ACCOUNTING FUNDAMENTALS

CHAPTER 4
Recording Business Transactions

ACCOUNTING CYCLE
The accounting cycle refers to a series of sequential steps or procedures
performed to accomplish the accounting process. The steps in the cycle and
their aims follow:

Step 1: Identification of Events to be Recorded

Aim: To gather information about transactions or events generally
through the source documents.
Step 2: Transactions are Recorded in the Journal
Aim: To record the economic impact of transactions on the firm in a
journal, which is a form that facilitates transfer to the accounts.
Step 3: Journal Entries are Posted to the Ledger
Aim: To transfer the information from the journal to the ledger for
classification.
Step 4: Preparation of a Trial Balance
Aim: To provide a listing to verify the equality of debits and credits in the
ledger.
Step 5: Preparation of the Worksheet including Adjusting Entries
Aim: To aid in the preparation of financial statements.
Step 6: Preparation of the Financial Statements
Aim: To provide useful information to decision-makers.
Step 7: Adjusting Journal Entries are Journalized and Posted
Aim: To record the accruals, expiration of deferrals, estimations and
other events from the worksheet.
Step 8: Closing Journal Entries are Journalized and Posted
Aim: To close temporary accounts and transfer profit to owner’s equity.
Step 9: Preparation of a Post-Closing Trial Balance
Aim: To check the equality of debits and credits after the closing entries.

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ACCOUNTING FUNDAMENTALS

Step 10: Reversing Journal Entries are Journalized and Posted

Aim: To simplify the recording of certain regular transactions in the next
accounting period.

This cycle is repeated each accounting period. The first three steps in the
accounting cycle are accomplished during the period. The fourth to the ninth
steps generally occur at the end of the period. The last step is optional and
occurs at the beginning of the next period.

TRANSACTION ANALYSIS (Step 1)

The analysis of transactions should follow these four basic steps:
1. Identify the transaction from source documents.
2. Indicate the accounts – either assets, liabilities, equity, income or expenses -
affected by the transaction.
3. Ascertain whether each account is increased or decreased by the
transaction.
4. Using the rules of debit and credit, determine whether to debit or credit the
account to record its increase or decrease.

Source Documents
Transactions and events are the starting points in the accounting cycle. By
relying on source documents, transactions and events can be analyzed as to
how they will affect performance and financial position. Source documents
identify and describe transactions and events entering the accounting process.
These original written evidences contain information about the nature and the
amounts of the transactions. These are the bases for the journal entries; some
of the more common source documents are sales invoices, cash register tapes,
official receipts, bank deposit slips, bank statements, checks, purchase orders,
time cards and statements of account.

TRANSACTIONS ARE JOURNALIZED (Step 2)

After the transaction or event has been identified and measured, it is recorded
in the journal. The process of recording a transaction is called journalizing.

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ACCOUNTING FUNDAMENTALS

The Journal
The journal is a chronological record of the entity's transactions. A journal
entry shows all the effects of a business transaction in terms of debits and
credits. Each transaction is initially recorded in a journal rather than directly
in the ledger. A journal is called the book of original entry. The nature and
volume of transactions of the business determine the number and type of
journals needed. The general journal is the simplest journal.

Format
The standard contents of the general journal are as follows:
1. Date. The year and month are not rewritten for every entry unless the year
or month changes or a new page is needed.
2. Account Titles and Explanation. The account to be debited is entered at
the extreme left of the first line while the account to be credited is entered
slightly indented on the next line. A brief description of the transaction is
usually made on the line below the credit. Generally, skip a line after each
entry.
3. P. R. (posting reference). This will be used when the entries are posted,
that is, until the amounts are transferred to the related ledger accounts.
The posting process will be described later.
4. Debit. The debit amount for each account is entered in this column.
5. Credit. The credit amount for each account is entered in this column.

Assume that on Nov. 1, 2019, Galicano Del Mundo invests P450,000 to open
his business, Del Mundo Landscape Specialist. The journal entry as follows:

Journal
Date Account Titles and Explanation P.R. Debit Credit
1 2019
2 Nov. 1 Cash 450,000
3 Del Mundo, Capital 450,000
4 Initial investment.
5

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ACCOUNTING FUNDAMENTALS

Simple and Compound Entry

In a simple entry, only two accounts are affected – one account is debited and
the other account credited. An example of this is the entry to record the initial
investment of Del Mundo. However, some transactions require the use of more
than two accounts. When three or more accounts are required in a journal
entry, the entry is referred to as a compound entry.

Illustration: To understand how to record a variety of transactions, we shall

analyze the business of Del Mundo Landscape Specialist.
For better appreciation of the nature of the affected accounts, the letter A (for
asset), L (liability) or OE (owner’s equity) is inserted after each entry. In
addition, owner’s equity is further classified into OE: I (income) and OE: E
(expenses).
Note that the rules of double-entry system are observed in each transaction:
1. Two or more accounts are affected by each transaction.
2. The sum of the debits for every transaction equals the sum of the credits.
3. The equality of the accounting equation is always maintained.

Initial Investment

Nov. 1 The owner of the Del Mundo Landscape Specialist, Galicano del
Mundo, invests P450,000 to open the business.

Entry: Dr. Cr.

Cash (A) 450,000
Del Mundo, Capital (OE) 450,000

Rent Paid in Advance

Nov. 1 Rented office space and paid three months’ rent in advance,
P21,000.

Entry: Dr. Cr.

Prepaid Rent (A) 21,000
Cash (A) 21,000

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ACCOUNTING FUNDAMENTALS

Vehicle Acquired by Issuing a Note

Nov. 2 Del Mundo purchases a P300,000 used truck by paying P200,000

in cash and signing a P100,000 note payable which is due in
eighteen months.

Entry: Dr. Cr.

Vehicles (A) 300,000
Cash (A) 200,000
Notes Payable (L) 100,000

Equipment Acquired for Cash

Nov. 3 Del Mundo purchases mechanical lawn mowers for P54,000 in

cash.

Entry: Dr. Cr.

Equipment (A) 54,000
Cash (A) 54,000

Expenses Incurred and Paid

Nov. 4 Del Mundo purchases P1,500 worth of gasoline.

Entry: Dr. Cr.

Gas Expense (OE:E) 1,500
Cash (A) 1,500

Insurance Premiums Paid

Nov. 5 Del Mundo pays P24,000 for a one-year insurance contract that
protects his business from Nov. 1 until Oct. 31 of the following
year.

Entry: Dr. Cr.

Prepaid Insurance (A) 24,000
Cash (A) 24,000

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ACCOUNTING FUNDAMENTALS

Supplies Purchased on Account

Nov. 8 Del Mundo purchases P1,000 worth of office supplies, placing the
purchase on his account with the store rather than paying cash.

Entry: Dr. Cr.

Supplies (A) 1,000
Accounts Payable (L) 1,000

Revenues Earned and Cash Collected

Nov. 14 The Del Mundo Landscape Specialist cuts grass for seven
customers, receiving P2,500 from each.

Entry: Dr. Cr.

Cash (A) 17,500
Lawn Cutting Revenues (OE:I) 17,500

Unearned Revenues Collected

Nov. 20 Del Mundo receives P13,500 from a customer for six future
maintenance visits.

Entry: Dr. Cr.

Cash (A) 13,500
Unearned Revenues (L) 13,500

Revenues Earned on Account

Nov. 22 Del Mundo Landscape Specialist cuts grass for eight customers,
billing each one P2,500 but receiving no cash.

Entry: Dr. Cr.

Accounts Receivable (A) 20,000
Lawn Cutting Revenues (OE:I) 20,000

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ACCOUNTING FUNDAMENTALS

Salaries Paid

Nov. 26 Del Mundo pays P4,000 in salaries to a part-time

employee. Entry: Dr.

Cr.
Salaries Expense (OE:E) 4,000
Cash (A) 4,000

Advertising Paid

Nov. 28 Del Mundo pays P1,750 to print advertising fliers.

Entry: Dr. Cr.

Advertising Expense (OE:E) 1,750
Cash (A) 1,750

Withdrawal of Cash by Owner

Nov. 29 Del Mundo withdraws P5,000 for personal use.

Entry: Dr. Cr.

Del Mundo, Withdrawals (OE) 5,000
Cash (A) 5,000

Accounts Receivable Partially Collected

Nov. 30 Five of eight customers billed last Nov. 22 each pay

P2,500. Entry: Dr.

Cr.
Cash (A) 12,500
Accounts Receivable 12,500

THE LEDGER
A grouping of the entity’s accounts is referred to as a ledger. Although some
firms may use various ledgers to accumulate certain detailed information, all
firms have a general ledger. A general ledger is the "reference book" of the
accounting system and is used to classify and summarize transactions, and to
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ACCOUNTING FUNDAMENTALS

prepare data for basic financial statements. The accounts in the general ledger
are classified into two general groups:

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ACCOUNTING FUNDAMENTALS

1. balance sheet or permanent accounts (assets, liabilities and owner's

equity).
2. income statement or temporary accounts (income and expenses).
Temporary or nominal accounts are used to gather information for a
particular accounting period. At the end of the period, the balances of
these accounts are transferred to a permanent owner's equity
account.

Each account has its own record in the ledger. Every account in the ledger
maintains the basic format of the T-account but offers more information (e.g.
the account number at the upper right corner and the journal reference
column). Compared to a journal, a ledger organizes information by account.

CHART OF ACCOUNTS
A listing of all the accounts and their account numbers in the ledger is known
as the chart of accounts. The chart is arranged in the financial statement
order, that is, assets first, followed by liabilities, owner's equity, income and
expenses. The accounts should be numbered in a flexible manner to permit
indexing and cross-referencing.
When analyzing transactions, the accountant refers to the chart of accounts to
identify the pertinent accounts to be increased or decreased. If an appropriate
account title is not listed in the chart, an additional account may be added.
Presented below is the chart of accounts for the illustration:

Del Mundo Landscape Specialist

Chart of Accounts

Balance Sheet Accounts Income Statement Accounts

Assets Income
110 Cash 410 Landscaping Revenues
120 Accounts Receivable 420 Lawn Cutting Revenues
130 Supplies
140 Prepaid Rent Expenses
150 Prepaid Insurance 510 Salaries Expense
160 Vehicles 520 Supplies Expense
165 Accumulated Depreciation- 530 Rent Expense
Vehicles 540 Insurance Expense
170 Equipment 550 Gas Expense

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ACCOUNTING FUNDAMENTALS

175 Accumulated Depreciation- 560 Advertising Expense

Equipment 570 Depreciation Expense-Vehicles
580 Depreciation Expense-Equipment
Liabilities 590 Interest Expense
210 Notes Payable
220 Accounts Payable
230 Salaries Payable
240 Interest Payable
250 Unearned Revenues

Owner’s Equity
310 Del Mundo, Capital
320 Del Mundo, Withdrawals
330 Income Summary

POSTING (Step 3)
Posting means transferring the amounts from the journal to the appropriate
accounts in the ledger. Debits in the journal are posted as debits in the ledger,
and credits in the journal as credits in the ledger. The steps are the following:
1. Transfer the date of the transaction from the journal to the ledger.
2. Transfer the page number from the journal to the journal reference (J.R.)
column of the ledger.
3. Post the debit figure from the journal as a debit figure in the ledger and the '
credit figure from the journal as a credit figure in the ledger.
4. Enter the account number in the posting reference column of the journal
once the figure has been posted to the ledger.

LEDGER ACCOUNTS AFTER POSTING

At the end of an accounting period, the debit or credit balance of each account
must be determined to enable us to come up with a trial balance.
 Each account balance is determined by footing (adding) all the debits
and credits.
 If the sum of an account’s debits is greater than the sum of its credits,
that account has a debit balance.
 If the sum of its credits is greater, that account has a credit balance.

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ACCOUNTING FUNDAMENTALS

Illustration. The ledger accounts of Del Mundo Landscape Specialist after

posting are shown below. The account numbers and journal reference
columns are purposely omitted. The balance of each account has been
determined.

Cash Notes Payable

Nov 1 21,000 Nov2 100,000
Nov 1 450,000
2 200,000 Balance 100,000
14 17,500
20 13,500 3 54,000
30 12,500 4 1,500
5 24,000 Accounts Payable
26 4,000 Nov8 1,000
28 1,750 Balance1,000
29 5,000
493,500 311,250
Balance 182,250 Unearned Revenues
Nov 20 13,500
Balance13,500

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ACCOUNTING FUNDAMENTALS

Accounts Receivable
Nov 22 20,000 Nov 30 12,500
Balance7,500
Del Mundo, Capital
Nov1 450,000
Balance 450,000

Supplies Nov8 1,000 Del Mundo, Withdrawals Nov 29 5,000

Balance1,000 Balance 5,000

Prepaid Rent Nov1 21,000 Lawn Cutting Revenues

Balance21,000 Nov 1417,500
22 20,000
37,500
Balance37,500

Prepaid Insurance Nov5 24,000 Salaries Expense Nov 26 4,000

Balance24,000 Balance 4,000

Vehicles Nov2 300,000 Gas Expense Nov4 1,500

Balance 300,000 Balance 1,500

Equipment Nov3 54,000 Advertising Expense Nov 28 1,750

Balance54,000 Balance 1,750

TRIAL BALANCE (Step 4)

The trial balance is a list of all accounts with their respective debit or credit
balances. It is prepared to verify the equality of debits and credits in the ledger
at the end of each accounting period or at any time the postings are updated.
The procedures in the preparation of a trial balance follow:
1. List the account titles in numerical order.
2. Obtain the account balance of each account from the ledger and enter
the debit balances in the debit column and the credit balances in the

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ACCOUNTING FUNDAMENTALS

credit column.
3. Add the debit and credit columns.

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ACCOUNTING FUNDAMENTALS

4. Compare the totals.

The trial balance is a control device that helps minimize accounting errors.
When the totals are equal, the trial balance is in balance. This equality provides
an interim proof of the accuracy of the records but it does not signify the
absence of errors. For example, if the bookkeeper failed to record payment of
rent, the trial balance columns are equal but in reality, the accounts are
incorrect since rent expense is understated and cash overstated. The trial
balance for the illustration follows:

Del Mundo Landscape

Specialist Trial Balance
Nov. 30, 2019

Cash 182,250
Accounts Receivable 7,500
Supplies 1,000
Prepaid rent 21,000
Prepaid Insurance 24,000
Vehicles 300,000
Equipment 54,000
Notes Payable 100,000
Accounts Payable 1,000
Unearned Revenues 13,500
Del Mundo, Capital 450,000
Del Mundo, Withdrawals 5,000
Lawn Cutting Revenues 37,500
Salaries Expense 4,000
Gas Expense 1,500
Advertising Expense 1,750
602,000 602,000

LOCATING ERRORS
An inequality in the totals of the debits and credits would automatically signal
the presence of an error. These errors include:
1. Error in posting a transaction to the ledger:
 an erroneous amount was posted to the account.
 a debit entry was posted as a credit or vice versa.
 a debit or credit posting was omitted.

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ACCOUNTING FUNDAMENTALS

2. Error in determining the account balances:

 a balance was incorrectly computed.
 a balance was entered in the wrong balance column.
3. Error in preparing the trial balance:
 one of the columns of the trial balance was incorrectly added.
 the amount of an account balance was incorrectly recorded on the trial
balance.
 debit balance was recorded on the trial balance as a credit or vice versa,
or a balance was omitted entirely.

What is the most efficient approach in locating an error? The following

procedures when done in sequence may save considerable time and effort in
locating errors:
1. Prove the addition of the trial balance columns by adding these columns in
the opposite direction.
2. If the error does not lie in addition, determine the exact amount by which
the trial balance is out of balance. The amount of the discrepancy is often a
clue to the source of the error. If the discrepancy is divisible by 9, this suggests
either a transposition (reversing the order of numbers) error or a slide (moving
of the decimal point). For example, assume that the cash account balance is
P21,750, but in copying the balance into the trial balance the figures are
transposed and written as P21,570. The resulting error amounted to P180 and
is divisible by 9. Another common error is the slide, or incorrect placement of
the decimal point, as when P21,750.00 is copied as P2,175.00. The resulting
discrepancy in the trial balance will also be an amount divisible by 9.
Assume that the office equipment account has a debit balance of P42,000 but
it is erroneously listed in the credit column of the trial balance. This will cause
a discrepancy of two times P42,000 or P84,000 in the trial balance totals. Since
such errors as recording a debit in a credit column are common, it is advisable,
after determining the discrepancy in the trial balance totals, to scan the
columns for an amount equal to exactly one-half of the discrepancy.
It is also advisable to look over the transactions for an item of the exact amount
of the discrepancy. An error may have been made by recording the debit side of
the transaction and forgetting to enter the credit side.
3. Compare the accounts and amounts in the trial balance with that in the
ledger. Be certain that no account is omitted.
4. Recompute the balance of each ledger account.

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ACCOUNTING FUNDAMENTALS

5. Trace all postings from the journal to the ledger accounts. As this is done,
place a check mark in the journal and in the ledger after each figure is verified.
When the operation is completed, look through the journal and the ledger for
unchecked amounts. In tracing postings, be alert not only for errors in amount
but also for debits entered as credits, or vice versa.

Note that even when a trial balance is in balance, the accounting records may
still contain errors. A balanced trial balance simply proves that, as recorded,
debits equal credits. The following errors are not detected by a trial balance:
1. Failure to record or post a transaction.
2. Recording the same transaction more than once.
3. Recording an entry but with the same erroneous debit and credit amounts.
4. Posting a part of a transaction correctly as a debit or credit but to the wrong
account.

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