Simplified Accounting for

Entrepreneurs

Tricia G. Custodio-Ascan

University of the Philippines

OPEN UNIVERSITY
Simplified Accounting for Entrepreneurs
By Tricia G. Custodio-Ascan

Copyright © 2012 Tricia G. Custodio-Ascan

and the University of the Philippines Open University

Apart from any fair use for the purpose of research or private study,
criticism or review, this publication may be reproduced, stored
or transmitted, in any form or by any means
ONLY WITH THE PERMISSION
of the author and the UP Open University.

Published in the Philippines by the UP Open University

Office of Academic Support and Instructional Services
2/F National Computer Center
C.P. Garcia Avenue, Diliman, Quezon City 1101
Telephone 63-2-426-1515
Email [email protected]

First printing, 2012

Layout by Cecilia Geronimo-Santiago

Printed in the Philippines

 Table of Contents

Module 1 Overview of Accounting

Accounting as the Language of Business, 2

Accounting Principles Board, 2
American Institute of Certified Public Accountants (AICPA), 3
American Accounting Association (AAA), 3
Functions of Accounting, 3
Recording Function, 4
Classifying Function, 4
Summarizing Function, 4
Interpreting Function, 4
What are the Types of Accounting Information?, 5
How is Accounting Information Used as a Tool in the Business Functions?, 5
Who are the Users and for What Purpose Do they Use Accounting
Information?, 7
What are the Different Forms of Business Organization?, 8
What are the Different Types of Business Operations?, 9
ASAQs, 10
References, 11

Module 2 Basic Financial Statements

What is a Balance Sheet (Statement of Financial Position)?, 14

What are the Elements of a Balance Sheet?, 15
What is an Income Statement (Statement of Comprehensive Income)?, 16
What is a Statement of Cash Flows?, 16
What is a Statement of Changes in Equity?, 17
What are Notes to Financial Statements?, 18
Relationships among the Financial Statements, 18
Income Statement, 18
Balance Sheet, 18
Statement of Cash Flows, 19
Account Titles and Classification, 20
Assets, 20
Liabilities, 21
Owner’s Equity/Capital, 21
Income, 21
Expense, 22
ASAQ, 24
References, 24
Module 3 Accounting Equation

Effects of Business Transactions, 27

ASAQs, 34

Module 4 Using Debit and Credit in Recording Transactions

Transaction #1, 36
Transaction #2, 37
Transaction #3, 37
Transaction #4, 38
Transaction #5, 39
Transaction #6, 39
Transaction #7, 40
Transaction #8, 41
ASAQs, 43

Module 5 The Accounting Cycle a) The Journal Entry, Ledger, and

Trial Balance

The Recording Function, 46

The Classifying Function, 50
General Ledger, 53
The Summarizing Function, 54
Trial Balance, 54

Module 5 The Accounting Cycle: b) The Adjustment Process

Posting the Adjustments, 64

The Adjusted Trial Balance, 66
General Ledger, 67
ASAQ, 70

Module 5 The Accounting Cycle: c) Financial Statements,

The Interpreting Function, 72

The Income Statement (Statement of Comprehensive Income), 72
The Statement of Changes in Equity, 74
The Balance Sheet (Statement of Financial Position), 74
ASAQ, 78
Module 5d The Accounting Cycle: d) The Closing Process

Closing the Revenue Account/s, 80

Closing the Expense Accounts, 81
Closing the Income Summary Account, 82
The Post-Closing Trial Balance, 82
Additional Notes to the Closing Process, 83
General Ledger, 85
ASAQ, 87

Module 6 Cash Flow Analysis

The Cash Budget, 90

What is Statement of Cash Flows?, 92
Purposes of Statement of Cash Flows, 92
How are Cash Flows Classified?, 92
References, 96
 Module 1 1

Module 1
Overview of Accounting

A s an entrepreneur, you would want to know what is happening to

your business most especially the financial part. This is when account-
ing comes into the picture. Accounting gives you an idea of how your
business performs financially. Even a simple accounting system can go a
long way if you can understand how it works. This module provides an
introduction to the basic accounting concepts and terminologies.

Objectives
At the end of this module, you should be able to:

1. Define and explain the purpose of accounting;

2. Identify the types of accounting information;
3. Determine how accounting is used as a tool in
business functions;
4. Identify the users of accounting and what they
use accounting for; and
5. Identify the forms of business organizations
and types of business operations.

Before you read the rest of the module, please read the short case found at
the end of this Module (p. 12).

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Case in Point: Rowena Cruz’ Laundry Shop

We learned that Rowena has had problems with the Bureau of Internal
Revenue because she wasn’t knowledgeable about accounting. She now
recognizes the importance of keeping records for compliance with the
agency. But that is not all there is to it. How does accounting really help
the business? What is its purpose? Are there different accounting
information that an entrepreneur/business owner need to know of? Who
are the users of accounting and what do they use it for? Does accounting
vary depending on the form of business organization as well as the type
of business operations?

As you embark on discovering the concepts in this first module, you will
learn the very basics of what accounting is all about. I hope that you will
enjoy your journey!

Let us now look at the different meanings and definitions of accounting.

Accounting As the Language of Business

Accounting is often called the “language of business” because it is so widely
used in every nook and cranny of business activities. Every investor,
manager, and business decision maker needs a clear understanding of
accounting, its terms, concepts, processes, and procedures if he or she is
to participate and communicate effectively in the business community.

There are several definitions of accounting as defined by the different

bodies of the accountancy profession.

Accounting Principles Board

Accounting is viewed by the Accounting Standards Council as a service
activity, the function of which is to provide quantitative information,
primarily financial in nature, about economic entities that is intended to
be useful in making economic decisions—in making reasoned choices
among alternative courses of action. (SFAS No. 1)

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American Institute of Certified Public Accountants

(AICPA)
Accounting is defined as the art of recording, classifying, 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. This is the classic definition for accounting and is the most widely
used and most accepted definition.

American Accounting Association(AAA)

This association gives an encompassing description of what accounting
is. It defines accounting as the process of identifying, measuring, and com-
municating economic information to permit informed judgment and de-
cisions by users of information. The economic entity must be able to rec-
ognize which transactions or activities are accountable or quantifiable,
measure these activities by assigning peso value, and communicate them
by providing reports that can be easily understood by the users of these
information (as cited by Valix and Peralta, 2000).

The basic purpose therefore, of accounting is to provide decision makers

with information useful in making economic decisions. Clearly, accounting
provides financial information about an enterprise and its importance
depends largely on the relevance and timeliness of information it gener-
ates. A businessperson, an entrepreneur, or a manager needs accounting
information so as to make sound business decisions. Should s/he rent or
build a plant site? Should s/he open a new branch or wait until next
year? Should s/he hire or fire people? Should s/he invest additional funds
or look for financial assistance? Wrong decisions could result in a loss of,
or damage to, the firm’s assets. When there is less information available,
there is a higher risk that decisions will go wrong. Accounting clearly
occupies a significant role in the business because it provides that infor-
mation that will reduce the risk of making wrong decisions.

Functions of Accounting
There are four functions of accounting, namely, recording, classifying,
summarizing, and interpreting.

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Recording function
In this function, the business transactions are recorded systematically and
chronologically in the accounting books. This function is popularly known
as “bookkeeping.”

Classifying function
Once the transactions are recorded, items are then “classified” or “sorted”
such that similar transactions are grouped. This makes the next function
easier to prepare.

Summarizing function
Under this, all the recorded transactions for a particular period (e.g.,
annual) are summarized into a readable format, called “financial state-
ments or reports” to make these more meaningful to the readers.

Interpreting function
The reports are then analyzed and interpreted by those who use them.
These reports show a combination of figures and explanations, and may
be presented in percent or ratios. This is a crucial function because read-
ers need to understand the relationships among the figures presented to
be able to make certain decisions about the business.

SAQ 1-1
1. What is the difference between “accounting” and “bookkeep-
ing”?

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What Are the Types of Accounting

Information?
Here are three types of accounting information that you would find use-
ful in making financial decisions. All these are available to you when you
have an accounting system at hand:

1. Financial Accounting
l often called “general purpose” accounting information
l refers to information describing the financial resources, obligations,
and activities of an enterprise.
l designed to help investors and creditors in deciding where to place
their investment resources.
l mainly used for external purposes, e.g., bank loan, tax returns.

2. Management Accounting
l involves development and interpretation of accounting informa-
tion intended specifically to aid management in running the busi-
ness.
l used in setting company goals, evaluating performance of indi-
viduals and departments, and other types of managerial decisions.
l often includes evaluations of “non-financial’ factors, such as po-
litical and environmental considerations, product quality, customer
satisfaction, etc.
l mainly used for internal purposes.

3. Tax Accounting
l accounting information is adjusted or reorganized to conform with
income tax reporting requirements.
l most appropriately called as tax planning, that is, anticipating the
“tax effect” of business transactions and structuring these tran-
sactions in a manner that will minimize the income tax burden.

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Activity 1-1
What type of business operation are you engaged in or are planning
to engage in? What accounting information do you think you would
need with it?

How Is Accounting Information Used As a

Tool in Business Functions?
a. Marketing Function
Marketing uses accounting information to help determine selling prices,
to evaluate alternative distribution channels, and to evaluate market-
ing success, among others.

b. Human Resource Function

Human resource managers use accounting information to determine
employees’ monthly, retirement, and vacation earnings.

c. Operations Function
It uses accounting information to determine the goals of operating
activities (e.g., inventory management) and to evaluate the success or
failure of those activities.

d. Finance Function
Finance uses accounting information to evaluate investment propos-
als, determine the cost of alternative financing strategies, and to man-
age the amount and timing of cash flows.

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Who Are the Users and for What Purpose Do

They Use Accounting Information?
In general, there are two users of accounting information. They are the
internal users – those who make decisions for the business; and external
users – those who make decisions about the business. Further classifica-
tion are hereby presented. Let’s check the table below:

Users of Accounting Information Use the Information for

Internal Users:
Managers/Owner-managers Evaluation of past results; formulation of
new plans and strategies, and internal
control measures
External Users:
Current and potential investors Identification and evaluation of investment
opportunities; monitoring the performance
of existing investments
Current and potential creditors Decision whether to extend credit and
how much to lend
Investment advisors and economists Forecast of future performance of
companies, industries, and the economy
Major customers Evaluation of the financial ability of a
business to complete long-term projects
and/or to service its products
Current and prospective employees Analysis of the employers’ ability to pay
wages and salaries
Competitors Formulation of competitive strategies
Governmental regulatory agencies Formulation of regulatory and tax
policies
The media Report on business and the economy
in general
Students Learning about business and economics
The general public Exercise of its “right to know” about
those institutions that affect the economy

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SAQ 1-2
Try to identify the user/s of accounting information who may be in-
terested in:

1. Net profit for the year

2. 13th month pay

3. Taxes to be paid

4. Ability to pay loans

5. Volume of production

Now that you have a basic idea of what accounting is and what it is used
for, let’s take a look at the different forms of business organizations as
well as the different types of business operations. These are important
considerations in accounting because different forms of business organi-
zations will have different accounting for ownership. In the same way,
accounting for some transactions will vary with each type of business
operations.

What Are the Different Forms of Business

Organization?
Business organization refers to the structure and ownership of the business.
There could be one or many who own or manage the business.

1. Sole Proprietorship
This is a business registered to a single person. This is the most common
form of business organization especially those in the micro-level and small-
scale enterprises. Entrepreneurs usually start with this form and later
reorganize when the business expands.

2. Partnership
This form of a business is owned by two or more persons who voluntarily
contribute money, property and/or industry. The profit of the enterprise
is divided between the two or among the many involved according to a
specified agreement. There are legal provisions on the formation of the

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partnership, including requiring it to provide Articles of Partnership

and By-Laws.

3. Corporation
A corporate type of business organization is governed by law specifi-
cally the Corporation Code of the Philippines. Ownership is in the
form of shares of stocks and owners are called the stockholders. It
may be privately owned such as those family-owned corporations or
it can be publicly owned, whereby the shares of stocks are traded in
the stock market.

4. Cooperative
This is a type of business organization whose existence is primarily to
produce goods and services for its members. The member-owners
manage the cooperative and whatever is the profit/surplus is divided
and distributed among the members. But just like a corporation, it is
governed by its own code, of which the Cooperative Code (R.A. 9520)
and the Cooperative Development Authority (CDA) are the govern-
ing agency.

What Are the Different Types of Business

Operations
Business operation refers to the nature in which the enterprise conducts
business. There could be a product or service involved or a combination of
both.

1. Service Business
This is an organization whose income is derived from providing
services. Common examples are repair shops, beauty parlors and spas,
educational institutions, and those offering professional services (e.g.,
lawyers, doctors, architects)

2. Trading or Merchandising or Buy-and-Sell Business

This is an enterprise engaged in the buying and selling of merchan-
dise. The traditional sari-sari store is an example. If we go to a mall,
we could find all sort of boutiques and shops engaged is this type of
business. Can you name one example?

3. Manufacturing
This type of business buys raw materials and converts or processes
these into finished goods which will be sold to the public. Factories
and processors are classified under this type, whether industrial (e.g.,
car manufacturing) or agricultural (e.g., poultry raising)

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Try the exercise below.

SAQ 1-3
Listed below are businesses often engaged in by small-scale entre-
preneurs. Identify the type of business operation where each one
belongs.

1. grocery store/sari-sari store

2. barber shop

3. automobile repair shop

4. animal feeds and supply store

5. organic farming

You may want to refer to the answers below.

Congratulations! You finished our first module. Way to go!

Answers to Self-Asssessment Questions

ASAQ 1-1
Accounting encompasses the four functions of accounting, namely: re-
cording, classifying, summarizing, and interpreting while bookkeeping is
only a part of accounting, that is, the recording function.

ASAQ 1-2
1. Current and potential investors, owner/manager, investment advisors
2. Current and prospective employees
3. Government agencies, tax authorities
4. Current and potential creditors
5. Major customers, owner/manager

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ASAQ 1-3
1. trading/merchandising
2. service
3. service
4. trading/merchandising
5. manufacturing

References

Accounting Standards Council. (1995). Compilation of statements of financial

accounting standards.
Ainsworth, P., D. Daines. (2004). Introduction to accounting, an integrated
approach. 3rd edition. McGrawhill, Inc.
Arganda, A. et. al. (1991). Accounting principles. Revised Edition. National
Bookstore, Inc.
Ascan, T.C. (2005). Syllabus in Management 111 (Principles of accounting). J.D.
Drilon Faculty Grant. UP Los Banos, College, Laguna.
Echanis, E.S., R.A. Rodriguez. (2001). Fundamentals of management: Text and
Philippine cases. 4th edition. Diwata Publishing Inc.
Entrepreneur Philippines. (2008). Accounting 101 for small businesses. A step-
by-step, easy-to-use guide. Summit Publishing Co. Inc.
Frias. S. A. (2001). Introductory accounting. 1st edition. Busybook Distributors.
Harrison, W. T. Jr., C. T. Horngren. (2004). Financial accounting. 5th edition.
Pearson Education International.
http://www.aicpa.org/
http://www.accountingexplanation.com/
http://www.ifrs.org
http://picpa.com.ph
Horngren, C.T. et. al. (2002). Accounting. 5th edition. Prentice Hall Inter-
national.
Meigs, R.F. et. al. (1996). Accounting: The basis for business decisions. 10th
edition. McGrawhill, Inc.
Meigs, R.F., W.B. Meigs., M.A. Meigs. (1995). Financial accounting. 8th
edition. McGrawhill. Inc.
R.A 9520. The New Cooperative Code of the Philippines.
Statement of Accounting Principles Board No. 4, “Basic Concepts and Account-
ing Principles Underlying Financial Statements of Business Enterprises”.
New York American Institute of Certified Public Accountants, 1970), par.
40.
Stice, J.D. et al. (2007). Intermediate accounting 16th ed. Thomson Learning
Asia.
Valix, C.T., J.F. Peralta. (2000). Financial accounting Volume 1. Rex Publish-
ing.

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12 Simplified Accounting for Entrepreneurs

Why Entrepreneurs Need Accounting

Case in point:

Rowena’s Laundry Shop

Rowena Cruz started a laundry shop using an extra space in her residence.
She thought that since she stays at home, she might as well earn by provid-
ing laundry service in her area. She thought that it would be a good business
since she lives in a middle-class subdivision where most of the residents are
working and do not have the time to do their own laundry. She started with
only one laundry equipment and hired a helper to assist her in the business.

It proved to be a success as it had developed enough customers to generate a

comfortable income. However, Rowena noticed that while business is good,
she is always short of cash when it’s time to shop for supplies or pay for other
expenses. She also did not have an idea how much is she making monthly.
She thought that maybe her pricing was too low or that she maybe using
more supplies that what should be.

As most small and home-based businesses are, Rowena maintained only

a small notebook to record all her purchases and other transactions. But
because she sometimes forgot to record, she was unable to keep track of
where all the funds have been going, including those cash receipts from
the business that she somehow used pay for personal groceries and those
that she gave her children as “baon” for school.

Her biggest concern happened when she was tax mapped by the BIR. She
was asked to show her book of accounts but she could not show them
any, save for the small notebook that she kept. She had to pay a penalty
for this. This made her think of maintaining a record which will not only
comply with the BIR, but also to know how the business is really doing.

For entrepreneurs like Rowena, they must have a good knowledge on

where and when the money is coming in and going out. A good way to
know is to keep a reliable record of income and expenses that can be
reviewed on a regular basis. This is where accounting would fill the need.

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Module 2
Basic Financial Statements

F inancial statements give the entrepreneurs information about the

profitability, financial condition, and cash flow of a business. While
preparing the financial statements is not the first step in the accounting
process, it is a more logical point at which to begin our study. This is
because financial statements summarize the hundreds or even thousands
of transactions recorded during the year in the company’s financial books.
Financial statements are in a way the end product of the accounting pro-
cess.

Objectives
At the end of this module, you should be able
to:

1. Identify the basic financial statements

and understand their format;
2. Classify and explain the elements of a
balance sheet and income statement;
3. Show the relationship among the finan-
cial statements; and
4. Identify common accounts used in
preparing financial statements.

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Before you read the rest of the module, please read the following short
case.

Case in Point: Rowena Cruz’ Laundry Shop

Why does Rowena need to understand the different financial state-

ments? What do these reports tell? How do they help Rowena make
business decisions? Will they make her a better business person?

In this module you will be exposed to the different types of financial

statements, their purpose, uses, and how they are related to each
other.

Based on the new Philippine Accounting Standards and the IFRS for SMEs,
a complete set of financial statements of an entity shall include all the
following:

1. Statement of Financial Position (commonly known as Balance Sheet)

2. Statement of Comprehensive Income (commonly known as Income
Statement)
3. Statement of Cash Flow
4. Statement of Changes in Equity
5. Notes to Financial Statements

To simplify our discussion, let us use the common and more popular names
of the first two financial statements.

Let us look at each financial statement more closely.

What is a Balance Sheet (Statement of

Financial Position)?
A balance sheet shows the financial position of the business as of a
specific date. It indicates the resources that it owns (Assets), the debts
that it owes (Liabilities), and the amount of the owner’s equity in the
business (Owner’s Equity/Owner’s Capital). This is now termed as State-
ment of Financial Position.

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What are the elements of a Balance Sheet?

a. Assets
These are economic resources that are owned by a business and are
expected to benefit future operations. Assets are normally grouped
into:

Currents assets – those that can be converted into cash within 1 year
or within the normal operating cycle of the business.

Fixed Assets – assets that are permanent in nature. It means that

their useful life to the business exceeds beyond 1 year. These assets
are used in the operation of the business and not intended for sale.

Long-term Investments – investments held for purposes of regular

income, appreciation, or ownership control.

Intangible Assets – these are long term rights and privileges of a non-
physical character acquired for use in business operations.

Other Assets – assets that do not fall within conventional categories

mentioned above. Included in this category are items such as long-
term prepaid expenses and obsolete equipment held for resale at an
indefinite future date.

b. Liabilities
These are economic obligations of a business, arising from past events,
to a party known as the creditor. Liabilities may be classified as:

Current Liabilities – those that are due for payment within 1 year or
within a short period of time; and

Long-term Liabilities – those that mature beyond one year from

balance sheet date.

c. Equity/Owner’s Equity or Net Assets

It shows the residual interest of the entrepreneur (your ownership) on
the business. It is what is left when all liabilities are deducted from the
total assets.

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What is an Income Statement (Statement of

Comprehensive Income)?
An income statement shows the results of operation of the business for a
specified period of time. It indicates the revenues earned and the expenses
incurred by the business in the conduct of its operations.

What are the “basic elements” of an Income Statement?

a. Revenue/Income
It represents inflows of cash or other assets arising from the rendering
of service or the sale of goods to customers.

b. Expenses
These include outflows of cash or those incurred in the process of
producing the revenue.

The term Statement of Comprehensive Income is coined to include the

following additional elements: (Statement of Financial Accounting
Concepts No. 6.)

c. Gains
These are increases in equity (net assets) from peripheral or incidental
transactions of an entity and from all other transactions, and other
events and circumstances affecting the entity.

d. Losses
These are decreases in equity from peripheral or incidental tran-
sactions of an entity and from all other transactions, and other events
and circumstances affecting the entity.

What is a Statement of Cash Flows?

A Statement of Cash Flows shows the cash movements (inflows and out-
flows) of a business entity during the accounting period. It provides informa-
tion regarding the enterprise’s operating, investing, and financing activities.
As you may well be aware of, business activities may either result in a net
cash inflow (receipts greater than payments) or net cash outflow (payments
greater than receipts). The statement of cash flows shows the net increase or
net decrease in cash during the period and the cash balance at the end of the
period.

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What can you see in a Statement of Cash Flows?

Statement of Cash Flows is divided into three activities, namely:

a. Operating Activities

Operating activities are those transactions that result from the earn-
ing process of the company. Operating activities are the lifeblood of
the business and the main source of your revenues. Cash inflows are
primarily from customers though cash also increases due to interest
and dividends received by the company. Cash outflows from operat-
ing activities result from payments made for operating expenses,
including purchase of inventory.

b. Investing activities

Investing activities involve the acquisition and disposal of property

and equipment; these also include other long-term investments.
Investing activities come from the transactions pertaining to the fixed
asset portion of the balance sheet and one can obtain information by
looking at the changes in the related fixed assets during a given
period.

c. Financing activities

Financing activities involve borrowing from and repaying creditors,

raising funds from owners (as an additional investment), and distrib-
uting funds to owners (as a result of profit or personal withdrawal
made by the owner).

We will further explore cash flows analysis in a separate module. Let us

now look at how these financial statements relate to each other.

What is a Statement of Changes in Equity?

This statement shows the investments made by owners, the profits earned
or loss incurred for a reporting period, distributions made to the owners,
effects of changes in accounting policies, and other prior period adjust-
ments. This presents how the investments of the owners fared over time.

The elements under this statement include the following:

l Investment by Owners
They are increases in equity resulting from transfers to it from or an
increase in ownership interests in it.

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l Distribution to Owners
They are decreases in equity resulting from transferring assets or
incurring liabilities by the enterprise to owners. They decrease owner-
ship interests in an enterprise.

l Comprehensive Income
This is the change in equity of a business enterprise during a period
from transactions and other events. This is simply the profit (or loss)
resulting from the business for a period of time.

What are Notes to Financial Statements?

These contain information in addition to what is presented in the four
financial statements mentioned above. It provides a narrative description
of the items presented in those statements, including disclosures such as
significant accounting policies, and other information relevant to under-
standing the financial statements.

Relationships among the Financial

Statements
Income Statement
1. It reports all revenues and all expenses during the period.

2. It reports net income or net profit for the period if the total revenues
exceed total expenses. If the total expenses exceed total revenues, a
net loss is reported instead.

Balance Sheet
1. It reports all assets, all liabilities, and owner’s equity at the end of the
period.

2. It shows that the total assets equals the sum total of liabilities plus
total owner’s equity.

3. It reports the owner’s ending capital balance.

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Statement of Cash Flows

1. It reports cash flows from three types of business activities (operating,
investing, and financing activities) during the period.

2. Each type of cash-flow activities includes both cash receipts, which

are positive amounts, and cash payments, which are negative amounts
(denoted by parentheses). Each activity results in either a net cash
inflow or a net cash outflow for the period.

3. It reports a net increase or net decrease in cash during the period and
ends with the cash balance at the end of a particular period. This is
the amount of cash that is also reported on the balance sheet.

Sample Financial Statements are available in our course site. Be sure that
you download them and study them. Take note of how these are related
to each other.

Activity 2-1
1. Look at the sample financial statements. Compare the value of the
financial statements. Do you think that one is more informative
than the others? As an entrepreneur, which do you think would
be most useful to you? Why?

2. If you own a business, look at your financial statements. Do you

have the complete set as now required by the Philippine Ac-
counting Standards? How are they useful to you in terms of
decision making?

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Account Titles and Classification

To be able to prepare the statements, you need to get familiar with the
different account titles that you will use in recording the transactions.
These accounts form part of the business’ Chart of Accounts which you
will learn about in the next modules. The list of different account titles
shown below is not exhaustive, but the more common ones are given.

Assets
Cash on Hand This includes coins, currency, checks, and
other cash equivalents owned by the business
and not yet deposited in the bank.
Cash in Bank This includes cash deposited in savings or in
a current account.
Account Receivable These are amounts due from customers,
arising from goods sold or services rendered
on credit.
Notes Receivable This include amount due from customers/
others that are supported by promissory notes.
Merchandise Inventory These are goods or stocks purchased by the
business to be sold at a profit.
Supplies These are supplies bought but are unused as
(e.g., Office Supplies, of balance sheet date.
Laboratory Supplies,
Medical Supplies)
Prepayments These are expenses paid in advance.
(e.g. Prepaid Rent,
Prepaid Insurance)
Furniture & Fixtures These include tables, chairs, cabinets, and
other assets of similar nature.
Land This is real property owned by the business.
Buildings This refers to the physical structure on the
land.
Equipment This is equipment used by the enterprise in
(e.g., Office Equipment, the conduct of its business.
Laboratory Equipment,
Agricultural Equipment)
Accumulated This is a special valuation account that reduces
Depreciation the total cost of fixed assets.

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 Module 2 21

Liabilities
Accounts Payable These refer to amounts due to creditors for the
goods or services bought on credit.
Accrued Expense This is a liability arising from unpaid expense
Notes Payable This refers to amounts due to creditors
supported by promissory notes.
Interest Payable This refers to interest that has accrued, but has
not yet been paid.
Salaries Payable This includes amounts paid to employees for
services they rendered.
Income Tax Payable This refers to amounts due to government
agency (e.g., BIR) for taxes incurred.

Owner’s Equity/Capital
Owner’s Capital This refers to the amount of capital contribu
(e.g., Rowena Cruz, tions of the owner or owners to the business.
Capital)
Capital Stock This refers to the amount of capital contribu-
tions by investors of a corporation
Owner’s Drawing This refers to the amount withdrawn by the
(e.g., Nena Cruz, owner from the assets of the business
Drawing) for personal use.

Income
Sales This refers to total sales of merchandise sold.
Professional Fees This refers to amounts earned by professionals
(e.g., lawyer, CPA, doctor) for services they
render.
Rent Income This refers to amounts of rental earned for
the period.
Service Income This refers to amounts of income earned from
services rendered.
Interest Income This refers to amounts earned for lending
money.

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22 Simplified Accounting for Entrepreneurs

Expense
Cost of Sales/Cost of This is the cost of goods purchased and sold
Goods Sold or materials manufactured and sold.
Advertising Expense This includes expenses incurred to promote
product of the business.
Salaries Expense This refers to the amount paid to employees
Utilities Expense This refers to the amount of light and water
consumed by the business
Repairs & Maintenance This refers to expenses incurred for repairing
the assets of the business.
Bad Debts Expense This refers to the estimated amount of losses
from uncollectible accounts of the business.
Depreciation Expense This is the allocated cost of fixed asset in the
current period.
Taxes & Licenses This includes duties incurred in the current
period (e.g., mayor’s permit, vat registration,
municipal taxes).
Transportation/ This refers to fare for trips and travels; or
Travel Expense the cost of gasoline, and oil used by the business
Representation Expense This refers to amount paid to restaurants, hotels,
etc., for expenses incurred from providing refresh-
ments, accommodations and similar items to treat
customers.
Interest Expense This interest incurred on debts or other
monetary obligations.

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 Module 2 23

Answer the self-assessment question below.

SAQ 2-1
Classify the following according to whether each is an Asset,
Liability, Equity, Income, or Expense:

1. Land 6. May Santos, Capital

2. Salaries payable 7. Taxes and Licenses

3. Rent Expense 8. Service Revenues

4. Accounts Receivable 9. Note payable

5. Sales 10. Equipment

Answer key is on the next page.

Now let’s have an online exercise! Go to Myportal and open the link
provided in the course site.

Good luck!

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24 Simplified Accounting for Entrepreneurs

Answers to Self-Assessment Question

ASAQ 2-1
1. Asset 6. Equity
2. Liability 7. Expense
3. Expense 8. Income
4. Asset 9. Liability
5. Income 10. Asset

References

Ascan, T.C. (2005). Syllabus in management 111 (Principles of Account-

ing). J.D. Drilon Faculty Grant. UP Los Banos, College, Laguna.
Frias. S. A. (2001). Introductory Accounting. 1st edition. Busybook Distri-
butors.
Meigs, R.F., W.B. Meigs., M.A. Meigs. (1995). Financial Accounting. 8th
edition. McGrawhill. Inc.
Harrison, W. T. Jr., C. T. Horngren. (2004). Financial accounting. 5th edition.
Pearson Education International.
Horngren, C.T. et. al. (2002). Accounting. 5th edition. Prentice Hall Inter-
national.
http:// www.ifrs.org
International Financial Accounting Standards for SMEs. (2009). Inter-
national Accounting Standards Board.
Statement of Accounting Principles Board No. 6. pp.ix-x.
Stice, J.D. et al. (2007). Intermediate accounting 16th ed. Thomson Learning
Asia.

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 Module 3 25

Module 3
Accounting Equation

A re you excited? This module is the first step in understanding the

accounting process particularly the double-entry system. You will
learn that every transaction affects two accounting elements. This can be
expressed in the accounting equation. But don’t worry, the accounting
equation is very simple and you don’t have to be a math wizard to under-
stand it.

In this module, we are going to discuss the

accounting equation and the effects of business
Objectives
transactions on the accounting equation.
At the end of this module,
Let us start by identifying the accounting you should be able to:
elements involved in the accounting equation.
These are Assets, Liabilities, and Capital or 1. State the accounting
Owner’s Equity. equation; and
2. Identify the effects of
Assets are things of value or those things that business transactions on
the business owns; the accounting equation.
Liabilities are things owed or obligations by
the business to the third parties; this tech-
nically means that your supplier or your bank creditor owns a piece of
your business;
Capital or Owner’s Equity shows the resources supplied by the owner to
the business.

Accounting equation can then be expressed as:

Assets = Liabilities + Capital

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26 Simplified Accounting for Entrepreneurs

The equation shows the relationship among the assets, liabilities, and the
capital accounts. Assets appear on the left side of the equation while
liabilities and owner’s equity appear on the right side. It’s that simple.

The total figure for assets always equals the total of liabilities plus the
owner’s equity.

But why do total assets have to equal the total liabilities and owner’s
equity? Do you want to know the answer?

Ok then, here it is: The two sides are always equal because they are merely
two views of the same business property. The listing of assets shows us
what things the business owns, while the listing of liabilities and owner’s
equity tells us who supplied these resources and how much each group
supplied. Remember that everything a business owns has been supplied
to it by the creditors or by the owners. And so, the total claims of the
creditors plus the claims of the owners equal the total assets of the busi-
ness.

How’s that so far?

I’ll give you an example. Suppose you start a business. You have in your
possession some cash amounting to Php50,000 which you invested using
your savings. You bought a piece of equipment worth Php20,000 which
you got on credit. How would you express using the accounting equa-
tion?

The answer: Assets = Liabilities + Owner’s Equity

Php 70,000 = Php20,000 + Php50,000

Your assets totaling Php70,000 are: your cash, Php50,000; and your equip-
ment, Php20,000. Your liabilities of Php20,000 come from buying the equip-
ment on credit. Your equity is the amount of cash you invested in the
business.

Can you follow? I hope you can now see the relationship among the three.

It is also important to remember that regardless of whether the business

grows or contracts, this equality is always maintained. Any increase in
the amount of total assets is necessarily accompanied by an equal increase
on the other side of the equation, that is an increase in either the liabilities
or the owner’s equity. Any decrease in the amount of total assets would
be accompanied by an equal decrease in either liabilities or the owner’s
equity.

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 Module 3 27

We shall deal with this continuing equality when we go to the effects of

business transactions on the accounting equation.

Effects of Business Transactions

You are already familiar with the accounting equation. Now, every busi-
ness transaction no matter how simple or complicated, can be expressed
in terms of its effect on the accounting equation.

Let us use an example to illustrate these effects. We will use a brand-new

business to make it simpler.

Let us take a look at the case of Rowena Cruz – the lady who started a
laundry shop. Her services include wash and fold, and dry cleaning. Let’s
go over the transactions that her business engaged in during the month of
March.

Her first eight transactions for the month of March include:

March 1 Deposited Php300,000 in the bank as her initial investment.

March 2 Purchased laundry equipment for Php150,000. Her credi-
tor gave her 15 days to pay.
March 5 Purchased laundry supplies in cash, Php8,000.
March 9 Paid rent for the month, Php3,500.
March 12 Paid the creditor partially, Php90,000 for March 2 pur-
chase.
March 14 Performed laundry services for the day, amounting to
Php3,000.
March 15 Paid the salary of the assistant, Php1,500.
March 17 Accepted the provision of laundry service to a hotel,
amounting to Php7,000. Payment will be made by the ho-
tel after 3 days.

Let us now analyze the effects of these transactions on the accounting

equation.

March 1 transaction:

Her first transaction includes a deposit of cash in the bank. This creates
an asset, cash, and also creates an owner’s equity in the business. The
accounting equation after this initial transaction looks like this:

Assets = Liabilities + Owner’s Equity

Cash Php 300,000 Php 300,000

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28 Simplified Accounting for Entrepreneurs

Assets increase by Php300,000 while the owner’s equity side increases by

the same amount.

The effect of this transaction is an increase in asset and an increase in the

owner’s equity.

March 2 transaction:

The second transaction includes a purchase of laundry equipment. This is

on account, which means on credit. The laundry equipment increases the
asset side. At the same time, it creates a liability since no payment has yet
been made. The accounting equation looks like this:

Assets = Liabilities + Owner’s Equity

Equipment Php150,000
Php 150,000

Assets increase by Php150,000 and liability also increases by the same

amount.

The effect of this transaction is an increase in asset and an increase in

liability.

March 5 transaction:

The next transaction involves purchase of laundry supplies with cash.

Both are asset accounts, cash and supplies. While cash decreases as a
result of payment for supplies, the same amount increases the supplies
account. This transaction merely converts one asset into another of equal
value. You will notice that there is no change in the right side of the equa-
tion.

Assets = Liabilities + Owner’s Equity

Supplies Php 8,000
Cash (Php 8,000)

Please take note that a decrease in value of an accounting element is

presented within a pair of parentheses as in this case, whereby the value
of cash is enclosed in parenthesis.

Assets in the form of supplies increase by Php8,000 while Cash, which is

also an asset, decreases by Php8,000.

The effect of this transaction is an increase in one form of asset and a

decrease in another form of asset.

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 Module 3 29

March 9 transaction:

The fourth transaction involves payment of rental expense. An expense

reduces the owner’s equity account. This also decreases an asset account,
cash, by the same amount. The accounting equation looks like this:

Assets = Liabilities + Owner’s Equity

Cash ( Php 3,500) Rent Expense (Php 3,500)

Assets decrease by Php3,500 as a result of payment of rentals. Owner’s

equity also decreases because of this expense.
The effect of this transaction is a decrease in asset and a decrease in owner’s
equity.

March 12 transaction:

The fifth transaction pays the liability that was created on March 2. This
transaction reduces both the asset and the liability sides by the same
amount. The accounting equation looks like this:

Assets = Liabilities + Owner’s Equity

Cash ( Php90,000) ( Php 90,000)

Assets are decreased by Php90,000 and the liability side also decreases by
the same amount as a result of payment to creditor.
The effect of this transaction is a decrease in asset and also a decrease in
liability.

March 14 transaction:

The next transaction has something to do with performing the service of

the business. This transaction creates a revenue account and increases the
owner’s equity account. It also increases the asset side because cash has
been received as a result of performing the service. The accounting equa-
tion looks like this:

Assets = Liabilities + Owner’s Equity

Cash Php 3,000 Service Revenue
Php 3,000

Assets are increased by Php3,000 and the owner’s equity also increases
by the same amount. The effect of this transaction is an increase in asset
and an increase in owner’s equity.

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30 Simplified Accounting for Entrepreneurs

March 15 transaction:

The seventh transaction involves paying the salary of the assistant. Just
like in the fourth transaction, an expense is created and therefore reduces
the owner’s equity account. Payment of salary also reduces the asset,
cash. The accounting equation looks like this:

Assets = Liabilities + Owner’s Equity

Cash ( Php 1,500) Salary Expense
(Php 1,500)

Assets decrease by Php1,500 as a result of payment of rentals. Owner’s

equity also decreases because of this expense. The effect of this tran-
saction is a decrease in asset and a decrease in owner’s equity.

March 17 transaction:

The last transaction is similar to the transaction on March 14, which is

performing the service of the business. The only difference is that pay-
ment is not yet received but creates a claim against the client, the hotel.
This again creates a revenue for the business which increases the owner’s
equity account. On the other side of the equation, the claim represents a
new account called account receivable which means that collection of
cash will take place at some future date. The accounting equation looks
like this:

Assets = Liabilities + Owner’s Equity

Account Receivable Service Revenue
Php 7,000 Php 7,000

The asset called account receivable increases by Php7,000 while the owner’s
equity account also increases as a result of the revenue derived from the
service performed.

The effect of this transaction is an increase in asset and an increase in

owner’s equity.

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 Module 3 31

If we all put this together, you will see something like this:

Date Assets = Liabilities + Owner’s Equity

March 1 300,000 300,000
2 150,000 150,000
5 8,000
-8,000
9 -3,500 -3,500
12 -90,000 -90,000
14 3,000 3,000
15 -1,500 -1,500
17 7,000 7,000
Balances 365,000 60,000 305,000

The balances were computed by totaling all the amounts of all the trans-
actions that were entered in the accounting equation.

The balances show that assets total Php365,000 as shown on the left side
of the equation, while total liabilities amount to Php60,000 plus the owner’s
equity of Php305,000, equals Php365,000.

In summary, we could say that the following are the effects of business
transactions on the accounting equation:

ü An increase in asset with a corresponding increase in owner’s equity.

ü An increase in asset with a corresponding increase in liability.
ü An increase in one form of asset and a corresponding decrease in
another asset.
ü A decrease in asset with a corresponding decrease in owner’s equity.
ü A decrease in asset with a corresponding decrease in liability.

You can always go back and review the examples. Once you become
familiar with the effects of the transactions, it will be easier for you to
analyze them.

If you have an existing business, you can start by identifying your busi-
ness transactions and apply their effects on the accounting equation. Re-
member, practice makes perfect.

Use the following exercises to hone your skills.

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32 Simplified Accounting for Entrepreneurs

SAQ 3-1
Compute the missing amount on the following transactions:

Remember the Accounting Equation: Asses = Liabilities + Capital/

Owner’s Equity

1. If the liabilities and the capital of an enterprise amount to

Php80,000 and Php100,000, respectively, what is the total
amount of the assets owned?

2. If the assets and the capital of an enterprise amount to

Php140,000 and Php70,000, respectively, what is the total
amount owed to the creditors?

3. If the assets and liabilities of an enterprise amount to Php170,000

and Php90,000, respectively, what is the amount of the owner’s
capital?

4. If the total assets of the company amount to Php100,000 and

the company has no liability, what is the total owner’s capital?

5. If the total owner’s equity of the company amounts to

Php300,000 and is equal to one-third of the total assets, what is
the amount of total liabilities?

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 Module 3 33

Let’s have another set. Try to answer the items in this set before looking
at the answer key found on the next page.

SAQ 3-2
Identify the effects of the following transactions on the assets,
liabilities, and capital by placing a plus (+) sign for increase, a
minus (-) sign for decrease, and NE for no effect on the spaces
provided. Remember that you should have answers entered for
every row and column in the table below.

TRANSACTIONS ASSETS LIABILITIES CAPITAL

1. Invested cash and

office furniture

2. Collected cash from

customer

3. Purchased equipment on
credit

4. Paid the assistant’s

salary

5. Billed a customer for

services rendered

6. Paid the telephone bill

7. Paid the account due in

no. 3

8. Purchased supplies
using cash

9. Received payment from

customer in no. 5

10. Withdrew cash from the

business for personal
use

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34 Simplified Accounting for Entrepreneurs

Answers to Self-Assessment Question

ASAQ 3-1
1. Php 180,000
2. Php 70,000
3. Php 80,000
4. Php 100,000
5. Php 600,000

ASAQ 3-2

Transactions ASSETS LIABILITIES CAPITAL

1 Invested cash and office
furniture + NE +
2 Collected cash from
customer + NE +
3 Purchased equipment on
credit + + NE
4 Paid the assistant’s salary - NE -
5 Billed a customer for services
rendered + NE +
6 Paid the telephone bill - NE -
7 Paid the account due in no. 3 - - NE
8 Purchased supplies for cash +/- NE NE
9 Received payment from
customer in no. 5 +/- NE NE
10 Withdrew cash from the
business for personal use - NE -

If you’re still having trouble, review the module again. You don’t have to
get it all at once. Take your time.

When you are ready, go to Myportal for our online quiz. Good luck!

UP Open University
 Module 4 35

Module 4
Using Debit and Credit in
Recording Transactions

W e will now have an application of the rules

of debit and credit on business tran-
sactions. The rules make it easy to accumulate
Objectives
all information about changes in each account- At the end of this module,
ing element. They determine the increases or you should be able to:
decreases of accounts and become the bases for
recording transactions. 1. Enumerate and apply
the rules of debit and
Be sure that you have thoroughly read the text credit; and
provided to you. Supplementary materials are 2. Use the rules debit and
available in our course site. credit in analyzing
transactions.
Before we start and as a review, the rules of
debit and credit are as follows:

Debit Credit

Increase in assets Decrease in asset

Decrease in liability Increase in liability
Decrease in owner’s equity Increase in owner’s equity
Increase in owner’s withdrawal Decrease in owner’s withdrawal
Decrease in revenue Increase in revenue
Increase in expense Decrease in expense

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36 Simplified Accounting for Entrepreneurs

Remember that each transaction affects at least two elements. One will be
recorded as debit and another as credit.

Now, to illustrate the rules of debit and credit, we will use the same trans-
actions in the accounting equation module. These transactions pertain to
the laundry business of Mrs. Rowena Cruz.

Here are the transactions again:

March 1 Deposited Php300,000 in the bank as her initial investment.

March 2 Purchased laundry equipment for Php150,000. Her credi-
tor gave her 15 days to pay.
March 5 Purchased laundry supplies in cash, Php8,000.
March 9 Paid rent for the month, Php3,500.
March 12 Paid the creditor partially, Php 90,000 for March 2 pur-
chase.
March 14 Performed laundry services for the day, amounting to
Php3,000.
March 15 Paid the salary of the assistant, Php1,500.
March 17 Accepted the provision of laundry service to a hotel, amount-
ing to Php7,000. Payment will be made by the hotel after 3
days.

Transaction No. 1:

Mrs. Rowena Cruz deposited Php300,000 in the bank as her initial invest-
ment.

Here is the analysis:

The asset, cash, increased by Php300,000 and Mrs. Cruz’s capital account
increase by the same amount.

If we apply the debit and credit rule, this is how it is done:

Increases in assets are recorded by debit, so debit cash, Php300,000;

Increases in capital are recorded by credit, so credit Mrs. Cruz, Capital,
Php300,000.

What you will see in the ledger is this:

Cash
Debit Credit
300,000

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 Module 4 37

Mrs. Cruz, Capital

Debit Credit
300,000

Transaction No. 2:

She purchased laundry equipment for Php150,000. Her creditor gave her
15 days to pay.

Here is the analysis:

The asset, equipment, increased by Php150,000 and a liability account is

created and therefore increased by the same amount.

Applying the debit and credit rule is like this:

Increases in assets are recorded by debit, so debit equipment, Php150,000;

Increases in liability is recorded by credit, so credit account payable,
Php150,000.

What you will see in the ledger is this:

Equipment
Debit Credit
150,000

Account Payable
Debit Credit
150,000

Transaction No. 3:

Rowena Cruz purchased laundry supplies for cash, Php8,000.

Here is the analysis:

The asset, supplies, increased by Php8,000 and the asset, cash, decreased
by the same amount.

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38 Simplified Accounting for Entrepreneurs

If we apply the debit and credit rule, it looks like this:

Increases in asset are recorded by debit, so debit supplies, Php8,000;

Decreases in asset are recorded by credit, so credit cash, Php8,000.

What you will see in the ledger is this:

Supplies
Debit Credit
8,000

Cash
Debit Credit
8,000

Transaction No. 4:

Mrs. Cruz paid rent for the month, Php3,500.

Here is the analysis:

The expense account, Rent increased by Php3,500 and the asset Cash
decreased by the same amount.

Applying the debit and credit rule would show this:

Increases in expense are recorded by debit, so debit rent expense, Php3,500;

Decreases in asset are recorded by credit, so credit cash, Php3,500.

What you will see in the ledger is this:

Rent Expense
Debit Credit
3,500

Cash
Debit Credit
3,500

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 Module 4 39

Transaction No. 5:

Mrs. Cruz paid the creditor partially, Php 90,000 on March 2 purchase.

Here is the analysis:

The liability account decreased by Php90,000 and the asset, cash, decreased
by the same amount.

The debit and credit rule shows that:

Decreases in liability are recorded by debit, so debit account payable,

Php90,000;

Decreases in asset are recorded by credit, so credit cash, Php90,000.

What you will see in the ledger is this:

Account Payable
Debit Credit
90,000

Cash
Debit Credit
90,000

Transaction No. 6:

Mrs. Cruz business performed laundry services for the day, amounting to
Php3,000.

Here is the analysis:

The asset, cash increased by Php3,000 and the revenue account increased
by the same amount.

Applying the debit and credit rule will show that:

Increases in asset are recorded by debit, so debit cash, Php3,000

Increases in revenue are recorded by credit, so credit service revenue,
Php3,000

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40 Simplified Accounting for Entrepreneurs

What you will see in the ledger is this:

Cash
Debit Credit
3,000

Service Revenue
Debit Credit
3,000

Transaction No. 7:

Mrs. Cruz paid the salary of the assistant, Php1,500

Here is the analysis:

The asset, cash, is decreased by Php1,500 and the expense account in-
creased by Php1,500.

The debit and credit rule will show that:

Increase in expense account is recorded by debit, so debit salary expense

for Php1,500

Decrease in asset account is recorded by credit, so credit cash for Php1,500.

What you will see in the ledger is this:

Salary Expense
Debit Credit
1,500

Cash
Debit Credit
1,500

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 Module 4 41

Transaction No. 8:

Mrs. Cruz accepted the job of providing laundry service to a hotel, amount-
ing to Php7,000. Payment will be made after 3 days.

Here is the analysis:

An asset account called Account Receivable increases and the revenue

account also increases by the same amount.

The debit and credit rule shows that:

Increases in asset are recorded by debit, so debit account receivable,

Php7,000

Increases in revenue account are recorded by credit, so credit service

revenue, Php7,000.

What you will see in the ledger is this:

Account Receivable
Debit Credit
7,000

Service revenue
Debit Credit
7,000

We have finished applying the rules of debit and credit on the eight tran-
sactions. This will give you an overview on how transactions are recorded
in the accounting books, particularly the ledger. But we’ll have more on
that in our next module. You can go over the example again until you
have mastered the rules.

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42 Simplified Accounting for Entrepreneurs

SAQ 4-1
What are the rules of debit and credit?

UP Open University
 Module 4 43

Let’s apply the rules of debit and credit below.

SAQ 4-2
From the transactions given below, identify accounts to be debited
and credited.

1. Ms. Wa invested Php50,000 in her new beauty shop.

2. Purchased shop supplies in cash, Php 10,000.
3. Purchased equipment on credit, Php20,000.
4. Paid rent for the shop space, Php5,000.
5. Received Php2,000 for services rendered.

Answers to Self-Assessment Questions

ASAQ 4-1
The rules of debit and credit are as follows:

Debit – Increase in Asset

Decrease in Liability
Decrease in Equity/Capital
Decrease in Income/Revenue
Increase in Expense

Credit – Decrease in Asset

Increase in Liability
Increase in Equity/Capital
Increase in Income/Revenue
Decrease in Expense

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44 Simplified Accounting for Entrepreneurs

ASAQ 4-2
Debit Credit
1 Cash Ms. Wa, Capital
2 Supplies Cash
3 Equipment Liabilities
4 Rent expense Cash
5 Cash Service income

Now let’s have an online quiz! Log in to Myportal and click on the link
provided in the course site.

Good luck!

UP Open University
 Module 5a 45

Module 5
The Accounting Cycle:
a) The Journal Entry,
Ledger, & Trial Balance

I n the preceding lesson, you learned the rules

of the debit and credit and how they are
applied to analyzing and recording business
Objectives
transactions. In this module, we begin the tran- At the end of this module,
sition from using the T-account to a more you should be able to:
formal recording called journalizing.
1. Prepare journal entries;
Please make sure that you have read the supple- 2. Post to ledger and
mentary material provided to you in our course compute for the
site. That will serve as your reference while we balances of each ac-
go over the process of recording business tran- count; and
sactions. 3. Summarize the accounts
by preparing a Trial
To make it consistent, we will use the same Balance.
example in the previous module. Remember the
laundry business? We will use those tran-
sactions again as the bases of items to record in the journal. We will also
highlight the accounting functions as we go through the accounting cycle
modules.

Before we start, let us have a brief review of what a journal entry looks
like:

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46 Simplified Accounting for Entrepreneurs

GENERAL JOURNAL

DATE ACCOUNT TITLE DEBIT CREDIT

Jan 2 Cash xxxxx
Mr. A, Capital xxxxx
To record initial investment

The date is written on the first column of the general journal. You only
write the year and the month at the start of each page of the general
journal. The next column is for the account titles to be debited and
credited. There is also a brief explanation for each journal entry. The money
columns are for the amount debited and amount credited. Note that a
journal entry always begins with the account and amount debited
followed by the account and amount credited.

So let’s get started. Here are the transactions again.

March 1 Mrs. Rowena Cruz deposited Php300,000 in the bank as her

initial investment.
March 2 Purchased laundry equipment for Php150,000. Her creditor
gave her 15 days to pay.
March 5 Purchased laundry supplies in cash, Php8,000.
March 9 Paid rent for the month, Php3,500.
March 12 Paid the creditor partially, Php 90,000 for March 2 purchase.
March 14 Performed laundry services for the day, amounting to
Php3,000.
March 15 Paid the salary of the assistant, Php1,500.
March 17 Accepted the provision of laundry service to a hotel, amount-
ing to Php8,000. Payment will be made by the hotel after 3
days.

The Recording Function

Let’s enter Rowena’s transactions into our general journal. Write the fol-
lowing headings in the columns provided.

In the first column, we have the DATE.

In the second column is the ACCOUNT TITLE.
In the third and fourth columns are for DEBIT and CREDIT, respectively.

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GENERAL JOURNAL
DATE ACCOUNT TITLE DEBIT CREDIT

The first transaction occurred on March 1. It pertains to the investment of

Rowena Cruz in the business.

To prepare a journal entry, write the month when the transactions

occurred. Remember, we only write the month at the beginning of every
page of the general journal. So, let us write the month, March 1.

In the account title column, write the account debited. Our first tran-
saction includes a debit to Cash. On the corresponding debit column, we
write the amount 300,000. On the next line on the account title column,
write the account credited. The transaction has a credit to owner’s equity
account. Write the account Rowena Cruz, Capital. Note how we indented
it a little so as to distinguish which account is debited or credited. In the
corresponding credit column, write the amount 300,000.

On the next line of the account title column, write a brief description of
the transaction. This does not have to be long. For this transaction, we
can simply state—initial investment made by owner.

GENERAL JOURNAL
DATE ACCOUNT TITLE DEBIT CREDIT
March 1 Cash 300,000
Rowena Cruz, Capital 300,000
Initial investment of the owner

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On March 2, Rowena Cruz purchased laundry equipment. To record the

journal entry for this transaction, we write the date on the date column,
which is March 2. In the account title column, we indicate the account
debited. Our transaction has a debit to equipment, so we write the word
Equipment. On the corresponding debit column, write the amount 150,000.
On the next line on the account title column, write the account credited. We
credit account payable on this transaction, so we write Account Payable. In
the credit column, we put the amount, 150,000. Again, on the next line in the
account title column, write a brief explanation of the transaction. We could
write: purchased laundry equipment on credit.

GENERAL JOURNAL
DATE ACCOUNT TITLE DEBIT CREDIT
March 2 Equipment 150,000
Accounts Payable 150,000
Purchased laundry equipment
on credit

The third transaction involves the purchase of supplies. For our third tran-
saction, we write the date on the date column which is March 5. In the
account title column, we write the account debited. Our debit is supplies,
so write supplies. On the debit column, we indicate the amount 8,000. On
the next line of the account title column, we write the account credited.
Our credit here on this transaction involves cash, so we write, cash. In the
credit column, write the amount, 8,000. On the next line on the account
title column, let us write—purchased laundry supplies.

GENERAL JOURNAL
DATE ACCOUNT TITLE DEBIT CREDIT
March 5 Supplies 8,000
Cash 8,000
Purchased laundry supplies

Now are you getting the hang of it?

The next transactions are recorded in the same manner so that what you
will see in your general journal when all the transactions are recorded is
this:

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GENERAL JOURNAL

DATE ACCOUNT TITLE DEBIT CREDIT

March 1 Cash 300,000.00

Rowena Cruz, Capital 300,000.00
Initial investment made
by owner

2 Equipment 150,000.00
Account Payable 150,000.00
Purchased laundry equip-
ment on credit

5 Supplies 8,000.00
Cash 8,000.00
Purchased laundry
supplies

9 Rent Expense 3,500.00

Cash 3,500.00
Paid rent for the month

12 Account payable 90,000.00

Cash 90,000.00
Made partial payment for
the laundry equipment

14 Cash 3,000.00
Service revenue 3,000.00
Laundry service for the
day

15 Salary expense 1,500.00

Cash 1,500.00
Paid salary of assistant

17 Account receivable 7,000.00

Service revenue 7,000.00
Performed laundry
service on account

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The Classifying Function

After recording the transactions in the general journal, we will transfer
these to the general ledger. This is called posting. Each account on the
general journal will have its own ledger. This summarizes all similar trans-
actions that occurred during the period.

Recall that there were 8 transactions that were recorded in the general jour-
nal as journal entries. Let us go over those transactions again and identify
what ledger accounts were used.

On March 1, the accounts used were Cash and the capital account
which we called Rowena Cruz, Capital.
On March 2, accounts used were Equipment and Account Payable.
On March 5, the accounts used were Supplies and Cash.
On March 9, we used the accounts Rent Expense and Cash.
On March 12, the accounts used were Account Payable and Cash.
On March 14, the accounts Cash and Service Revenue were used to
record the transaction.
On March 15, we used Salary Expense and Cash to record the tran-
saction.
On March 17, the accounts used were Accounts receivable and Service
revenue.

Notice that there are accounts that were used several times such as cash
and service revenue. When these transactions are posted to their respec-
tive ledger accounts, all transactions that involve the same account, say
Cash, for example will be grouped.

The cash account was used 6 times.

The capital account was used only once.
Equipment was used once.
Supplies were used once.
Account payable was used twice.
Service revenue was also used twice.
Account receivable was used only once.
The expense accounts Rent and Salary were both used only once.

Okay. Let’s proceed to the next step that is posting the journal entry to the
ledger.

There are nine accounts, so each account would have its own T-account
as our ledger. Remember the T–account? The account title is written at
the top of the T-account and the left side is used to record the amounts
debited, and while the right side for the amounts credited.

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Again, we start with our first transaction. The journal entry shows a
debit to cash for 300,000 and a credit to Rowena Cruz, capital for 300,000.
For the Cash account, in the debit column, we write the date at the far left
of the debit column to record when this transaction happened; then we
write the amount debited, 300,000. Then we move to Rowena Cruz,
capital. In the credit column of the account, write the date of the tran-
saction first, and then write the amount 300,000.

Cash
1 300,000

Rowena Cruz, Capital

1 300,000

That is your first posting!

On March 2, which is our second transaction, we will use the Equipment

and Account payable accounts. On the Equipment ledger, write the date
at the far left of the debit column, then write the amount, 150,000. On the
Account payable ledger, on the credit side of the account, write the date
of the transaction and then write the amount 150,000.

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Equipment
2 150,000

Account Payable
2 150,000

The third transaction includes a debit to supplies and a credit to cash.

Can you guess how this will be posted? On the supplies ledger, write the
date at the far left of the debit column, then write the amount, Php8, 000.
In the Cash account, write the date in the credit column and then write
the amount, 8,000.

Supplies
5 8,000

8,000

Cash
1 300,000 5 8,000

Now there are two amounts posted on the Cash ledger. One is the tran-
saction on March 1 which is posted in the debit column, and the other is
the transaction on March 5 which is posted in the credit column.

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Again, the next 5 transactions are posted in the same manner as we have
done for the first three. This is what you will see after all the transactions
are posted on the ledger.

Activity 5a-1
If you have an existing business, list down all your transactions for
the week. Then try to prepare journal entries for those tran-
sactions.

General Ledger

Cash Account Receivable Service Revenue

1 300,000 5 8,000 17 7,000 14 3,000

14 3,000 9 3,500 17 7,000

12 90,000

15 1,500

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Supplies Equipment Rent Expense

5 8,000 2 150,000 9 3,500

Account Payable Rowena Cruz, Capital Salary expense

12 90,000 2 150,000 1 300,000 15 1,500

When all the transactions are posted on their respective ledger accounts,
usually at the end of a period, say one month, all the debited and credited
amounts are totaled and their respective balances are computed.

Let us have Cash as an example. In the ledger, there are 2 amounts posted
as debits and 4 amounts posted as credits. First we get the total debits
amounting to 303,000. Then we get the total credits amounting to 103,000.
Now we compute the balance which gives us a debit balance of 200,000.

The same goes for the other accounts. When only one amount is posted, it
is usually copied as the balance of the account.

The Summarizing Function

The Trial Balance

After all the transactions have been posted in from the journal to the
ledger, and the respective balances of each ledger account have been
computed, it is time to prepare a trial balance. A trial balance lists all the
ledger accounts and their balances to check whether the debits equal the
credits.

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In other words, we will lift all the balances from the ledger and summa-
rize them to see if all the balances of the debited amounts equal the
balances of the credited accounts.

The trial balance has a general heading. The name of the company is
written first, then the words “Trial Balance” are written on the second
line. On the third line, the date is written to show what period it covers.

Rowena’s Laundry Shop

Trial Balance
March 17, 20xx

The arrangement the accounts in the trial balance starts with asset, then
liabilities, then the capital account, the revenue account, and the expense
accounts.

In our example this is how our trial balance would look like:

The heading shows the name of the company which we call Rowena’s
Laundry Shop. The second line of the heading shows the Trial Balance,
and the third line shows March 17, 20xx since that is the last transaction
that we recorded.

Then we write all the accounts and their respective balances that were in
the ledger, starting with cash,200,000 in the debit column followed by
Account receivable, 7,000 in the debit column, then supplies, 8,000,debit
column, then equipment, 150,000, still in the debit column. These will be
followed by account payable, 60,000, in the credit column, then Rowena
Cruz, capital, 300,000, in the credit column. Then the revenue account,
service revenue, 10,000, in the credit column, followed by rent expense,
3,500 and salary expense 1,500, both in the debit column.

We then get the total of the debit and credit columns. Remember, the
totals of the two columns should agree. What do we have? We have a
total of 370,000 in both columns.

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Rowena’s Laundry Shop

Trial Balance
March 17, 20xx

Debit Credit

Cash 200,000.00

Account receivable 7,000.00

Supplies 8,000.00

Equipment 150,000.00

Account payable 60,000.00

Rowena Cruz, Capital 300,000.00

Service revenue 10,000.00

Rent expense 3,500.00

Salary expense 1,500.00

Total 370,000.00 370,000.00

Congratulations! You have come this far. You can start working on
the assignment given to you in your Course Guide.

See you next time, when you start the next module.

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GENERAL
LEDGER

Cash Account Receivable Service Revenue

1 300,000 5 8,000 17 7,000 14 3,000

14 3,000 9 3,500 7,000 17 7,000

12 90,000 10,000

15 1,500

303,000 103,000

200,000

Supplies Equipment Rent Expense

5 8,000 2 150,000 9 3,500

8,000 150,000 3,500

Account Payable Rowena Cruz, Capital Salary expense

12 90,000 2 150,000 1 300,000 15 1,500

60,000 300,000 1,500

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Module 5
The Accounting Cycle:
b) The Adjustment Process

I n the preceding lesson, you learned how to

record business transactions in the general
journal. You also learned how to post the journal
Objectives
entries to the ledger and to summarize the ledger At the end of this module,
and prepare a trial balance. you should be able to:

Now we go to the tricky part, the adjustment 1. Show the process of

process. I hope that you have gone through your adjusting the accounts;
supplementary materials for this portion and have 2. Prepare adjusting
read the concepts on the topic. Maybe it is still a bit journal entries;
hard for you to understand at this time. After you 3. Post the adjusting
have finished reading this module, you can go over journal entries to the
the materials again. But don’t worry; this portion ledger and compute for
really takes time to understand. the balances of each
account; and
Why do we need to adjust at the end of the 4. Prepare an adjusted
accounting period? trial balance.

Because certain items in the accounting records

have to be updated to reflect the actual amount
for a particular period. Say for example, the supplies that the business
had bought may not have been all used up for the period (say a month or
a year). We have to reflect the actual amount of the supplies that were
used up and the amount that is still in the inventory. This would mean
part of the original amount will be reported as expense (the used up
portion) and part will be reported as asset (the unused portion). This has
to be done prior to preparing your financial statements. Remember, we

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need an accurate financial report and the adjusting process helps in doing
so. This is also consistent with the accrual basis of accounting whereby we
recognize revenue when it is earned (regardless of when it is received) and
we recognize expense when it is incurred (regardless of when it is paid).

Okay, let’s get started. To simplify the process, the data for adjustments
have been pre-identified. Given are the transactions that need adjust-
ments.

Assume that at the end of the month, the following accounts should be
adjusted.

1. Supplies used for the month amounted to Php1, 200.

2. Electric bill was received covering the month of March amounting to
Php1, 800. This has not yet been recorded in the books.
3. A total of Php2,200 laundry services was not yet collected.
4. The laundry equipment has a useful life of 4 years. Depreciation for
the month should be recorded.

Adjustment No. 1

For the first adjustment, supplies that were used were Php1,200.
Remember, we bought Php8,000 worth of supplies on March 5. So at the
end of the month, only Php6,800 of the supplies was left. What will
happen to the used supplies? We need to record this as an expense. This
increased the expense account and decreased the asset account. Increase
in expense is recorded as debit, so debit Supplies Used/Expense; while
decrease in asset is recorded as credit, so we credit the Supplies account.

In the general journal, write the date, March 31, in the date column. In
the account title column, write a heading—Adjusting entries. This is to
distinguish the adjusting journal entries from the regular journal entries
of transactions resulting from normal business operations. Skip some lines
on the account title column, and then write the first adjusting journal
entry. Remember, we write first the debited account, then the credited
account. Don’t forget to write the amounts in their proper debit and credit
columns. The adjusting journal entry would then be:

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 Module 5b 61

DATE ACCOUNT TITLE DEBIT CREDIT

Adjusting Entries:

March 31 Supplies Used 1,200

Supplies 1,200
To adjust supplies that were
used up during the period

Adjustment No. 2

The second adjustment involves an expense, utilities in particular. Since

the bill was intended for the month of March we need to include this as
part of the expenses of March. And since this is not yet recorded in the
books, it becomes an obligation or a liability. This is an example of
accrued expense. This particular adjustment increased the expense
account and also increased a liability account. Increase in expense is
recorded as debit, so we debit Utility expense, while increase in liability is
recorded as credit, so we credit utilities payable. Why call it utilities pay-
able? It is our way of distinguishing it from the usual liabilities arising
from the company’s operations. The adjusting journal entry that will
appear on the general journal would be:

DATE ACCOUNT TITLE DEBIT CREDIT

Adjusting Entries:

March 31 Utilities expense 1,800

Utilities payable 1,800
To record accrued utilities

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Adjustment No. 3

The third adjustment is an example of an accrued income. The tran-

saction involves performing laundry services on account. This creates an
account receivable and increases the revenue account. While this is not
yet collected, we need to include this as part of the revenues for the month
of March. Increase in asset is recorded as debit; so we debit the account
receivable; increase in revenue is recorded as credit; so we credit the
service revenue. The adjusting journal entry that will appear on the
general journal would be:

DATE ACCOUNT TITLE DEBIT CREDIT

Adjusting Entries:

March 31 Accounts receivable 2,200

Service revenue 2,200
To record accrued
laundry services

Adjustment No. 4

The last adjustment is a bit more complicated. I suggest that you go over
your materials again and review the concept of depreciation. We need to
compute the so-called depreciation expense that will be applied to the
laundry equipment. The formula to compute the annual depreciation is:

Cost of the asset-salvage value

Useful life of the asset

Now let us compute the annual depreciation. The cost of the asset is
Php150,000. For the sake of simplicity, no salvage value is given. The use-
ful life of the equipment is 4 years. So the annual depreciation is:

150,000 = 37,500
4 years

This means that every year, 37,500 goes to expense as depreciation. But
we do not stop there. Since it only involves the month of March, we need
to get the monthly depreciation expense. The computation is shown as

Annual depreciation = monthly depreciation

12

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37,500 = 3,125
12

Depreciation decreases a fixed asset. However, we do not deduct the

expense from the amount of the asset itself. We use an account called
accumulated depreciation. The cost of the asset would then remain the
same. The analysis would then be: Increase in expense is recorded as debit,
so we debit depreciation expense-equipment; decrease in asset is recorded
as credit, so we credit accumulated depreciation account instead of the
equipment account.

Just a note: If it happens that the computed amount is not exact, you may
round it off to the nearest whole number for easy recording.

The adjusting journal entry that would appear on the general journal is:

DATE ACCOUNT TITLE DEBIT CREDIT

Adjusting Entries:

March 31 Depreciation expense-equipment 3,125

Accumulated depreciation-
equipment 3,125
To record monthly
depreciation

To summarize, here is what you will see after all the four adjusting journal
entries are recorded in the general journal:

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DATE ACCOUNT TITLE DEBIT CREDIT

Adjusting Entries:

March 31 Supplies Used 1,200.00

Supplies 1,200.00
To adjust supplies that
were used up during the period

31 Utilities expense 1,800.00

Utilities payable 1,800.00
To record accrued utilities

31 Accounts receivable 2,200.00

Service revenue 2,200.00
To record accrued laundry
services

31 Depreciation expense-
equipment 3,125.00
Accumulated depreciation-
equipment 3,125.00
To record monthly
depreciation
Computation:
Annual Depreciation:
150000/4 = 37500

Monthly depreciation:
37500/12 = 3125

Posting the Adjustments

The next step is to post the adjusting journal entries to the general ledger.
Remember, the previous transactions were already posted and these are
just additions to the ledger. Previously, we have 9 accounts in the ledger.
Because of the adjustments, we now have 14 accounts. So 5 accounts
have been added to the general ledger. These are supplies used, utility

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expense, utilities payable, depreciation expense-equipment, and accumu-

lated depreciation-equipment.

Our first adjustment shows a debit to supplies used and a credit to

supplies account. To post this, we need to create a ledger account for the
Supplies used account. On the far left of the debit column, write the date
and then the debited amount, 1,200. In the supplies account, write the
date in the credit column, then write the amount debited, 1,200. You will
see here that the supplies account has a debit balance of 8,000 after post-
ing the adjustment; supplies account has a credit balance of 1,200. If we
get the difference between the total debited amount and credited amount,
it will show a debit balance of 6,800.

Supplies Used

31 1,200

31 1,200 Balance

Supplies

5 8,000

8,000

31 1,200

31 6,800 Balance

This goes on for the next 3 adjusting journal entries. See if you can post
them yourself. After all the adjustments have been posted, the balances of
the accounts are again computed. There are accounts that are not af-
fected and so their balances would remain the same. Look at the general
ledger on page 67 to see the adjusted balances.

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The Adjusted Trial Balance

Next step is to prepare a new trial balance. This time it is called the
adjusted trial balance. The purpose is the same—to determine whether
the debits equal credits. The adjusted trial balance will be used to prepare
the financial reports. As with our previous module, it starts with a head-
ing and then the accounts are written in the following order: assets,
liabilities, capital, revenue, and expense accounts. The debited and
credited balances will then be written opposite their respective accounts.

The adjusted trial balance would look like this:

Rowena’s Laundry Shop

Adjusted Trial Balance
March 31, 20xx

Debit Credit

Cash 200,000.00
Account receivable 9,200.00
Supplies 6,800.00
Equipment 150,000.00
Accumulated depreciation—equipment 3,125.00
Account payable 60,000.00
Utilities payable 1,800.00
Rowena Cruz, Capital 300,000.00
Service revenue 12,200.00
Rent expense 3,500.00
Salary expense 1,500.00
Supplies used 1,200.00
Depreciation expense—equipment 3,125.00
Utilities expense 1,800.00
Total 377,125.00 377,125.00

The total debits and credits now amount to 377,125.

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The next module is about preparing the financial reports. This time you
will see what it looks like to present all the transactions as formal finan-
cial statements. Try to answer the Self-assessment questions. After you
are done, you can go on to the next module. See you!

GENERAL
LEDGER
Cash Account Receivable
1 300,000 5 8,000 17 7,000
14 3,000 9 3,500 7,000
12 90,000 31 2,200
15 1,500 31 9,200 Balance
303,000 103,000
31 200,000 Balance

Supplies Equipment
5 8,000 2 150,000
8,000 31 150,000 Balance
31 1,200
31 6,800 Balance

Accumulated Depreciation-
equipment Service Revenue
31 3,125 14 3,000
Balance 31 3,125 17 7,000
10,000
31 2,200
Balance 31 12,200

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Account Payable Rowena Cruz, Capital

12 90,000 2 150,000 1 300,000
Balance 31 60,000 Balance 31 300,000

Rent Expense Utilities payable

9 3,500 31 1,800
31 3,500 Balance Balance 31 1,800

Utilities Expense Salary expense

31 1,800 15 1,500
31 1,800 Balance 31 1,500 Balance

Depreciation expense-
equipment Supplies Used
31 3,125 31 1,200
31 3,125 Balance 31 1,200 Balance

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SAQ 5b-1
Compute for and prepare the adjusting journal entry required by
each of the following:

1. The business has an account receivable of Php22,000 of which

10% is considered uncollectible.

2. The company owns a building that was completed and

occupied on July 1 of the current year. The building costs
Php300,000, has an estimated useful life of 20 years, and is
expected to have a salvage value of Php40,000.

3. Per the statement of account received, unpaid utilities amounted

to Php5,000.

4. During the year, the business bought supplies amounting to

Php15,000. At the end of the year, it was estimated that about
Php3,000 of these supplies were still on hand.

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Answers to Self-Assessment Question

ASAQ 5b-1
1. Uncollectible accounts = 22000 * .10 = 2,200

Adjusting journal entry:

Debit Credit
Bad debts expense 2,200
Allowance for bad debts 2,200

2. To compute for annual depreciation:

Cost of the building – salvage value = 300000 - 40000 = 13,000

20 years 20

To compute for six months’ depreciation (since the building was

completed on July 1): 13000 * 6/12 = 6500

Adjusting journal entry:

Debit Credit
Depreciation expense - Building 6,500
Accumulated depreciation - Building 6,500

3. Unpaid utilities, Php5,000.

Adjusting journal entry:

Debit Credit
Utilities expense 5,000
Utilities payable 5,000

4. Supplies bought Php15,000

Supplies on hand 3,000
Supplies used Php12,000

Adjusting journal entry:

Debit Credit
Supplies expense 12,000
Supplies 12,000

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Module 5
The Accounting Cycle:
c) Financial Statements

A fter going through the adjustment process, you are now ready to
prepare financial statements. For this module, we will prepare three
financial statements. However, we will deal with the Statements of Cash
Flows later on, Module 6.

Objectives
At the end of this module, you should be
able to:

1. Prepare an Income Statement;

2. Prepare a Statement of Changes in
Equity; and
3. Prepare a Statement of Financial
Position/Balance Sheet.

The adjusted trial balance is shown again for your reference. This is your
basis for preparing the financial statements. Here is the trial balance.

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72 Simplified Accounting for Entrepreneurs

Rowena’s Laundry Shop

Adjusted Trial Balance
March 31, 20xx

Debit Credit

Cash 200,000.00
Account receivable 9,200.00
Supplies 6,800.00
Equipment 150,000.00
Accumulated depreciation-equipment 3,125.00
Account payable 60,000.00
Utilities payable 1,800.00
Rowena Cruz, Capital 300,000.00
Service revenue 12,200.00
Rent expense 3,500.00
Salary expense 1,500.00
Supplies used 1,200.00
Depreciation expense-equipment 3,125.00
Utilities expense 1,800.00
Total 377,125.00 377,125.00

The Interpreting Function

The Income Statement
(Statement of Comprehensive Income)
Let us prepare the Income Statement first. We have to prepare this first
because the net profit or loss will form part of your statement of owner’s
equity, and consequently, the balance sheet.

In any financial statement, a heading is necessary to identify what it is

and the period or date it covers.

For the Income Statement, write the name of the company first: In our
example it is Rowena’s Laundry Shop. On the second line, write the name
of the report, Income Statement. On the third line, write the period it
covers, (in this case, it covers the month of March), so write, for the month
ended March 31, 20xx. That constitutes the heading of our report.

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Skip some lines, maybe 2 or 3 and then write the title Revenues on the left
side below the heading. Below our title write the account: Service
Revenue. Then we put the corresponding amount on the right side across
the service revenue account. Let us write Php12,200. This amount is based
on what is in the Trial Balance.

Skip some lines again, and then write the title Less: Expenses on the left
side. Below the title, list all the expenses that appear in the adjusted trial
balance. Write their respective amounts on the right side but not on the
same and column as the line with the revenue amount. Write the amounts
a column before the and column of the revenue amount. This is called left
indention. This is used to present the details of the expense accounts. Only
the total amount for expenses is written in line with the revenue amount.
The total expenses amount to Php11,125. Subtract the total expenses from
the revenues and you will get either a net profit or a net loss. We get a net
profit if the revenues exceed expenses and net loss if expenses exceed
revenues. In the example, we have a net profit of Php1,075. The Income
Statement of Rowena’s Laundry shop looks like this:

Rowena’s Laundry Shop

Income Statement*
For the month ended March 31, 20xx

Revenues:
Service revenue Php 12,200.00

Less: Expenses
Rent expense Php 3,500.00
Salary expense 1,500.00
Supplies used 1,200.00
Depreciation expense-equipment 3,125.00
Utilities expense 1,800.00
Total expenses 11,125.00
Net profit Php 1,075.00

* For purposes of simplifying the references, we will use the term Income Statement.
However, the new standard term for reporting is Statement of Comprehensive Income.

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The Statement of Changes in Equity

The next statement is the Statement of Changes in Equity. It shows the
changes made to the capital account brought about by net profit or owner’s
withdrawal. Again, we prepare a heading for this statement. We start
with the name of the company which I’m sure you are familiar with, by
now: Rowena’s Laundry Shop. Then, write the title of the report—State-
ment of Changes in Equity. The last line shows the period it covers—we
write for the month ended March 31, 20xx. Skip some lines again and
then we write the capital account that appears on the adjusted trial bal-
ance on the left side—Rowena Cruz, Capital, March 1. This refers to the
owner’s beginning capital balance at the start of March. Write the amount
on the right side—Php300,000. Then we add the amount of the net profit
from the income statement. It amounts to Php1,075. We write add: net
profit and then the corresponding amount. The total of the two repre-
sents the ending capital balance on March 31 since we do not have a
withdrawal account which by the way reduces the capital balance. Write
Rowena Cruz, Capital, March 31 and then the amount on the right side—
Php301,075. The ending balance is the amount that will appear on the
balance sheet which you will see later. The Statement of Changes in Equity
of Rowena’s Laundry shop looks like this:

Rowena’s Laundry Shop

Statement of Changes in Equity
For the month ended March 31, 20xx

Capital balance, March 1 Php 300,000.00

Add: Net income 1,075.00
Capital balance, March 31 Php 301,075.00

The Balance Sheet

(Statement of Financial Position)
Now we go to the Balance Sheet. Again we start with the heading, Rowena’s
Laundry Shop. Then we write the name of the report on the next line we
write, Balance Sheet. On the third line, we write the date, March 31, 20xx.
We skip some lines and below the heading, we write the title ASSETS on the
left side. We skip some columns and the write LIABILITIES AND OWNER’S
EQUITY on the right side.

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Let us start with the ASSET section first. We grouped the current assets
that appear on the adjusted trial balance. These accounts are cash,
accounts receivable, and supplies. We place a subtitle under the Asset
section called Current Assets. We then list all the current assets and their
corresponding amounts. We place a subtotal title called Total Current
Assets. We then get the total amounting to Php216,000. Then we group
all the non-current assets and write them after the current asset subtotal.
In the example, we only have one non-current asset and its correspond-
ing accumulated depreciation account. Write a subtitle called Non-
current assets. Under that, write Equipment and its amount on the proper
column. This is followed by the Accumulated Depreciation-Equipment
account. This is deducted from the Equipment amount so we usually place
the word “Less” before the account title. Then we get the balance of the
non-current assets under the subtotal title, Total Non-current assets. The
amount is Php146,875. This is the balance of the non-current assets after
deducting the accumulated depreciation form the equipment amount. The
next step is to get the total assets by adding the subtotals of current assets
and non-current assets. Thus, our total assets amount to Php362,875.

On the right side of the balance sheet is our heading, Liabilities and
Owner’s equity. We start with placing a subtitle under this section we
call Current Liabilities. From our adjusted trial balance we can see that
we only have two liabilities, accounts payable and utilities payable and
both of these are payable within a short period of time. So we consider
these two as current liabilities. We list these two accounts and their corre-
sponding amounts. Then we get their total and place subtotal called Total
Current Liabilities. This amounts to Php61,800. This since we do not have
any other liability, that amount is also our total liabilities. After the liabil-
ity section, we place another subtitle called Owner’s Equity. This is where
we place the equity balance that was computed in the previous state-
ment, the statement of owner’s equity. We write Rowena Cruz, Capital
and the amount of Php301,075. The next step is to get the total of the
liabilities and owner’s equity to complete our balance sheet. Of course,
the total liabilities and owner’s equity should equal our total assets. The
complete balance sheet of Rowena’s Laundry shop now looks like this:

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Rowena’s Laundry Shop

Balance Sheet*
March 31, 20xx

ASSETS

Current Assets:
Cash Php 200,000.00
Account Receivable 9,200.00
Supplies 6,800.00
Total Current Assets Php 216,000.00

Non-Current Assets:
Equipment 150,000.00
Accumulated Depreciation -
Equipment (3,125.00)
Total Non-Current Assets 146,875.00
Total Assets Php 362,875.00

LIABILITIES AND OWNER’S EQUITY

Current Liabilities:
Account Payable 60,000.00
Utilities Payable 1,800.00
Total Current Liabilities Php 61,800.00

Owner’s Equity:
Rowena Cruz, Capital 301,075.00
Total Liabilities and Owner’s Equity Php 362,875.00

* For reporting, the standard term is now Statement of Financial Position.

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Take your time to go over the financial statements. Study the format as
well as the relationship among the three. Once you familiarize yourself
with it, you can now proceed with our exercise.

SAQ 5c-1
Choose the correct answer.

1. Information about the profit or loss of the firm is reported in

the:

a. Statement of Financial Position/Balance Sheet

b. Statement of Comprehensive Income/Income Statement
c. Statement of Changes in Equity
d. Statement of Cash Flows

2. The Statement of Financial Position/Balance Sheet shows:

a. the results of the firm’s operation

b. the changes in the owner’s equity
c. the financial condition of the firm as of a given date
d. none of the above

3. Which of the following items would not affect the Income State-
ment?

a. drawings made by the owner

b. salary expense
c. service revenue
d. rent expense

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Answers to Self-Assessment Question

ASAQ 5c-1
1. b
2. c
3. a

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Module 5
The Accounting Cycle:
d) The Closing Process

W elcome to this module.We’re almost done

with the accounting process. You have
learned how to record the transactions in the
Objectives
general journal, post to the ledger, prepare a At the end of this module,
trial balance, prepare adjusting journal entries you should be able to:
and an adjusted trial balance, and prepare fi-
nancial statements. Finally, we are in the last 1. Explain the closing
part of the accounting process. This is the clos- process;
ing process. 2. Identify accounts that
should be closed;
At the end of an accounting period, usually a 3. Prepare closing journal
year, the accounting books should be closed to entries;
have a fresh start in the next period. What items 4. Post the closing journal
should be closed? We need to close the revenue, entries to the ledger and
expense, and withdrawal accounts if any. compute for the
These are called nominal accounts. What do balances of each ac-
we do when we close these accounts? We bring count; and
their balances to zero. This makes it easier for 5. Prepare a post-closing
the business to keep track of the revenues and trial balance.
expenses for each accounting period.

How do we do that? If you still recall, a revenue account has a credit

balance, an expense account has a debit balance, and a withdrawal account
has debit balance. To bring these balances to zero, we will transfer them to
the opposite side; say for example, in the revenue account, the credit balance

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will be debited so it will become zero. For the expense account; the debit
balance will be credited to make it zero. The same goes for the withdrawal
account, its debit balance will be credited to make it zero.

To bring the accounts to zero balances, we prepare the closing journal

entries. Closing the accounts involves a special ledger account which is
used only during the closing process. The account is called Income
Summary or sometimes Income and Expense Summary. All the revenue,
expense and withdrawal accounts will use this special ledger account to
close their balances. All the amounts are based on the balances in the
general journal.

Closing the Revenue Account/s

Here is how it goes. On the general journal just after the adjusting journal
entries, write again the date when the account will be closed. In our ex-
ample, Rowena’s Laundry Shop, the date would be March 31 since it is
the end of the month or our accounting period. In the account title col-
umn, write closing journal entries to separate and distinguish them from
the other journal entries made. Then skip a few lines and write our first
closing journal entry. Our first closing journal entry is this:

GENERAL JOURNAL

DATE ACCOUNT TITLE DEBIT CREDIT

Closing journal entries:

March 31 Service revenue 12,200.00
Income summary 12,200.00
To close the revenue
account

The Service Revenue account is debited by 12,200. That is the amount of

the total credits of service revenue in the ledger. Then we credit the
account Income Summary by 12,200. It’s like transferring the balance of
the revenue account to this special account.

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Closing the Expense Accounts

The second closing journal entry is to bring all the expense accounts to
zero balance. The closing journal entry looks like this:

GENERAL JOURNAL

DATE ACCOUNT TITLE DEBIT CREDIT

31 Income summary 11,125.00

Rent expense 3,500.00
Salary expense 1,500.00
Supplies used 1,200.00
Depreciation expense-
equipment 3,125.00
Utilities expense 1,800.00
To close all the
expense accounts

The Income Summary account is debited by 11,125. This is the total amount
of all the expense accounts. If you still remember, this is the total expenses
that we presented in the Income Statement. Then all the expense accounts,
such as Rent Expense, Salary Expense, Supplies Used, Depreciation Expense-
Equipment, and Utilities Expense are credited with their respective balances.

When you post them to the general ledger and get their balances, you will
find that the revenue account and all the expense accounts will have zero
balances. But since we have a new ledger account called Income Sum-
mary account, what you will see after posting is a debit balance of 11,125
and a credit balance of 12,200. If you get the difference, the amount would
be 1,075 or the amount of the net income reported in the Income State-
ment.

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Closing the Income Summary Account

This special account needs to be closed, too. The 1,075 balance will be
transferred now to the capital account. Our final closing journal entry is
this:

GENERAL JOURNAL

DATE ACCOUNT TITLE DEBIT CREDIT

31 Income summary 1,075.00

Rowena Cruz, Capital 1,075.00
To close the income
summary account

The Income Summary account is debited and the capital account is credited
by 1,075. If you post this journal entry to the ledger, the balance of the
Income Summary account is reduced to zero while the capital account will
have a total credit balance of 301,075.

Refer to the general ledger after posting the closing journal entries.

You will notice that only balance sheet accounts have balances while the
revenue and expense accounts have zero balances.

The Post-Closing Trial Balance

As a final step to the closing process, a Post-Closing Trial Balance is
done just to check whether all the revenue and expense accounts have
been closed. What you will see in the post-closing trial balance are
balance sheet accounts only. Of course, the total debits should equal the
total credits. The post-closing trial balance of Rowena’s Laundry shop is
shown on the next page. It now has total debits and credits amounting to
Php366,000.

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Rowena’s Laundry Shop

Post-closing Trial Balance
March 31, 20xx

Debit Credit

Cash 200,000.00
Account receivable 9,200.00
Supplies 6,800.00
Equipment 150,000.00
Accumulated depreciation-equipment 3,125.00
Account payable 60,000.00
Utilities payable 1,800.00
Rowena Cruz, Capital 301,075.00
Total 366,000.00 366,000.00

Additional Notes to the Closing Process

Personal withdrawal made by the owner from the business should also be
closed at the end of the accounting period. For reference purposes, here is
a sample closing journal entry.

GENERAL JOURNAL

DATE ACCOUNT TITLE DEBIT CREDIT

31 Capital Account (e.g., Rowena

Cruz,Capital) xxxxxx
Drawing Account
(e.g., Rowena Cruz, Drawing) xxxxxx
To close the drawing account

The drawing account is closed to the capital account. When you post this
entry in the ledger, the capital account is decreased.

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SAQ 5d-1
Answer the following questions:

1. What is the purpose of preparing closing journal entries?

2. What accounts should be closed at the end of the accounting

period?

Congratulations! You made it this far. You have finished the accounting
process. Now you can finish the assignment.

I do hope that with practice and determination, you will be able to apply
this to your business or the future business.

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GENERAL LEDGER

Cash Account Receivable Supplies

1 300,000 5 8,000 17 7,000 5 8,000

14 3,000 9 3,500 7,000 8,000

12 90,000 31 2,200 31 1,200

15 1,500 31 9,200 Balance 31 6,800 Balance

303,000 103,000

31 200,000 Balance

Accumulated Depreciation-
Equipment equipment Service Revenue

2 150,000 31 3,125 14 3,000

31 150,000 Balance Balance 31 3,125 17 7,000

10,000

31 2,200

Balance 31 12,200

31 12,200

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Account Payable Rowena Cruz, Capital Rent Expense

12 90,000 2 150,000 1 300,000 9 3,500

Balance 31 60,000 Balance 31 300,000 31 3,500 Balance

31 1,075 31 3,500
31 301,075

Utilities payable Utilities Expense Salary expense

31 1,800 31 1,800 15 1,500

Balance 31 1,800 31 1,800 Balance 31 1,500 Balance

31 1,800
31 1,500

Depreciation expense-
equpment Supplies Used Income Summary
31 3,125 31 1,200 31 11,125 31 12,200

31 1,125 Balance 31 12,200 Balance 31 1,075

31 3,125 31 1,200 12,200 12,200

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Answers to Self-Assessment Question

ASAQ5 d-1
1. The purpose of preparing closing journal entries is to clear all nominal
accounts or temporary accounts and bring their balances to zero. This
is done so that the next accounting period will have a fresh start in
terms of revenue, expense, and drawing accounts.

2. All revenue, expense, and personal drawing accounts should be closed

at the end of the accounting period.

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Module 6
Cash Flow Analysis

E ntrepreneurs need to measure their cash

flows in order to meet obligations, evaluate
business performance, or even plan business
Objectives
activities (e.g., expansion). A business must At the end of this module,
generate enough cash flows to keep going, you should be able to:
otherwise, it just won’t make it. Let’s take a look
at how cash flows are used to determine the 1. Explain the usefulness
financial health of a business. of cash flow analysis;
2. Describe the classifica-
Do you know that a business may have consis- tion of cash flows; and
tent sales and profits, but can still go bankrupt 3. Identify sources and
because of cash flow problems? Think about uses of cash.
this: is profit “cash”? Definitely not! Profit is
income less expenses, while Cash is receipts less
disbursements. We record income whether we received cash or not,
remember (which gives rise to receivables)? On the other hand, we record
expenses whether we paid cash or not (which gives rise to payables or
liabilities). Cash is what is actually received versus what is actually paid.

In business, Cash is KING! Cash flow therefore is the lifeblood of any

business. If you cannot collect your receivables on time, you won’t be able
to have enough funds to pay for your operating expenses. Sooner or later,
your will run into financial troubles and that may be the start of your
business’ folding up.

The cash that comes in and goes out of the business actually determines
your financial position. Cash may be sourced internally such as generat-
ing sales, selling your assets, reducing inventories, reducing your receiv-
ables, and increasing the payables; or it may also come externally such as

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when you borrow from the bank or other financing institutions including
the angel investors (your friends and relatives ☺), and from your own
pocket as your investment in the business. On the other hand, the uses of
cash may include for the following: your salaries and bills to be paid,
taxes to be paid, assets to be purchased, and loan and interest payments.

As an entrepreneur, you need to understand the different factors that

may affect your cash flow. For instance, if you have excess cash, you may
put this in short-term investments until such time that you need it; or if
you have cash deficit, you may need to look for short-term financing to
meet your shortfall. Managing cash flow therefore, is essential in the
business. It starts with making a sales forecast. The cash projection can be
made by estimating the amount of sales that you expect to generate from
the business for a particular period, say a month. Then from here on, you
align all your expenses accordingly to determine whether you will have
enough cash to cover them or not. Your sales forecast would also depend
on whether your business provides long-term credit to customers or not.
Seasonality of your product or service also affects the sales pattern of the
business. You need to know how soon your credit customers pay you or
whether you experience difficulty in collecting your receivables. For your
cash disbursements, you can make a projection of your various expenses
such as rental, salaries, utilities, etc. These may be based on your past
figures. You should also know how much you will pay your suppliers
based on the given credit terms. For example, if your credit term is 30
days, you have to input the amount that you expect to pay for that pe-
riod. Other major disbursements would include purchase of fixed assets
such as equipment. If you also withdraw cash from the business regu-
larly, you also have to input that.

The Cash Budget

Once you have a forecast of your total cash receipts and disbursements,
you can get the difference between these to get your net cash flow for a
particular period. A positive cash flow shows that you have generated
additional cash while a negative cash flows means that you have over-
spent. A simple and useful template that you may wish to adopt is shown
on the next page.

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Month 1 Month 2 Month 3…

Cash receipts xxx xxe xxi
Less: cash disbursements xxa xxf xxj
Net cash flow xxb xxg xxk
Add: Beginning cash balance xxc xxd { xxh
{
Ending cash balance xxd xxh xxl

Your net cash flow will be added to the beginning cash balance (the
balance from the previous period) to arrive at your ending cash balance
for the month. The ending cash balance will be the starting balance for
the next month, which will be added again to the net cash flow for that
month. This procedure can be done for the rest of the months of the year.

During the year, you may have to constantly modify your cash flow fore-
casts depending on how the business events unfold. You may need to
increase your expected cash receipts when, say, for example you added
store outlet. Likewise, you may have to adjust your expenses as an addi-
tional store outlet would mean additional expenses for rentals, for sales
personnel, and so on.

We will further discuss the preparation of the statement of cash flows

after you have done Activity 6-1.

Activity 6-1
List the sources of cash in your business. What are the cash out-
lays that your business commonly encounters? Do your cash
inflows show more than your cash outflows?

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What is a Statement of Cash Flows?

A statement of cash flows is a formal financial statement that summa-
rizes all operating, investing, and financing activities of an enterprise. It
provides information about a company’s cash receipts and cash payments
during the accounting period.

Purposes of the Statement of Cash Flows

Per Philippine Accounting Standards, the primary purpose of a state-
ment of cash flows is “to provide relevant information about the cash
receipts and cash disbursements of an enterprise during a period.”

The information provided in the statement of cash flows should help

investors, creditors, and others to:

1. Assess the enterprise’s ability to generate positive future net cash flows
2. Assess the enterprise’s ability to meet its obligations, its ability to pay
dividends, and its needs for external financing.
3. Assess the reasons for the differences between net income and asso-
ciated cash receipts and payments.
4. Assess the effects on an enterprise’s financial position of both its cash
and non-cash investing and financing transactions during the period.

How are cash flows classified?

1. Operating Activities
Operating activities include transactions that result from the earning
process of the company.

2. Investing Activities
These activities usually involve acquiring and disposing of property,
plant, and equipment, other long-term investments; and short-term
or temporary investments that are not considered cash equivalents.

3. Financing Activities
Financing activities involve borrowing from and repaying creditors,
raising funds from owners, and distributing funds to owners.

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The table below provides a good picture of the different sections found in
the statement of cash flows.

Business Activities Cash Inflows Cash Outflows

Operating activities Collections from customers Payments to suppliers of
Collections of interest goods and services
Collections of dividends Payments to employees
Payments for interest
Payments for taxes
Investing activities Proceeds from sale of Purchases of long-term
long-term assets assets
Collections of loans made Loans made to other
to other entities entities
Proceeds from sale of Purchases of short-term
short-term investments investments
Financing activities Proceeds from issuance of Payment of long-term
debt debt
Proceeds from issuance Payment of cash
of stock dividends

The Critical Importance of Cash Flows from Operating Activities

l A business must generate a positive net cash flow from its operating
activities in the long run if the business is to survive.

l A business with negative cash flows from operations will not be able
to raise cash from other sources indefinitely. The ability of a business
to raise cash through financing activities is highly dependent upon its
ability to generate cash from its normal business operations.

l Creditors and stockholders are reluctant to invest in a company that

does not generate enough cash from operating activities.

What about cash flows from investing and financing activities?

It is not important for the net cash flows from investing or financing
activities to be positive in any given year. Many successful businesses
usually report negative cash flows for these activities.

Purchases of plant assets require cash outlays. Therefore, growing busi-

nesses usually report negative net cash flows from investing activities.

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94 Simplified Accounting for Entrepreneurs

Major financial transactions such as borrowing, issuance of capital stock

(in case of a corporation), or the repayment of a large loan occur less
frequently. Companies may or may not engage in these transactions in
any given year.

Activity 6-2
Take a look at the Statements of Cash Flows on the next page:
What information does the statement of cash flows report that is
not shown on the Balance Sheet and Income Statement?

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Golden Enterprises
Statement of Cash Flows
For the Year Ended December 31, 20xx

Cash flows from operating activities:

Receipts:
Cash received from customers Php 425,050
Interest received 3,500
Payments:
Cash paid to suppliers and employees (378,600)
Interest paid ( 1,800)
Net cash flow from operating activities 48,150

Cash flows from investing activities:

Purchases of property and equipment ( 23,280)
Net cash flow from investing activities ( 23,280)

Cash flows from financing activities:

Proceeds from loan 30,000
Additional investment by owner 15,000
Personal withdrawal by owner ( 5,000)
Net cash flows from financing activities 40,000
Net increase in cash 64,870
Cash balance, Jan 1 15,200
Cash balance, Dec 31 Php 80,070

Comment on Activity 6-2

The Statement of Cash Flows shows the movement of cash in the
business. It reflects only pure cash transactions that resulted in the
increase in cash balance at the end of the year. Because of accrual
accounting, the Income Statement presents all the revenues for
the year (whether collected or not) and all the expenses for the
year (whether paid or not). The Balance Sheet, on the other hand,
shows only the cash balance at the end of the year.

An additional exercise on preparing a cash budget is available in the course

site. Take time to answer them.

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Now you have finished the six modules. I hope that you learned a lot from
this basic accounting course. The last module is equally interesting. It is about
the basics of business taxation for entrepreneurs. You will find it in the course
site. See you there!

References

Ascan, T.C. (2005). Syllabus in Management 111 (Principles of accounting).

J.D. Drilon Faculty Grant. UP Los Banos, College, Laguna.
Ainsworth, P., D. Daines. (2004). Introduction to accounting, An Integrated
Approach. 3rd edition. McGrawhill, Inc.
Entrepreneur Philippines. (2008). Accounting 101 for small businesses. A
step-by-step, easy-to-use guide. Summit Publishing Co. Inc.
http://www.referenceforbusiness.com/management/Bun-Comp/Cash-
Flow-Analysis-and-Statement.html
http://www.picpa.com.ph
Harrison, W. T. Jr., C. T. Horngren. (2004). Financial accounting. 5th edition.
Pearson Education International.
Meigs, R.F., W.B. Meigs., M.A. Meigs. (1995). Financial accounting. 8th
edition. McGrawhill. Inc.

UP Open University