Adjusting journal entries

Solutions
Problem 1
Account Debited Account Credited
Deferrals:
Prepaid expenses
Asset method Expense Asset
Expense method Asset Expense
Unearned revenues
Liability method Liability Revenues
Income method Revenues Liability

Accruals:
Accrued expenses Expense Liability
Accrued revenues Asset Revenues
Problem 1
Asset method
Prepaid asset XX
Cash XX

Expense XX
Prepaid asset XX

Expense method
Expense XX
Cash XX

Prepaid asset XX
Expense XX
Problem 1
Liability method
Cash XX
Unearned revenues XX

Unearned revenues XX
Revenues XX

Income method
Cash XX
Revenues XX

Revenues XX
Unearned revenues XX
Problem 1
Accrued expense (Payable)
Salary expense XX
Salaries payable XX

Accrued revenues (Receivable)

Accounts receivable XX
Revenues XX
Problem 4
Prepaid insurance
Prepaid insurance 19,000
Cash 19,000

Insurance expense (19,000/2) 9,500

Prepaid insurance 9,500
Problem 4
Accrued salaries/Salaries payable
Salary expense (10,000 x 3) 30,000
Salaries payable 30,000
Problem 4
Supplies
Supplies 11,000
Cash 11,000

Supplies expense 9,080

Supplies 9,080

Supplies, beg. 4,480

Supplies bought 11,000
Available supplies for the year 15,480
Supplies, end (6,400)
Supplies expense for the year 9,080
Problem 4
Equipment
Depreciation expense 101,600
Accumulated depreciation – equipment 101,600

Cost 588,000
Salvage value 80,000
Depreciable amount 508,000
Divided by estimated useful life 5
Annual depreciation 101,600
 Problem 3
Batangas Solutions Diaz Technologies
2018 2018
Dec. 31 Royalty expense 600,000 Dec. 31 Royalty receivable 600,000
Royalty payable 600,000 Royalty income 600,000

2019 2019
May 1 Royalty payable 600,000 May 1 Cash 600,000
Cash 600,000 Royalty receivable 600,000

Jun. 30 Royalty expense 1,000,000 Jun. 30 Royalty receivable 1,000,000

Royalty payable 1,000,000 Royalty income 1,000,000

Nov. 1 Royalty payable 1,000,000 Nov. 1 Cash 1,000,000

Cash 1,000,000 Royalty receivable 1,000,000

Dec. 31 Royalty expense 1,250,000 Dec. 31 Royalty receivable 1,250,000

Royalty payable 1,250,000 Royalty income 1,250,000
Problem 3
Software sales 15,000,000
Multiply by 15%
Royalty expense/income 2019 2,250,000
Royalty expense/income recognized (1,000,000)
Accruals for royalty 1,250,000

Royalty payable – 2019

Payments 1,600,000 Beg. 600,000
Royalty expense 2,250,000

Ending balance 1,250,000

Problem 3
Royalty receivable – 2019
Beg 600,000 Collections 1,600,000
Royalty income 2,250,000

Ending balance 1,250,000

 Problem 3
Batangas Solutions Diaz Technologies
2018 2018
Dec. 31 Royalty expense 600,000 Dec. 31 Royalty receivable 600,000
Royalty payable 600,000 Royalty income 600,000

2019 2019
May 1 Royalty payable 600,000 May 1 Cash 600,000
Cash 600,000 Royalty receivable 600,000

Nov. 1 Royalty expense 1,000,000 Nov. 1 Cash 1,000,000

Cash 1,000,000 Royalty income 1,000,000

Dec. 31 Royalty expense 1,250,000 Dec. 31 Royalty receivable 1,250,000

Royalty payable 1,250,000 Royalty income 1,250,000
Problem 5
a. Rent expense (360K x 2/6) 120,000
Prepaid rent 120,000

b. Office supplies expense (63K – 27K) 36,000

Office supplies 36,000

c. Depreciation expense 75,000

Accumulated depreciation 75,000

d. Salaries expense 105,000

Salaries payable 105,000

e. Interest expense 54,000

Interest payable 54,000
Problem 5
Interest = Principal x rate x time
Interest expense = 900,000 x 24% x 3/12
Interest expense = 54,000
Problem 6
Prepaid rent
Beg. 0 Rent expense 780,000
Payments (SQUEEZE) 793,500

End. 13,500

Beg, prepaid rent 0

Payment 793,500
Available prepaid rent 793,500
Rent expense (780,000)
End, prepaid rent 13,500
Problem 6
Interest payable
Payments 135,000 Beg 18,000
Interest expense 117,000

End 0

Beg. Interest payable 18,000

Interest expense 117,000
Total 135,000
Less: Interest payments (135,000)
End interest payable 0
Problem 6
Salaries payable
Payments 1,206,000 Beg 75,000
Salaries expense 1,245,000

End 114,000

Beg. salaries payable 75,000

Salaries expense 1,245,000
Total 1,320,000
Less: Payments (1,206,000)
End salaries payable 114,000
Problem 6
Accounts receivable
Beg XX Collections XX
Sales on account/Credit sales XX

End XX

Beg. A/R XX
Sales on accounts/Credit sales XX
Total XX
Collections (XX)
End A/R XX
Problem 6
Unearned revenues
Earned revenues XX Beg XX
Collections XX

End XX

Beg. Unearned revenues XX

Advance collections XX
Total XX
Earned revenues (XX)
End Unearned revenues XX
Adjusting the accounts
Accrual basis vs. cash basis
Under the accrual basis of accounting, the effects of transactions and other events are recognized
when they occur and not as cash is received or paid.

This means that revenues are recognized only when they are earned, and expenses are recognized
as they are incurred.

Under the cash basis of accounting, the accountant does not recognize revenues and expenses until
cash is received or paid.

The generally accepted accounting principle is to record revenue and expense under accrual basis.
Accounting periods
Accounting periods are generally a month, a quarter or a year. The most basic accounting period is
one year. An account period of less than one year is called an interim period.

Entities differ in their choice of the accounting year which may either be calendar year or fiscal year.

Calendar year – an annual period ending on December 31.

Fiscal year – a period of any twelve consecutive months.
Recognition vs. derecognition
Recognition - is the process of capturing for inclusion in the financial statements items that meet
the definition of an asset, liability, equity, income and expenses.

Derecognition - is the removal of all or part of a recognized asset or a liability from an entity’s
statement of financial position.
Accruals and deferrals
Accrual is the recognition of an expense already incurred but not yet paid (accounts payable) or
revenue already earned but not yet collected (accounts receivable).

Deferral is the postponement of recognition of an expense already paid but not yet incurred
(prepayments) or revenue already collected but not yet earned (unearned revenue).
Accrued revenue (Receivable)
X Company recognizes its revenue on a cash basis. For the year ended December 31, 2021, the
following sales occurred:

Feb. 3 – Collected cash for services performed 20,000

Mar. 24 – Billed customers for services performed 30,000
Jul. 29 – Collected Mar. 24 billing 30,000
Nov. 20 – Performed services on account 45,000

Feb. 3 Cash 20,000

Service revenue 20,000

Jul. 29 Cash 30,000

Service revenue 30,000
Accrued revenue (Receivable)
Feb. 3 – Collected cash for services performed 20,000
Mar. 24 – Billed customers for services performed 30,000
Nov. 20 – Performed services on account 45,000
Sales revenue for the year ended, Dec. 31 95,000

Adjusting journal entry:

Dec. 31 Accounts receivable 45,000
Service revenue 45,000
To record sales on account – Nov. 20
Accrued expense (Payable)
X Company started its operations on January 1, 2021. On its first year of operations, X company pays
its monthly rent of P10,000 on a quarterly basis. Each payment is to be made on the 10th day
following the end of each quarter. X records its expenses on a cash basis.

April 10 Rent expense 30,000

Cash 30,000

Jul. 10 Rent expense 30,000

Cash 30,000

Oct. 10 Rent expense 30,000

Cash 30,000
Accrued expense (Payable)
Rent expense Jan. – Dec. (10,000 x 12) 120,000

Adjusting journal entry:

Dec. 31 Rent expense 30,000
Rent payable 30,000
To record rent expense last quarter of 2021
Deferred revenue (Unearned revenue)
There are two methods in accounting for deferred revenue, namely:
1. Liability method – the account credited is a liability upon collection of receipts for services not
yet performed.
2. Income method – the account credited is an income upon collection of receipts for services not
yet performed.
Deferred revenue (Unearned revenue)
X company started its operations on January 1, 2021. On June 1, 2021, X received P1,200,000 from a
customer for services to be rendered from June 1, 2021 – May 31, 2022.
Liability method Income method
Jun. 1 Cash 1,200,000 Jun. 1 Cash 1,200,000
Unearned revenue 1,200,000 Service revenue 1,200,000
To record receipt of advance payment from To record receipt of advance payment from
customers customers

Dec. 31 Unearned revenue 700,000 Dec. 31 Service revenue 500,000

Service revenue 700,000 Unearned revenue 500,000
To record earned portion of advances from To record unearned portion of advances from
customer customer
Deferred revenue (Unearned revenue)
Liability method Income method

Unearned revenue Unearned revenue

Dec. 31 700,000 Jun. 1 1,200,000 Dec. 31 500,000

Balance 500,000 Balance 500,000

Service revenue Service revenue

Dec. 31 700,000 Dec. 31 500,000 Jun. 1 1,200,000

Balance 700,000 Balance 700,000

Deferred expense (Prepayments)
There are two methods in accounting for deferred expense, namely:
1. Asset method – the account debited is an asset upon payment for expenses not yet incurred.
2. Expense method – the account debited is an expense upon payment for expenses not yet
incurred.
Deferred expense (Prepayments)
X company started its operations on January 1, 2021. On March 1, 2021, X paid P1,200,000 for a 1 –
year insurance to be consumed from March 1, 2021 to February 28, 2022.
Asset method Expense method
Mar. 1 Prepaid insurance 1,200,000 Mar. 1 Insurance expense 1,200,000
Cash 1,200,000 Cash 1,200,000
To record payment for 1 – year insurance To record payment for 1 – year insurance

Dec. 31 Insurance expense 1,000,000 Dec. 31 Prepaid insurance 200,000

Prepaid insurance 1,000,000 Insurance expense 200,000
To record expired portion of insurance To record unexpired portion of insurance
Deferred expense (Prepayments)
Asset method Expense method

Prepaid insurance Prepaid insurance

Mar. 1 1,200,000 Dec. 31 1,000,000 Dec. 31 200,000

Balance 200,000 Balance 200,000

Insurance expense Insurance expense

Dec. 31 1,000,000 Mar. 1 1,200,000 Dec. 31 200,000

Balance 1,000,000 Balance 1,000,000

Depreciation
Property, plant and equipment (PPE) are assets that will be used for more than one year, therefore,
the economic benefits of such assets will be consumed for more than one accounting period.

To properly reflect the consumption of the economic benefits of PPE, the cost of the PPE will be
allocated over its estimated useful life by recognizing depreciation expense for each accounting
period.
Depreciation
Proforma computation of annual depreciation:

Cost of PPE XX
Estimated salvage value/residual value (XX)
Depreciable amount XX
Divided by: Estimated useful life in years XX
Annual depreciation XX
Depreciation
X Company paid P1,640,000 for equipment purchased on July 31, 2021. The equipment has an
estimated salvage value of 200,000 and estimated useful life of 6 years.

Cost of PPE 1,640,000

Estimated salvage value/residual value (200,000)
Depreciable amount 1,440,000
Divided by: Estimated useful life in years 6
Annual depreciation 240,000

Dec. 31 Depreciation expense (240K x 5/12) 100,000

Accumulated depreciation 100,000
To record 5 months depreciation of equipment
Doubtful accounts expense
In some cases, customers who purchased goods or avail services on credit will never pay for the
amounts due to the entity.

Instead of waiting for objective evidence that accounts receivable are uncollectible, entities need to
estimate the uncollectible accounts for each accounting period to properly match the expense for
these uncollectible accounts with revenues for the period.
Doubtful accounts expense
X Company made credit sales of P2,000,000 for the year ended December 31, 2021. Prior experience indicates
that a rate of 4% of the credit sales will be uncollectible.

Dec. 31 Doubtful accounts expense (2M x 4%) 80,000

Allowance for doubtful accounts 80,000
To recognize provision for doubtful accounts expense

On January 10, 2022, P50,000 of receivables was proven to be worthless.

Jan. 10 Allowance for doubtful accounts 50,000

Accounts receivable 50,000
To write-off worthless accounts
Effects of omission of accruals and deferrals
Understated ((Overstated))

Year of omission Following year

Owner’s Owner’s
Adjustment omitted Asset Liability Net income Equity Asset Liability Net income equity

Accrued revenue Understated Understated Understated (Overstated)

Accrued expense Understated (Overstated) (Overstated) Understated

Deferred revenue
(income method) Understated (Overstated) (Overstated) Understated
Deferred expense
(expense method) Understated Understated Understated (Overstated)
Deferred revenue
(liability method) (Overstated) Understated Understated (Overstated) Understated Understated
Deferred expense
(asset method) (Overstated) (Overstated) (Overstated) (Overstated) (Overstated) (Overstated)
Effects of omission of accruals and deferrals
Understated (Overstated)

Year of omission Following year

Owner’s Owner’s
Adjustment omitted Asset Liability Net income Equity Asset Liability Net income equity

Accrued revenue 45,000 45,000 45,000 (45,000)

Accrued expense 30,000 (30,000) (30,000) 30,000

Deferred revenue
(income method) 500,000 (500,000) (500,000) 500,000
Deferred expense
(expense method) 200,000 200,000 200,000 (200,000)
Deferred revenue
(liability method) (700,000) 700,000 700,000 (1,200,000) 500,000 1,200,000
Deferred expense
(asset method) (1,000,000) (1,000,000) (1,000,000) (1,200,000) (200,000) (1,200,000)
Recording Business
Transactions
Accounting Cycle
The accounting cycle refers to a series of sequential steps or procedures performed to accomplish
the accounting process.
Step 1 – Identification and analysis
Gathering of information about accounting transactions or events generally through source
documents and analyzing the effects of such transactions.

Source documents – original written evidences containing information about the nature and the
amounts of the transactions. These are the bases for the journal entries.

Common examples of source documents are sales invoices, cash register tapes, official receipts,
bank deposit slips, bank statements, checks, purchase orders, timecards and statement of account.
Step 2 – Journalizing
Recording the economic impact of transactions on the firm in a journal, which is a form that
facilitates transfer to the accounts.

Journal (Book of original entry) – a chronological record of the entity’s transactions in the form of
journal entries. A journal entry shows all the effects of a business transaction in terms of debits and
credits.
Journal entries may be either a simple journal entry or a compound journal entry.
Simple journal entry – affects only two accounts, therefore, one account is debited, and one
account is credited.
Compound journal entry – affects three or more accounts, therefore, there may be two or more
accounts debited and/or two or more accounts credited.
General Journal
Standard contents of a general journal are as follows:

Date Account Title and Description P.R. Debit Credit

1
2
3
4
Step 3 – Posting
Transferring of information from the journal to the ledger for classification and summarization of
transactions.

A grouping of the entity’s accounts is referred to as a ledger. The most basic form of ledger is the
general ledger.

General ledger – is the “reference book” of the accounting system and is used to classify and
summarize transactions, and to prepare data for basic financial statements.
Permanent and temporary accounts
The accounts in the general ledger are classified into two general groups:
1. Permanent accounts – accounts for the items presented in the balance sheet (assets, liabilities
and owner’s equity).
2. Temporary accounts/nominal accounts – accounts for the items presented in the income
statement (income and expenses). The balances of these accounts are closed and transferred to
a permanent owner’s equity account at the end of each accounting period.
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: (1) assets, (2) liabilities, (3) owner’s
equity, (4) income and (5) expenses.

Chart of accounts
Account number Account name
110 Cash
120 Accounts Receivable
210 Accounts Payable
220 Notes Payable
310 Owner’s Equity
320 Drawings
410 Service Income
510 Salary Expense
General Ledger
Standard contents of a general ledger are as follows:

Date Description J.R. Debit Credit Balance

1
2
3
4
Step 4 – Preparation of Trial Balance
Summarizing a listing of accounts to verify the equality of debits and credits.

Trial balance – is a list of all accounts with their respective debit or credit balances from the general
ledger. The trial balance is a control device that helps minimize accounting errors.
Trial Balance
Standard contents of a trial balance are as follows:
Company Name
Trial Balance
End of accounting period
Account title Debit Credit

Total
Step 5 – Preparation of Worksheet and Adjusting Entries

Preparing worksheet to aid in the preparation of financial statements and including any necessary
adjustments in the worksheet to be properly reflected in the financial statements.
Step 6 – Preparation of Financial Statements

Preparing financial reports that provides useful information to decision-makers.

Step 7 – Journalizing Adjusting Entries

Recording of adjusting entries from the worksheet to the journal.

Step 8 – Closing Journal Entries are Journalized and Posted

Closing of temporary accounts and transferring profit or loss and withdrawals to the owner’s equity
account.
Step 9 – Post – Closing Trial Balance

Preparation of a post – closing trial balance to check the equality of debits and credits after the
closing entries.
Step 10 – Reversing Journal Entries

Reversing some adjusting entries to simplify the recording of certain transactions for the next
accounting period.
Del Mundo Landscape Specialist
Initial investment
Nov. 1 The owner of the Del Mundo Landscape Specialist, Galicano Del Mundo, invests P450,000 to
open the business.
Del Mundo Landscape Specialist
Rent Paid in Advance
Nov. 1 Rented office space and paid three months’ rent in advance, P21,000.
Del Mundo Landscape Specialist
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.
Del Mundo Landscape Specialist
Equipment Acquired for Cash
Nov. 3 Del Mundo purchases mechanical lawn mowers for P54,000 in cash.
Del Mundo Landscape Specialist
Expenses Incurred and Paid
Nov. 4 Del Mundo purchases P1,500 worth of gasoline.
Del Mundo Landscape Specialist
Insurance Premium 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.
Del Mundo Landscape Specialist
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.
Del Mundo Landscape Specialist
Revenues Earned and Cash Collected
Nov. 14 The Del Mundo Landscape Specialist cuts grass for seven customers, receiving P2,500 from
each.
Del Mundo Landscape Specialist
Unearned Revenues Collected
Nov. 20 Del Mundo receives P13,500 from a customer for six future maintenance visits.
Del Mundo Landscape Specialist
Revenues Earned on Account
Nov. 22 Del Mundo Landscape Specialist cuts grass for eight customers, billing each one P2,500 but
receiving no cash.
Del Mundo Landscape Specialist
Salaries Paid
Nov. 26 Del Mundo pays P4,000 in salaries to a part-time employee.
Del Mundo Landscape Specialist
Advertising Paid
Nov. 28 Del Mundo pays P1,750 to print advertising fliers.
Del Mundo Landscape Specialist
Withdrawal of Cash by Owner
Nov. 29 Del Mundo withdraws P5,000 for personal use.
Del Mundo Landscape Specialist
Accounts Receivable Partially Collected
Nov. 30 Five of the eight customers billed last Nov. 22 each pay P2,500.
Common errors
Common errors that will cause inequality in the trial balance:
• Transposition
• Slide
• Omission or error in one side of the entry
Common errors that will not cause inequality in the trial balance:
• Omission
• Duplicating an entry
• Equal error in debit and credit
• Posting in wrong account
Accounting Equation and the
Double-Entry System
Elements of financial statements
I. Financial position
A. Asset – is a present economic resource controlled by the entity as a result of past
events. An economic resource is a right that has the potential to produce
economic benefits.
B. Liability – is a present obligation of the entity to transfer an economic resource
as a result of past events. An obligation is a duty or responsibility that the entity
has no practical ability to avoid.
C. Equity – the residual interest in the assets of the entity after deducting all its
liabilities.
Elements of financial statements
I. Financial position
A. Asset – is a present economic resource controlled by the entity as a result of past
events. An economic resource is a right that has the potential to produce
economic benefits.
B. Liability – is a present obligation of the entity to transfer an economic resource
as a result of past events. An obligation is a duty or responsibility that the entity
has no practical ability to avoid.
C. Equity – the residual interest in the assets of the entity after deducting all its
liabilities.
Elements of financial statements
II. Financial performance
A. Income – is increases in assets, or decreases in liabilities, that result in increases
in equity, other than those relating to contributions from holders of equity
claims.
B. Expenses – are decreases in assets, or increases in liabilities, that result in
decreases in equity, other than those relating to distributions to holders of equity
claims.
Assets
Assets may be classified into current assets and noncurrent assets. An entity shall classify
an asset as current when:
a. It expects to realize the asset, or intends to sell or consume it, in its normal operating
cycle.
b. It holds the asset primarily for the purpose of trading.
c. It expects to realize the asset within twelve months after the end of the reporting
period.
d. The asset is cash or a cash equivalent unless it is restricted from being exchanged or
use to settle a liability for at least twelve months after the end of the reporting period.
An entity shall classify all other assets as noncurrent.
Current assets
The following are the common current assets of most businesses:
I. Cash
II. Cash equivalents – Short-term, highly liquid investments that are readily convertible to known
amounts of cash and which are subject to insignificant risk of changes in value.
III. Accounts receivable – Claims against customers arising from sale of services or goods on credit.
IV. Notes receivable – Written pledge that the customer will pay the business a fixed amount of
money on a certain date.
V. Inventories – Assets which are held for sale in the ordinary course of business; in the process of
production for such sale; or in the form of materials or supplies to be consumed in the
production process or in the rendering services.
VI. Prepaid expenses – Expenses paid for by the business in advance.
Noncurrent assets
The following are the common noncurrent assets of most businesses:
I. Property, plant and equipment – Tangible assets that are held by an enterprise for use
in the production or supply of goods or services, or for rental to others, or for
administrative purposes and which are expected to be used during more than one
period.
II. Accumulated depreciation – A contra account that contains the sum of the periodic
depreciation charges of property, plant and equipment.
III. Intangible assets – Identifiable, nonmonetary assets without physical substance held
for use in the production or supply of goods or services, for rental to others, or for
administrative purposes.
Liabilities
Liabilities may be classified into current liabilities and noncurrent liabilities. An entity shall
classify a liability as current when:
a. It expects to settle the liability in its normal operating cycle.
b. It holds the liability primarily for the purpose of trading.
c. The liability is due to be settled within twelve months after the end of the reporting
period.
d. The entity does not have an unconditional right to defer settle of the liability for at
least twelve months after the end of reporting period.
An entity shall classify all other liabilities as noncurrent.
Current liabilities
The following are the common current liabilities of most businesses:
I. Accounts payable – Obligations to suppliers arising from purchase of services or goods
on credit.
II. Notes payable – Reverse of note receivable.
III. Accrued liabilities – Amounts owed to others for unpaid expenses such as salaries
payable, utilities payable, interest payable and taxes payable.
IV. Unearned revenues – Obligations to perform services or deliver goods that are paid in
advance.
V. Current portion of long-term debt – Portion of long-term debts which are to be paid
within one year at the end of reporting period.
Current liabilities
The following are the common noncurrent liabilities of most businesses:
I. Mortgage payable – Long-term debt of the business for which the business has
pledge3d certain assets as security.
II. Bonds payable – Contract between the issuer and lender specifying the terms of
repayment and interest to be charged.
Owner’s equity
I. Capital – Used to record original and additional investments of the owner of the
business entity. It is also increased by the amount of profit earned and decreased by
the amount loss incurred for the year.
II. Withdrawals – Temporary account used to record withdrawal or drawings of the
business owners.
III. Income summary – Temporary account used at the end of accounting period to
summarize and close income and expenses.
Income
I. Service income – revenues earned by performing services for a customer or client.
II. Sales – Revenues earned as a result of sale of merchandise.
Expenses
I. Cost of sales - cost incurred to purchase or to produce the products sold to customers during the
period.
II. Cost of services – cost incurred for performing services to customers or clients.
III. Salaries or wages expense – expenses for services performed by employees to the company.
IV. Utilities expense – expenses related to use of communication, electricity, water, etc.
V. Supplies expense – expense of using supplies for administrative services.
VI. Rent expense – expense for using leased spaces, equipment or other assets.
VII. Insurance expense – expired portion of premiums paid for insurance coverage.
VIII. Depreciation expense – portion of the cost of a tangible asset allocated or charged as expense
during the period.
IX. Doubtful accounts expense – amount of receivables estimated to be doubtful of collection and
charged as expense during the period.
X. Interest expense – an expense related to use of borrowed funds.
Accounting event and transactions
An accounting event is an occurrence that causes changes in an enterprise’s assets,
liabilities and/or equity.

An accounting transaction is a particular kind of event that involves the transfer of

something of value between entities.
Accounting equation
The most basic tool of accounting is the accounting equation. This equation states that
assets must always equal liabilities and owner’s equity. The basic accounting model is:

Assets = Liabilities + Owner’s Equity

Recording of any accounting event and transaction must maintain this equality.
Financial transaction worksheet
The financial transactions may be analyzed by means of a financial transaction worksheet
which is a form used to analyze increases and decreases in the assets, liabilities or owner’s
equity of a business entity.
Illustration
Modesto Accounting Services is a firm that provides a wide range of bookkeeping and
accounting services. This sole proprietorship business is owned by Dr. Emerita Modesto, a
CPA. The office is managed by Francisco Roxas, MBA.

During October 2019, the first month of operations, various financial transactions took
place. These transactions are described and analyzed in the following slides.
Initial transactions
Initial investment
Oct. 1 Emerita Modesto obtained the funds to start the business by withdrawing P800,000
from her personal savings. He deposited the money in a new bank account that he opened
in the name of the firm, Modesto Accounting Services.
Initial transactions
Purchasing Equipment on Credit
Oct. 3 Roxas bought a computer, a copy machine, a fax machine, calculators and other
necessary equipment from M. Medina, Inc., at a cost of P100,000. M. Medina, Inc., agreed
to allow 60 days for the firm to pay the bill.
Initial transactions
Purchasing Supplies for Cash
Oct. 5 Roxas placed an order for toner, fax paper, bond paper, CDs, pens, folders and other
supplies that had a total cost of P20,000. The entity that sold the items, Cavite Supplies,
Inc., requires cash payments from businesses that are under six months old. Modesto
Account Services therefore included a check with its order.
Initial transactions
Paying a creditor
Oct. 9 Roxas decided to pay P40,000 to M. Medina, Inc. to reduce the firm’s debt to that
business.
Effects of revenue and expenses
Selling services on credit
Oct. 13 Modesto Accounting Services earned P70,000 of revenue from charge account
clients. These clients are allowed 30 days to pay.
Effects of revenue and expenses
Employee’s salaries
Oct. 18 Modesto Accounting Services hired an accounting staff on Oct. 1 to help in the
business. The firm paid P25,000 in salaries for this employee and Francisco Roxas.
Effects of revenue and expenses
Collecting receivables
Oct. 23 Modesto Accounting Services received P30,000 from clients who had previously
bought services on account. This cash was applied to their accounts.
Effects of revenue and expenses
Selling Services for Cash
Oct. 27 Modesto Accounting Services earned a total of P210,000 in revenue from clients
who paid cash for accounting and bookkeeping services.
Effects of revenue and expenses
Utilities expense
Oct. 30 Modesto Accounting Services received a P35,000 bill for the utilities that it had
used during the month. A check was issued to pay the bill immediately.
Effects of revenue and expenses
Rent expense
Oct. 31 Modesto Accounting Services issued a check as payment for office rent for October.
The lease contract Modesto signed specified a monthly rent of P45,000.
Effects of Owner’s Withdrawals
Owner’s Withdrawal
Oct. 31 Emerita Modesto withdrew P150,000 in cash from the business to pay for personal
expenses.
The account
The account is the basic summary device of accounting. A separate account is maintained
for each element that appears in the statement of financial position and the statement of
comprehensive income. Increases, decreases and balances are reflected in these accounts.

The simplest form of account is known as the T-account because of its similarity to the
letter T.

Account Title
Debit Credit
(Left side of the account) (Right side of the account)
Double-entry system
Accounting is based on a double-entry system which means that the dual effects of a
business transaction is recorded. Each transaction affect at least two accounts, therefore,
for every one or more accounts debited there must be one or more accounts credited.

The total debits for a transaction must always equal the total credits.
Normal balance of an account
The normal balance of an any account refers to the side of the account where increases are
recorded.
Assets (Normal balance debit) Liabilities (Normal balance credit)
Debit Credit Debit Credit
Increases Decreases Decreases Increases

Drawings (Normal balance debit) Owner’s equity (Normal balance credit)

Debit Credit Debit Credit
Increases Decreases Decreases Increases

Expenses (Normal balance debit) Income (Normal balance credit)

Debit Credit Debit Credit
Increases Decreases Decreases Increases
Conceptual Framework
Fundamental concepts
Several fundamental concepts underlie the accounting process. In recording business
transactions, accountants should consider the following:

1. Entity concept
2. Periodicity concept
3. Stable Monetary Unit Concept
Entity concept
Entity concept assumes that an entity is different from its owners therefore, accounting of
events and conditions of the entity and its owners should not be merged.
Periodicity concept
Periodicity concept assumes that the indefinite life on an entity is divided into time periods
or accounting periods for the purpose of preparing financial statements.
Stable monetary unit concept
Stable monetary unit concept assumes that the purchasing power of peso is stable or
constant and its instability is insignificant.
Criteria for general acceptance of an
accounting principle
The general acceptance of an accounting principle usually depends on how well it meets
three criteria:

1. Relevance
2. Objectivity
3. Feasibility
Relevance
An accounting principle is relevant if it results in information that is meaningful and useful
to the users of the accounting information.
Objectivity
A principle is objective to the extent that the accounting information is not influenced by
personal bias or judgment of those who provide it.
Feasibility
A principle is feasible to the extent that it can be implemented without much complexity or
cost.
Conceptual Framework
The Conceptual Framework for Financial Reporting describes the objective of, and the
concepts for, general purpose financial reporting.

Conceptual Framework for Financial Reporting was issued by the International Accounting
Standards Board in September 2010. It was revised in March 2018.
Objective of financial reporting
The objective of general purpose financial reporting is to provide financial information
about the reporting entity that is useful to existing and potential investors, lenders and
other creditors in making decisions relating to providing resources to the entity.

Those decisions involve decisions about:

1. buying, selling or holding equity and debt instruments;
2. providing or settling loans and other forms of credit; or
3. exercising rights to vote on, or otherwise influence, management’s actions that affect
the use of the entity’s economic resources.
Objective of financial reporting
General purpose financial reports provide information about the financial position of a
reporting entity, which is information about the entity’s economic resources and the
claims against the reporting entity.

Financial reports also provide information about the effects of transactions and other
events that change a reporting entity’s economic resources and claims.

Both types of information provide useful input for decisions relating to providing resources
to an entity.
Economic resources and claims
Information about the nature and amounts of a reporting entity’s economic resources and
claims can help users to identify the reporting entity’s financial strengths and weaknesses.
Changes in economic resources and
claims
Changes in a reporting entity’s economic resources and claims result from that entity’s
financial performance and from other events or transactions such as issuing debt or equity
instruments.
Financial performance reflected by
accrual accounting
Accrual accounting depicts the effects of transactions and other events and circumstances
on a reporting entity’s economic resources and claims in the periods in which those effects
occur, even if the resulting cash receipts and payments occur in a different period.
Revenue recognition principle
Revenue is to be recognized in the accounting period when goods are delivered, or services
are rendered or performed.
Expense recognition principle
Expenses should be recognized in the accounting period in which goods and services are
used up to produce revenue and not when the entity pays for those goods and services.
Financial performance reflected by past
cash flows
Information about a reporting entity’s cash flows during a period also helps users to assess
the entity’s ability to generate future net cash inflows and to assess management’s
stewardship of the entity’s economic resources.
Changes in economic resources and claims
not resulting from financial performance
A reporting entity’s economic resources and claims may also change for reasons other than
financial performance, such as issuing debt or equity instruments.

Information about this type of change is necessary to give users a complete understanding
of why the reporting entity’s economic resources and claims changed and the implications
of those changes for its future financial performance.
Qualitative characteristics of useful financial
information
The qualitative characteristics of useful financial information are divided into:
1. Fundamental qualitative characteristics
• Relevance
• Faithful representation
2. Enhancing qualitative characteristics
• Verifiability
• Consistency
• Understandability
• Timeliness
Relevance
Relevant financial information is capable of making a difference in the decisions made by
users. Financial information is capable of making a difference in decisions if it has
predictive value, confirmatory value or both.

Financial information has predictive value if it can be used as an input to processes

employed by users to predict future outcomes.

Financial information has confirmatory value if it provides feedback about (confirms or

changes) previous evaluations.
Materiality
Information is material if omitting, misstating or obscuring it could reasonably be expected
to influence decisions that the primary users of general purpose financial reports make on
the basis of those reports, which provide financial information about a specific reporting
entity
Faithful representation
Financial reports represent economic phenomena in words and numbers. To be useful,
financial information must not only represent relevant phenomena, but it must also
faithfully represent the substance of the phenomena that it purports to represent.

To be a perfectly faithful representation, a depiction would have three characteristics:

completeness, neutrality, and freedom from error.
Completeness
A complete depiction includes all information necessary for a user to understand the
phenomenon being depicted, including all necessary descriptions and explanations.
Neutrality
A neutral depiction is without bias in the selection or presentation of financial information.
Neutrality is supported by the exercise of prudence.

Prudence is the exercise of caution when making judgements under conditions of

uncertainty. The exercise of prudence means that assets and income are not overstated
and liabilities and expenses are not understated.
Freedom for error
Faithful representation does not mean accurate in all respects. Free from error means
there are no errors or omissions in the description of the phenomenon, and the process
used to produce the reported information has been selected and applied with no errors in
the process.
Verifiability
Verifiability helps assure users that information faithfully represents the economic
phenomena it purports to represent.

Verifiability means that different knowledgeable and independent observers could reach
consensus, although not necessarily complete agreement, that a particular depiction is a
faithful representation.
Comparability
Information about a reporting entity is more useful if it can be compared with similar
information about other entities and with similar information about the same entity for
another period or another date.

Comparability is the qualitative characteristic that enables users to identify and understand
similarities in, and differences among, items.
Consistency
Consistency, although related to comparability, is not the same. Consistency refers to the
use of the same methods for the same items, either from period to period within a
reporting entity or in a single period across entities.

Comparability is the goal; consistency helps to achieve that goal.

Intracomparability and intercomparability
Intracomparability – comparability within an entity.
Intercomparability or dimensional comparability – comparability across entities.
Understandability
Classifying, characterizing and presenting information clearly and concisely makes it
understandable.

Financial reports are prepared for users who have a reasonable knowledge of business and
economic activities and who review and analyze the information diligently.
Timeliness
Timeliness means having information available to decision-makers in time to be capable of
influencing their decisions. Generally, the older the information is the less useful it is.
Cost constraint on useful financial reporting
Cost is a pervasive constraint on the information that can be provided by financial
reporting. Reporting financial information imposes costs, and it is important that those
costs are justified by the benefits of reporting that information.
Going concern assumption
Financial statements are normally prepared on the assumption that the reporting entity is
a going concern and will continue in operation for the foreseeable future.
Elements of financial statement
1. Asset – is a present economic resource controlled by the entity as a result of past
events. An economic resource is a right that has the potential to produce economic
benefits.
2. Liability – is a present obligation of the entity to transfer an economic resource as a
result of past events. An obligation is a duty or responsibility that the entity has no
practical ability to avoid.
3. Equity – the residual interest in the assets of the entity after deducting all its liabilities.
4. Income – is increases in assets, or decreases in liabilities, that result in increases in
equity, other than those relating to contributions from holders of equity claims.
5. Expenses – are decreases in assets, or increases in liabilities, that result in decreases in
equity, other than those relating to distributions to holders of equity claims.
Recognition and derecognition
Recognition is the process of capturing for inclusion in the statement of financial position
or the statement(s) of financial performance an item that meets the definition of one of
the elements of financial statements—an asset, a liability, equity, income or expenses.

Derecognition is the removal of all or part of a recognized asset or liability from an entity’s
statement of financial position. Derecognition normally occurs when that item no longer
meets the definition of an asset or of a liability.
Measurement of the elements of financial
statements
1. Historical cost
2. Current value
• Fair value
• Value in use
• Fulfillment value
• Current cost
Historical cost
Historical cost measures provide monetary information about assets, liabilities and related
income and expenses, using information derived, at least in part, from the price of the
transaction or other event that gave rise to them.
Fair value
Fair value is the price that would be received to sell an asset, or paid to transfer a liability,
in an orderly transaction between market participants at the measurement date.
Value in use
Value in use is the present value of the cash flows, or other economic benefits, that an
entity expects to derive from the use of an asset and from its ultimate disposal.
Fulfilment value
Fulfilment value is the present value of the cash, or other economic resources, that an
entity expects to be obliged to transfer as it fulfils a liability.
Current cost
The current cost of an asset is the cost of an equivalent asset at the measurement date,
comprising the consideration that would be paid at the measurement date plus the
transaction costs that would be incurred at that date.
Capital and capital maintenance
A financial concept of capital is adopted by most entities in preparing their financial
statements.
Under a financial concept of capital, such as invested money or invested purchasing power,
capital is synonymous with the net assets or equity of the entity.
Under a physical concept of capital, such as operating capability, capital is regarded as the
productive capacity of the entity based on, for example, units of output per day.
Concepts of capital
A financial concept of capital is adopted by most entities in preparing their financial
statements.
Under a financial concept of capital, such as invested money or invested purchasing power,
capital is synonymous with the net assets or equity of the entity.
Under a physical concept of capital, such as operating capability, capital is regarded as the
productive capacity of the entity based on, for example, units of output per day.
Capital maintenance
1. Financial capital maintenance – Under this concept a profit is earned only if the
financial amount of the net assets at the end of the period exceeds the financial
amount of net assets at the beginning of the period, after excluding any distributions
to, and contributions from, owners during the period.
2. Physical capital maintenance – Under this concept a profit is earned only if the physical
productive capacity of the entity at the end of the period exceeds the physical
productive capacity at the beginning of the period, after excluding any distributions to,
and contributions from, owners during the period.
Basic Business Environment
Fundamental Business Model
For a business to be successful, it needs to develop a product or service that customers will pay for
and thus create a revenue stream. It can be a new product or service that meet specify needs.

The business model is built on five activities:

1. Financing
2. Investment
3. Production
4. Sale and collection
5. Use of cash inflows from sales
Types of business
The following are the seven broad categories of business depending on its products and
services:
Type Activity Examples
1. Services Selling people’s time and skills Accounting and legal services
2. Trader/Merchandising Buying and selling products Wholesaler, Retailer
3. Manufacturing Converting raw materials into other Consumer goods
finished products
4. Raw materials Growing or extracting raw materials Farming, Mining
5. Infrastructure Selling the use of infrastructure Expressways, Hotels, Sports
facilities
6. Financial Receiving deposits, lending and investing Banks
money
7. Insurance Pooling premiums of many to meet claims Insurance
of a few
Forms of business organizations
The following are three major legal forms of business entities:

1. Sole proprietorship
2. Partnership
3. Corporation
Sole Proprietorship
Sole proprietorship has a single owner called the proprietor. This is most common for small
service businesses and retail establishments.
Partnership
A partnership is a business owned and operated by two or more persons who bind
themselves to contribute money, property, or industry to a common fund, with the
intention of dividing the profits among themselves.
Corporation
A corporation is a business owned by its stockholders. It is an artificial being created by
operation of law, having the rights of succession and the powers, attributes and properties
expressly authorized by law or incident to its existence.
Comparison
Sole Proprietorship Partnership Corporation
Ownership Single owner Two or more owners Usually owned by many
stockholders
Formation Easy to form Easy to form Difficult to form
Ability to generate capital Limited Limited Unlimited
Liability Unlimited liability Unlimited liability Limited liability
Life Limited Limited Unlimited
Tax Low High High
Regulation Low Low High

Regardless of the form of the business, the business should be treated as distinct and separate from
that of the owners.
Activities in Business Organizations
The three types of organizational activities are divided into three, namely:

1. Financing activities
2. Investing activities
3. Operating activities
Financing activities
Financing activities are the methods of an organization uses to obtain financial resources
from financial markets and how it manages these resources.

Primary sources of financing most business are owners and creditors, such as banks and
suppliers. Repaying creditors and paying returns to the owners are also financing activities.
Investing activities
Investing activities involve the selection and management including disposal and
replacement of long-term resources that will be used to develop, produce and sell goods
and services.

Investing activities include buying land, equipment, buildings and other resources that are
needed in the operation oof the business, and selling these resources when they are no
longer needed.
Operating activities
Operating activities involve the use of resources to design, produce, distribute and market
goods and services.

Operating activities include research and development, design and engineering,

purchasing, human resources, production, distribution, marketing and selling, and
servicing.
Business stakeholders
Stakeholders need information in order to make economic decisions. The stakeholders
utilize financial statements in order to satisfy some of their different needs for
information.

The primary users of the financial statements as defined in the Conceptual Framework are
the potential and existing investors, lenders and others creditors.
Users and the information needs
The following are different users of financial statements and their information needs:
User Information needs
Investors To help them determine whether they should buy, hold
or sell.
Lenders Interested in information that enables them to
determine whether their loans and the related interest
will be paid when due.
Suppliers and other trade creditors Interested in information that enables them to
determine whether amounts owing to them will be
paid when due.
Customers Interested in information about the continuance of an
enterprise
Employees Interested in information about the stability and
profitability of their employers
Users and the information needs
The following are different users of financial statements and their information needs:
User Information needs
Government and their agencies Interested in order to regulate the activities of the
enterprises, determining taxation policies as the basis
for national income.
Public Financial statements may assist the public by providing
information about the trends and recent developments
in the prosperity of the enterprise.
Introduction to Accounting
Accounting
Accounting is a service activity. Its function is to provide quantitative information, primarily
financial in nature, about economic entities that is intended to be useful in making
economic decisions.
Republic Act No. 9298
Republic Act No. 9298 also known as known as the “Philippine Accountancy Act of 2004”.

This Act shall provide for and govern:

a) The standardization and regulation of accounting education;
b) The examination for registration of certified public accountants; and
c) The supervision, control, and regulation of the practice of accountancy in the
Philippines.
Professional Regulatory Board of
Accountancy
The Professional Regulatory Board of Accountancy (or BOA) is the regulatory body for the
accountancy practice in the Philippines.

The following are some of the important functions of the Board:

• To supervise the registration, licensure and practice of accountancy in the Philippines
• To issue, suspend, revoke, or reinstate the Certificate of Registration for the practice of
the accountancy profession
• To prescribe and/or adopt a Code of Ethics for the practice of accountancy
Philippine Institute of Certified Public
Accountant (PICPA)
The integrated national professional organization of Certified Public Accountants
accredited by the Board and the Commission per PRC Accreditation No. 15 dated October
2, 1975.

The group set forth the following objectives:

1. To promote and maintain high professional and ethical standards among accountants;
2. To advance the science of accounting;
3. To develop and improve accountancy education;
4. To encourage cordial relations among accountants, and
5. To protect the Certificate of Certified Public Accountant granted by the Republic of the
Philippines.
Scope of practice
1. Practice of Public Accountancy
2. Practice in Commerce and Industry
3. Practice in Education/Academe
4. Practice in the Government
Code of ethics
The International Code of Ethics for Professional Accountants “the Code” sets out
fundamental principles of ethics for professional accountants, reflecting the profession’s
recognition of its public interest responsibility.
Code of ethics
The fundamental principles are:

1. Integrity – to be straightforward and honest in all professional and business relationships.

2. Objectivity – not to compromise professional or business judgments because of bias, conflict
of interest or undue influence of others.
3. Professional competence and due care
a. Attain and maintain professional knowledge and skill at the level required to ensure that a
client or employing organization receives competent professional service, based on current
technical and professional standards and relevant legislation; and
b. Act diligently and in accordance with applicable technical and professional standards
4. Confidentiality – to respect the confidentiality of information acquired as a result of
professional and business relationships.
5. Professional behavior – to comply with relevant laws and regulations and avoid any conduct
that the professional accountant knows or should know might discredit the profession.
Accounting Standards in the Philippines
Accounting standards are authoritative statements of how particular types of transaction
and other events should be reflected in financial statements. Accordingly, compliance with
accounting standards will normally be necessary for the fair presentation of financial
statements.
Financial Reporting Standards Council (FRSC)

The FRSC (formerly known as Accounting Standards Council “ASC”) was established by the
Professional Regulatory Commission under the Implementing Rules and Regulations of the
Philippine Accountancy of Act of 2004 to assist the Board of Accountancy in carrying out its
power and function to promulgate accounting standards in the Philippines. The FRSC’s
main function is to establish generally accepted accounting principles in the Philippines.
International Accounting Standard Boards
(IASB)
The International Accounting Standards Board (formerly known as International Accounting
Standards Committee “IASC”) is an independent private sector. Its objective is to achieve
convergence in the accounting principles that are used by businesses and other
organizations for financial reporting around the world.
Philippine Accounting Standards (PAS)
Philippine Financial Reporting Standards (PFRS)
The Philippine Financial Reporting Standards (PFRS)/Philippine Accounting Standards (PAS)
are the new set of Generally Accepted Accounting Principles (GAAP) issued by the
Accounting Standards Council (ASC) to govern the preparation of financial statements.

These standards are patterned after the revised International Financial Reporting
Standards (IFRS) and International Accounting Standards (IAS) issued by the International
Accounting Standards Board (IASB).
Philippine Accounting Standards (PAS)
Philippine Financial Reporting Standards (PFRS)
The Philippine Financial Reporting Standards (PFRS)/Philippine Accounting Standards (PAS)
are the new set of Generally Accepted Accounting Principles (GAAP) issued by the
Accounting Standards Council (ASC) to govern the preparation of financial statements.

These standards are patterned after the revised International Financial Reporting
Standards (IFRS) and International Accounting Standards (IAS) issued by the International
Accounting Standards Board (IASB).
Philippine Accounting Standards (PAS)
Philippine Financial Reporting Standards (PFRS)
International Philippines
International Accounting Standards (IAS) Philippine Accounting Standards (PAS)
International Financial Reporting Standards (IFRS) Philippine Financial Reporting Standards (IFRS)
Branches of Accounting
The following are the main branches of accounting:

1. Auditing
2. Bookkeeping
3. Cost bookkeeping, Costing, and Cost accounting
4. Financial accounting
5. Financial management
6. Management accounting
7. Taxation
Auditing

Auditing forms a most important branch of accountancy. Once financial statements have
been prepared, they may need to be validated to ensure that the financial statements are
presented fairly for the users of the reports.

The checking of accounts and the reporting on them is known as auditing.

Bookkeeping

Bookkeeping is a mechanical task involving the collection of basic financial data. The
bookkeeping procedures usually end when the basic data have been entered in the books
of account and the accuracy of each entry has been entered.

Bookkeeping is the process of maintaining and recording all financial transactions in the
original books of entry of a business while accounting is the process of interpreting,
analyzing, summarizing and reporting the financial transactions of a business.
Cost bookkeeping, costing and cost accounting

Cost bookkeeping is the process that involves the recording of cost data in the books of
account. It is similar to bookkeeping except that data are recorded in very much greater
detail.

Cost accounting makes use of those data once they have been extracted from the cost
books in providing information for managerial planning and control.
Financial accounting

Financial accounting is the more specific term applied to the preparation and subsequent
publication of highly summarized financial information.

The information supplied is usually for the benefit of the owners of an entity, but it can
also be used by management for planning and control purposes.
Financial management

Financial management is a relatively new branch of accounting. Financial managers are

responsible for setting financial objectives, making plans based on those objectives,
obtaining the finance needed to achieve plans, and generally safeguarding all the financial
resources of the entity.
Management accounting

Management accounting incorporates cost accounting data and adapts them for specific
decisions which management may be called upon to make. A management accounting
system incorporates all types of financial and non-financial information from a wide range
of resources.
Taxation

Taxation is a highly complex technical branch of accounting. Accountants involved in tax

work are responsible for computing the amount of tax payable of an entity.