Fundamentals of

Accounting
Course Material No. 7

EJ Blanco, CPA
Course Instructor
2 FUNDAMENTALS OF ACCOUNTING • NU LAGUNA

The Accounting
Cycle (Part 3) 1
LEARNING OUTCOMES

Here’s what I will teach you in this course material:

LESSON OUTLINE
• Understand the last steps of the accounting cycle

• The Accounting • Understand the purpose and types of financial statements

Cycle (steps 7 Understand the nature of closing entries
Unit
andOutline
8)
•

RESOURCES NEEDED

For this lesson, you would need the following resources:

Accounting books and other references as uploaded in the files

section in MS Teams.
Powerpoint materials
FUNDAMENTALS OF ACCOUNTING • NU LAGUNA 3

TABLE OF CONTENTS

Pretest

Before you start, try answering the following

questions. The Accounting Cycle
5
Can you recall the fifth and sixth steps of the
accounting cycle?
9 Post Test

10 References

Post Test
9

10 References
4 FUNDAMENTALS OF ACCOUNTING • NU LAGUNA

Fundamentals
of Accounting

Key Point
This topic will introduce you
to the accounting cycle and
its last two steps namely:
Preparation of Financial
Statements and Journalizing
Closing Entries.
 FUNDAMENTALS OF ACCOUNTING • NU LAGUNA 5

Accounting Cycle

The accounting cycle is a continuous process of accumulating, summarizing and reporting

financial information.

Before we go through the last 2 steps in the accounting cycle, let us first review the first 6 steps
as discussed in the previous course materials
• Step 1- Transactions and/or Events: Identification and measurement of external
transactions and internal events
• Step 2 - Preparation of Journal Entries (Journalization): Business transactions are
recorded in the journals using debits and credits.
• Step 3 – Posting: Posting of journal entries to general ledgers.
• Step 4 – Unadjusted Trial Balance: Preparation of unadjusted trial balance
• Step 5 – Worksheet: Preparation of Worksheet
• Step 6 – Adjusting Journal Entries: Determination and recording of adjusting journal
entries
Now, let’s tackle the last 2 steps of the accounting cycle: preparation of financial statements and
journalization of closing entries.
Step 6. Financial Statements

There are questions that the owner of a business periodically asks – How much did the business
entity earn? What is the financial condition of the business? How much is the owner’s interest
in the entity today? What happened to the cash receipts? Where did the cash go? Investors,
creditors, taxing authorities, and other users have their own questions about the business
which need to be answered.

The financial statements are the means by which the information accumulated and processed in
financial accounting is periodically communicated to the users. Without accounting information,
users may not be able to arrive at sound economic decisions.

Per March 2018 Conceptual Framework for Financial Reporting, the objective of financial
statements is to provide financial information about the reporting entity’s assets, liabilities,
equity, income and expenses that is useful to users of financial statements in assessing the
prospects for future net cash inflows about the reporting entity and in assessing management’s
6 FUNDAMENTALS OF ACCOUNTING • NU LAGUNA

stewardship of the entity’s economic resources. Once the worksheet is completed, it is easy to
prepare the financial statements since the account balances have been extended to the
appropriate columns. Most of the information needed to prepare the financial statements are
available from the worksheet.

The following are the financial statements to be prepared:

1. Statement of Financial Position (SFP) - Also known as the balance sheet. This statement
includes the amounts of the company’s total assets, liabilities and owner’s equity which
in totality provides the financial position of the company on a specific date.
2. Statement of Comprehensive Income (SCI) – Also known as the income statement. This
contains the results of the company’s operations for a specific period of time. This can
be prepared on a monthly, quarterly or yearly basis.
3. Statement of Changes in Equity (SCE) - This statement is prepared prior to preparation
of the Statement of Financial Position in order to obtain the ending balance of the equity
to be used in the SFP. All changes, whether increases or decreases to the owner’s
interest on the company during the period, are reported here.
4. Cash Flow Statement - Provides an analysis of inflows and/or outflows of cash from/to
operating, investing and financing activities.

The income statement is prepared first so that net income can then be recorded in the
statement of changes in equity. The statement of changes in equity is then prepared to
determine the ending balance of equity or capital account. Once the ending balance is
determined, the statement of financial position is prepared. The cash flow statement is
prepared last. Continuing our illustration Encanto Travel and Tours, the financial statements
should appear as follows:

Worksheet
For the month ending February 28, 2021
Adjusted Trial Balance Balance Sheet Income Statement
Debit Credit Debit Credit Debit Credit
Balance Sheet Accounts
Cash 221,000 221,000
Accounts Receivable 30,000 30,000
Supplies 2,000 2,000
Office Equipment 25,000 25,000
Accumulated Depreciation - Office Equipment 200 200
Acconts Payable 5,000 5,000
Utilities Payable 3,800 3,800
Unearned Service Revenue 30,000 30,000
Matapang, Capital 200,000 200,000

Income Statement Accounts

Service Revenue 50,000 50,000
Supplies Expense 30,000 3,000
Salaries Expense 40,000 4,000
Utilities Expense 3,800 3,800
Depreciation Expense 200 200
11,000 50,000
Net income 39,000
FUNDAMENTALS OF ACCOUNTING • NU LAGUNA 7

Encanto Travel and Tours

Income Statement
For the month ending February 28, 2021

Service Revenue 50,000

Less: Expenses
Supplies Expense 3,000
Salaries Expense 4,000
Utilities Expense 3,800
Depreciation Expense 200
Total Expenses 11,000
NET INCOME 39,000

For purposes of this course, only the income statement and balance sheet will be discussed.

Step 8. Journalize the Closing Adjusting Entries

The income, expense, withdrawal (equity) accounts are called temporary accounts or nominal
accounts. They are called temporary because they accumulate the transactions of only one
accounting period. At the end of this accounting period, the changes in owner’s equity
accumulated in these temporary accounts are transferred into the owner’s capital account. This
process serves two purposes: (1) to update the balance of the owner’s capital; and (2) it returns
the balance of the temporary accounts to zero, so that they are ready to measure the income,
expenses and drawings of the next accounting period again. The owner’s capital account and
other statement of financial position accounts are referred to as permanent or real accounts
because their balances continue to exist beyond the current accounting period. Closing the books
is the process of transferring the balances of the temporary accounts to the owner’s permanent
capital account.

The closing journal entries should consist of the following:

• All of the nominal revenue accounts should be closed to the income summary account by
a Debit to revenue and a Credit to income summary.
• All of the nominal expense accounts should be closed to the income summary by a Credit
to expense and a Debit to income summary.
• The balance in the income summary account should now reflect the net income for the
accounting period. The next journal entry should close the income summary account to
the equity or capital account. If there is a net profit this entry will be a Debit to income
summary and a Credit to owner’s capital account.
• Once the closing journal entries have been entered into the general journal, the
information should be posted to the general ledger. When this is accomplished, all of the
nominal accounts in the general ledger should have zero balances. To double check on
this, we should prepare another trial balance based on the new balances in the general
ledger. If we have any nominal accounts with positive balances, a mistake was made along
the way and will need to be corrected before proceeding to the next accounting period.
8 FUNDAMENTALS OF ACCOUNTING • NU LAGUNA

To illustrate:
General Journal
Date Account Title and Explanation Ref Debit Credit
2/28/21 Service Revenue P50,000
Income Summary P50,000
To close the nominal revenue accounts

Income Summary 11,000

Supplies Expense 3,000
Salaries Expense 4,000
Utilities Expense 3,800
Depreciation Expense 200
To close the nominal expense accounts

After the above entries, the balance for these accounts are as follows:

Notice that the ending balance of the Income Summary Account amounting to PHP39,000 credit
represents the net income for the period of Encanto. The balance of the Income Summary
Account is then closed to the Capital Account by this entry:
General Journal
Date Account Title and Explanation Ref Debit Credit
2/28/21 Income Summary P39,000
Encanto, Capital P39,000
To close the income summary account to capital account

After the above closing entries, the balance sheet would look like this:

Encanto Travel and Tours

Balance Sheet
February 28, 2021

ASSETS
Cash 221,000
Accounts Receivable 30,000
Supplies 2,000
Office Equipment 25,000
Less: Accumulated Depreciation - Office Equipment 200 24,800
TOTAL ASSETS 277,800

LIABILITIES
Acconts Payable 5,000
Utilities Payable 3,800
Unearned Service Revenue 30,000
TOTAL LIABILITIES 38,800

EQUITY
Encanto, Capital 239,000
TOTAL LIABILITIES AND EQUITY 277,800
FUNDAMENTALS OF ACCOUNTING • NU LAGUNA 9

POSTTEST

I. Multiple Choice
_______ 1. Which of the following is not a financial statement?
a. Balance sheet
b. Income statement
c. Statement of changes in equity
d. Worksheet

_______ 2. Which of the following is not an objective of financial statements?

a. To provide information about the assets, liabilities, equity, income and expense of a
company
b. To help users make informed decisions
c. To provide information about the entity’s financial performance
d. To show the company’s bank account details
_______ 3. Which financial statement is prepared first?
a. Balance sheet
b. Income statement
c. Statement of changes in equity
d. None of the above
_______ 4. Preparation of worksheet is essential in preparing financial statements.
a. True
b. False
_______ 5. If revenues are higher than expenses, there is net income.
a. True
b. False
_______ 6. Which is the last step in the accounting cycle?
a. Preparation of financial statements
b. Journalizing closing entries
c. Journalizing adjusting entries
d. Preparation of worksheet

_______ 7. Income summary should be closed to which account?

a. Cash
b. Revenue
c. Capital
d. Drawing

_______ 8. This is also known as balance sheet.

a. Statement of changes in equity
b. Statement of financial position
c. Statement of income
d. Cash flow statement
_______ 9. Which of the following is not a step in the accounting cycle?
a. Posting to general ledger
b. Adjusting entries
10 FUNDAMENTALS OF ACCOUNTING • NU LAGUNA

c. Payment of expenses
d. Worksheet
_______ 10. Assume that you are preparing the financial statements for March 2022. Service revenues
total P100,000. Expenses include salaries of P15,000, supplies of P5,000 and depreciation of P3,000. How
much is the net income?
a. P123,000
b. P77,000
c. P37,000
d. There is no income to be recognized

II. Financial Statement Preparation (30 points)

You are asked to prepare the March 31, 2022 financial statements of Cardi Bee Dalisay Beauty Salon.
The following information is provided by Ms. Cardi Bee, the proprietor of the business.
Balance Sheet Accounts: Income Statement Accounts:
Cash ₱60,000 Service Revenue ₱170,000
Accounts Receivable ₱40,000 Store Expense ₱30,000
Store Supplies ₱10,000 Salaries Expense ₱50,000
Store Equipment ₱70,000 Depreciation Expense ₱10,000
Office Equipment ₱25,000 Rent Expense ₱10,000
Accounts Payable ₱20,000 Utilities Expense ₱35,000
Dalisay, Capital ₱150,000 Net income ?

A. Prepare an income statement for the period ending March 31, 2022.
B. Prepare a balance sheet as of March 31, 2022.

Pro tips:
• Solve for the net income first before preparing the income statement.
• Close the net income to the capital account. No need to show the closing
entries.
• Once net income is closed to the capital account, you can now prepare
the balance sheet.
• Use the format in the above examples. Upload only 1 excel file.

REFERENCES

Ballada, W. et al (2021). Basic Financial Accounting and Reporting Made Easy (23rd edition).
Manila: DomDane Publishers & Made Easy Books
Label, W. (2016). Accounting for Non-Accountants (3rd ed.). Naperville: Sourcebooks.