CHAPTER 1

ACCOUNTING PROCESS
INTRODUCTION

• Accounting- the process of identifying, measuring, and communicating economic

information to permit informed judgments and decisions by users of the
information. (American Association of Accountants)

▪ This is effected through an entity’s accounting information system.

• Accounting information system

✓ The system of collecting and processing transaction data and

disseminating financial information to interested parties.

✓ This is a subsystem of Management Information System (MIS)

• Management Information System

✓ A set of data gathering, analyzing, and reporting functions designed to

provide management with the information it needs to carry out its
functions.

✓ Major components:
a. Accounting Information System or Financial Information System
b. Personnel Information System
c. Logistics Information System

• Components of accounting information system

a. Personnel directly involved in accounting work

b. Accounting policies and standards
✓ Accounting policies are the specific principles, bases,
conventions, rules and practices applied by an entity in
preparing and presenting financial statements
c. Procedures or set of interrelated activities involving the originating,
processing and reporting of financial and related information.
d. Equipment and devices used in the system to expedite works, to provide
controls, and prevent fraud and errors.
 e. Records and reports necessary to gather, process store and transmit
financial and other information.
THE ACCOUNTING CYCLE
✓ This represents the steps or procedures used in recording transactions and
preparing financial statements. This implements the accounting process.

Steps in the accounting cycle:

1. Identifying and analyzing business documents or transactions
2. Journalizing
3. Posting
4. Preparing the unadjusted trial balance
5. Preparing the adjusting entries
6. Preparing the adjusted trial balances (worksheet preparations)
7. Preparing the financial statements
8. Closing the books
9. Preparing the post-closing trial balance
10. Recording of reversing entries
“Those highlighted in red are optional.

ACCOUNTING RECORDS OF A BUSINESS ENTITY

1. Business or source documents- these are the original source materials evidencing
a transaction.

2. Books of accounts
a. Journal
b. Ledger

SYSTEMS OF RECORDING TRANSACTIONS

1. Double- entry system- Under this system, each transaction is recorded in 2 parts-
debit and credit.

This system makes use of the following concepts:

a. Duality- this concept views each transaction as having two-fold effect on values
b. Equilibrium- this concept requires each transaction to be recorded in terms of
equal debits and credits

2. Single-entry system- Under this system, each transaction is recorded through

simple narrative. Profit or loss for the period is determined through “capital
 maintenance approach” or by comparing the beginning and ending balance of
equity.

Books of accounts used under the single- entry system:

a. Cash books
b. Subsidiary ledgers (personal accounts)

JOURNAL
➢ This is also called book of original entry. A formal record where transactions are
initially recorded chronologically through journal entries.

➢ Journalizing is the process of recording transactions in the journal by means of

journal entries.

➢ Types of journal:

a. General journal- used to record transactions other than those that are recorded
in the special journals. Special journals- used to record transactions of a similar
nature.

▪ Sales journal- used to sales on account

▪ Purchases journal- used to record purchases of inventory on account
▪ Cash receipts journal- used to record all transactions involving
receipts of cash
▪ Cash disbursement journal- used to record all transactions involving
payments of cash

➢ Types of Journal entries:

a. Simple journal entry- one which contains a single debit and a single credit
b. Compound journal entry- one which contains two or more debits or credit
c. Adjusting entries- entries made prior to the preparation of financial statements
to update certain accounts so that they reflect correct balances as at the
designated time
d. Closing entries- entries made at the end of the accounting period after all
adjustments have been made to zero-out the balances of all nominal and to
update the retained earnings account
e. Reversing entries- entries usually made on the first day of the accounting
period to reverse certain adjusting entries in the immediately preceding period
f. Correcting entries- entries mad to correct accounting errors
 g. Reclassification entries- entries made to transfer an amount from one account
to another account that better describes the nature of the transaction being
recorded.

LEDGER

➢ Posting is the process of transferring data from the journal to the appropriate
accounts in the ledger. The purpose is to classify the effects of transactions on
specific asset, liability, equity, income and expense accounts in order to provide
more meaningful information.

➢ Ledger is a systematic compilation of a group of accounts

✓ Kinds of ledger
a. General- contains all the accounts appearing in the trial balance. Controlling
accounts are shown here.
b. Subsidiary ledger- provides a breakdown of the balances of controlling
accounts

ACCOUNT
➢ Account is the basic storage of information in accounting, e.g., “cash”, “accounts
receivable”, “land”, etc.

➢ Accounts in the ledger follow the format of a T-account

➢ Chart of Accounts is a list of all the accounts used by the entity. To promote
comparability, account titles should conform to PFRSs and industry practices.

Types of Accounts

1. Real (permanent) Accounts- are accounts that are not closed at the end of the
accounting period. These accounts are shown in the statement of financial
position.
2. Nominal (temporary)- are accounts that are closed at the end of the accounting
period.
3. Mixed- accounts that have both real and nominal account components. These
accounts are subject to adjustment.
4. Contra accounts- are accounts that are deducted from a related account, ex,
accumulated depreciation
 5. Adjunct accounts- are accounts that are added to a related account, ex. Premium
on bonds payable.

TRIAL BALANCE
➢ Trial balance is a list of general ledger accounts and their balances. It is prepared
to check the quality of total debits and total credits in the ledger. The preparation
of the trial balance creates a starting point for the preparation of the financial
statements.

✓ Types of trial balance:

a. Unadjusted trial balance- this is prepared before adjusting entries. It contains real,
nominal and mixed accounts
b. Adjusted trial balance- this is prepared after adjusting entries. It contains real and
nominal accounts
c. Post-closing trial balance- this is prepared after the closing process. It contains the
real accounts only

✓ Errors revealed by a trial balance:

The trial balance can reveal errors that caused the total debits and total credits to
be unequal. Examples of error:

a. Journalizing or posting one-half of an entry, ex. a debit without a credit, or vice

versa.
b. Recording one part of an entry at a different amount than the other part
c. Transplacement error (slide error) on one side of an entry. This is committed when
the number of digits in an amount is incorrectly increased or decreased, ex. a Php
1,000 amount is recorded as Php 100 or 10,000
d. Transposition error on one side of an entry. This is committed when digits in an
amount are interchanged, ex. 15,652 amount is recorded as 15,625 or 15, 265.

✓ Errors revealed by a trial balance:

The trial balance cannot reveal errors that do not cause the total debits and total
credits to be unequal. Examples:

a. Omitting entirely the entry for a transaction

b. Journalizing or posting an entry twice.
c. Using a wrong account with the same normal balance as the correct account, ex,
a debit to transportation expense is erroneously debited to supplies expense
 d. Wrong computation with the same erroneous amount posted to both the debit and
credit sides.

ADJUSTING ENTRIES
➢ These are entries made prior to the preparation of financial statements to update
certain accounts so that they reflect correct balances as of the designated time.

Purpose:

a. To take up unrecorded income and expense of the period (ex. accruals for
income and expenses).

b. To split mixed accounts into their real and nominal elements (ex. adjustments
to prepayments and unearned income)

METHODS OF INITIAL RECORDING OF INCOME AND EXPENSES

INCOME
➢ Advanced collections income may initially be recorded using either the (1) liability
method or the (2) income method.

1. Liability method- Under this method, advanced collections of income are

initially credited are initially credited to a liability account. At the end of the
period, the earned portion is recognized as income while the unearned portion
remain as liability.

2. Income method- under this method, advanced collections of income are

initially credited to an income account. At the end of the period, the
unearned portion is recognized as liability while the earned portion remains
as income.

Illustration 1: Liability method vs. Income method

A business rents out its building. On April 1, 2021, the business receives one-
year rent in advance of 120,000. The rent per month is 10,000.

The receipt of the advance rent is recorded as follows:

 Liability Method Income method
1-Apr-21 1-Apr-21
Cash 120,000 Cash 120,000
Unearned rent 120,000 Rent income 120,000
to record the receipt of 1-year to record the receipt of 1-year
rent in advance rent in advance

Adjustment on December 31, 2021:

Adjusting entry is needed to
separate the following:
(Earned portion- Income)
90,000 (120,000 x9/12)
April 1 to Dec. 31, 2021
Before adjustment

Mixed Account
Php 120,000
One year rent in advance
(Unearned portion- Liability)
30,000 (120,000 x3/12)
Jan. 1 to Mar. 31, 2022

Adjusting entries:
Liability Method Income method
Dec. 31, 2021 Dec. 31, 2021
Unearned rent income 90,000 Rent income 30,000
Rent Income 90,000 Unearned rent 30,000
to recognize the earned portion to recognize the unearned
of the 1-year rent in advance portion of the 1-year rent in advance

EXPENSES
➢ Prepayments of expenses may initially be recorded using either the (1) asset
method or (2) expense method.

1. Asset method- under this method, prepayments of expenses are initially debited
to an asset account. At the end of the period, the incurred portion (used up or
expired is recognized as expense while the unused portion remains as asset.
 2. Expense method- under this method, prepayments of expenses are initially
debited to an expense account. At the end of the period, the unused portion (not
yet incurred or unexpired) is recognized as asset while the incurred portion
remains as expense.

Illustration 2: Asset method vs. Expense method

A business prepays one-year insurance for 120,000 on Oct. 1, 2021. The prepayment
of insurance is recorded as follows:

Asset Method Expense Method

Oct. 1, 2021 Oct. 1, 2021
Prepaid insurance 120,000 Insurance expense 120,000
Cash 120,000 Cash 120,000
to record the prepayment of 1 to record the prepayment of 1
year insurance year insurance

Adjusting entry is needed to separate the following:

(Incurred portion- Expense)

30,000 (120,000 x3/12)
Before adjustment Oct 1 to Dec. 31, 2021

Mixed Account
Php 120,000
One year prepaid
insurance
(Not yet incurred portion-
Asset)
90,000 (120,000 x9/12)
Jan. 1 to Sept. 30, 2022

Adjusting Entries:
Asset Method Expense Method
Oct. 1, 2021 Oct. 1, 2021
Insurance expense 30,000 Prepaid insurance 90,000
Prepaid insurance 30,000 Insurance Expense 90,000
to record the expired portion of to record the unexpired portion of the 1
the 1- year insurance year insurance
WORKSHEET
➢ An analytical device used to facilitate the gathering of data for adjustments and the
preparation of financial statements and closing entries.

➢ This is optional and not part of formal accounting records but they greatly facilitate
the orderly preparation of the financial statements.

Heading of the worksheet:

a. Name of the entity
b. Title of the report
c. Date covered by the report

FINANCIAL STATEMENTS
➢ These are the means by which the information accumulated and processed in
financial accounting is periodically communicated to the users.

➢ End products of accounting process

Complete set of financial statements:

a. Statement of financial position- dated as at the end of the reporting period
b. Statement of profit or loss and other comprehensive income
c. Statement of changes in equity dated covering the reporting period
d. Statement of cash flows
e. Notes; Comparative information; and
f. Additional statement of financial position (required only when certain instances
occur)
Heading:
a. Name of the reporting entity
b. Title of the financial statement
c. Reporting period
Illustration:
Types of financial statement Date
1. Statement of financial statements > As of (or As at) December 31, 2021
2. Statement of profit and loss and other
> For the year ended December 31,2021
comprehensive income
3. Statement of changes in equity > For the year ended December 31,2021
4. Statement of cash flows > For the year ended December 31,2021
5. Notes > December 31, 2021
CLOSING ENTRIES
➢ Closing of the books is the process of preparing closing entries for the
nominal accounts and ruling and balancing real accounts.
➢ Closing entries are prepared at the end of the accounting period to “zero
out” all temporary or nominal accounts in the ledger.
➢ Closing the books is an application of the periodicity concept.

POST- CLOSING ENTRIES

➢ This is prepared in order to prove the equality of debits and credits in the
ledger after the closing process.
➢ The post-closing trial balance contains the balances that are extended to
the next accounting period.
REVERSING ENTRIES
➢ These entries are usually made on the first day of the accounting period to
reverse certain adjusting entries in the immediately preceding period.
Purpose:
a. To facilitate recording of cash receipts and disbursements in the next
accounting period.
b. To promote convenience in recording the next period’s year-end
adjustments for accrual
c. To promote consistency of accounting procedure.

Adjusting entries that may be reversed:

a. Accruals for income or expense

b. Prepayments initially recorded using the expense method
c. Advanced collections initially recorded using the income method