CHAPTER 1

INTRODUCTION TO ACCOUNTING

ACCOUNTING AND THE BUSINESS

Accounting is introduced primarily for a business enterprise Is has evolved in response to the
need of business managers for relevant financial information necessary to run the business effectively
and to guide them in making plans or making decisions Accounting satisfies this need by providing and
communicating the required information not only to the decision makers (managers) but also to other
interested parties Accounting is useful not only for a business enterprise but also for any kind of
organization or association that will need financial information. Even individuals can also make use of
accounting information although on an informal basis When they borrow money, compute their take
home pay, pay their income taxes, buy a new car on installment. or when they plan for retirement, all
these will require accounting information. The usefulness therefore of accounting to everyone,
especially to a business organization, cannot be overemphasized

WHAT IS A BUSINESS?

To explore the role of accounting in relation to a business. let us first understand what a
business is A business is the exchange of goods or services that results in mutual benefit for both parties
involved. The primary objective of a business is to make profits. To make money, a business must sell
What it will sell will depend on the nature or kind of business.

KINDS OF BUSINESS

A business can generally be classified into three kinds depending on the nature of its operations
or what it is selling

1. Trading or Merchandising - this involves the buying of goods or merchandise. which will be sold at a
price higher than the purchase cost Examples are supermarkets, groceries, hardware stores, bookstores,
drug stores, shoe stores, etc

2. Manufacturing - this involves the conversion of raw material into finished product, which will be sold
at a price higher than the cost of production Examples are manufacturers of drugs, soft drinks, tables
and chairs. computers. pencils, ball pens, etc

3. Servicing - this involves the rendering of services for a certain fee which is higher than the cost of the
services rendered Examples are repair shops, parlors, movie houses, banks, insurance companies,
education

FORMS OF BUSINESS (As to Ownership Structure)

As to ownership, a business may be classified as follows;

1. Sole Proprietorship - this is a business owned and operated by only one person

2. Partnership - this is a business owned by two or more persons.

3. Corporation - this is a business whose capital is divided into shares of stock owned by several people
called shareholders or stockholders.
4. Cooperative - this is a business whose capital is owned by several people (generally poor people)
called members

Characteristics of the Different Forms of Business Organization

Sole Proprietorship

 The owner called proprietor

 Unlimited liability
 Owner manages the business

Partnership

 Two or more owners called partners

 Unlimited liability
 There is a managing partner

Corporation

 Unlimited owners called shareholders

 Limited liability
 Management is vested in the board of directors

Cooperative

 Unlimited owners called members

 Limited liability
 Management is vested in the board of directors

In a sole proprietorship, if the business has unpaid debts which it can no longer way, the
creditors can run after the owner and attach his personal properties to satisfy their claim. The same is
true in the case of a partnership. This is the meaning of unlimited liability of the owner/s. In a
corporation and cooperative, the liability of the shareholders or members is limited only up the extent
of their paid up capital. In the event the business gets bankrupt, the creditors cannot run after the
owners. This is the reason why a corporation or cooperative is the more popular choice of prospective
owners or investors.

This book (volume 1) will cover or discuss the operations of a servicing, trading and
manufacturing concerns owned and operated by a single proprietor. The operations of a partnership of
corporate form of business organization will be covered in volume 2 of this book.

Users of Accounting Information

The information provided by accounting is useful not only to the owners and managers of the
business but also to other interested parties. The users may be classified into two; the internal and
external user.
 The internal user refers to the management. As stated earlier, in a corporation or cooperative,
management is vested in the board of directors (BOD). In a single proprietorship, the owner is also the
manager. In a partnership, the partners usually appoint a managing partner.

The external users are those who have financial claim or interest in the business which include
the following:

1. Owner/s (who are not the manager/s) - being the owner or ow are naturally interested in what's
happening to the business.
2. Prospective investors - they want to know whether it is worthwhile investing in the business, Is
the return (income) on investment worth the risk?
3. Suppliers and creditors - they want to know the risk they are taking when they give credit terms
to the business.
4. Lending institutions - they want to know whether or not to grant loan to the business or
whether the business can pay its outstanding loan.
5. Customers - they are interested in the stability of the business, which is the of their needs.
6. Employees - they are interested to know the stability and profitability of the business so they
can look for another company when necessary. They also want to know whether the business
can afford an increase in their salaries and other fringe benefits.
7. Government - is interested to know whether the business is paying the correct taxes or is
complying with all the government requirements.
8. General Public - The public may be interested in the affairs of the business for their own
personal and varied reasons.

NATURE OF ACCOUNTING
Accounting' is a service activity whose function is to provide quantitative information, primarily
financial in nature, about economic entities that is intended to be useful in making economic decision.
The term "financial in nature" means that the information provided is expressed in monetary terms, i.e.,
expressed in pesos.

For an effective stewardship of any organization, the manager will need all the necessary
financial information. This is precisely the nature of accounting, which is "information provider"
Accounting communicates financial information not only to the owners or managers but to anybody
who may have an interest or financial claim in the business hence accounting is often described as the
"language of business".

DEFINITION OF ACCOUNTING
Accounting has been defined in several ways, but the most complete is the definition
pronounced by the Committee on Terminology of the American Institute of Certified Public
Accountants (AICPA) as follows:

Accounting is the art of recording, classifying, summarizing, in a significant manner and in terms
of money. transactions and events. which are in part at least of a financial character and interpreting the
results thereof.
 Accounting is described as an art because. The information or report is presented in an
artistic and orderly manner easily understood and appreciated by the reader or user information.
Accounting may also be considered as a science because the accounting methods and procedures are in
accordance with the generally accepted accounting principles, which are widely used and internationally
accepted.

Based on the definition stated, it can be noted that there are four distinct functions of
accounting namely, recording, classifying. summarizing and interpreting. Of the four functions. the
interpreting function may be considered as the most important simply because the first three functions
can now be easily performed faster and with reasonable degree of accuracy by the computer.

Recording - this involves putting into writing all the business transactions including significant events
which might occur and which will affect the business. This is more popularly known as Bookkeeping.
Considering the voluminous transactions of a business enterprise for a given period of time, it is
necessary that they be recorded. Furthermore, this is a BIR requirement. The recording can be done
manually or with the use of a computer.

Classifying - this involves grouping together similar items or accounts for purposes of systematic
recording and preparation of reports.

Summarizing - this involves the preparation of the formal accounting reports or financial statements at
the end of an accounting period.

Interpreting - this involves the analysis of the financial statements by developing financial ratios and
explaining their significance to make the statements more meaningful. In a computerized system of
accounting. this is the only function the computer cannot perform hence accountants are still useful.

All the above functions will be discussed lengthily and thoroughly in the subsequent chapters of
this book for a better understanding. It is premature to discuss them at this time.

Role of Accounting in Business

The role of accounting in business may be summarized as follows:

1. It helps the owner's or managers make plans and decisions.

2. It reports and analyzes business transactions thru the financial statements.

3. It communicates financial information to all interested parties.

BRANCHES OF ACCOUNTING
Because different users of accounting information have different needs and requirements. and
with the proliferation and diversification of business enterprises.

Objectivity - This simply means that transactions recorded or amounts reported can be verified thru the
supporting documents. This is necessary to maintain the trust, faith and confidence of the users or
readers on the financial statements. It also means that the information provided is free from bias.
Cost Principle - This simply means that properties or assets acquired must be recorded at the actual
acquisition cost and not at an estimated cost.

Matching Costs Against Revenue - This simply means that all cost and expenses incurred during the
period in generating the revenue, must be matched (subtracted) against the revenue for the same
period.

Consistency - This simply means that for the financial statements to be comparative, the application of
the accounting methods, procedures, or principles must be consistent with the previous period.
However, if the change will produce more accurate result, the change may be allowed provided the
effect on the financial statements will be disclosed.

Accounting Period - Considering that the business is assumed to be a going concern, its life is divided
into periods (usually one year) at the end of which financial statements are prepared. In this manner,
interested users or readers will know the status of the business on a period-to-period basis.

Full Disclosure - This simply means that the financial statements should reflect all significant events or
facts, which might influence the decisions to be made by any interested party. This can be done by using
footnotes, parenthetical notations, or if warranted, a separate document called "Notes to the financial
statements" can be attached to the financial statements.

GOVERNMENT REGULATORY AGENCIES (Applicable to Accounting)

Professional Regulation Commission (PRC) - is in charge of administering the professional examination
(including the CPA licensure examination), regulating and licensing of professionals. promulgation and
enforcement of professional ethics and standards.

Board of Accountancy (BOA) - is in charge of conducting semi-annually the CPA licensure examination. It
is likewise in charge of regulating the practice of accountancy. The board is composed of a chairman.
vice chairman, and 5 other members to be appointed by the President of the Philippines upon the
recommendation of the Philippine Institute of Certified Public Accountants (PICPA) and the Professional
Regulation Commission (PRC). The Board of Accountancy is under the jurisdiction of the Professional
Regulation Commission.

Financial Reporting Standards Council (FRSC) - formerly known as the Accounting Standards Council
(ASC) is in charge of formulating or developing the accounting standards, which will guide CPA
practitioners. This council is a creation of the Professional Regulation Commission thru the
recommendation of the Board of Accountancy.

Securities and Exchange Commission (SEC) - is in charge of regulating the business operations of a
partnership, corporation, and foundations

Cooperative Development Authority (CDA) - is in charge of regulating the business operations of a

cooperative.

Bureau of Internal Revenue (BIR) - is in charge with the collection of taxes.

Bangko Sentral ng Pilipinas (Formerly Central Bank of the Philippines) - is in charge of regulating the
operations of banks and other financial institutions.
ACCREDITED PROFESSIONAL ORGANIZATIONS OF CERTIFIED PUBLIC ACCOUNTANTS (CPAS)
Philippine Institute of Certified Public Accountants (PICPA) - this is the recognized organization of all
certified public accountants (CPAs) in the Philippines whose primary objective is to improve the quality
of service rendered by CPA practitioners’ collaboration with the Board of Accountancy and Financial
Reporting Standards Council Under its umbrella are the other accredited associations of CPAs such as
Association of Certified Public Accountants in Education (ACPAE). Government Associations of Certified
Public Accountants (GACPA), Association of Internal (AIA). Association of Certified Public Accountants in
Commerce and Industry (ACPACI) and Association of Certified Public Accountants in Public Practice
(ACPAPP)

FIELDS OF ACCOUNTING
The fields of accounting simply refer to the career opportunities available to graduates of
Bachelor of Science in Accountancy (BSA) or certified public accountants.

Private Accounting - Accountants can be employed in any private was or position requiring accounting
knowledge. They can be employed as accounting clerks. hookkeepers, internal auditor. chief accountant
or even controller depending on their qualifications and experience.

Government Accounting - Accountants can be employed in any any capacity or position requiring
accounting knowledge. Statistics will show that the government hires the most number of accountants.

Public Accounting - Accountants can practice their profession by rendering professional services for a
certain fee just like lawyers, dentists, doctors, etc. Under the Accountancy Act, only CPAs can engage in
public accounting. CPAs may offer the following services;

1. Auditing Service - The CPA (who must be independent) will audit the books and certify to the
fairness of the financial statements prepared by the client's accountant. This is called external
auditing as distinguished from internal auditing whose function is to examine and evaluate the
systems of internal control of the company The external auditor is not an employee of the client
(to be independent) while the internal auditor is an employee.

2. Tax Service - The CPA will prepare the tax return (the form to be filled up when paying different
kinds of taxes) of the client company.

3. Management Advisory Services - The CPA will act as the management consultant on matters
pertaining to accounting and finance.

In addition to the above services, the CPA can also be a college instructor or professor,
Subjects like accounting, finance, taxation, and other allied subjects can be considered as within the
areas of competence of the CPA. The new Accountancy Act now allows CPA's to teach even commercial
law subjects.
BRIEF HISTORY OF ACCOUNTING
Although accounting (informal recording) was introduced as early as 2000 BC in Babylonia and
in 3500 BC in Assyria, it was the book written by Benedetto Cotrugli entitled Delia Mercatura et del
Mercante Perfetto (Of Trading and the Perfect Trader) sometime in the 14th century. which included a
brief chapter describing many of the features of double entry, where accounting originated. In 1494, an
Italian friar by the name of Frater Luca Bartolomes Pacioli wrote a book Summa de Arithmetica,
Geometria Proportioni et Proportionalita (Everything about about Arithmetic, Geometry and Proportion)
in which bookkeeping was one of the topics covered. Although he never claimed to have developed the
double entry method of bookkeeping and he even acknowledged the book of Cotrugli, yet he was the
one recognized as the "Father of Accounting"

PHILIPPINE ACCOUNTANCY ACT OF 2004 (Republic Act No. 9298)

This is an act regulating the practice of accountancy in the Philippines

Scope of the Practice of Accountancy (Applicable only to CPAs)

Section 4 of this act enumerates the scope of the practice of accountancy

1. Practice of Public Accountancy

2. Practice in Commerce and Industry

3. Practice in Education/Academe

4. Practice in the Government

Definition of Terms - As used in the Philippine Accountancy Act of 2004

Practice of Accountancy - shall refer to the practice of a Certified Public Accountant of his/her
profession providing any service requiring accountancy or related skills including accounting, auditing.
(taxation, and management consulting) and financial management services.

a. Certified Public Accountant shall refer to a person who is a holder of a valid certificate of
registration/professional license and professional identification card issued by the Professional
Regulation Commission in accordance with this act. A certified public accountant is one who is
included in the roster of certified public accountants under section 20 and a member of the
accredited professional organization under section 29 of this act.

b. A Certified Public Accountant in Public Practice shall refer to an individual, sole practitioner and
staff or, partner and staff of a general partnership offering or rendering an opinion on the
fairness of the financial statements, or both, to more than one client on a fee basis or otherwise,
and other services requiring accounting or related skills.

c. A Certified Public Accountant in Commerce and Industry shall refer to officer or employee in a
private enterprise involved in accounting, audit and related function; decision making, requiring
professional knowledge in the science of accounting; or representing his/her private employer
 before any government agency on tax matters related to accounting; and such employment or
position requires that the holder thereof be a certified public accountant.

d. A Certified Public Accountant in Education shall refer to person involved in teaching accounting,
auditing, management advisory services, finance, business law and taxation, and other
technically related subjects leading to the degree of accountancy, provided that members of the
integrated bar of the Philippines may be allowed to teach business law and taxation subjects.

e. A Certified Public Accountant in Government Service shall refer to officer or employee holding
or appointed to a position in the professional accounting or auditing group in government or in
government-owned and controlled corporation, involved in accounting, audit, and related
function; decision making requiring professional knowledge in the science of accounting,
including those performing proprietary functions, where civil service eligibility as a certified
public accountant is pre-requisite.

Prohibition in the Practice of Accountancy

Section 26 of the act states that no person shall practice accountancy in this country, or use the
title "Certified Public Accountant", or use the abbreviated title "CPA" or display or use any title, sign,
card, advertisement, or other device to indicate such practices or offers to practice accountancy, or is a
certified public accountant, unless such person shall have received from the Board a certificate of
registration/professional license and be issued a professional identification card or a valid
temporary/special permit duly issued to him/her by the Board and the Commission.

The Certified Public Accountant Examination

Section 13 of the Accountancy Act states that all applicants for registration for the practice of
accountancy shall be required to undergo a licensure examination to be given by the Board in such
places and dates as the Commission may designate subject to compliance with the requirements
prescribed by the Commission in accordance with Republic Act. No. 8981.

Qualifications of Applicants for Examination

Section 14 states that any person applying for examination shall establish the following requisites
to the satisfaction of the board that he/she:

a. is a Filipino citizen

b. is of good moral character

c. is a holder of the degree of Bachelor of Science in Accountancy conferred by a university, school.

college, academy. or institute duly recognized and accredited by the Commission on Higher Education
(CHED) or other authorized government offices; and

d. has not yet been convicted of any criminal offense involving moral turpitude (An NBI clearance is now
required).
Scope of Examination
Section 15 states that the licensure examination for certified public accountants shall cover but
are not limited to, the following subjects:

a. Theory of Accounts (TOA)

b. Business Law and Taxation (BLT)

c. Management Services (MS)

d. Auditing Theory (AT)

e. Auditing Problems (AP)

f. Practical Accounting Problems I (P1)

g. Practical Accounting Problems II (P2)

The Board, subject to approval of the commission, may revise or exclude any of the subjects in the
syllabi. and add new ones as the need arises.

Ratings in the Licensure Examination

Section 16 states that to be qualified as having passed the licensure examination for accountants, a
candidate must obtain that 65% in any subject. In the event a candidate obtains the rating of 75% and
above in at least majority of the subjects as provided for by this Act, he/she shall receive a conditional
credit for the subjects passed. Provided that a candidate shall take an examination in the remaining
subjects within two years from the preceding examination; Provided further, that if the candidate fails
to obtain at least a general average of 75% and a rating of at least 65% in each of the subjects re-
examined, he/she shall be considered as failed in the entire examination.

Accreditation to Practice Public Accountancy

Section 31 states that certified public accountants, firms and partnerships of certified public
accountants, engaged in the practice of public accountancy, including partners and staff members
thereof, shall register with the Commission and the Board, such registration to be renewed every three
(3) years: Provided, that subject to the approval of the Commission, the Board shall promulgate rules
and regulations for the implementation of registration requirements including the fees and penalties for
violation thereof.

Continuing Professional Education (CPE)

Section 32 states that all certified public accountants shall abide by the requirements, rules and
regulations on continuing professional education to promulgated by the Board, subject to the approval
of the Commission, in coordination with the accredited national professional organization of certified
public accountants or any duly accredited educational institution. For this purpose, a CPE Council is
hereby created to implement the CPE Program.
Foreign Reciprocity
Section 34 states that subjects or citizens of foreign countries may be allowed to practice
Accountancy in the Philippines in accordance with the provisions of existing laws, international treaty
obligations including mutual recognition agreements entered into by the Philippine Government with
other countries. A person who is not a citizen of the Philippines shall not be allowed to practice
accountancy in the Philippines unless he/she can prove, in the manner provided by the rules of the court
that, by specific provision of law, the country of which he/she is a citizen, subject or national admits
citizens of the Philippines to the practice of the same profession without restriction.
 Chapter 2
RECORDING THE BUSINESS TRANSACTIONS
THE RECORDING PROCESS
To be able to learn how to record formally the various business transactions which is the first step
in the accounting process, it is necessary to introduce first some technical accounting terms that will be
used. Familiarization of these terms will facilitate understanding of the manner and procedure of
recording,

In this chapter, the focus is on the transactions of a servicing concern. In the subsequent
chapters, the recording of the transactions of a trading concern will be discussed and illustrated, It
should be emphasized however, that the discussions in this book are based on the assumption that
manual bookkeeping system is used which is a good starting point in studying accounting A
computerized system will drastically change the procedures and formats

BASIC ACCOUNTING ELEMENTS OR VALUES

There are three basic accounting values or elements, which will be affected by the business
transactions or events to be recorded, They are as follows:

1. Assets - Are properties or economic resources owned by the business. The most common
properties or assets of a business are; Cash, receivables, furniture and fixtures (such as tables,
cabinets, chairs, etc.), office equipment (such as calculators, computers, copying machines, fax
machine, etc.), machineries, delivery truck, land, building, etc . Before a property can be
considered as an asset, it is necessary that it has a value, and it is owned by the business. The
above-mentioned assets are called tangible assets in the sense that they can be seen and
touched. However, there are some assets of the business, which have no physical appearance
(cannot be seen nor touched) but their values, sometimes are even higher than some of the
tangible assets. They are called intangible assets. Examples are franchise, patent, trademark,
copyright, goodwill, etc. These intangible assets will be discussed in detail in the higher
accounting subjects.

2. Liabilities - These are amounts owed by the business. In simple terms, they are debts or legal
obligations of the business to individuals or other businesses. Examples are payables to
suppliers, loan with a bank, mortgage payable, races, payable, and other unpaid (accrued)
expenses, etc.

3. Capital (Also called Owner's Equity) - This is the owner's interest or claim in the assets of the
business after subtracting the interest of the creditors. It is the difference between the amount
of assets and amount of liabilities.

The relationship of these 3 accounting values or elements can be expressed in the form
of a simple equation known as the Accounting Equation.
ADDITIONAL ACCOUNTING VALUES OR ELEMENTS
A business is operated to make profit, which is simply the difference between the revenues
earned and expenses incurred. Also, from time to time, the owner in the case of sole proprietorship or
the partners in the case of a partnership, may withdraw money from the business for personal use
(considered as advanced distribution of profit). To account for these revenues, expenses, and
withdrawals, three additional accounting elements or values will be introduced.

4. Drawing (Sometimes called Personal) - is the withdrawal made by the owner or partners which
is not considered as a reduction of capital but rather an advanced distribution of profits.

5. Revenues (Also called Income) - inflows of assets resulting from the sale of goods or services.
Revenues increase the owner's equity. Example - In a repair shop, the amount charged to the
customer for repair service is the revenue or income

6. Expenses - outflows of assets resulting from cash spent or liability incurred in order to generate
the revenue, Expenses decrease the owner's equity. Salaries of the employees, office supplies
used, rent of the office space are examples of expenses.

If the revenues earned are greater than the expenses incurred for a given accounting period,
there is a NET PROFIT or NET INCOME, which will be added to the owner's equity. Conversely, if the
expenses exceed the revenues, there is a NET LOSS which will be subtracted from the owner's equity.

THE ACCOUNTING EQUATION

The fundamental accounting equation is shown below. All business transactions are recorded
within the framework of this accounting equation. This is the foundation of the modern double entry
method of bookkeeping.

Also, the equality of the accounting equation (the peso amount of the assets and the peso
amounts of the liabilities and capital) will always be maintained for every transaction to be recorded.

THE DEBIT AND CREDIT

Traditionally, the left side of the accounting equation is called DEBIT abbreviated DR. (derived
from the word debtor) and the right side is called CREDIT abbreviated CR. (derived from the word
creditor).

Based on the above positions of the3 accounting elements in the accounting equation, the
assets have normally debit balances (being on the left side) while the liabilities and owner's equity have
normally credit balances (being on the right side).

RULES OF ADDITION AND SUBTRACTION BY POSITION

After knowing the position of the different accounting elements, an increase in the amount
should be added on the same side and a decrease in the amount should be subtracted on the opposite
side.
 To illustrate the "rules of addition and subtraction by position". a T account be used. What is a T
ACCOUNT? It is an accounting device that is used to summa the changes in the accounting elements. It is
called T account because of its T shape. This will be a convenient tool to analyze and record the effect of
a transaction on the different accounting elements.

Because revenues will increase the owner's equity, which is on the credit side, increases in revenues
should be on the same side, (credit) and (credit) and decreases should be on the opposite side (debit).
For expenses and drawings, because equity. They should be placed on the opposite side of the owner's
equity (debit). Increases therefore in the expenses and drawing should be on the same side (debit) and
decreases will be on the opposite side (credit).

CHART OF ACCOUNTS
Considering that there are numerous items of assets, liabilities, revenues and expenses to be
accounted for by the business enterprise, it is necessary that similar items of these accounting elements
be grouped together and then assign a name to facilitate the recording process. Each grouping will be
called an account. What is an ACCOUNT? It is a grouping of similar items to reduce the number of items
to be provided for in the recording process Each account will be assigned a name number for easy
reference A list of account titles to be used in the recording is called Chart of Accounts. The accounts
are normally listed in the order in which they appear in the financial statements The balance sheet
accounts first, in the order of assets, liabilities and owner's equity. The income statement accounts are
then listed in the order of revenues and expenses.

It is the accountant who prepares the chart of accounts to facilitate the recording bookkeeper. An
example of a chart of accounts of a typical servicing concern is shown on the next page

Note: Accounts, which are not easily understandable yet and premature to include, are deliberately
omitted for the time being

RECORDING THE BUSINESS TRANSACTIONS (BOOKKEEPING)

After the accounting terms to be used have been introduced, the recording process will be
understood and appreciated better if the following questions will be answered, prior to the actual
recording.

1. What will be recorded? Only the business transactions and events affecting the business should be
recorded.
This means that the personal transactions of the owner are to be separated or divorced from the
business transactions following the "business entity" concept

Business Transaction - is an economic activity that directly changes a business enterprise's financial
condition or directly affects its result of operations. A transaction takes place when a business exchanges
a thing or things of value for another. In a business transaction, there are two parties involved. Examples
are buyer and seller, lessor and lessee, borrower and lender, debtor and creditor, mortgagor and
mortgagee, etc.

It should be noted that the effects in the business of fortuitous events such as fire, flood and
other natural calamities are likewise to be recorded.
2. Where are the business transactions recorded? In the Books of Accounts.

Books of Accounts - are the formal accounting books where the business transactions are recorded.
They consist of two books as follows;

Book of Original Entry - the accounting book where the business to recorded hence the term "original
entry". The book of original entry is called the JOURNAL. The process of recording in the journal is called
JOURNALIZING. There are several kinds of journals but in this chapter only the general journal will be
illustrated (see exhibit 1 below).

Book of Final Entry - the accounting book where the business transactions are finally recorded hence
the term "final entry". The book of final entry is called the LEDGER. The process of recording in the
ledger is called POSTING. There are two kinds of ledger, the general ledger and the subsidiary ledger.

It will be noted that all the business transactions are recorded twice, the first in the journal and
the second in the ledger.

3. Who will do the recording? This is the function of the bookkeeper.

4. Why must the transactions be recorded? It is a requirement by the BIR.

5. How are the business transactions recorded? They are recorded first in the journal chronological
manner (according to dates) in terms of DEBIT and CREDIT entries, The entry as recorded in the journal
is called journal entry. The entry in the journal will then be transferred (recorded) in the general ledger
If the recording of the transactions is in terms of debit and credit, this is called the "Double Entry
Method of Bookkeeping" as opposed to a "Single Entry Method of Bookkeeping" where the recording is
done informally without a debit or credit entry.

RULES OF DEBIT AND CREDIT

Debit - the value received by the business or what the business paid for, and

Credit - the value parted with or given up by the business or the source of the

value received by the business.

The appropriate account title as listed in the chart of accounts is what is debited or credited.

For every business transaction, there will always be a two-fold effect on any of the accounting
elements (assets, liabilities, owner's equity, drawing, income, and expenses). There will always be a
debit entry and a credit entry in the journal hence the term "double entry method of bookkeeping".
These accounting elements may either be increased or decreased by a transaction but the equality of
the accounting equation ASSETS = LIABILITIES + OWNER'S EQUITY will always be maintained. The rules of
addition and subtraction by position will be applied when making the journal entry.

Note; If a journal entry has only one debit and one credit, it is called a SIMPLE ENRTY.
If a journal entry has two or more debit and credit, it is called a COMPOUND ENTRY.
THE GENERAL JOURNAL
As mentioned earlier, different kinds of journal are used in business. One of the most common
is the two-column general journal. (see exhibit 1 on page 21). It is an all- purpose journal in which all the
business transactions may be recorded. Each entry made in this journal includes the following
information, entered in this order.

1. The date of the transaction.

2. The name of the account debited as well as the amount.

3. The name of the account credited as well as the amount.

4. A posting reference (PR) indicating the account number of the account.

S. A brief explanation of the transaction being recorded.

The manner of recording in the general journal is as follows:

1. Write the page number on the upper right-hand corner of the general journal.
2. Write the date (month and day) on the DATE column
3. In the PARTICULARS column, enter the accounts to be debited. The amount/'s will be enter
column provided.
4. Below the debit entry, enter the accounts to be credited. The amount/'s will be entered on the
CREDIT column provided
5. Below the credit entry, write a brief explanation of the transaction being recorded
6. Leave one space (line) after every journal entry.
7. Immediately post (transfer) the entries in the general journal to the general ledger.

Note: To distinguish the account/s debited from the account/'s credited, the credit entry or entries
should be indented a little to the right. The brief explanation, which is written below the credit entry or
entries is likewise indented to the right.

THE GENERAL LEDGER

The general ledger is called the book of final entry because this is where the business
transactions, as originally recorded in the general journal, are finally recorded. This is the T account
expanded and formalized as a book.
 For each account listed in the chart of accounts, one ledger (one page) is opened. The account
title or name is written in the center and the account number is written on the right hand corner in line
with the account title on top of the column headings. Every page of the general ledger book will show
the following column headings:

Left Side (Debit Side) Right Side (Credit Side)

1. Date 1. Date

2. Particulars 2 Particulars

3, Posting reference (PR) 3. Posting reference (PR)

4. Amount of debit entry 4. Amount of credit entry

The manner of recording in the general ledger is as follows:

1. Write the date of the transaction in the appropriate side (debit side or credit side)

2. Write the amount in the appropriate money column (debit side or credit side).

3. Indicate in the posting reference (PR) column, the page number of the general journal where the
accounts are originally recorded.

4. In the general journal, indicate in the posting reference (PR) column, the account number of the
account recorded (posted) in the general journal.

5. The recording in the general journal and general ledger should be made chronologically on a day to
day basis as the transaction occurs

Note: If the transaction to be recorded in the general journal or the general ledger falls on the same
date, a check mark is used instead of the date.

Note: The account number of the different accounts listed in the chart of accounts is what will be
reflected in the Posting Reference (PR) column of the general ledger.

THE TRIAL BALANCE

After the entries in the general journal are transferred (posted) to the general ledger, a trial
balance is prepared. What is a Trial Balance?

A Trial Balance is a listing of all the balances of the different accounts (asset liabilities, capital, drawing,
revenues and expenses), as of a given time, This is usually prepared at the end of each month. The total
of all the accounts with debit balances must equal with the total of all the accounts with credit balances.
If not, then an error in both journalizing (recording in the general journal) and posting (recording in the
general ledger) must have been committed.
Purposes of the Trial Balance:

A trial balance is prepared for the following purposes:

1. To check the accuracy of posting (recording in the general ledger) by testing the equality of the debit
and credit amounts.

2. It aids in locating errors in posting.

3. It serves as a basis in the preparation of the financial statements

Kinds of Trial Balance

The following are the different kinds of trial balance:

1. Preliminary Trial Balance (the trial balance before adjustments)

a. Trial balance of balances

b. Trial balance of totals

2. Adjusted Trial Balance (the trial balance after adjustments)

3. Post-closing Trial Balance (the trial balance after the closing entries)

In this chapter, only the preliminary trial balance will be illustrated. The other kinds of trial
balance will be discussed and illustrated in the subsequent chapters.

The trial balance of balances is the traditional or conventional way of preparing the trial
balance. Only the accounts with balances (whether debit or credit balance) are listed. Accounts with
zero balances (the total of the debit amount is equal to the total of the credit amount) are not included
or shown in the trial balance.

It should be emphasized that the total of the amounts on the DEBIT side must equal to the
total of the amounts on the CREDIT side. In other words, the trial balance is said to be balanced if the
total debit is equal to the total credit.

Note: Accounts with zero balances are not listed. This kind of Trial Balance is widely used in practice
because this is the traditional presentation.

Note: All accounts with postings or entries with or without balances are listed. This kind of Trial
Balance is used for auditing purposes.

A trial balance is prepared to check the accuracy of posting to the general ledger and to prove the
equality of the debits and credits. If the trial balance is imbalance, error/s in the recording in the general
journal as well as posting to the general ledger must have been committed and must be located and
corrected.

However, a balanced trial balance (the total of the debit column is equal to the total of the of the
credit column) does not necessarily mean that no errors have been committed. There are errors that
cannot be detected by the trial balance.
The following errors cannot be detected by the trial balance:

1) No entry was made for a given transaction.

2) A journal entry was not posted to the general ledger.

3) A journal entry was posted twice.

4) Incorrect accounts were used to record a given transaction

5) Incorrect amounts were recorded for a given transaction.

The following procedures for each type of error above must be followed tocorrect the errors.
Error 1 - Just prepare the correct journal entry which was advertently or inadvertently omitted.

Error 2 - Just post to the general ledger the journal entry omitted

Error 3 - Reverse the second entry made and post to the general ledger.

Error 4 - Reverse the erroneous entry made and prepare the correct entry in the general journal and
then post to the general ledger.

Error S - Same procedure in error 4.

If the trial balance does not balance, the following are the common mistakes or errors:

1. Error in addition or subtraction in the general ledger or error in addition in the trial balance
itself.
2. Error of transposition, which means that digits are incorrectly interchanged. (e.g. P 890 is
recorded as P 980.)
3. Slide error or transplacement error, which means error in placing the decimal point (e.g. P
150.00 is recorded as P 15.00)

Short Cuts in Locating Error's in the Trial Balance

If the total of the debit column in the trial balance is not equal to the total of the credit column,
the following procedures may be followed to detect the error/s:

1. Get the difference between the total debits and total credits

2. A difference of P 10, 100, 1,000, etc., would probably indicate a simple error in addition either in the
trial balance or the general ledger.

3. If the difference is divisible by two (2), the error would probably be in posting to the wrong side (i.e., a
debit is posted on the credit side or vice-versa).

4. If the difference is divisible by nine (9), the error would probably be an error in transposition or error
in transplacement
Procedures to Correct Errors in Journalizing or Posting

1. Draw a straight horizontal-line through the error and insert the correct title or amount if the
entry is incorrect or the posting is incorrect; or
2. Make a correcting entry. This will correct the wrong entry recorded.

Note: Do not make erasures when correcting errors to avoid suspicion. Just follow the above procedure

Example of error in the account used - Insurance Expense for P 2,000 was erroneously debited to
Advertising Expense in both the general journal and general ledger

Example of error in the amount - Rent Expense for P 3.060 was erroneously recorded as P 300 in both
the general journal and general ledger.

After correcting the amounts in the general journal as shown above, correct the amounts also in the
general ledger

Note: Correction of the other more complicated errors or prior years' errors will be taken up in the
higher accounting subject (particularly in auditing subject).
 Chapter 3

FINANCIAL STATEMENTS

FINANCIAL STATEMENTS
At the end of every accounting period, accounting reports are prepared by the accountant to
inform the owner/s, management and other interested parties regarding status of the business,
particularly the results of its operations and its financial condition. These reports are called financial
statements. These statements serve as the means of communication between the business and all
interested parties

The Accounting Period is the period at the end of which financial statements are prepared. The
period generally covers one year because it jibes with the payment of which is annually.

The annual accounting period can be classified into

Calendar Year - A 12-month period which ends December 31.

Fiscal Year - Any 12-month period which does not end December 31

Natural Business Year - A 12-month period which ends in the month business activities are at their
lowest

The financial statements to be prepared as mentioned earlier in chapter one includes the following
(listed in the order they will be prepared)

Income Statement - This statement summarizes the different revenues and expenses of the business to
arrive at the net income The statement will show whether the business makes a profit or incurs a loss It
shows the results of operations of the business. All the accounts appearing in this statement are called
nominal accounts in the sense that they are merely temporary accounts and are not carried forward
from period to period

Statement of Changes in Owner's Equity - This statement will show the changes (increase or decrease)
in the owner's equity Owner's equity will increase as a result of additional investment of the owner and
the net income earned by the business. Conversely, the owner's equity will decrease as a result of the
regular withdrawal (drawing) of the owner or the net loss incurred. This statement merely supplements
the Balance Sheet.

Balance Sheet - This statement will show the assets. liabilities, and owner's equity of the business as of a
given date (the end of the accounting period) It shows the financial condition of the business All
accounts appearing in this statement are called real accounts in the sense that they are more or less
permanent in nature and their balances are carried forward from period to period.

Cash Flow Statement - This statement will show the sources and uses of cash. It shows the net cash flow
(inflow less outflow) from the three activities of the business; operating, investing, and financing
activities.

All businesses are required by the Bureau of Internal Revenue (BIR) to submit quarterly and
annually, the above financial statements for income tax purposes.
CLASSIFICATION OF ASSETS AND LIABILITIES
In the Balance Sheet, assets and liabilities are classified as follows:

Current Assets - these are assets which are expected to be converted into cash within one year.
Included in this classification are Cash, Note and Accounts Receivable, Unused Supplies, Prepaid
Expenses, etc.

Non-Current Assets - these are assets which are more or less permanent in nature in the sense that
they are acquired for use in the business and are not intended to be converted into cash. Included in this
classification are Land, Building, Machinery, Furniture & Fixtures, Office Equipment, Tools, Delivery
Truck, etc. Assets which do not qualify as current assets will fall under this classification.

Current Liabilities - are liabilities payable within one year Included in this classification are short-term
Note Payable, Accounts Payable, Accrued Expenses, Unearned Income, etc.

Non-Current liabilities - are liabilities payable beyond one year (more than a year) Included in this
classification are long-term Note Payable. Bonds Payable, Mortgage Payable, etc. Liabilities which do not
qualify as current liabilities will fall under this classification.

THE STATEMENT OF CASH FLOWS

The transactions that will be reflected in the Statement of Cash Flows are classified into three.

Operating Activities - These are transactions or activities that will affect net income.

Investing Activities - These are transactions or activities that will affect non-operating current assets and
non-current assets.

Financing Activities - These are transactions or activities that will affect non-operating current liabilities
and non-current liabilities and owner's equity

There are two ways of presenting the Statement of Cash Flows; the direct approach and the
indirect approach. Only the direct approach will be illustrated in this book. The indirect approach will be
taken up in the higher accounting subject.

Note. All the transactions reflected in the Statement of Cash Flow are merely lifted from the CASH
account in the general ledger (see page 34). In other words, only cash transactions (collections and
payments) are shown in the statement. The cash transactions appearing in the general ledger will be
merely classified into Operating, Investing and Financing activities.
In the preparation of the Statement of Cash Flows, the following guides may be useful:

 Cash transactions which will result in the generation of income and the incurring of expenses
will be shown under the caption Operating Activities.
 Cash transactions affecting the non-operating current assets as well as the acquisition or sale of
non-current assets will be shown under the caption Investing Activities.
 Cash transactions which will affect non-current liabilities, non-operating current liabilities and
owner's equity (additional investment or withdrawal) will be shown under the caption Financing
Activities.

ADJUSTING ENTRIES
After all the business transactions during the accounting period are recorded in the books of
accounts (this is the recording function of accounting) and the different accounts and their balances are
summarized in the trial balance, the next step in the accounting process is to update the books by
making adjustments. The adjustments to be made are the unrecorded income and expenses, as well as
the under or overstatement of any of the accounting values or elements at the end of the period. The
adjustments to be recorded in the general journal are called adjusting entries. The purposes of the
adjusting entries include the following:

1. To conform to the principle of "Matching Costs Against Revenue" which will result in a more
accurate measurement of the net income
2. To arrive at the correct valuation of assets and liabilities.
3. To arrive at the correct determination of the owner's equity

The following are the usual adjustments made at the end of an accounting period of a servicing
business prior to the preparation of the financial statements (this is the summarizing function of
accounting) together with the adjusting entries in the general journal:

1. Unused supplies
2. Prepaid expenses
3. Accrued expenses
4. Unearned income
5. Accrued income
6. Bad debts
7. Depreciation

Unused Supplies (sometimes called Supplies Iventory) – these are supplies that remain unused at the
end of the accounting period. These supplies therefore partake the nature of prepaid expenses. At the
time they are bought. Supplies Expense is debited hence, at the end of the accounting period, this
account will be overstated by the amount of the unused supplies hence there is a need to reduce the
balance of this account recognize the asset Unused Supplies.
Note: Unused Supplies are considered as current assets.

Prepaid Expenses - (sometimes called Deferred Expenses) - These are expenses not yet incurred but
already paid. Examples of these expenses which are usually paid. Examples of these expenses which are
usually paid in advance are Rent Expense. Insurance Expense, Advertising Expense, etc. If at the end of
the accounting period, these expenses are not yet used up or the benefit has not yet been received, an
adjustment is necessary to reduce the amount of the expense and recognize the asset Prepaid Expense.
The adjusting journal entry is (assuming that the account involved is Rem Expense)

Note: Prepaid Expenses are considered as current assets

Supplies bought and expenses paid in advance can be recorded as assets rather than as expenses
on the date bought or paid although by the very nature of these items, they are really expenses. This m
anner of recording which is only an alternative and not the conventional way. will be illustrated in the
subsequent chapter.

Accrued Expenses - These are expenses already incurred but not yet paid. Considering that the item of
expense is not yet paid, hence is not yet recorded, there is a need to recognize the expense and the
liability in the books. The adjusting journal entry is (assuming that the unpaid expense is the (hilities
Expense)

Note: Accrued Expenses are considered as current liabilities.

Unearned Income (sometimes called Deferred Income) - This is an income not yet earned but already
collected. A good example is Rental Income. Rentals are usually paid in advance by the tenants.

If at the end of the accounting period, a portion of the amount collected is not yet cared,
there is a need to reduce the Rental Income and recognize the liability Unearned Rental Income.

Note: Unearned Income is considered as current liability.

Similar to the prepaid expenses, precollected income or income collected in advance can be
recorded as a liability on the date of collection although by its nature, it is really an income. This manner
of recording which is only an alternative and not the conventional way. will be illustrated in the
subsequent chapter.

Accrued Income - This is an income already earned but not yet collected. Considering that this item of
income is not yet collected, hence is not yet recorded, there is a need to recognize the asset Accrued
Income and the Income (specify what item of income). A good example is the interest due on the note
receivable.

Note: The term Accrued can either mean unpaid if it is an expense or uncollected if it is an income.
Similarly, the term Deferred can mean prepaid if it is an expense or pre-collected if it is an income.

Bad Debts (now called Impairment Loss) - This refers to the estimated receivables which may not be
collected. This being the case, the bad debts will be considered as an additional expense and should be
recognized as such.
Note: The Allowance for Impairment Loss (*contra asset account) will be shown in the Balance Sheet as
a deduction from the Accounts Receivable to arrive at the Net Realizable Value (NRV). Contra assets
account is an account shown as a deduction from the asset.

How to Compute Estimated Bad Debts

Bad debts may be estimated by any of the following methods

1. A fixed percentage of sales

2. A fixed percentage of the accounts receivable

3. Aging the receivables (to be taken up in higher accounting subject)

The Impairment Loss account is an expense (nominal account) hence will be shown in the Income
Statement as part of the operating expenses.

Depreciation - Refers to the decrease in the value of a non-current asset (fixed asset) due to the
ordinary wear and tear or passage of time. Examples of assets which depreciate in value are furniture,
equipment, machinery, building, etc. Because the value of the asset decreases, the decrease is
considered as an expense and should be recognized as such.

Note: The Accumulated Depreciation account ("contra asset account) will be shown in the Balance Sheet
as a deduction from the asset account being depreciated to arrive at the Carrying Amouni (formerly
called net book value)

How to Compute Estimated Depreciation

Cost - Salvage or Scrap Value (at the end of the life) x Number of months divided by Life

Interim Financial Statements - are statements prepared prior to the end of the accounting period.
These are statements prepared as of a certain cut off period just to determine the status of the business
or as per BIR requirement.

WORKSHEET (Working Paper)

After preparing the adjusting entries, the next step in the accounting process is to prepare the
Worksheet (Optional). This is where the effects of the adjusting entries will be shown. It is prepared
merely to facilitate the preparation of the financial statements.

A worksheet is a columnar working paper which will show all the accounts together with their
adjusted amounts that will appear in the financial statements. The adjusted balances of different
accounts are classified into nominal and real accounts and extended to the Income Statement or
Balance Sheet column. The worksheet will show whether there is a net income or loss. It can also serve
as the basis for preparing the closing entries and the post-closing trial balance. The money columns of
the worksheet may vary from 8 columns to 12 columns.
 CHAPTER 4
COMPLETING THE ACCOUNTING PROCESS

THE ACCOUNTING CYCLE

The entire accounting process is considered a cycle. This is simply because the steps or procedures
involved are repeated on a period-to-period basis. The steps in the accounting cycle in a sequential
order are summarized below.

1. Journalizing - This is the process of recording the business transactions in the journals (book/s of
original entry) The bases for recording in the journal are the different business forms such as the
purchase sales invoice, official receipts, delivery receipts, bank statements, bank deposit slips, check
vouchers, petty cash vouchers, credit debit memo, etc. This is done on a day-to-day basis

2. Posting - This is the process of transferring the entries in the journal s to the general ledger. Entries in
the general journal are posted to the general ledger on a day-to-day basis. However, entries in the
special journals (to be discussed in the subsequent chapter) with separate columns for specific accounts,
are posted at the end of each month.

3. Preliminary Trial Balance (Unadjusted Trial Balance) This is prepared to check the accuracy of posting
and to prove the equality of the debits and credits. A trial balance is prepared every end of the month

4. Adjusting Entries - These are prepared at the end of the accounting period to update the books The
items to be adjusted are the transactions which are still unrecorded (accrued income or expense) or
accounts which are under or overstated. (prepayments of expenses or pre-collection of income) These
adjusting entries are recorded in the general journal and they are prepared prior to the preparation of
the financial statements so they can be incorporated or included.

5. Worksheet (Working Paper) - The purpose of preparing the worksheet is merely facilitate the
preparation of the financial statements This is accomplished by showing the adjustments in the
worksheet and then classifying all the accounts into real accounts (Balance Sheet accounts) and nominal
accounts (Income Statement accounts). Preparation of the worksheet is optional if interim financial
statements are prepared, a worksheet will be very useful.

6. Financial Statements - These are the accounting reports prepared at the end of the accounting
period. The principal statements are the Income Statement, Statement of Changes in Owner's Equity.
Balance Sheet, and Statement of Cash Flows. These are the means of communication between the
business and the interested parties. The preparation of the financial statements is the summarizing
function of accounting

The above-mentioned steps or procedures (1- 6) in the accounting process are merely
recapitulation of the discussions in the previous chapters.
COMPLETING THE ACCOUNTING PROCESS (Closing the Books)
To complete the accounting cycle, the remaining steps or procedures are as follows:

7. Closing Entries - These are entries prepared in the general journal at the end of the accounting period
(after the financial statements are completed) to close all the nominal accounts preparatory to formally
closing the books. This is accomplished by reversing the position of the accounts, i.e, accounts with
credit balances are debited and accounts with debit balances are credited. An Income & Expense
Summary account is used as balancing account. If the Income & Expense Summary account will have a
credit balance after all the nominal accounts are closed to this account, it means there is a net income,
conversely, if it will have a debit balance, it means there is a net loss. The balance of the Income &
Expense Summary account will then be closed to the Drawing account of the owner, and finally,
whatever will be the balance of the Drawing account, will be closed to the Capital account of the owner.

If, however, a worksheet is prepared (see pages 70 and 71), the Income Statement column in
the worksheet will show whether there is a net income or loss without the benefit of preparing the
closing entries. Furthermore, the adjusted balances of all the nominal accounts are already summarized
in the worksheet, hence, will serve as the basis for preparing the closing entries.

After the closing entries are posted to the general ledger, all the nominal accounts will have
zero balances (the total debit is equal to the total credit).

8. Post-Closing Trial Balance - As the term implies, this is a trial balance prepared after the closing
entries. Considering that the nominal accounts are already closed, then only the real accounts will be
shown in this trial balance. All these real accounts which are still open (with balances) are easily found in
the Balance Sheet column of the worksheet instead of looking for the individual accounts in the general
ledger The post-closing trial balance therefore is a trial balance of all real accounts. This will serve as the
basis for preparing the opening entry in the new books of accounts.

9. Ruling the Ledger - Books of accounts (journals and ledgers) are registered with the Bureau of
Internal Revenue (BIR) on a year-to-year basis, hence at the end of each accounting period, the books
need to be closed. This is accomplished by getting the total debits and credits of all the accounts and
then double-ruling or double-lining the totals.
As far as the nominal accounts are concerned, because of the closing entries, the debits and
credits of all the accounts are already equal. It is a matter of getting the totals and putting a double line
under the total debit and credit as an indication that the account is already closed.

For the real accounts with open balances as per the post-closing trial balance, the total of the
debit and credit entries for all the accounts are totaled. The balance of each account, if any, is placed on
the opposite side (the side where the total is lower) so that the total debit will be equal to the total
credit. A double line is then placed under the total of the debit and credit as an indication that the
account is closed. For real accounts which are already closed (total debit is already equal to the total
credit, a double- line will just be placed under the total of the debit and credit.

When all the accounts in the general ledger have been double-lined or double ruled, the books
are said to be closed.
10. Opening Entry - Considering that new books of accounts (as registered with the BIR) will be used in
the following accounting period, there is a need to transfer the balances of the real accounts (Balance
Sheet accounts) to the new books. This is accomplished by preparing an opening entry in the new
general journal which will be posted to the new general ledger The basis for the opening entry is the
post-closing trial balance.

11. Reversing Entries (the last stage) - There are some adjusting entries prepared at the end of the
accounting period which need to be reversed at the start of the new accounting period (in the new
general journal) This is effected by simply reversing the adjusting entries made (the debit entry is
credited and the credit entry is debited to reverse the effect on the accounts)

The following adjusting entries need to be reversed

a. Prepaid expenses
b. Unearned Income
c. Accrued Expenses
d. Accrued Income

It should be emphasized that the Expense Method for recording expenses paid in advance is the
traditional or conventional method. The Asset Method is merely an alternative method to avoid the
necessity of reversing entry. The Expense method is the preferable method for the following reasons or
justifications:

1. By the very nature of the item, it is really an expense. It is only considered as an asset because at
the end of the accounting period it may still be prepaid or not yet used up. On the date it is
assumed that it will be used up before the preparation of the financial statements hence an
expense account is used.
2. It is expedient in the sense that there is no need to prepare an adjusting entry at the end of the
accounting period should the expense be used up.
3. Principle of Materiality dictates that if the amount of the expense is negligible or immaterial,
although not yet used up, it should be charged to an expense.
4. There will be is no consistency in the recording of expenses because there are expenses payable
in advance and there are expenses which are not.
5. Charging to expense rather than to asset an expense paid in advance is more conservative.

For income collected in advance, the Income Method is likewise preferable than the Liability
Method for consistency in the recording of the income. The liability method is merely to avoid the
necessity of reversing entry.

To illustrate the remaining procedures or steps to complete the accounting process, the
transactions and books of Quality Auto Repair Shop will again be used.

Closing Entries - All the adjusted balances of the nominal accounts in the general ledger as shown in the
worksheet (see pages 70 & 71) will be closed by preparing the closing entries in the general journal.
Post-Closing Trial Balance – this is the trial balance of the accounts which are still open after the closing
entries are posted to the general ledger.

Ruling the Ledger – this general ledger book after the closing entries are posted and after all the
accounts are closed and double-ruled (an indication that the books are closed)

Reversing Entries – after the opening entry, the last procedure is to prepare the reversing entries in the
general ledger. This is done by simply reversing some of the adjusting entries prepared at the end of the
accounting period. The reversing entries are prepared for consistency in the treatment of income and
expenses.

Effects of the Reversing Entries

On the Prepaid Expenses

After the reversing entries, the prepaid expenses (Unused Supplies and Prepaid Advertising) are
closed, and the expenses (Supplies Expense and Advertising Expense) are recognized as expenses for the
new period. When the prepaid expenses recognized in the previous period are used up in the new
accounting period, there is no more need to prepare any adjusting entry. Also, the expenses recognized
are true expenses of the new period rather than the previous period. This is in conformity with the
principle of "Matching Cost Against Revenue" which simply means that the costs incurred during a given
period must be matched against the revenue generated during the same period.

On the Accrued Expenses

Because the liability (Light & Water Payable) is closed by the reversing entry, on the date of
payment, the debit will be consistently charged to an expense account. If it is not reversed, then on the
date of payment, the debit will be to a liability account.

On the Unearned Income

After the reversing entry, the Unearned Repair Income account is closed and the account.
Repair Income is recognized. When unearned income becomes earned in the next accounting period,
there is no more need to prepare adjusting entry. Also, the income earned as recognized truly pertains
to the income of the next accounting period and not of the previous period.

On the Accrued Income

Because the Rental Receivable account is closed by the reversing entry, on the date of
collection, the amount will be consistently credited to an income account. If no reversing entry is made,
rental receivable account will be credited upon collection instead of the Rental Income account

As already mentioned earlier, to avoid the necessity of preparing reversing entries the asset
method for recording expenses paid in advance and the liability method for recording income collected
in advance can be used so long as they will be used consistently. But it must be that the methods
mentioned are merely alternative methods. The expense method for recording expenses whether
prepaid or accrued, and the income method for recording accrued (uncollected) are still conventional
methods because there is consistency. Also, not all expenses are paid in advance and not all income can
be collected in advance.
 Chapter 5
ACCOUNTING FOR MERCHANDISING BUSINESS

NATURE OF MERCHANDISING BUSINESS

A merchandising or trading business is engaged in the buying of merchandise or goods which

will be sold (in their original form) at a price higher than the purchase cost.
Examples of these goods are clothings, drugs, appliances, books, groceries, hardware items, etc.

When the merchandise is purchased, the account used to record the acquisition is called
Purchases. When the merchandise is sold, (at a price higher than the purchase cost) the account used to
record the revenue is called Sales. Unsold merchandise at the end of the accounting period is called
Merchandise Inventory which is subtracted from the Purchases to arrive at the Cost of Goods Sold.

A simple computation of the net profit of a merchandising concern is shown below (figures assumed)

Sales P 120,000
Less: Cost of Goods Sold:
Purchases P 80,000
Ending Inventory 15,000 65,000
Gross Profit P 55,000
Less: Expenses 35,000
NET PROFIT P 20,000

ACCOUNTING FOR PURCHASES OF MERCHANDISE

When merchandise is purchased, the following are the usual terms

Cash or COD (Cash on Delivery) - it means that the purchase of merchandise is payable in cash.

On Credit or On Account - it means that the purchase of merchandise is payable at some future time

Credit Term or Credit Period - is the time within which the payment should be made

Examples of Credit Terms

1/30 - payable within 30 days from the date of the invoice

n/EOM - payable at the end of the month when the purchase is made

10 EOM - payable up-to 10 days after the end of the month of the purchase

Trade Discount - is a special discount given to the buyer for buying in large quantity. The discount is an
outright deduction from the list price hence the amount to be recorded is the net amount.

Purchase Discount - is a discount given to the buyer for paying within a specified period of time which is
usually earlier than the credit period. This is offered to encourage the buyer to pay promptly.

Discount Period - is the period of time within which to pay to be entitled to a discount.
 The difference between a trade discount and a purchase discount is that a trade discount is
deducted on the date of purchase while the purchase discount is deducted on the date of payment.

Examples of Credit Terms with Discounts Offered

2/10, n/30 - there is a 2% discount if paid within 10 days from the date of the invoice, or if it is
after the discount period, it must be paid not later than 30 days from the date of the invoice

2/10. 1/15, n/30 - there is a 2% discount if paid within 10 days from the date of the invoice, or
only 1% if paid after the 10th day but on or before the 15" day from the date of the invoice, or if it is
after the discount period, it must be paid not later than 30 days from the date of the invoice.

3/EOM, 1/60 - there is a 3% discount if paid on or before the end of the month of purchase, or
if it is after the discount period, it must be paid not later than 60 days from the date of the invoice.

2/10EOM, n/60 - there is a 2% discount if paid on or before the 10th day after the end of the
month of purchase, or if it is after the discount period, it must be paid not later than 60 days from the
date of the invoice.

COST OF DELIVERING OR TRANSPORTING THE GOODS

Freight In - the costs incurred by the buyer for transporting the goods from the seller's place to the
buyer's place.

FOB Shipping Point - this means Free on Bound up to the shipping point Freight charges will be
shouldered by the seller up to the shipping point before loading to a common carrier. Once the goods
are loaded, the buyer will pay for the freight charges and other incidental costs.

POB Destination - this means Free on Board up to the point of destination. The seller will pay all the
freight charges and incidental costs up to the buyer’s place.

Freight Collect - this means that the buyer will pay for the freight charges upon receipt of the goods.
However, if the term is FOB Destination, the buyer can deduct the freight charges when paying for the
invoice price.

Freight Prepaid - this means that the seller has paid the freight charges at the time of shipment.
However, if the term is FOB Shipping Point, the seller can add the freight charges to the invoice price

PURCHASE RETURNS AND ALLOWANCES

The buyer may return the merchandise purchased for any of the following reasons.

1. The merchandise or goods may have some defects or they are not in good or satisfactory
condition.
2. The merchandise may have been damaged while in transit.
3. The merchandise may have arrived too late.
4. The merchandise received is not what is ordered.
5. The term may not be what has been agreed upon

In some cases however, the buyer may just agree to keep the merchandise provided an allowance (a
reduction in the original price) will be granted
RECORDING THE PURCHASE OF MERCHANDISE
There are two methods for recording purchases of merchandise.

1. Periodic Inventory Method - Under this method, every time a purchase of merchandise is made, an
account PURCHASES is debited When a sale is made, a revenue account SALES is credited At the end of
the accounting period, a physical count of the goods unsold (called MERCHANDISE INVENTORY) will be
made. This will be subtracted from the purchases to arrive at the Cost of Goods Sold. The ending
merchandise inventory will be carried forward to the next accounting period and will become the
beginning merchandise inventory This method is normally employed by a merchandising business

2. Perpetual Inventory Method - Under this method, an asset account Merchandise (instead of
Purchases) is debited to record the purchase. When a sale is made, two entries are required, first is to
recognize the revenue account called Sales and the second to debit the Cost of Goods Sold with a
corresponding credit to Merchandise. In this manner, the Merchandise account will have a running
balance and as such, there is no need to make a physical count just to determine the balance all count is
made, it is only for purposes of checking whether the balance as per the physical count tallies with the
balance as per the ledger This method is normally employed by a manufacturing business

Note: In this book only the Periodic Inventory Method is used The Perpetual Inventory Method is taken
up in cost accounting subject

ACCOUNTING FOR SALES OF MERCHANDISE

Whenever a sale of merchandise is made, new purchase must be initiated to replenish the items
sold lest stockout occurs Sale of merchandise is considered a revenue and credited to Sales account. The
terms of the sale are practically similar if not the same as the terms of the purchase.

Sales Invoice - is a document that the seller gives to the buyer listing the items ordered or sold together
with the quantity, price, description, value added tax, terms of the sale and the total price of all the
items sold.
Delivery Receipt - is a document issued by the seller and signed by the customer evidencing receipt of
the goods ordered or sold as per the sales invoice. In some companies, the sales invoice serves as the
delivery receipt.
Credit Memo - is a business form used by the seller to notify the buyer that his account is credited (i.e,
the balance is reduced) for returns made or allowance granted for defective merchandise.
Sales Returns & Allowances - These are deductions from sales as a result of merchandise returned or
allowance granted for damaged or defective merchandise. This is supported by the credit memo issued
by the seller.
Sales Discount - is the discount given to customers for paying earlier than the credit term,
Trade Discount - this is a special discount given to customers for buying in large quantity. The discount is
automatically deducted from the invoice price and as such is not recorded.
Freight Out - this is the expense incurred by the seller to transport the goods to the buyer's place when
the term stipulates that the seller will shoulder the freight.
COMPUTATION OF THE GROSS PROFIT

The new accounts introduced applicable to a merchandising business will be we in the

computation of the Gross Profit as shown below (figures are all assumed)

Sales P 800,000
Less: Sales Returns & Allowances P 10,000
Sales Discount 40,000 50,000
Net Sales P 750,000
Less: Cost of Goods Sold:
Beginning Inventory P 100,000
Purchases P 600,000
Freight In 20,000
Gross Purchases P 620,000
Less: Purchase Returns & Allowances P 15,000
Purchase Discount 5,000 20,000 600,000
Cost of Goods Available for Sale P 700,000
Less: Ending Inventory 150,000 550.000
GROSS PROFIT P 200,000

Note: Only the account Freight Our is not included in the computation of the gross profit. It is treated as
part of the selling expenses in the Income Statement. The account Delivery Expense is more appropriate
account to use instead of Freight Out.

FINANCIAL STATEMENTS OF A MERCHANDISING BUSINESS

Income Statement - there are two acceptable formats for presenting the income statement of a
merchandising business as per the recommendation of the Financial Reporting Standards Council (FRSC),
the Natural and Functional formats. The presentation will depend on whether the expenses are
classified as to their nature or as to their function. Also, it is likewise suggested that comparative income
statements (current year is compared with the previous year) are to be presented to be more
informative.

Other Income - may include commission income, rental income, interest income, etc.

Change in the Merchandise Inventory - it is added (positive) if the ending inventory is greater than the
beginning inventory or subtracted (negative) if it is vice versa.

Employees Benefit Costs - refer to the fringe benefits paid by the company to the employees which
include the 13th month pay, vacation leave, sick leave and other benefits being enjoyed by the
employees.

Depreciation - refers to the decrease in the value of a fixed asset due to ordinary wear and tear or due
to passage of time.
Other Expenses - these expenses refer to the ordinary and necessary expenses to operate the business
(distribution and administrative expenses) which include rent, salaries, advertising, insurance, supplies,
utilities, etc. These expenses are listed and classified according to their nature.

Financing Costs - these costs include interest expense and other expenses incurred in relation to the
borrowing of money and have nothing to do with the costs of operation
 Chapter 6
RECORDING TRANSACTIONS WITH VAT

VALUE-ADDED TAX (VAT) - is an indirect tax levied on the buyer of goods or services, or on the
transferee or lessee of properties. The VAT rate is fixed at 12% of the net revenue.

VAT OUTPUT - is the value-added tax on the sale or leese of taxable goods, properties, or services by a
business entity which is registered with the BIR as VAT registrant.

VAT INPUT - is the value-added tax due on the purchase or lease of taxable goods properties or services
by a person or business entity which is registered with the BIR as VAT registrant.

A firm has an option of registering with the BIR as VAT registrant or non-VAT registrant provided
that the annual gross sales is not more than P 1,500,000. A VAT registrant can offset the Input Vat (the
tax on the purchase) against the Output Vat (the tax on the sale). A non-VAT registrant will be charged a
percentage tax of 3% of the gross sales or gross reeipts in lieu of the value added tax of 12%. However,
the Input VAT cannot be offset against the percentage tax but will be considered instead as an expense

Practically all business transactions (sale of goods or services) are subject to a 12% value-added
tax which is added by the seller, transferor, or lessor to the price of the goods, properties, or services.
Sale of merchandise is subject to VAT whether for cash or on credit, however, income from service
rendered is subject to VAT only when collected.

There are some items of goods or services however, which are non-Vatable or VAT exempt such
as agricultural products, books, publications, or goods sold at their original form, marine products, etc.
Schools and hospitals are also VAT exempt.

As far as the buyer is concerned, the VAT is chargeable (debited) to an account VAT Input while
the seller uses the account (credited) VAT Output. At the end of each month, the two VAT accounts are
closed. If the VAT output is higher, it represents the VAT payable by the business. On the other hand, it
the VAT input is higher, it means that the business has a receivable for the BIR (to be deducted or offset
from the future VAT payable assuming the firm is a VAT registrant). Vat is payable monthly and quarterly
to the BIR. The deadline is 20 days after the end of the month.

It should be emphasized that the recognition or recording of the VAT Input and VAT Output does
not affect the amount of purchase cost or sales revenue. The business is merely assuming the role of a
collector for the BIR.

In the case of sale of goods, the VAT Input or VAT output is based on the net purchases or net sales
regardless of the terms (cash or on credit) but in the case of income from services, the VAT is based on
the gross or net receipts.
 Chapter 7
SPECIAL JOURNALS
(INTERNAL CONTROL FOR CASH)

THE USE OF SPECIAL JOURNALS

As mentioned in chapter 2, the books of accounts where all business transactions are recorded
consist of the book of original entry which is the general journal, and the book of final entry which is the
general journal, and the book of final entry. The transactions therefore are recorded twice: first in the
general journal and the second in the general ledger.

In this chapter, new books of original entry called Special Journals and another ledger called
Subsidiary Ledger are introduced. Most if not all businesses make use of the special journals for the
expediency and convenience in the recording of business transactions. Considering voluminous
transactions to be recorded in one accounting period, it is not practical to use only one journal.
Furthermore, with only one journal, only one bookkeeper can record at a given time hence, special
journals are used not only for convenience but also to facilitate the recording process

SPECIAL JOURNALS
These are multi-column journals which have special money columns for specific accounts which
are commonly and oftenly used in the recording process. For a business prime number of transactions,
the use of special journals will result in faster, more efficient and lesser error in recording the
transactions. The recording can be done by two or more bookkeepers.

The special journals (books of original entry) which are normally used in addition to the general
journal are the following:

Purchases Journal (also called Purchase Book) - see exhibit I on page 197
Sales Journal (also called Sales Book) - see exhibit 2 on page 197
Cash Receipts Journal (also called Cash Receipts Book) - see exhibit 3 on page 198.
Cash Payments Journal (also called Cash Disbursements Book) see exhibit 4 on page 199

With the use of the above Special Journals the transactions to be recorded in the General
Journal will be limited only to those which cannot be recorded in any of the above special journals.
There is still another journal which combines all the special journals into one It is called the Combination
Journal However, it is not widely used and accepted because it defeats the purpose of the special
journals. which is to facilitate the recording process.

Purchases Journal
This is a special journal used to record all purchases of merchandise whether for cash or on
credit. In this manner, the recording of purchases is centralized in this journal.

Whenever a purchase of merchandise is made, the debits are PURCHASES and VAT INPUT, and the credit
is either CASH PURCHASES or ACCOUNTS PAYABLE for the total of the debits. At the end of each month,
the total money & doubled ruled. The total of the Purchases, Vat Input and Accounts Payable columns
are posted to the general ledger. The account number is written in parenthesis below the total. The
Cash Purchases column is not posted because it is not an account. Entries in the Accounts Payable
column are posted further to the accounts of the suppliers in the subsidiary ledger. A check mark is
placed in the posting reference column after posting is made

If a promissory note is issued on the date of purchase, it is recorded first in the Purchases
Journal as if it were a purchase on account after which, another entry is prepared in the General Journal
debiting Accounts Payable and crediting Notes Payable. The total purchases therefore for each month
can be easily found in the Purchases Journal without the necessity of looking at the other special
journals.

It should be emphasized that only purchases of merchandise are recorded in the Purchases
Journal. Purchases of other assets are recorded either in the General Journal or Cash Payments Journal
depending on whether the purchase is for cash or on credit.

Sales Journal
This is a special journal used to record all sales of merchandise whether for cash or on credit.
Similar to the purchases, all sales are centralized in this journal for easy reference.

Whenever a sale of merchandise is made, the debit is either ACCOUNTS RECEIVABLE or CASH SALES
(inclusive of VAT) and the credits are SALES and VAT OUTPUT.

At the end of each month, the total money columns are totaled and double ruled. The total of
the Accounts Receivable, Sales and VAT Output columns are posted to the general ledger. The account
number is written in parenthesis below the total. The Cash Sales column is not posted because it is not
an account. Entries in the Accounts Receivable column are posted further to the accounts of the
customers in the subsidiary ledger. A check mark is placed in the posting reference column after posting
is made.

It should likewise be emphasized that only sales of merchandise are recorded in the Sales
Journal. Sale of other asset is recorded either in the General Journal or Cash Receipts Journal depending
on whether the sale is for cash or on credit.

Cash Receipts Journal

As the term implies, this is a special journal where all receipts of cash are recorded. The format
and number of money columns will vary depending on the number of accounts frequently used by the
business.

Accounts that have no money columns are recorded in the SUNDRY CREDIT column and are immediately
posted to the general ledger. Special money columns may be provided for accounts which are frequently
used. At the end of each month, the money columns are totaled and double ruled. The total of the
accounts with money columns are posted to the general ledger and the account numbers are written in
parenthesis below the totals. A check mark is placed in the posting reference column of the accounts
receivable after posting is made to the subsidiary ledger. The Cash Sales column is not posted because it
is not an account, and the total of this column should be equal to the total of the same column in the
Sales Journal.
Cash Payments Journal
This is a special journal where all cash payments are summarized and recorded. Just like the
Cash Receipts Journal, the format and number of money columns will vary depending on the number of
accounts frequently used by the business.

Accounts that have no money columns are recorded in the SUNDRY DEBIT COLUMN and are
immediately posted to the general ledger; Special money columns may be provided for accounts which
are frequently used. At the end of each month the money columns are totaled and double ruled. The
total of the accounts with money columns are posted to the general ledger and the account numbers
are written in parenthesis below the totals. A check mark is placed in the posting reference column of
the Accounts Payable after posting is made to the subsidiary ledger. The Cash Purchases column is not
posted because it is not an account, and the total of this column should be equal to the total of the
same column in the Purchases Journal.

SUBSIDIARY LEDGER
When the business has numerous customers and suppliers, an accounting record should be
designed to provide detailed information regarding their accounts. This record is called the Subsidiary
Ledger

Subsidiary Ledger - this is a special ledger which shows in detail the transactions affecting the account of
a customer or supplier. For the customers, it is called Accounts Receivable Subsidiary Ledger and for
suppliers, It is called Accounts Payable Subsidiary Ledger

Controlling Account - this is a control account of the different subsidiary ledgers. For the customers. the
controlling account is the Accounts Receivable and for the suppliers, the controlling account is the
Accounts Payable.

INTERNAL CONTROLS - refer to the control measures a business entity is adopting to safeguard its
assets. Of all the assets of the business, cash being liquid, is the most susceptible to theft,
embezzlement, and misappropriation. Steps and procedures therefore must be taken to safeguard cash.
Also, it must be accurately and correctly accounted for from the time it is received up to the time it is
used or spent.

To safeguard cash, the following policies or procedures can be adopted:

1. The cashier must not have access to the accounting records
2. The number of persons handling cash must be limited.
3. The employees handling cash must be bonded (insured)
4. The use of a cash register and a safe vault is recommended.

The concept of cash to a layman is different from the accounting point of view. To a layman,
cash means money. In accounting however, CASH refers to money and all forms of money substitutes
(such as coins, postal money orders, checks, bank drafts, and treasury bills) which can be accepted at
face value upon deposit and can be used for general disbursement purposes.
 One of the most widely used controls for cash is the IMPREST CASH SYSTEM. Practically ALL
businesses are adopting this system. The salient features of this system are the following;

1. A checking account (also called current account) will be opened with a bank. This is an account that
allows a business or a person to deposit cash and to write or issue checks against the account balance.

2. All collections are deposited intact the following business day. An Official Receipt (see exhibit A on
page 201) must be issued for all collections regardless of the source.

3. All payments are made by check except small payments which are paid out of the Petty Cash Fund
created for this purpose.

Payment by check is supported by a Check Voucher (see exhibit B on page 201) which is an
accounting form which shows among other information, the nature of the item being paid for, together
with the supporting papers or documents attached thereto.

Under the Imprest Cash System there is no cash on hand. The account Cash will be replaced by
the account Cash In Bank (usually, the name of the depositary bank is used for the account name). The
petty cash fund will be handled by a petty cashier who will be accountable for all the expenses paid out
of the fund. A fixed amount for the petty cash fund is usually established and will only be increased if the
situation warrants. When the fund is about to be exhausted, all the expenses paid out of the fund will be
replenished by issuing a check. A Petty Cash Voucher (see exhibit C on page 202) is prepared to support
the small expenses to be paid.

All entries in the General Journal on the other hand must be supported by a Journal Voucher
(see exhibit D on page 202). For verification and audit purposes, all transactions to be recorded must
have supporting documents or papers attached to the journal voucher.
RECORDING THE TRANSACTIONS IN THE SPECIAL JOURNALS
The summary transactions listed below are generally applicable to a merchandising business
owned and operated by a single proprietor.

TRANSACTIONS TO BE RECORDED IN THE:

1. Initial or additional cash investment of the owner Cash Receipts Journal

2. Additional investment of non-cash assets by the owner General Journal

3. Cash purchases of merchandise Purchase & Cash Payment Journal

4. Purchases of merchandise on credit Purchase Journal

5. Issuance of note for merchandise bought Purchase & General Journal

6. Cash sales of merchandise Cash Receipts & Sales Journal

7. Sales of merchandise on credit Sales Journal

8. Received a note for merchandise sold Sales & General Journal

9. Purchase returns:
a. If originally bought for cash Cash Receipts Journal
b. If originally bought on credit General Journal

10. Sales returns

a. If originally sold for cash Cash Payments Journal
b. If originally sold on credit General Journal

11. Payment of accounts or notes payable Cash Payments Journal

12. Collection of accounts or notes receivable Cash Receipts Journal

13. Short-term or long-term borrowing Cash Receipts Journal

14. Payments of short-term or long-term borrowing Cash Payments Journal

15. Conversion of Accounts Payable into Notes Payable General Journal

16. Conversion of Accounts Receivable into Notes Receivable General Journal

17. Payment of expenses Cash Payments Journal

18. Collection of other income Cash Receipts Journal

19. Sale of fixed assets for cash Cash Receipts Journal

20. Cash purchases of fixed assets Cash Payments Journal

21. Fixed assets purchased on credit General Journal

22. Adjusting, correcting, closing, opening, and General Journal

reversing entries.
 Chapter 8

BANK RECONCILIATION STATEMENT

THE NEED FOR CHECKING ACCOUNT

Keeping cash collections in the office (whether it is secured in the cash vault) is

not safe. The same is true when making large payments in cash. It is an invitation to

theft, embezzlement, or misappropriation because temptation is very great For these

reasons, most if not all businesses maintain a CHECKING ACCOUNT (also called

CURRENT ACCOUNT) with a bank for safekeeping purposes and for convenience in

making payments. For accounting purposes, the use of a checking account will also

provide additional record for all cash transactions.

DEFINITION OF TERMS

Checking Account (also called Current Account) - is a bank account that allows a

bank customer to deposit cash and to write checks (withdraw or pay by means of a check)

against the account balance.

Depositor - is a person, organization, or business that has a deposit in a bank. To be a

depositor, the person or the authorized signatory or signatories of the business or

organization must first fill up a Signature Card.

Signature Card - this is a bank form (to be filled up by the depositor) which contains

the signature/'s of the person/s authorized to sign in the check. This will prevent

unauthorized person/s to issue check. It will also detect checks issued with forged signatures.

Checkbook - is a booklet consisting of detachable blank checks which are pre-numbered

with a check stub.

Check Stub - a stub attached to the checkbook which will contain all the records

pertaining to the checking account as to deposit and withdrawal. The balance of cash in

bank as per the check stub should be matched against the balance as per the general

ledger.

Check – it is negotiable instrument signed by the depositor ordering the bank to pay a sum of money to
a person or entity.
Drawer - is the one who signs the check ordering the bank to make payment.

Drawee - is the bank on which the check is drawn.

Payee - is the person or entity to whom payment is to be made.

Deposit Slip - is a bank form where the deposits can be listed down in detail by the

depositor. Usually this is filled up in duplicate (one copy for the bank and the duplicate

copy for the depositor) for cross checking purposes. The deposits in currency (coins and

bills) are usually separated from deposits in the form of checks for easy reference, The

bank teller usually validates the deposit slip before the duplicate copy is given to the

person making the deposit.

KINDS OF CHECKS

Cancelled Checks - checks paid by the bank that were deducted from the depositor's account and
returned together with the monthly bank statement.

Stale Check - a check issued but not yet presented to the bank for payment and has been outstanding
for 6 months or more. This check is already invalid.

Certified Check - a check certified by the bank as to sufficiency in funds and guaranteed to be honored
when presented for payment.

Crossed Check - a check which can not be encashed by the payee and can only be deposited in his
account.

Post-Dated Check - a check which is dated sometime in the future.

Dishonored Check - a check not accepted for deposit or not honored for payment due to some defects
in the check (e.g. no signature, with erasures, the words do not tally with the figure, unauthorized
signature/s, etc.).

Bank Statement - is a monthly statement given by the bank to the depositor summarizing all the cash
transactions (deposits and checks paid by the bank) during the month. It will also include the beginning
balance, bank charges, bank collections made by the bank in favor of the depositor if any, and the
ending cash balance.

Bank Reconciliation - is the process of reconciling the cash balance as per the bank statement with the
cash balance as per the records of the depositor. The cash balance of the depositor can be found in the
check stub of the checkbook or in the CASH account in the general ledger.

Bank Reconciliation Statement - a statement which reconciles the bank balance with the depositor's
cash balance (the end-product of bank reconciliation) It is prepared by the depositor for purposes of
preparing the adjusting entries (items recorded by the bank but not by the depositor) to correct the cash
balance recorded in the books.
The following may be the reasons (reconciling items) why the balance per bank does not tally with the
balance per book:

1. Deposit in Transit - this is a deposit made by the depositor usually at the end of the month, which is
received by the bank but too late to be included in the bank statement.

2. Outstanding Checks - these are checks issued by the depositor but not yet paid by the bank or
presented for payment (opposite of cancelled checks).

3. Bank Service Charge - is the fee charged by the bank for services it is rendering A DEBIT MEMO is
attached to the bank statement as supporting document.

4. Bank Collection - a collection made by the bank in favor of the depositor or the interest earned on the
deposit. A CREDIT MEMO is attached to the bank statement as supporting document.

5. Interest Income - the interest earned on the deposit.

6. Drawn Against Insufficient Fund (DAIF) - is a check deposited by the depositor returned by the bank
because the funds (cash balance) in the drawer's checking account. is not sufficient to cover the amount
of the check.

7. Error - this refers to the mistake committed by one or both parties (the bank and the depositor).

Bank Credit Memo - a form used by the bank notifying the depositor that his account is CREDITED (the
cash balance is increased) which may be due to the interest earned on the depositor or collection made
by the bank in favor of the depositor.

Bank Debit Memo – a form used by the bank to notify the depositor that his account is DEBITED (the
cash balance is decreased) due to the bank service change.