owner.
 OWNERS, DRAWING – This refer to temporary withdrawal of the owner of cash, supplies, goods
or property.
REVENUE:
 SERVICE REVENUE / SERVICE INCOME – Income derived from rendering of services. Primary
income for service business.
 SALES – Income derived from selling goods.
 GAIN ON SALE – Excess of selling price over the net book value of an asset.
 For other income, use an account representing the nature of the income. EG for Rent, use Rent
Income/Rent Revenue.
EXPENSE:
 For expense, use an account representing the nature of the expense. EG for Rent, use Rent
Expense.
POSTING
 Posting is the process of transferring data from the journal to the appropriate accounts in the
ledger.
o Ledgers are books of final entry. Ledgers are systematic compilation of a group of
accounts.
 Posting involves the following steps.
o In the ledger, in the appropriate columns of the account(s) debited, enter the date,
journal page, and debit amount shown in the journal.
o In the reference column of the journal, write the account number to which the debit
amount was posted.
o In the ledger, in the appropriate columns of the account(s) credited, enter the date,
journal page, and credit amount shown in the journal.
o In the reference column of the journal, write the account number to which the credit
amount was posted.
FORM OF A LEDGER

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 The simple T-account form used in accounting textbooks is often very useful for illustration
purposes. However, in practice, the account forms used in ledgers are much more structured.
The format used in practice is called the three-column form of account.
ACCOUNT TITLE Account No.

DATE EXPLANATION REF DEBIT CREDIT BALANCE
It has three money columns—debit, credit, and balance. The balance in the account is determined after each
transaction. Companies use the explanation space and reference columns to provide special information
about the transaction.
TRIAL BALANCE
 This refers to the summary of balances in the ledger accounts. The accounts are arranged in the
order of assets, liabilities, equity, income and expenses.
 A balanced trial balance means that journal entries are properly posted and ledger accounts are
properly balanced.
END

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HO 5: ADJUSTING THE ACCOUNTS

TIMING ISSUES
 Time Period Assumption - the economic life of a business into several time periods.
o Accounting time periods (a month, a quarter, a year)
 Monthly and Quarterly – Interim Periods
 Year – Annual Periods
 Calendar Year – starts January ends December
 Fiscal Year – 12-month period not starting on January
o Accrual v. Cash Basis Accounting
 Accrual Basis - companies record transactions that change a company’s financial
statements in the periods in which the events occur. Regardless when received or
paid.
 Cash Basis - companies record transactions that change a company’s financial
statements in the periods in which there is an effect to cash. When cash is received
or paid.
NOTE: Cash-basis accounting is not in accordance with generally accepted
accounting principles (GAAP).
o Recognition Principle for Revenue and Expenses
 Revenue Recognition
 Pervasive principle: The earning process is complete or virtually complete
and exchange has taken place
 Broad principle: Revenue from exchanges is recorded when products are
sold, services provided
 Revenue should be recognized in the accounting period in which it is earned
(generally when service is performed and product is sold).
 Expense Recognition
 Associating cost and effect – matching - costs are recognized as expenses
when the related revenue is recognized. (Efforts be matched with results)
 Systematic and rational allocation
 Immediate Recognition – when expenditure has no future economic
benefits
ADJUSTING ENTRIES
Adjusting entries ensure that the revenue recognition and expense recognition principles are followed. It splits
the mixed accounts. Rule of Adjusting Entry: Every adjusting entry will include one income statement account
and one balance sheet account.
Deferrals (To defer means to postpone or delay. Deferrals are costs or revenues that are recognized at a
date later than the point when cash was originally exchanged.)
 Prepayments
o Prepaid expenses are costs that expire either with the passage of time (e.g., rent,
advertising, insurance) or through use (e.g., supplies, buildings, equipment).
o Two Methods (For supplies, rent, advertising, insurance)
 Asset Method
 Initially recorded as asset. The amount of adjustment is the amount expired
because we need to recognize the expense. Hence, the amount expired is
the expense.
 Expense Method
 Initially recorded as expense. The amount of adjustment is the amount
unexpired because we need to recognize the asset portion. Hence, the
amount unexpired is the asset.
o For Depreciation
 Depreciation is the process of allocating the cost of an asset to expense over its
useful life. Depreciation is an allocation concept, not a valuation concept. That is,

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depreciation allocates an asset’s cost to the periods in which it is used. Depreciation

does not attempt to report the actual change in the value of the asset.
 Statement Presentation
 Accumulated Depreciation is called a contra asset account. Such an
account is offset against an asset account on the balance sheet.
 Depreciation Expense. Expense account.
 Book value is the difference between the cost of any depreciable asset and its
related accumulated depreciation.
 Formula for Depreciation: Amount – Residual Value / Useful Life
Type of Prepayment Method Used Accounts Before Adjusting Entry

Adjustment
Rent, advertising, Asset Method Asset overstated. Dr. Expense
insurance, supplies, Expense understated. Cr. Asset / Contra
depreciable assets Asset
Rent, advertising, Expense Method Asset understated Dr. Asset
insurance, supplies Expense overstated. Cr. Expense
 Deferred Revenues
o When a company receives payment for services to be provided in a future accounting period.
(Opposite of Prepayments)
 Two Methods
 Liability Method
o Initially recorded as liability. The amount of adjustment is the
amount earned because we need to recognize the income. Hence,
the amount earned is the income.
 Income Method
o Initially recorded as income. The amount of adjustment is the
amount unearned because we need to recognize the liability.
Hence, the amount unearned is the liability.
Method Used Accounts before Adjustment Adjusting Entry

Liability Method Liability overstated. Dr. Liability
Income understated. Cr. Income
Income Method Income overstated. Dr. Income
Liability understated. Cr. Liability
Accruals
These are income earned and expenses incurred but not yet paid/received or recorded.
 Accrued Expenses
o Expenses incurred but not yet paid or recorded at the statement date are called accrued
expenses. Interest, taxes, and salaries are common examples of accrued expenses.
o Dr. Expense Cr. Liability
 Accrued Revenues
o Revenues earned but not yet received or recorded at the statement date are called accrued
revenues. Interest is one common example.
o Dr. Receivable/Asset Cr. Income
ADJUSTMENT FOR DOUBTFUL ACCOUNTS

 3 methods:
o Percentage of Accounts Receivable – the amount computed using this method is the Ending
Allowance for Doubtful Accounts
o Percentage of Sales – the amount computed using this method is the Doubtful Accounts
Expense
o Aging of AR – the amount computed using this method is the Ending Allowance for Doubtful
Accounts

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 T-Account for Allowance for Doubtful Accounts

Allowance for Doubtful Accounts
Debit Credit
Beginning Balance Beginning Balance

Write-Off Doubtful Accounts Exp
Recovery
Ending Balance
ADJUSTED TRIAL BALANCE

After a company has journalized and posted all adjusting entries, it prepares another trial balance from the
ledger accounts. This trial balance is called an adjusted trial balance. It shows the balances of all accounts,
including those adjusted, at the end of the accounting period.
FINANCIAL STATEMENTS
Financial Statements Companies can prepare financial statements directly from the adjusted trial balance.
END

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HO6: COMPLETING THE ACCOUNTING CYCLE
WORKSHEET
 A worksheet is a multiple-column form used in the adjustment process and in preparing financial
statements. As its name suggests, the worksheet is a working tool. It is not a permanent
accounting record; it is neither a journal nor a part of the general ledger. The worksheet is merely
a device used in preparing adjusting entries and the financial statements.
 STEPS in Preparing a Worksheet

o Prepare a trial balance on the worksheet – enter all ledger accounts with balances in
the account titles space. Enter debit and credit amounts from the ledger in the trial
balance columns.
o Enter adjustment data
 Add additional accounts as needed to complete the adjustments.
 Enter adjustment amounts in appropriate columns, and use letters to
crossreference the debit and credit adjustments.
 A different letter identifies the debit and credit for each adjusting entry.
The term used to describe this process is keying.
o Enter adjusted balances – combine trial balance amounts with adjustment amounts to
obtain the adjusted trial balance.
o Extend all revenue and expense account balances to the income statement columns.
The difference between the totals of the two income statement columns determines net
income or net loss.
o Extend all asset and liability account balances, as well as owner’s capital and drawings
account balances, to the balance sheet columns. Net income or net loss is also extended
to the balance sheet columns.
CLOSING THE BOOKS
TEMPORARY ACCOUNTS PERMANENT ACCOUNTS

These accounts are closed. These accounts are not closed.
All revenue accounts All asset accounts

All expense accounts All liability accounts
Owner’s Drawings Account Owner’s Capital Account
Closing entries
 At the end of the accounting period, the company transfers temporary account balances to the
permanent owner’s equity account, Owner’s Capital, by means of closing entries.
 Closing entries formally recognize in the ledger the transfer of net income (or net loss) and
owner’s drawings to owner’s capital. The owner’s equity statement shows the results of these
entries. Closing entries also produce a zero balance in each temporary account.
 Four closing entries:
o Close Revenues to Income Summary. Debit each revenue account for its balance, and
credit Income Summary for total revenues.
o Close Expenses to Income Summary. Debit Income Summary for total expenses, and
credit each expense account for its balance.
o Close Income Summary to Owner’s Capital. Debit Income Summary and credit Owner’s
Capital for the amount of net income.
o Close Owner’s Drawings to Owner’s Capital. Debit Owner’s Capital for the balance in
the Owner’s Drawings account, and credit Owner’s Drawings for the same amount.

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POST CLOSING TRIAL BALANCE

 The post-closing trial balance lists permanent accounts and their balances after journalizing and
posting of closing entries.
 The purpose of the post-closing trial balance is to prove the equality of the permanent account
balances carried forward into the next accounting period. Since all temporary accounts will have
zero balances, the post-closing trial balance will contain only permanent—balance sheet—
accounts.
REVERSING ENTRIES
 Use of reversing entries is an optional bookkeeping procedure; it is not a required step in the
accounting cycle.
 Companies make a reversing entry at the beginning of the next accounting period. Each
reversing entry is the exact opposite of the adjusting entry made in the previous period.
 The purpose of reversing entries is to simplify the recording of a subsequent transaction related
to an adjusting entry.
 Adjusting entries to be reversed:
o Accruals
o Prepayments recorded using the expense method
o Unearned income recorded using the income method
END

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HO 7: ACCOUNTING FOR MERCHANDISING OPERATIONS

Introduction / Definitions
 A Merchandising Business is engaged in the buy and sell of goods. Therefore, in accounting for a
merchandising business, an entity can be a buyer or a seller.
 Merchandise (or merchandise inventory)—goods held for sale to customers in the normal course of
business.
 A merchandiser’s primary source of revenue is sales revenue or sales.
 Expenses for a merchandising company are divided into two categories:

o Cost of goods sold (COGS)—total cost of merchandise sold during the period and
o Operating expenses (OP)—expenses incurred in the process of earning sales revenue that
are deducted from gross profit in the income statement). Examples are sales salaries and
insurance expense.
 Gross profit (GP) is equal to Sales Revenue less Cost of Goods Sold.
 Income measurement process for a merchandising business:

Sales - COGS = Gross Profit - Operating Exp. = Net Income (Loss)
Inventory systems
In accounting for Merchandising Operations, there are two methods in recording inventory transactions –
Perpetual method and Periodic method.
1. Perpetual System—Detailed records of the cost of each item are maintained, and the cost of each
item sold is determined from records when the sale occurs. This system involves:
a. Record purchase of Inventory.
b. Record revenue and record cost of goods sold when the item is sold.
c. At the end of the period, no entry is needed except to adjust inventory for losses, etc.
2. Periodic System—Cost of goods sold is determined only at the end of an accounting period. This
system involves:
a. Record purchase of Inventory.
b. Record revenue only when the item is sold.
c. At the end of the period, you must compute cost of goods sold (COGS):
i. Determine the cost of goods on hand at the beginning of the accounting period
(Beginning Inventory = BI),
ii. Add it to the cost of goods purchased (COGP),
iii. Subtract the cost of goods on hand at the end of the accounting period (Ending
Inventory = EI) illustrated as follows:
BI + COGP = Cost of goods available for sale - EI = COGS
The differences of the two methods or systems are outlined below:
Perpetual Periodic
As to the account debited
on the recording of Merchandise Inventory Purchases
Purchase of Inventory
As to the recording of the Need to recognize the cost of sale every time Do not need to
corresponding cost of sale there is a sale. recognize the cost of
at the point of sale Dr. Cost of Sales sale every time there is
Cr. Merchandise Inv. a sale.

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As to the recording of Need to set-up the

Need not to set-up the ending inventory because
Ending Inventory at the ending inventory.
inventory account is properly updated. Unless, the
end of the period
amount recorded in the books for the ending
Dr. Merchandise
inventory is not the same to the should be ending
Inventory
inventory.
Cr. Cost of Sales
As to the closing of Need to close the
accounts relating to the accounts relating to
purchase of inventory purchase in the cost of
sales.
No need to close the accounts relating to the
purchase to cost of sales because every time Dr. Cost of Goods Sold
there is a sale cost of sales is properly updated. Dr. Purch Discount
Dr. Purch Return
Dr. Purch Allow.
Cr. Purchases
Cr. Freight In
As to the account debited
on the freight cost on the Merchandise Inventory Freight In
purchase of inventory
As to the account credited
on the recording of Merchandise Inventory Purchase Discount
purchase discount
As to the account credited
on the recording of
Merchandise Inventory Purchase Return
purchase return or
allowance
As to the return of Merchandise Inventory is Credited and Cost of
No Entry
merchandise sold Goods Sold is Debited
3. Other Considerations
a. Perpetual systems have traditionally been used by companies that sell merchandise with
high unit values such as automobiles, furniture, and major home appliances. But with the
use of computers and scanners, many companies now use the perpetual inventory system.
b. The perpetual inventory system is named because the accounting records continuously—
perpetually—shows the quantity and cost of the inventory that should be on hand at any
time. The periodic system only periodically updates the cost of inventory on hand.
c. A perpetual inventory system provides better control over inventories than a periodic
inventory since the records always show the quantity that should be on hand and then any
shortages from the actual quantity and what the records show can be investigated
immediately.
Accounting for Purchase Transactions (Buying of Inventory)
1. Basic Purchase
PERPETUAL PERIODIC
When merchandise is purchased for resale to When merchandise is purchased for resale to
customers, the account, Merchandise Inventory, is customers, the account, Purchases, is debited for
debited for the cost of goods purchased. Purchases the cost of goods purchased. Purchases may be
may be made for cash or on account (credit). The made for cash or on account (credit). The
purchase is normally recorded by the purchaser purchase is normally recorded by the purchaser
when the goods are received from the seller. when the goods are received from the seller.
Journal Entry: Journal Entry:
Dr. Merchandise Inventory Dr. Purchases
Cr. Cash / Accounts Payable Cr. Cash / Accounts Payable

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2. Purchase Returns and Allowances
A purchase return or a purchase allowance is a deduction from the purchase price when
unsatisfactory goods are kept. A purchaser may be dissatisfied with merchandise received because
the goods (1) are damaged or defective, (2) are of inferior quality, or (3) are not in accord with the
purchaser’s specifications.
The purchaser initiates the request for a reduction of the balance due through the issuance of a debit
memorandum. The debit memorandum is a document issued by a buyer to inform a seller that the
seller’s account has been debited because of unsatisfactory merchandise.
PERPETUAL PERIODIC
To show that the merchandise is reduced and the corresponding decrease to the accounts payable or the
receipt of the return of cash (assuming the merchandise is purchased thru cash).
Dr. Cash / Accounts Payable Dr. Cash / Accounts Payable
Cr. Merchandise Inventory Cr. Purchase Returns and Allowances
3. Purchase Discounts
Discounts may either be trade discounts or cash discounts.
TRADE Discount CASH Discount

Due to bulk buying / bulk purchase. Due to prompt payment.
Not presented nor recorded in the books. Recorded and presented in the books.
Not conditioned, as long as purchase is made. Discounts is conditioned to prompt payment.
Credit terms specifies the amount of cash discount and time period during which a discount is offered
which may permit the buyer to claim a cash discount for the prompt payment of a balance due.
If the credit terms show 10, 2/10, n/30.

The 10 means 10% trade discount.
The 2 in 2/10 represents the 2% cash discount if the buyer pays within 10 days and the 10
in 2/10 represents the discount period.
The 30 in n/30 is the due date of the credit which means that the credit is due 30 days upon
receipt of the invoice.
Hence we read 2/10, n/30 as it means that a 2% discount is given when the credit is paid within 10
days (called the discount period); otherwise the invoice is due in 30 days.
PERPETUAL PERIODIC
If paid within the discount period
Dr. Accounts Payable Dr. Accounts Payable
Cr. Merchandise Inventory Cr. Purchase Discount
Cr. Cash Cr. Cash
The amount of credit in the Merchandise Inventory is The amount of credit in the Purchase Discount is
amount of the discount which is computed as follows: amount of the discount which is computed as
Invoice Price x Discount follows:
Invoice Price x Discount
If paid after the discount period
Dr. Accounts Payable Dr. Accounts Payable
Cr. Cash Cr. Cash
4. Freight Cost on Purchase

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The freight cost on the purchase is debited to Freight-In account if using Periodic Method and
Merchandise Inventory account if perpetual method is used.
Freight terms state who pays the freight charges (shipping costs) and who is responsible for the risk
of loss or damage to the merchandise during transit.
Freight Terms can be:

a. FOB (free on board) destination means that the seller is responsible for delivering the
goods to the destination. The ownership transfers only when the goods reach the buyer.
The seller is liable to pay the freight costs for transporting the goods to the buyer’s
destination and is responsible for any loss or damage that occurs along the way.
b. FOB (free on board) shipping point means that the buyer is liable for the freight costs
from the shipping point to the buyer’s destination (normally the buyer’s place of
business). The buyer is also responsible for any loss or damage that occurs along the
way. In other words, the buyer owns the goods at the point of shipping even though the
goods will not arrive at the buyer’s destination for several days, weeks, or even months.
FOB Destination FOB Shipping Point

When will the ownership be When the goods reaches it
At the point of shipment.
transferred? destination.
Who owns the goods during
The seller The buyer
shipment?
Who should pay the freight cost? The seller The buyer
Freight terms that are used to signify who actually paid the freight cost:
a. Freight Prepaid signifies that the shipper(seller) paid the freight cost.
b. Freight Collect signifies that the receiver(buyer) paid the freight cost.
Combination of these freight terms:
Who Should Pay Who Actually Paid Effect on the books of the
Freight Term
the Freight Cost the Freight Cost buyer
Increase in Freight-In or
FOB Shipping Point, Merchandise Inventory
Buyer Seller
Freight Prepaid Increase in Accounts Payable
to the Seller
Increase in Freight-In or
FOB Shipping Point,
Buyer Buyer Merchandise Inventory
Freight Collect
Decrease in Cash
FOB Destination,
Seller Seller No Effect
Freight Prepaid
Decrease on the Accounts
FOB Destination
Seller Buyer Payable to the Seller
Freight Collect
Decrease in Cash
Accounting for Sale Transactions (Selling of Inventory)
1. Basic Sale
PERPETUAL PERIODIC
When merchandise is sold to customers, the When merchandise is sold to customers, no entry
account, Merchandise Inventory, is credited for the is made to reflect the cost of goods sold because
cost of goods sold. Sales may be made for cash or the cost of goods sold is only reflected at the end
on account (credit). of the period.
Sales may be made for cash or on account (credit).
Journal Entry on the Sale: Journal Entry on the Sale:

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Dr. Cash / Accounts Payable Dr. Cash / Accounts Payable

Cr. Sales Cr. Sales
Journal Entry on the Cost of Goods Sold:

Dr. Cost of Goods Sold
Cr. Merchandise Inventory
2. Sales Returns and Allowances
Sales Returns result when customers are dissatisfied with merchandise and are allowed to return
the goods to the seller for credit or a refund.
Sales Allowances result when customers are dissatisfied, and the seller allows a deduction from
the selling price.
Sales Returns and Allowances account decreases the sale (contra-sales account) and is a nominal
account presented in the Income Statement.
PERPETUAL PERIODIC
Journal Entry on the return of the goods: Journal Entry on the return of the goods:
Dr. Merchandise Inventory No Entry
Cr. Cost of Goods Sold
Journal Entry to Reduce the Sale and the Accounts Journal Entry to Reduce the Sale and the Accounts
Receivable / Cash: Receivable / Cash:
Dr. Sales Returns and Allowances Dr. Sales Returns and Allowances
Cr. Cash / Accounts Receivable Cr. Cash / Accounts Receivable
3. Sales Discounts
A seller may give either trade or cash discount. As mentioned earlier, trade discount is not recorded
in the books, but a cash discount is to be recorded in the books.
Sales Discount account just like Sales Returns and Allowances decreases the sale (contra-sales
account) and is a nominal account presented in the Income Statement.
The entry whenever there is a cash discount:

Dr. Sales Discount
Cr. Accounts Receivable
4. Freight Cost on Sale
The freight cost of a seller is an operating expense. The usual account debited on a freight cost if
Transportation or Shipping Expense, however Freight-Out Account may also be used.
Combining the different freight terms:
Who Should Pay Who Actually Paid Effect on the books of the
Freight Term
the Freight Cost the Freight Cost Seller
Increase in Accounts
FOB Shipping Point,
Buyer Seller Receivable to the Buyer
Freight Prepaid
Decrease in Cash
FOB Shipping Point,
Buyer Buyer No Effect
Freight Collect
FOB Destination, Increase in Freight Out
Seller Seller
Freight Prepaid Decrease in Cash
FOB Destination
Seller Buyer Increase in Freight Out
Freight Collect

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Decrease in Accounts
Receivable to the Buyer
Completing the Accounting Cycle of a Merchandising Business
 Adjusting Entries
o A merchandiser has the same adjusting entries as a service company. Except as to the
setting up of the correct inventory.
PERPETUAL PERIODIC
The perpetual inventory records may be incorrect Since the inventory account is not properly
due to a variety of causes such as recording errors, adjusted, the ending inventory should be set-up:
theft, or waste. Dr. Merchandise Inventory
Dr. Cost of Goods Sold Cr. Cost of Goods Sold
 Closing Entries
o A merchandiser has the same closing entries as a service company. Except on the closing
of other merchandising accounts.
PERPETUAL PERIODIC
Closing of Beginning Inventory:
Closing of Purchase Accounts:

Dr. Purch Discount
Dr. Purch Return
Dr. Purch Allow.
Cr. Purchases
Cr. Freight In
Closing of Cost of Goods Sold: Closing of Cost of Goods Sold:

Dr. Income Summary Dr. Income Summary
Cr. Cost of Goods Sold Cr. Cost of Goods Sold
Determining Cost of Goods Sold Under a Periodic System
As outlined earlier:
 Under the Periodic system, separate accounts are used to record freight costs, returns, and
discounts.
 Under the Perpetual system all transactions affecting the cost of merchandise purchased is recorded
directly into Merchandise Inventory account.
 Also under the Periodic system, a running account of changes in inventory is not maintained.
Therefore, the balance in ending inventory (done by taking a physical inventory), as well as the cost
of goods sold for the period, is calculated at the end of the period.
 The Cost of Goods Sold Section in the Income Statement of a Periodic Inventory Systme Shows:
Beginning inventory (BI)
+ Gross purchases
- Purchase returns & allowances
- Purchase discounts
+ Freight-in
= Cost of Goods available for sale (CGAFS)
- Ending inventory (EI)
= Cost of goods sold (COGS)
Net Purchases =

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Gross purchases
- Purchase returns & allowances
- Purchase discounts
+ Freight-in
END

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HO 8: CORPORATION ACCOUNTING
A corporation is a legal entity that is separate and distinct from its owners, who are known as
shareholders.
Shareholder’s Equity
It is the residual interest of owners in the net assets of a corporation measured by the excess of
assets over liabilities. The Shareholder’s Equity section is composed of:
Share capital issued XX

Subscribed share capital XX
Less: Subscriptions receivable XX XX
Share premium:
Share premium excess over par XX
Share premium - Treasury shares XX
Share premium conversion option –
convertible bonds payable XX
Donated capital XX
Share premium warrants outstanding XX
Share premium options outstanding XX XX
Total paid in capital XX
Retained earnings - unappropriated XX
Retained earnings - appropriated XX XX
Revaluation surplus XX
Unrealized gain or (Loss) on FVTOCI XX
Total XX
Less: Treasury shares( at cost) XX
Total shareholders’ equity XX
Shareholders’ equity is divided into two parts: share capital and retained earnings, also known as
the contributed capital and the earned capital.
LEGAL CAPITAL
Legal capital is the portion of paid in capital which cannot be returned to stockholders in any form
(cash, property or stock dividends) during the lifetime of the corporation.
FORMULA:
1. With par value: Share capital issued XX
Add: Subscribed share capital XX
Total Legal Capital XX
2. No par value : Share capital issued XX

Add: Subscribed share capital XX
Paid in capital in excess of stated value XX
Total Legal Capital XX
ORGANIZATION COSTS AND EXPENSES RELATED TO SHARE CAPITAL
Organization cost represents costs incurred in forming or organizing a corporation. These costs
include:
1. Legal fees in connection with the incorporation – includes drafting of articles of incorporation and by-
laws and corporation registration.
2. Incorporation fees
3. Share issuance cost – direct costs to sell share capital which normally include the following:
a. Legal fees

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b. CPA fees
c. Underwriting fees and commissions
d. Cost of printing certificates
e. Documentary stamps
f. Filing fees with SEC
g. Cost of advertising and promoting the issue
Organization costs, except for share issuance costs, shall be recognized as expense in the first year
of operations.
According to PAS 32 paragraph 35, “transaction costs of an equity transaction shall be accounted
for as a deduction from equity, net of any related income tax benefit.” Therefore, stock issuance cost shall be
debited to the following:
1. Share Premium from issuance
2. Retained earnings if there is no share premium from issuance or if the share premium from
issuance is not sufficient.
Management salaries and other indirect costs related to the sale of share capital should be expensed
outright. Recurring cost of maintaining shareholder’s records and handling ownership transfers such as
registrar agent fees shall be charged as expense in the period incurred.
CONTRIBUTED CAPITAL
Contributed capital is the amount shareholders paid, or contributed, to the corporation in exchange
for shares of ownership. This includes share capital, which can consist of both common and preferred shares.
All corporations must issue common shares, whereas they can choose whether or not to issue preferred
shares.
Contributed capital can also include other sources of capital as a result of share transactions, known
as additional contributed capital.
Two kinds of shares: Ordinary and Preference. These shares may with par or without par.
ACCOUNTING FOR SHARE CAPITAL TRANSACTIONS
Two Methods:
1. Memorandum Method – Under the memorandum method, memorandum entry is to be made when
the corporation is authorized to issue shares of stocks. The company credits the share capital when
shares are issued.
2. Journal entry Method – Under the journal entry method, a journal entry debiting Unissued Share
capital and crediting Authorized Share capital is made when the corporation is authorized to issue
shares of stocks. When shares are issued, the Unissued Share capital account is then credited.
Memorandum Method Journal Entry Method

At capital authorization Memo entry indication the capital Journal entry to effect the
authorization. capitalization:
Dr. Unissued Share Capital
Cr. Authorized Share Capital
Equity account credited at every Share Capital Unissued Share Capital
issuance of share capital
Journal entry at every issuance of Dr. Asset / Liability Dr. Asset / Liability
share capital Cr. Share Capital Cr. Share Capital
ISSUANCE OF SHARE CAPITAL
Measurement Considerations:

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1. If issued for cash, the amount of cash received.

2. If issued in consideration for a non current asset - Share capital shall be recorded at an amount
equal to the following (in the order of priority):
a. Fair value of noncash consideration Received
b. Fair value of share capital Issued.
c. Par or stated value of share capital Issued.
3. If issued in exchange for liability
Items classified as debt for equity swap under IFRIC 19 (in order of priority):
a. Fair value of share capital issued
b. Fair value of liability extinguished
c. Carrying amount of liability extinguished
4. If issued at a lump sum or basket price
If the shares have fair value, use the relative fair value or proportional method
Under the relative fair value or proportional method, the lump-sum price shall be allocated using
their relative fair values.
If only one of them has an available fair value, use the incremental method. Under the
incremental method, the share with known fair value will have that value and any remainder on
the issue price is allocated to the share with unknown fair value.
Accounting problems in the issuance of share capital:

1. Issued at par or stated value
a. If issued at par, issue the share capital. Pro-forma entry:
Dr. Consideration Received (Asset/Liability)
Cr. Share Capital / Unissued Share Capital
2. Issued below par or stated value
a. The difference is treated as a reduction in equity called “Discount on Share Capital”. Pro-
forma entry:
Dr. Consideration Received
Dr. Discount on Share Capital
3. Issued above par or stated value
a. The difference is treated as a share premium. Share premium is an addition to the equity.
Pro-forma entry:
Dr. Consideration Received (Asset/Liability)
Cr. Share Premium
SUBSCRIPTION OF SHARES
A subscription is a written contract by which one engages to take and pay for the capital stock of a
corporation in some future date.
Minimum Subscription at Authorization of Shares

According to the law, the approval of incorporation requires that at least 25% of the authorized capital
stock should have been subscribed and 25% of which should have been paid.
Minimum subscription after Authorization of Share

No legal provision on minimum subscription after authorization.
Pro forma entries:

Upon Subscription:
Subscriptions receivable (shares x subscription price) XX

Discount on Share Capital (If Subscription Price < Par or Stated Value) XX
Subscribed share capital (shares x par or stated value) XX
Share Premium (If Subscription Price > Par or Stated Value) XX

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Upon Collection: Dual effect record the collection and the issuance of the share capital.
Cash XX
Subscriptions receivable XX
Subscribed share capital XX

Share capital XX
NOTE: The issuance of shares will only be done UPON FULL COLLECTION. No full collection, no issuance
of shares.
What if the subscription cannot be collected?

We call the subscriber or subscription as a delinquent subscriber.
If a stock subscriber does not pay in full his unpaid stock subscription on the date fixed by the board
of directors, he may be declared a delinquent subscriber.
Accounting for Delinquent Subscription:

The delinquent subscription may:
1. Auctioned Subscription
a. With Highest Bidder
b. Without Highest Bidder
i. Corporation acquires the shares
ii. Corporation is prohibited to acquire the shares
2. Not Auctioned
AUCTIONED SUBSCRIPTION
Offer Price
Whenever a subscription is declared delinquent and the shares are to be auctioned, the following
items composes the offer price:
1. Unpaid balance due on subscription
2. Cost of money, such as accrued interest on the subscription due
3. Related expenses in public auction, such as advertising and other cost in selling.
To determine the highest bidder, the highest bidder is a person willing to pay the offer price and is willing
to receive the smallest number of shares.
To record expenses incurred related to the auction

Advances from sales of delinquency share xxx
Cash xxx
AUCTIONED with highest bidder
To record collection from highest bidder

Cash xxx
Subscription receivable xxx
Interest income xxx
To record issuance of share certificates

Subscribed share capital xxx
Share capital xxx
AUCTIONED without highest bidder
Corporation Acquires
To record the acquisition of entity’s own shares
Treasury shares xxx

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Interest income xxx
To record issuance of share certificates

Share capital xxx
Corporation is prohibited to Acquire

The whole payment on the subscription is forfeited.

Premium on share capital xxx
Share premium – forfeited downpayment xxx
NOT AUCTIONED
The whole payment on the subscription is forfeited.

Premium on share capital xxx
Share premium – forfeited downpayment xxx
TREASURY SHARES
Treasury shares are company’s own stock previously issued, reacquired but not cancelled.
Accounting for treasury shares – Cost Method
I. Re-Acquisition
When entity’s own shares are reacquired, the cost of the reacquisition is recorded as treasury shares.
To record acquisition of entity’s own shares
Treasury shares (no. of treasury shares x cost per share) xxx
Cash xxx
II. Reissuance
When entity’s own shares are reissued.
Accounting problem:
Reissuance at cost – no problem
Reissuance above cost – remainder is credited to Share Premium – TS
Reissuance Below cost – remainder is debited to up to the extent of Share Premium TS is
SP – TS is not enough, Retained Earnings
To record reissuance of entity’s own shares

Cash (no. of TS re-issued x issue price per share) xxx
Treasury shares (no. of TS re-issued x cost per share) xxx
Balancing figures:
If Debit:
Share Premium-TS of the same class
Retained earnings
If Credit:
Share Premium-TS

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III. Retirement
When entity’s own share reacquired is retired. Under cost method, the journal entry for the retirement
of treasury stock is made by debiting the common stock with par value of shares being retired, debiting
additional paid-in capital (if any) associated with the shares being retired and crediting treasury stock with
the cost of shares being retired.
Accounting problem:
Retirement price is equal the original issuance price
Retirement price is greater than the original issuance price – Debit Retained Earnings
Retirement price is lesser than the original issuance price – Credit Share Premium Retiement
To record retirement of entity’s own shares

Ordinary shares (par value x no. of shares retired) xxx
Share Premium from original issuance
(if not given, total Share Premium/ no. of shares issued
X no. of shares retired) XXX
Treasury shares (no. of TS retired x cost per share) xxx
Balancing figures:
If Debit:
Retained earnings
If Credit:
Share Premium-Retirement
DONATED CAPITAL
Donations of shareholders in the business. Donated capital is a share premium account.

Entity’s own
Asset shares
Upon receipt Asset (at fair XX Memo
of donation value)
Donated XX
capital
Upon sale Cash XX Cash XX
Loss (if any) XX Donated XX
capital
Asset XX
Gain (if any) XX
ASSESSMENTS
Additional capital. The assessment is credited to share premium.
EARNED CAPITAL
RETAINED EARNINGS – Retained earnings are the profits that a company has earned to date, less any
dividends or other distributions paid to investors. It represents the cumulative profits which are not yet
distributed as dividends but rather retained to be reinvested in the business or to settle debt.
The Normal Balance of Retained Earnings is Credit, if the balance of Retained Earnings is negative we
describe it as Deficit.
Retained Earnings may be:

 Restricted (Appropriated)
o This may be a result of:
 Legal Requirement – e.g. Treasury Shares
 Contractual Requirement
 Voluntary

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 Unrestricted (Unappropriated)
NOTE: The restriction of retained earnings does not necessarily provide cash for any intended purpose. The
purpose is to show that assets in the amount of the appropriation are not available for dividends. When a
reserve is no longer needed it must be returned directly to unappropriated retained earnings by reversing the
entry that created it.
Distribution to Owners (Dividends)

 May be Return on Capital or Return of Capital
 Only Outstanding Shares are entitled to dividend.
o Outstanding Shares = Issued + Subscribed – Treasury
Dividends as Return of Capital – charged to capital liquidated (capital liquidated is a reduction on the capital
or share premium)
1. Liquidating Dividend
Dividends as Return on Capital – charged to retained earnings

1. Cash Dividends
2. Liability Dividends
3. Property Dividends
4. Choice between Cash and Property Dividends
5. Share Dividends
LIQUIDATING DIVIDEND
Measurement:
 The amount of capital liquidated.
CASH DIVIDENDS
Measurement:
 The amount of cash distributable
o certain amount of pesos per share (# of shares x dividend per share)
o certain percent of the par or stated value (outstanding shares par or stated value x
percentage of cash dividend)
Accounting:
 At the date of declaration, measure the dividends payable accordingly based on the rules above.
LIABILITY DIVIDENDS
 May be a scrip dividend or a bond dividend. The dividend declared may or may not include interest.
In case the liability carries interest, any interest is treated as an expense not an additional dividend.
o Scrip Dividend – short term.
o Bond Dividend – long term.
Measurement:
 Amount of liability or face amount of the liability for Scrip Dividends.
PROPERTY DIVIDENDS
Measurement:
 Noncurrent assets covered by PFRS No. 5 (Property, plant and equipment, Intangibles and
Investment in Associate)
o Lower between Carrying Amount or Fair Value Less Cost to Sell
 Assets other than those covered by PFRS No. 5 (for example current assets just like inventory,
noncurrent assets covered by PAS 39 or PFRS 9)
o Fair Value
Accounting:
 At the date of declaration, measure the dividends payable accordingly based on the rules above.
 At the end of each reporting, review and adjust the carrying amount of the dividends payable to equity
(retained earnings) as adjustments to the amount of the distribution.

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 At the date of settlement, get the difference between the carrying amount of dividends payable and
carrying amount (fair value) of the noncash assets, any difference is reported as gain or loss in the
profit or loss.
CHOICE BETWEEN CASH AND PROPERTY DIVIDENDS

Measurement:
 Consider the fair value of each alternative and the probability of shareholders selecting each
alternative.
Accounting:
 At the date of declaration, measure the dividend payable accordingly based on the rule above.
 At the end of each reporting, review and adjust the carrying amount of the property dividends payable
to equity (fair value) as adjustments to the amount of the distribution.
 At the date of settlement, review and adjust each alternative based on the actual selection of the
shareholders, further, get the difference between the carrying amount of property dividends payable
and carrying amount of the noncash assets, any difference is reported as gain or loss in the profit or
loss.
SHARE DIVIDENDS
Measurement:
 New Issuance of Shares:
o Small Stock Dividend – the stock dividend declared is less than 20%, measure at fair value
of the shares
o Large Stock Dividend – the stock dividend declares is at least 20%, measure at par value
 Old Share (Treasury Share):
o Measure at cost of the treasury share
Accounting:
 At the date of declaration, measure the dividend payable accordingly based on the rule above.
 At the date of settlement, issue the shares or reissue the treasury share.
Summary:
Cash Dividends Property Dividends Share Dividends
Date of Declaration Dr. Retained Earnings Dr. Retained Earnings Dr. Retained Earnings
Cr. Cash Dividends Cr. Property Dividends Cr. Stock Dividends
Payable Payable Payable
Cr. Share Premium
Note: You will only credit

share premium if it is a
small stock dividend.
Date of Record No Entry No Entry No Entry
Year End No Adjustment Adjustment of the No Adjustment
liability to the Fair Value
or Lower of CA or
FVLCTS of the Property
Date of Payment or Dr. Cash Dividends Dr. Property Dividends Dr. Stock Dividends
Settlement or Payable Payable Payable
Distribution Cr. Cash Cr. Asset Account for Cr. Share Capital /
the property Treasury Share
Note: The property

should be adjusted
again to Fair Value or
Lower of CA or FVLCTS,
any changes is treated
as gain or loss.
PREFERENCE SHARE DIVIDENDS

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 Preference over dividends

o Noncumulative
o Cumulative
o Participating
 When the Preference Shares are participating, the ordinary shares are given a basic
allocation based on the preference rate. If two or more preference shares, the lowest
preference rate is given to the ordinary share.
 The remainder is shared pro rata based on the aggregate par value of the shares if
the preference share is fully participating. If the preference share is partially
participating, the preference share must only be shared up to the amount of
participation (Participation Rate less Preference Rate( and any remainder is
allocated to the ordinary shareholder.
o Non-Participating
END

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HO 9: PARTNERSHIP ACCOUNTING
A partnership is defined in Article 1767 of a Civil Code of the Philippines as “a contract whereby two
or more persons bind themselves to contribute money, property, or industry into a common fund with the
intention of dividing profits among themselves.” Two or more persons may also form a partnership for the
exercise of a profession.
Characteristics of a Partnership
 Based on Contract – the relation partners arises from contract and not from statute, operation of law
or inheritance.
 Association of Individuals – at least two persons, having reciprocal rights and obligations towards
each other, are necessary to constitute a partnership.
 Ease of Formation – partnership is perfected by mere consent of the parties.
 Co-ownership of Partnership Property – assets invested by any of the partners became the property
of the partners because they co-own the partnership.
 Assignment of Partner’s Interest – a partner (assignor) can assign his interest to an assignee.
 Mutual Agency – every partner is assumed as an agent of the partnership for the purpose of its
business.
 Income Participation – the partnership business must be carried on with the object of sharing profits
among the partner.
 Unlimited Liability – a partnership is not considered a separate entity from the partners when it
involves debts to third party creditors. A general partner may be required to use his personal assets
to pay partnership debts authorized by any partner.
 Limited Life – a partnership is automatically dissolved when there is a change in the relationship
between or among the partners as this condition terminates partnership contracts.
Advantages and Disadvantages of a Partnership Business

Advantages:
 It is easy and inexpensive to organize, as it is formed by a simple contract between two or more
persons.
 The unlimited liability of the partners makes it reliable from the point of view of creditors.
 The combined personal credit of the partners offers better opportunity for obtaining additional capital.
 The participation in the business by more than one person makes it possible for a closer supervision
of all the activities.
 The direct gain to the partners is an incentive to give close attention to the business.
 The personal element in the characters of the partners is retained.
Disadvantages:
 The personal liability of a partner for firm debts deters many from investing capital in a partnership.
 A partner may be subject to personal liability for the wrongful acts or omissions of his/her associates.
 It is less stable because it can easily be dissolved.
 There is divided authority among the partners.
 There is constant likelihood of dissension and disagreement when each of the partners has the same
authority in the management of the firm.
Kinds of Partnership
1. As to Activity
 Trading partnership – one whose main activity is the manufacture and sale or the purchase and sale
of goods.
 Non-Trading partnership – one which is organized for the purpose of rendering services
2. As to Object
 Universal partnership of all present property – one in which the partners contribute at the time of the
constitution of the partnership, all the properties which actually belong to each of them.

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 Universal partnership of all profit – one which comprises all that the partners may acquire by their
industry or work during the existence of the partnership and the usufruct of movable or immovable
property.
 Particular partnership – one which has for its object determine things, their use or fruits or a specific
undertaking or the existence of a profession or vocation.
3. As to liability of partners
 General co-partnership – one consisting of general partners who are liable prorata and sometimes
solidarily with their separate property for partnership liabilities.
 Limited partnership – one formed by two or more persons having one or more general partners and
one or more limited partners, who as such are not bound by the obligations of the partnership. The
word “limited” or ltd” is added to the name of the partnership to inform the public that it is a limited
partnership.
4. As to Duration
 Partnership at will – one for which no term is specified and is not formed for a particular undertaking
or venture and which may be terminated any time by mutual agreement of the partners or the will of
one alone.
 Partnership with a fixed term – one in which the term or period for which the partnership is to exist is
agreed upon. It may also refer to a partnership formed for a particular undertaking and upon the
expiration of that term or completion of a particular undertaking the partnership is dissolved.
5. As to representative to others
 Ordinary partnership – one which actually exists among the partners and also as to third persons.
 Partnership by estoppel – one in which in reality is not a partnership but it is considered as one only
in relation to those who by their conduct or omission are precluded to deny or disprove the
partnership’s existence.
6. As to legality of existence
 De jure partnership – one which has complied with all the requirements for its stablishment.
 De facto partnership – one which failed to comply with one or more of the legal requirements for its
establishments.
7. As to Publicity
 Secret partnership – one wherein the existence of certain persons as partners is not made known to
the public by any of the partners.
 Open partnership – one wherein the existence of certain persons as partners is made known to the
public by the members of the firm.
Classes of Partners
1. As to contribution
 Capitalist partner – contributes money, property to the partnership.
 Industrial partner – contributes only his skills, knowledge, industry or personal service to the
partnership.
 Capitalist-Industrial partner – contributes money, property and industry in the partnership.
2. As to liability
 General partner – one whose liability extends to his separate properties.
 Limited partner – one whose liability for partnership obligation is limited to his contribution.
3. As to management
 Managing partner – one who is appointed by the partners to take charge of the partnership.
 Silent partner – one who has no active part in the management of the partnership.
4. Other classifications

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 Liquidating partner – one who takes charge of the winding up of the partnership affairs after
dissolution.
 Secret partner – one who is not known to third persons as a partner.
 Dormant partner – who is secret and silent partner.
 Nominal or Ostensible partner – one who is a partner in name only by permitting the use of his name
either for accommodation or for consideration; subject to liability by the doctrine of estoppel.
PARTNERSHIP FORMATION
It refers to the perfection of the partnership contract by the partners. When a partnership is formed,
partners commonly observe the following to effect fair and honest business:
 Execution of partners’ agreement
 Valuation of partners’ investments – the valuation of partners’ non-cash investment is based on the
partners’ agreed value. In the absence of any agreement, the fair value the property is used as its
value to measure the contribution of the partner.
 Adjustments of the accounts – if there is an existing sole proprietors business that would be
converted as a partnership, all accounts that are being revalued according to partnership agreement
would increase or decrease the contributing partner’s capital. The adjustments of the account are
very important because they reflect the fair and equitable value of the prospective partner’s
contributions to the partnership.
Partnership Contract
A partnership is created by an oral or a written agreement. Since partnerships are requires to be
registered with the Office of the SEC, it is necessary that the agreement be in writing. In this case,
misunderstandings and disputes among the partners relative to the nature and terms of the contract may be
avoided and minimized.
Articles of Co-Partnership – the written agreement between or among the partners governing the formation,
operation and dissolution of the partnership.
Valuation of Partner’s Contribution

Partners may contribute cash, property or industry to the partnership.
Cash = at face value
Property or non cash items = agreed value or fair market value (if no agreement)
Industry = memorandum entry
Methods in Accounting for Partner’s Contribution:

1. Bonus Method
2. Goodwill Method
Accounting for a partnership differs from other forms of business organizations with regard to capital
accounts.
Partner’s Capital
Debit Credit
Permanent withdrawal of capital original investment by a partner
share in partnership loss from operations additional investment by a partners
debit balance of drawing account closed to capital share in partnership profits from operations
Partner’s Drawing
Debit Credit
Personal withdrawal of capital
Illustrative:

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On June 1, 2018, AB, CD and EF decided to pool their assets and form BDF Partnership. After formation the
partners will participate in the profits and loss ratio of 40%, 25% and 35% for AB, CD and EF, respectively. The
balance sheet on June 1 before the adjustments were as follows:
AB CD EF
Cash P42,000 P28,000 P34,000
Accounts receivable 250,000 325,000 280,000
Allowance for doubtful accounts (18,000) (24,000) -
Notes receivable - - 120,000
Merchandise inventory 75,000 90,000 60,000
Prepaid rent - 36,000 20,000
Building 400,000
Accumulated depreciation (60,000)
Equipment 210,000
Total assets P689,000 P640,000 P514,000
Accounts payable P36,000 P41,000 P34,000
Note payable 240,000
Capital 653,000 359,000 480,000
P689,000 P640,000 P514,000
The firm is to take over business assets and assume business liabilities. Capitals are to be based on net assets
transferred after the following adjustments:
 4% of the accounts receivable of AB may prove to be uncollectible, while the accounts receivable of CD
is estimated to be 90% realizable and accounts receivable of EF amounting to P7,000 is deemed
worthless.
 Interest at 15% on notes receivable amounting to P90,000 dated April 1, 2018 should be accrued and
interest at 12% on the balance of the notes dated February 1, 2018. (use 360 days)
 The inventory of AB should be valued at P90,000, while P18,000 of the inventory of CD is considered
worthless.
 2/3 of the prepaid rent of CD is unexpired, while 1/4 of the prepaid rent of EF has expired.
 The building is under depreciated by P20,000.
 The equipment is to be valued at P160,000.
 Interest at 10% on notes payable dated May 1, 2018 should be accrued. (use 360 days)
 AB has office supplies on hand which have been charged to expense amounting to P9,000. These are
still to be used by the partnership.
 Accrued expense of P2,450 is to be recognized in the books of EF.
Required: Assume the use of new set of books, prepare:

1. Adjusting entries on the books of AB, CD and EF.
2. Closing entries on the books of AB, CD and EF.
3. Journal entries to record the investments of AB, CD and EF, under the:
a. Net investment method
b. The partners’ capital balances are to be made equal with their profit and loss ratio.
(1) Either by withdrawing or investing additional cash
(2) Bonus method
c. Goodwill Method
ANSWER:
ADJUSTING ENTRIES
AB’s Books CD’s Books EF’s Books
AFDA 8,000 CD, Capital 8,500 EF, Capital 7,000
AB, Capital 8,000 AFDA 8,500 AR 7,000
Interest Receivable 3,450
EF, Capital 3,450

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Interest on the notes:

On the 90k Note: 90K x 15% x
2/12 = 2,250
On the remainder: 30k x 12% x
4/12 = 1,200
Total: 3,450
Merch. Inv. 15,000 CD, Capital 18,000
AB, Capital 15,000 Merch. Inv. 18,000
CD, Capital 12,000 EF, Capital 5,000
Prepaid Rent 12,000 Prepaid Rent 5,000
Expired Portion 36,000 x 1/3 = Expired Portion 20,000 x 1/4 =
12,000 5,000
AB, Capital 20,000
Accum. Dep’n 20,000
CD, Capital 25,000
Accum. Dep’n 25,000
CD, Capital 2,000
Int. Payable 2,000
Interest = 240,000 x 10% 1/12 =

2,000
Supplies 9,000
AB, Capital 9,000
EF, Capital 2,450
Acct. Payable 2,450
ADJUSTED TRIAL BALANCE

AB CD EF
Cash P42,000 P28,000 P34,000
Accounts receivable 250,000 325,000 273,000
Allowance for doubtful accounts (10,000) (32,500) -
Notes receivable - - 120,000
Merchandise inventory 90,000 72,000 60,000
Prepaid rent - 24,000 15,000
Supplies 9,000
Building 400,000
Equipment 210,000
Total assets P701,000 P576,500 P505,450
Accounts payable P36,000 P41,000 P36,450
Interest Payable 2,000
Capital 665,000 293,500 469,000
P701,000 P576,500 P505,450
CLOSING THE BOOKS

AB CD EF
AFDA 10,000 AFDA 32,500 Acct. Pay. 36,450
Accum. Depn. 80,000 Accum. Depn. 50,000 EF, Capital 469,000
Acct. Pay. 36,000 Acct, Pay. 41,000 Cash 34,000
AB, Capital 665,000 Note Pay. 240,000 AR 273,000
Cash 42,000 Int. Payable 2,000 NR 120,000
AR 250,000 CD, Capital 293,500 Int. Rec. 3,450
Merch. Inv. 90,000 Cash 28,000 Merch Inv. 60,000
Supplies 9,000 AR 325,000 Prep. Rent 15,000

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Building 400,000 MI 72,000 #

# Prep. Rent 24,000
Eqpmt 210,000
#
ENTRIES ON FORMATION
To record the investment of AB:
Cash 42,000
AR 250,000
Merch. Inv. 90,000
Supplies 9,000
Building 400,000
AFDA 10,000
Accum. Depn. 80,000
Acct. Pay. 36,000
AB, Capital 665,000
To record the investment of CD:

Cash 28,000
AR 325,000
MI 72,000
Prep. Rent 24,000
Eqpmt 210,000
AFDA 32,500
Accum. Depn. 50,000
Acct, Pay. 41,000
Note Pay. 240,000
Int. Payable 2,000
CD, Capital 293,500
To record the investment of EF:

Cash 34,000
AR 273,000
NR 120,000
Int. Rec. 3,450
Merch. Inv. 60,000
Prep. Rent 15,000
Acct. Pay. 36,450
EF, Capital 469,000
Trial Balance at formation:

BDF Partnership
Trial Balance
June 1, 2018
Cash 104,000
Accounts receivable 848,000
Allowance for doubtful accounts 42,500
Notes receivable 120,000
Merchandise inventory 222,000
Prepaid rent 39,000
Supplies 9,000
Building 400,000
Accumulated depreciation 80,000
Equipment 210,000
Accumulated depreciation 50,000

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Accounts payable 113,450

Interest Payable 2,000
AB, Capital 665,000
CD, Capital 293,500
EF, Capital 469,000
1,955,450 1,955,450
Adjustment to Capital:
NET INVESTMENT METHOD
AB CD EF TOTAL
AC 665,000 293,500 469,000 1,427,500
CC 665,000 293,500 469,000 1,427,500
-0- -0- -0- -0-
No entry. TAC = TCC
BONUS METHOD
AB(40%) CD(25%) EF(35%) TOTAL
AC 571,000 356,875 499,625 1,427,500
CC 665,000 293,500 469,000 1,427,500
(94,000) 63,375 30,625 -0-
Addt’l Investment and Withdrawal:

AB, Capital 94,000
Cash 94,000
Cash 63,375
CD, Capital 63,375
Cash 30,625
EF, Capital 30,625
Purely Bonus:
AB, Capital 94,000
CD, Capital 63,375
EF, Capital 30,625
GOODWILL METHOD
AB(40%) CD(25%) EF(35%) TOTAL
AC 665,000 415,625 581,875 1,662,500
CC 665,000 293,500 469,000 1,427,500
-0- 122,125 112,875 235,000
Goodwill 235,000
CD, Capital 122,125
EF, Capital 112,875
PARTNERSHIP OPERATIONS
Methods of Distributing Profits Based on Partners’ Agreement

1. Equally – it is simple to apply but does not give due recognition on the disparity of capital contribution nor
does it recognize the time and effort that a partner may devote in running the firm’s business operations.
2. Arbitrary ratio (percentage, decimal, fraction, ratio) – it is simple to apply but does not give recognition on
the disparity of capital contributions nor does it recognize the time and effort that a partner may devote in
running the firm’s business operations.

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3. Capital ratio (Original, Beginning, Ending, Average) – this method recognizes the differences in the capital
contributions but does not take into account the time and effort that a partner may devote in running the firm’s
business operations.
4. Interest on capital and the balance on agreed ratio – this method recognizes the differences in the capital
contributions but does not take into account the time and effort that a partner may devote in running the firm’s
business operations.
Interest is allowed to partners for the use of invested capital. Interest as agreed by the partners shall be
allowed in proportion over the period such capital was actually used. Moreover, the interest shall be provided
whether the income is sufficient or insufficient or there is a net loss unless otherwise agreed upon by the
partners.
5. Salary allowances to partners and the balance on agreed ratio – this method recognizes the time and effort
that a partner may devote in running the firm’s business operations but does not take into consideration the
differences in capital contributions.
Salaries are allowed to partners as compensation for their time devoted in the business. Salaries as agreed
by the partners shall be allowed in proportion to the time the partners actually rendered services to the firm.
Such salaries shall be provided whether the profit is sufficient or not and when there is a loss unless otherwise
agreed upon by the partners.
6. Bonus to managing partner and the balance on agreed ratio – this method allows a bonus, as an incentive,
to the managing partner. It is usually a percentage of the profit. Bonus, therefore, is allowed only when there
is a profit.
PROBLEM 1
The Alphabet Partnership was established on June 1, 2017 with the following initial capital balances:
AB, Capital 350,000
CD, Capital 500,000
EF, Capital 150,000
The capital and drawing accounts of partner’s AB, CD, and EF show the following postings for the year ended
December 31, 2018:
AB, Capital CD, Capital EF, Capital
1/1 400,000 1/1 600,000 1/1 500,000
5/1 50,000 4/1 100,000 7/1 50,000
AB, Drawing CD, Drawing EF, Drawing

6/1 70,000 9/30 50,000
10/30 30,000
1. Assuming the partnership earned a profit of 450,000.

2. Assuming the partnership earned a loss of 450,000.
Required: Give the journal entry under each of the following independent assumptions:
a. The partners agree to share profits and losses equally.
b. The profit or loss agreement of the partners stipulates that the sharing is 25%, 40%, and 35% for
AB, CD, and EF respectively.
c. The partners agree to share profits in accordance with their original capital balances.
d. The partners agree to share profits in accordance with their beginning capital balances.
e. The partners agree to share profits in accordance with their ending capital balances.
f. The partners agree to share profits in accordance with their weighted average capital balances
assuming all withdrawals are temporary withdrawals.
g. The partners agree to share profits in accordance with their weighted average capital balances
assuming all withdrawals are permanent withdrawals.
h. The partners agree to share profits in accordance with their weighted average capital balances

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assuming all withdrawals in excess of 20,000 for the whole year are permanent withdrawals.
i. 10% interest is given based on beginning capital balances, any remainder is distributed equally.
j. 10% interest is given based on ending capital balances, any remainder is distributed equally.
k. 10% interest is given based on weighted average capital balances, any remainder is distributed
equally.
l. Annual salaries of 120,000, 90,000, and 60,000 to AB, CD, and EF respectively. Any remainder is
divided equally.
PROBLEM 2
X and Y has a net income of P400,000 before salaries, interest, and bonus to partners. The partnership
contract provides for the following:
a. Salaries to X and Y, P50,000 each.
b. Interest on capital account balances: P20,000, and P30,000 for X and Y respectively.
c. Bonus to X, 20%.
d. Any remainder, Equally.
Prepare the profit distribution schedule assuming:

a. Bonus is computed based on the net income before salaries, interest, and bonus.
b. Bonus is computed based on the net income before salaries and interest, but after bonus.
c. Bonus is computed based on the net income after salaries and interest, but before bonus.
d. Bonus is computed based on the net income after salaries, interest, and bonus.
PROBLEM 3
GH, IJ and KL are manufacturers’ representative in the wholesale business. Their capital accounts in the
AQX Partnership for 2018 were as follows:
GH IJ KL
January 1, Balances P135,000 P180,000 P75,000
March 1, withdrawal 36,000
April 1, investment 30,000
May 1, investment 72,000
June 1, investment 27,000
August 1, withdrawal 9,000
October 1, withdrawal 54,000
December 1, investment 18,000
Required: For each of the following independent income-sharing agreements, prepare an income distribution
schedule.
a. Monthly salaries are P30,000 to GH, P50,000 to IJ and P45,000 to KL. GH receives a bonus of 5% of
net income after deducting his bonus. Interest is 12% of ending capital balances. Any remainder is
divided by GH, IJ and KL in a 25:40:35 ratio. The Income Summary account has a credit balance of
P2,835,000 before closing.
b. Interest is 10% of weighted average capital balances. Annual salaries are P480,000 to GH, P630,000
to IJ and P510,000 to KL. IJ receives a bonus of 25% of net income after deducting the bonus and his
salary. Any remainder is divided in a 2:3:4 ratio by GH, IJ and KL, respectively. Net income was
P1,050,000 before any allocations.
c. KL receives a bonus of 20% of net income after deducting the bonus and the salaries. Annual salaries
are P600,000 to GH, P540,000 to IJ and P750,000 to KL. Interest is 15% of the ending capital in excess
of P140,000. Any remainder is to be divided by GH, IJ and KL in the ratio of their beginning capital
balances. Net income was P1,740,000 before any allocations.
d. Monthly salaries are P32,000 to GH, P40,000 to IJ and P42,000 to KL. IJ receives a bonus of 10% of
net income after deducting his bonus. Interest is 25% on the excess of the ending capital balances
over the beginning capital balances. Any remainder is to be divided by GH, IJ and KL in a 3:2:1 ratio.
The Income Summary account has a debit balance of P750,000 before closing.
e. Annual salaries of P450,000 to GH, P540,000 to IJ and P810,000 to KL are allowed to the extent of
the earnings only. Any remainder is to be divided equally among the partners. Net income before
allocation is P960,000.
PARTNERSHIP DISSOLUTION

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Changes in Ownership
Partnership dissolution occurs whenever there is a change in ownership (e.g., the addition of a new
partner, or the retirement or death of an existing partner). This is not to be confused with partnership
liquidation, which is the winding up of partnership affairs and termination of the business. Under dissolution
the partnership business continues, but under different ownership.
When partnership dissolution occurs a new accounting entity results. The following steps are followed in
the accounting of the partnership dissolution:
1. The partnership should first adjust its records so that all accounts are properly stated at the date of
dissolution.
2. After the income (loss) has been properly allocated to the existing partners’ capital accounts, all
assets and liabilities should be adjusted to their fair market value and their present values,
respectively.
a. This step is performed because the dissolution results in a new accounting entity.
3. After all adjustments have been made, the accounting for dissolution depends on the type of
transaction that caused the dissolution. These transactions can be broken down into two types:
a. Transactions between the partnership and a partner (e.g., a new partner contributes assets,
or a retiring partner withdraws assets)
b. Transactions between partners (e.g., a new partner purchases an interest from one or more
existing partners, or a retiring partner sells his/her interest to one or more existing partners).
ADMISSION OF A NEW PARTNER
Transaction between a partner and the

Transaction between partners
partnership
A new partner is admitted to the partnership by A new partner is admitted to the partnership by
transacting directly to the partnership. transacting directly to a partner.
When a new partner is admitted to the partnership The sale of a partnership interest is a transaction
essentially three cases can result. The new partner only between the partners. Thus, the treatment
can invest assets into the partnership and receive a accorded the transaction is determined by the
capital balance: partners involved. The accounting is to simply
(a) Equal to his/her investment transfer a portion of the existing partners’ capital to
(b) Greater than his/her investment a new capital account for the buying partner.
(c) Less than his/her investment
Illustrative 1: Admission of a new partner
Total old capital for ABC Partnership is P120,000.

Partner A B C
Capital P20,000 P40,000 P60,000
P&L Ratio 40% 40% 20%
Case 1: D is admitted to the partnership and purchases half of the interest of C for P50,000.
Case 2: D is admitted to the partnership and is given a 20% interest in the capital in return for a cash
contribution of P30,000.
Answer to Illustrative
Case 1: Case 1 is an admission of a partner through a transaction between the partners
In transaction between the partners, the total partnership’s contributed capital will not change.
Hence, any gain or loss is not recorded in the books of the partnership. The admission is recorded in the

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partnership’s books through a transfer of capital. The amount credited to the new partner is equal to the
interest purchased to the selling or existing partner. The proforma entry is:
Dr. Capital Account – Existing Partner

Cr. Capital Account – New Partner
Hence, to record the transaction, the entry is:
Dr. C, Capital 30,000

Cr. D, Capital 30,000
To compute the new capital balances:
A B C D Total
Balance P20,000 P40,000 P60,000 P120,000
Admission (P30,000) P30,000 -0-
Ending P20,000 P40,000 P30,000 P30,000 P120,000
Notice that:
1. The entry is only a transfer of capital between the existing or selling partner to the new or buying
partner;
2. The total contributed capital did not change;
3. We ignored the purchase price but only credited the new partner on the amount of interest
purchased to the existing or selling partner. This is computed by (Selling Partner Capital x
Interest Purchased) or (P60,000 x ½).
In Cases 2 to 4; the cases deal with an admission through a transaction between a partner and the
partnership
In an admission of a partner through a transaction between a partner and the partnership, the total
contributed capital changes. The change is equal to the investment of the new partner into the partnership.
Case 2: Case 2 is an admission of a partner through a transaction between a partner and the partnership
and the credited capital balance is EQUAL to the amount of new partners’ investment
If the new partner’s capital credit is equal to the new partner’s investment, there is no accounting
problem. The new partner’s capital is credited to the amount of his/her investment. The proforma entry is:
Dr. Asset Invested

Cr. Liability Assumed
But how can we say that the partner’s capital credit is equal to the new partner’s investment? Simply
we test the percentage of capital credit given to the partner versus the amount invested. The capital credit
or balance is equal to the product of the new total contributed capital and the percentage of capital interest.
To test:
New Capital Balance:

Old Balance 120,000
Plus: Investment 30,000
150,000
 Capital Credit = New Capital Balance x Percentage of Capital Interest

Capital Credit = 150,000 x 20%
Capital Credit = 30,000

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 Capital Credit = Investment

30,000 = 30,000
Dr. Cash 30,000

A B C D Total
Balance P20,000 P40,000 P60,000 P120,000
Admission P30,000 30,000
Ending P20,000 P40,000 P60,000 P30,000 P150,000
Notice that:
1. The entry is the same with the entries on partnership formation;
2. The total contributed capital changed which is commensurate to the amount of investment of the
new partner.
and the credited capital balance is LESSER to the amount of new partners’ investment
If the new partner’s capital credit is lesser to the new partner’s investment, there will be an accounting
problem. The accounting problem lies to the difference of the capital credit and the new partner’s investment.
In this case, the difference is treated as a bonus to old partner’s. The proforma entry is:
Dr. Asset Invested

Cr. Capital Account – Old Partner
But how can we say that the partner’s capital credit is lesser to the new partner’s investment? Simply
To test:

Old Balance 120,000
180,000

 Capital Credit < Investment

36,000 < 60,000
Difference: 24,000
How do we compute for the bonus? As mentioned above, the difference is treated as a bonus to old
partners. The bonus is shared using the old profit or loss ratio. To compute for the bonus:
Bonus to A = 24,000 x 40% = 9,600
Bonus to B = 24,000 x 40% = 9,600
Bonus to C = 24,000 x 20% = 4,800

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Dr. Cash 60,000

Cr. A, Capital 9,600
Cr. B, Capital 9,600
Cr. C, Capital 4,800
A B C D Total
Balance P20,000 P40,000 P60,000 P120,000
Bonus 9,600 9,600 4,800 (24,000) -0-
Ending P29,600 P49,600 P64,800 P36,000 P150,000
Notice that:
1. The entry is the same with the entries on partnership formation when there is a bonus;
new partner;
3. The new partner’s capital is not equal to the capital credit due to the bonus;
4. The old partner’s capital also changed which amounts to the bonus.
and the credited capital balance is GREATER to the amount of new partners’ investment
If the new partner’s capital credit is greater to the new partner’s investment, there will be an
accounting problem. The accounting problem lies to the difference of the capital credit and the new partner’s
investment. In this case, the difference is treated as a bonus from old partner’s. The proforma entry is:
Dr. Asset Invested

Cr. Capital Account – Old Partner
But how can we say that the partner’s capital credit is greater to the new partner’s investment? Simply
To test:

Old Balance 120,000
140,000

 Capital Credit > Investment

28,000 > 20,000
Difference: 8,000

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How do we compute for the bonus? As mentioned above, the difference is treated as a bonus to old
partners. The bonus is shared using the old profit or loss ratio. To compute for the bonus:
Bonus to A = 8,000 x 40% = 3,200
Bonus to B = 8,000 x 40% = 3,200
Bonus to C = 8,000 x 20% = 1,600
Dr. Cash 20,000

Cr. A, Capital 3,200
Cr. B, Capital 3,200
Cr. C, Capital 1,600
A B C D Total
Balance P20,000 P40,000 P60,000 P120,000
Bonus (3,200) (3,200) (1,600) 8,000 -0-
Ending P16,800 P36,800 P58,400 P28,000 P140,000
Notice that:
1. The entry is the same with the entries on partnership formation when there is a bonus;
new partner;
3. The new partner’s capital is not equal to the capital credit due to the bonus;
4. The old partner’s capital also changed which amounts to the bonus.
DEATH OR WITHDRAWAL OF A PARTNER
The death or withdrawal of a partner is treated in much the same manner as the admission of a new
partner. However, there is no new capital account to be recorded; we are dealing only with the capital
accounts of the original partners.
The key thing to remember in regard to a partner’s withdrawal from the partnership is that the
withdrawing partner’s capital account must be adjusted to the amount that the withdrawing partner is
expected to receive.
INCORPORATION OF A PARTNERSHIP
The incorporation of a partnership results in the formation of a new accounting (and legal) entity.
This means that the partnership must adjust its records up to the date of incorporation.
The accounting for incorporation of partnership is as follows:

1. First, the partnership closes its books and recognizes any income or loss up to the date of
incorporation.
2. Second, the books of the partnership are adjusted to reflect the fair market value of the partnership
assets and the present value of partnership liabilities.
3. A corresponding adjustment is made to the capital accounts in accordance with the partners’ P&L
ratio. Third, common stock is distributed to the partners in accordance with the amounts in their
capital accounts.
The entries to record the receipt of stock by the corporation are different depending upon whether
the corporation retains the partnership books or establishes new books.
a. Retention of the partnership books means that the issuance of common stock results in the closing
of the partners’ capital accounts with credits going to common stock and additional paid-in capital.

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b. Establishing new books means that the assets and liabilities are closed out and the difference
between their net value and the value of the corporate stock is debited to an asset “capital stock from
corporation.” This account is then credited and the partners’ capital accounts debited to record the
distribution of stock.
PARTNERSHIP LIQUIDATION
A partnership is liquidated when its business operations are completely terminated or ended. The
partnership assets are sold, the partnership creditors are paid, and the remaining assets, if any, are
distributed to the partners as a return of their investments.
Definitions:
 Dissolution – the termination of a partnership as a going concern; it is the termination of the life of a
partnership.
 Winding up – the process of settling the business or partnership affairs; it is synonymous to
liquidation.
 Termination – the point in time when all partnership affairs are ended.
 Liquidation – the interval of time between dissolution and termination of partnership affairs.
 Realization – the process of converting non-cash assets into cash.
 Gain on realization – the excess of the selling price over the cost or book value of the assets disposed
or sold through realization.
 Loss on realization – the excess of the cost or book value over the selling price of the assets disposed
or sold through realization.
 Capital deficiency – the excess of a partner’s share on losses over his capital.
 Deficient partner – a partner with a debit balance in his capital account after receiving his share on
the loss on realization.
 Right of offset – the legal right to apply part or all the amount owing to a partner on a loan balance
against deficiency in his capital account resulting from losses in the process of liquidation.
 Partner’s interest – the sum of a partner’s capital, loan balance and advances to the partnership.
Doctrine of MARSHALLING OF ASSETS

-involves the order of creditors’ rights against the partnership’s assets and the personal assets of the
individual partners. The order in which claims against the partnership’s assets will be marshaled is as follows:
 Partnership creditors other than partners
 Partner’s claims other than capital and profits, such as loans payable and accrued interest payable.
 Partner’s claim to capital or profits, to the extent of credit balances in capital accounts.
The order of claims against the personal assets of the individual partners is as follows:
 Personal creditors of individual partners
 Partnership creditors on unpaid partnership liabilities regardless of a partner’s capital balance in the
partnership.
RIGHT OF OFFSET
– involves offsetting a deficit in a partner’s capital (debit balance in the capital account of a partner)
against the loan payable to that partner. The loan payable to a partner has a higher priority in liquidation than
a partner’s capital balance but a lower priority than liabilities to outside creditors.
Hence in a liquidation the following is the order of priority on payment:

1. Payment of liquidation expense
2. Payment of liability of the partnership
3. Offsetting
4. Partner’s capital
TYPES OF LIQUIDATION
Lump-sum Liquidation – this is a process whereby the distribution of cash to the partner is done only after all
the non-cash assets have been realized, the total amount of gain or loss on realization is known and all
liabilities have been paid.

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Liquidation by installment or piecemeal liquidation – this is a process whereby assets are realized on a
piecemeal basis and cash is distributed to partners on a periodic basis as it becomes available; even before
converting all non-assets into cash.
STATEMENT OF LIQUIDATION
The Statement of liquidation is a statement prepared to summarize the liquidation process. It is the
basis of the journal entries made to record liquidation. This statement presents in working paper form the
effect of the liquidation on the Statement of Financial Position. It shows the conversion of assets into cash,
the allocation of gain or loss on realization, and the distribution of cash to creditors and partners.
Any gain or loss in realization of assets is allocated using the individual partner’s capital.
ILLUSTRATIVE: LUMP SUM

XYZ Partnership
Balance Sheet
Cash 8,000 Liabilities 44,800

Other Assets 130,000 Y, Loan 2,000
Loan from X 6,000 Z, Loan 3,200
X, Capital 38,000
Y, Capital 24,000
Z, Capital 32,000
The partners share profit or loss in 2:2:1 ratio respectively.

The partnership incurred 3,000 liquidation expenses.
Required: Prepare a statement of liquidation using the following assumptions:

Assets were sold for 140,000

XYZ Partnership
Statement of Liquidation
Notice the order of priority of payment:

1. Payment of liability
2. Right of offset
3. Payment to partners
Notice also that the first step in liquidation is the realization of non-cash assets. Any gain or loss is
allocated to the partners using their profit or loss ratio.
In this case, the Gain on Realization is equal to (140,000 – 130,000) 10,000.

XYZ Partnership

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2. Right of offset
In this case, the Loss on Realization is equal to (100,000 – 130,000) 30,000.

XYZ Partnership

2. Right of offset
In this case, the Loss on Realization is equal to (70,000 – 130,000) 60,000.
END
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1 Handout Accounting 1 - Partnership formation, operation,

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HO1: OVERVIEW OF ACCOUNTING

There are different forms of business organizations:

There are different types of business organizations:

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SECTORS IN THE PRACTICE OF ACCOUNTANCY

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)

Accounting as “Language of Business”

TYPES OF INFORMATION PROVIDED BY ACCOUNTING

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 Quantitative information – expressed in numbers, quantities or units

TYPES OF INFORMATION CLASSIFIED AS TO USERS’ NEEDS

USERS OF ACCOUNTING INFORMATION

As to whether the user is External or Internal:

BASIC ACCOUNTING CONCEPTS

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10. Going Concern

13. Matching Principle

14. Cost Benefit

THE ACCOUNTING PROCESS (according to the definition of AAA)

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- Measuring as the technical component

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HO 2: THE ACCOUNTING CYCLE

STEPS IN ACCOUNTING CYCLE

1. Identifying and Analyzing

4. Preparing the unadjusted trial balance

5. Preparing adjusting entries

6. Preparing Adjusted trial balance

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8. Closing the Books

9. Preparing the post-closing trial balance

10. Preparing Reversing entries

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HO 3: ANALYZING BUSINESS TRANSACTIONS

ELEMENTS OF FINANCIAL STATEMENTS

THE RULE OF DEBIT AND CREDIT

THE DOUBLE ENTRY SYSTEM

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o Equilibrium –this concept requires each transaction to be recorded in terms of equal

THE ACCOUNTING EQUATION

If we try to simplify the accounting equation:

If we try to expand the accounting equation:

NORMAL BALANCES OF ELEMENTS

Assets = Liabilities + Investment – Withdrawal + Revenue – Expense

Assets + Withdrawals + Expense = Liabilities + Investment + Revenue

SUMMARY ON THE RULE OF DEBIT AND CREDIT

ASSET W/DRAWALS EXPENSE LIABILITIES INVESTMENT REVENUE

BUSINESS TRANSACTIONS AND THE ACCOUNTING EQUATION

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HO 4: THE RECORDING PROCESS

DATE ACCOUNT TITLES REF DEBIT CREDIT

(1) The date of the transaction is entered in the Date column.

SIMPLE AND COMPOUND ENTRIES