Basic Accounting

Module 1

Prepared By:

MAFGEN JAMISOLA-CAPANGPANGAN,JD.
Course Instructor

1
 Introduction

Human beings have limitations, Everyday transactions cannot be

retained in the human brain for quite a period of time without confusions
and complications. To avoid these, transactions and other important
events should be recorded. Such written records serve as reference for
future recall.
In business, several parties are interested to its records to seek
answers to their questions and bases for their decisions. These parties can
be classified into direct users or those who have direct interest to
business records and indirect users or those who are indirectly interested
to the accounting information of the business. Among the direct users are
the following:

1. Owner. He is interested to know whether the business should

be maintained, increased, decreased or disposed completely.
Further, he is interested to know whether he is getting a fair
return of his investment.
2. Management. To management, financial information serves as
a measure for making future financial decisions and measure
of its effectiveness.
3. Investor. An investor is interested in the financial statement
for making future financial decisions and a measure of its
effectiveness.
4. Creditors. Creditors are interested in the financial statement
to determine the company’s ability to pay.
5. Employees. Employees are interested in information to enable
then to assess the ability of the firm to provide remuneration
and other benefits.
6. Government. The government needs accounting information
to regulate the firm’s activities and determine the basis for
taxation policies.

Why study Accounting?

In order to appreciate and understand the financial reports of the

business, one should have an understanding of how the data are gathered
and recorded. All these understanding are gained in the study of
Accounting. Accounting could also be one’s profession – a work which
interesting and highly rewarding.

Definition of Accounting

The Committee on Terminology, American Institute of

Accountants defined Accounting as the art of recording, classifying and
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.

2
Role and purpose of Accounting

The role and purpose of accounting is to provide useful and timely

information about the financial activities of an individual, business, or
other organization. In addition, accounting provides information to other
stakeholders to use in assessing the economic performance and condition
of the business. Without realizing it, you may have participated in an
accounting transaction today.

Four Phases of Accounting

Based on the definition, Accounting has four phases namely, recording,

classifying, summarizing, and interpreting.

Recording. This is technically called bookkeeping. Some people

confuse bookkeeping and accounting as one and same. However,
bookkeeping is only part of Accounting – the record phase. In this phase,
transactions are recorded systematically and chronologically in the proper
accounting books. There are two kinds of bookkeeping: the single entry
bookkeeping and the double entry bookkeeping. The single entry
bookkeeping does not show the two-fold effects of business transactions.
It show only the debit or credit of each transaction. The double entry
bookkeeping however reflects the two-fold effects of business
transactions. It has a debit and credit.

Classifying. In this phase, items are sorted and grouped. Similar

items are classified under the same name. They may classified as asset
accounts, liability accounts, capital accounts, revenue accounts and
expense accounts. This classification is useful to the needs of the
management.

Summarizing. After each accounting period, data are recorded and

summarized through financial statements. These reports are submitted to
the management at the end of each accounting period or as the need
arises.

Interpreting. Usually, due to technicality of accounting reports, the

accountant’s interpretation on the financial statement is needed. In this
case, analysis reports are submitted together with the financial
statements.

Bookkeeping

A mechanical task involving the collection of basic financial data.

The bookkeeping procedures usually end when the basic data have been
entered in the books of account and the accuracy of each entry has been

3
tested. At that stage the accounting function takes over. Accounting
tends to be used as a generic term covering almost anything to do with
the collection and use of basic financial data. It should, however, be more
properly applied to the use to which the data are put once they have been
extracted from the books of account. Bookkeeping is a routine operating,
while accounting requires the ability to examine a problem using financial
and non – financial data.

Source: Arganda, A.M. Accounting Principles 1 Textbook/Workbook;

National Bookstore, 2007
FORMS OF BUSINESS ORGANIZATIONS
There are three major legal forms of business entity: the single
proprietorship, the partnership, and the corporation. While the accounting
process for all three types of business entity is generally the same,
differences in their structures and in the laws that apply to these
structures require some differences in the way certain aspect of their
financial affairs are recorded. These specific differences in accounting
procedures are presented in detail in advanced accounting subjects.
However, for now you should understand the basic differences in the three
types of business entities.
Single Proprietorship. The business organization has a single owner
called the proprietor who generally is also the manager. Single
proprietorship tend to be small service – type (e.g. physicians, lawyers
and accountants) businesses and retail establishments. The owner may
operate alone or may employ others.
The owner receives all profits, absorbs all losses and is solely responsible
for all debts of business. From the accounting viewpoint, the single
proprietorship is distinct from its proprietor. Thus, the accounting records
of the single proprietorship do not include the proprietor’s personal
financial records.
Partnership. A partnership is a business owned and operated by two or
more persons who bind themselves to contribute money, property or
industry to a common fund, with the intention of dividing the profits
among themselves. A partnership is a form of business in which two or
more people operate for the common goal of making profit. They may
receive different shares of the profits, depending on their investment or
contribution. Accounting considers the partnership as a separate
organization, distinct from the personal affairs of each partner.
Corporation. A corporation is a business owned by its stockholders. It is
an artificial being created by operation of law, having the rights of
succession and the powers, attributes and properties expressly authorized
by law or incident to its existence. The stockholders are not personally
liable for the corporation’s debts. The corporation is a separate legal
entity.

4
Source: Arganda, A.M. Accounting Principles 1 Textbook/Workbook;
National Bookstore, 2007

Types of Business Activities

The forms of business organization above are classified according to

the ownership structure of the business entity. Entities, however, can also
be group by the type of business activities they perform. Any of these
types of activities may be performed by a business organization be it a
sole or single proprietorship, a partnership or a corporation.

1. Service. Service businesses offer intangible goods or services and

typically generate a profit by charging for their labor. Income is
produced by the rendering of personal service. Service businesses
can include home repair, education, dentistry, accounting,
and plumbing businesses.

2. Merchandising/ Trading or Retailing. Retailers and distributors

act as middlemen in making goods produced by manufacturers
available to the intended consumer, generating a profit as a result
of providing sales or distribution services. Or these companies
purchase goods that are ready for sale and then sell these to
customers. Most consumer-oriented stores, including chain
stores, department stores, as well as mail-order businesses are
distributors or merchandising concern.

3. Manufacturing. Manufacturers produce products, from raw

materials or component parts, which they then sell at a profit.
Companies that make physical goods, such as cars, computers, or
clothing, are considered manufacturers or businesses engaged in
manufacturing.

Source: Arganda, A.M. Accounting Principles 1 Textbook/Workbook;

National Bookstore, 2007

The Account

The basic summary device of accounting is the account. A separate

account is maintained for each element that appears in the balance sheet
(assets, liabilities and equity) and in the income statement (income and
expenses). Thus, an account may be defined as a detailed record of the
increase, decrease and balance of each element that appears in an
entity’s financial statements. The simplest form of the account is known
as the “T” account because of its similarity to the letter “T”. The account
has three parts as shown below:
Account Title

Left side or Right side or

5
 Debit side Credit side

THE ACCOUNTING EQUATION

Financial statements tell us how a business is performing. They are
final products of the accounting process. But how do we arrive at the
items and amounts that make up the financial statements? The most
basic tool of accounting is the accounting equation. This equation
presents the resources controlled by the enterprise, the present
obligations of the enterprise and the residual interest in the assets. It
states that assets must always equal to liabilities and owner’s equity. The
basic accounting model is:
Assets = Liabilities + Owner’s Equity
Note that the assets are on the left side of the equation opposite
the liabilities and owner’s equity. This explains why increases and
decreases in assets are recorded in the opposite manner (“mirror image”)
as liabilities and owner’s equity are recorded. The equation also explains
why liabilities and owner’s equity follow the same rules of debit and
credit.
The logic of debiting and crediting is related to the accounting
equation. Transactions may require additions to both sides (left and right
sides), subtractions from both sides (left and right sides), or an addition
and subtraction on the same side (left and right side), but in all cases the
equality must be maintained.

DEBITS AND CREDIT – THE DOUBLE – ENTRY SYSTEM

Accounting is based on a double – entry system which means
that the dual effects of a business transaction are recorded. A debit side
entry must have a corresponding credit side entry. For every transaction,
there must be one or more accounts debited and one or more accounts
credited. Each transaction affects at least two accounts. The total debits
for a transaction must always equal the total credits.

An account is debited when an amount is entered on the left

side of the account and credited when an amount is entered on the right
side. The abbreviations for debit and credit are Dr. and Cr., respectively.

The account type determines how increases or decreases in it

are recorded. Increases in assets are recorded as debits (on the left side
of the account) while decreases in assets are recorded as credit (on the

6
right side). Conversely, increases in liabilities and owner’s equity are
recorded by credits and decreases are entered as debits.

The rules of debit and credit for income and expense accounts
are based on the relationship of these accounts to owner’s equity. Income
increases owner’s equity and expense decreases owner’s equity. Hence,
increases in income are recorded as credits and decreases as debits.
Increases in expenses are recorded as debits and decreases as credits.
These are the rules of debit and credit.

The following summarizes the rules:

Balance Sheet Accounts

Assets Liabilities and Owner’s equity

Debit Credit Debit Credit

(+) (-) (-) (+)
Increases Decreases Decreases Increases

Income Statement Accounts

Debit for Credit for

Decreases in owner’s equity Increases in owner’s equity
Expenses Income

Debit Credit Debit Credit

(+) (-) (-) (+)
Increases Decreases Decreases Increases

ACCOUNTING EVENTS AND TRANSACTIONS

An accounting event is an economic occurrence that causes
changes in an enterprise’s assets, liabilities, and or equity. Events may be
internal actions, such as the use of equipment for the production of goods
and services. It can also be an external event, such as the purchase of
raw materials from a supplier.
A transaction is a particular kind of event that involves the
transfer of something of value between two entities. Examples of

7
transactions include acquiring assets from owner (s), borrowing funds
from creditors, and purchasing or selling goods and services.

TYPES AND EFFECTS OF TRANSACTIONS

It will be beneficial in the long – term to be able to understand a
classification approach that emphasizes the effects of accounting events
rather than the recording procedures involved. This approach is quite
pioneering.
Although business entities engage in numerous transactions, all
transactions can be classified into one of four types, namely:
1. Source of Assets (SA). An asset account increases and a
corresponding claims (liabilities or owner’s equity) account
increases. Examples: (1) Purchase of supplies on account; (2) Sold
goods on cash on delivery basis.
2. Exchange of Assets (EA). One asset account increases and
another asset account decreases. Example; Acquired equipment for
cash.
3. Use of Assets (UA). An asset account decreases and a
corresponding claims (liabilities or equity) account decrease.
Example: (1) settled accounts payable; (2) paid salaries of
employees.
4. Exchange of Claims (EC). One claims (liabilities or owner’s
equity) account increases and another claims (liabilities or owner’s
equity) account decreases. Example: Received utilities bill but did
not pay.

Every accountable event has a dual but self – balancing effect

on the accounting equation. Recognizing these events will not in any
manner affect the equality of the basic accounting model.
The four types of transaction above may be further expanded into nine
types of effects as follows:
1. Increase in Assets = increase in liabilities (SA)
2. Increase in Assets = increase in owner’s equity (SA)
3. Increase in one Asset = decrease in another Asset (EA)
4. Decrease in Assets = decrease in liabilities (UA)
5. Decrease in Assets = decrease in owner’s equity (UA)
6. Increase in liabilities = decrease in owner’s equity (EC)
7. Increase in owner’s equity = decrease in liabilities (EC)
8. Increase in one liability = decrease in another liability (EC)
9. Increase in one Owner’s Equity = decrease in another Owner’s
Equity (EC)
TYPICAL ACCOUNT TITLE USED
BALANCE SHEET

8
ASSETS
Assets are should be classified only into two: current assets and non –
current assets. Per Philippine Accounting Standards (PAS) No. 1, assets
are classified as current assets when it:
a. Is expected to be realized in, or is held for sale or consumption in,
the normal course of the enterprise’s operating cycle; or
b. Is held primarily for trading purpose or for the short – term and
expected to be realized within twelve months of the balance sheet
date; or
c. Is cash or a cash equivalent asset which is not restricted in its use

All other assets should be classified as non – current assets. Operating

cycle is the time between the acquisition of materials entering into a
process and its realization in cash or an instrument that is readily
convertible to cash.

Current Assets
Cash. Cash is any medium of exchange that a bank will accept for
deposit at face value. It includes coins, currency, checks, money orders,
bank deposits and drafts.
Cash Equivalents. Per PAS No. 7, these are short – term, highly liquid
investments that are readily convertible to known amount of cash and
which are subject to an insignificant risk of changes in value.
Notes Receivable. A note receivable is a written pledge that the
customer will pay the business a fixed amount on a certain date.
Accounts Receivable. These are claims against customers arising from
sale of services or goods on credit. This type of receivable offers less
security than a promissory note.
Inventories. Per PAS No. 2, these are assets which are (a) held for sale
in the ordinary course of business; (b) in the process of production for
such sale; or (c) in the form of materials or supplies to be consumed in the
production process or in the rendering of services
Prepaid Expenses. These are expenses paid for by the business in
advance. It is an asset because the business avoids having to pay cash in
the future for a specific expense. These include insurance and rent.
These prepaid items represent future economic benefits – assets – until
the time these start to contribute to the earning process; these then,
become expenses.

Non – Current Assets

9
Property, Plant and Equipment. Per PAS No. 16, these are tangible
assets that are held by an enterprise for use in the production or supply of
goods or services, or for rental to others, or for administrative purposes
and which are expected to be used during more than one period.
Included are such items as land, building, machinery and equipment,
furniture and fixtures, motor vehicles and equipment.
Accumulated Depreciation. It is a contra account that contains the
sum of the periodic depreciation charges. The balance in this account is
deducted from the cost of the related asset – equipment or building – to
obtain book value.
Intangible Assets. Per PAS No. 38, these are identifiable, non-monetary
assets without physical substance held for use in the production or supply
of goods or services, for rental to others, or for administrative purposes.
These include goodwill, patents, copyrights, licenses, franchises,
trademarks, brand names, secret processes, subscription lists and non-
competition agreements.

LIABILITIES
Per PAS No. 1, a liability should be classified as a current liability when it:
a. Is expected to be settled in the normal course of the enterprise’s
operating cycle; or
b. Is due to be settled within twelve months of the balance sheet date.

All other liabilities should be classified as non – current liabilities

Current Liabilities
Accounts Payable. This amount represents the reverse relationship of
the accounts receivable. By accepting the goods or services, the buyer
agrees to pay for them in the near future.
Notes Payable. A note payable is like a note receivable but in a reverse
sense. In the case of a note payable, the business entity is the maker of
note; that is, the business entity is the party who promises to pay the
other party a specified amount of money on a specified future date.
Accrued liabilities. Amounts owed to others for unpaid expenses. This
account includes salaries payable, utilities payable, interest payable and
taxes payable.
Unearned Revenues. When the business entity receives payment
before providing its customers with goods or services, the amounts
received are recorded in the unearned revenue account (liability method).

10
When the goods or services are provided to the customer, the unearned
revenue is reduced and income is recognized.
Current Portion of Long – term Debt. These are portions of mortgage
notes, bonds and other long – term indebtedness which are to be paid
within one year from the balance sheet date.

Non – Current Liabilities

Mortgage Payable. This account records long – term debt of the
business entity for which the business entity has pledged certain assets as
security to the creditor. In the event that the debt payments are not
made, the creditor can foreclose or cause the mortgaged asset to be sold
to enable the entity to settle the claims.

Bonds Payable. Business organizations often obtain substantial sums of

money from lenders to finance the acquisition of equipment and other
needed assets. They obtain these funds by issuing bonds. The bonds is a
contract between the issuer and the lender specifying the terms of
repayment and the interest to be charged.

OWNER’S EQUITY
Capital. This account is used to record the original and additional
investments of the owner of the business entity. It is increased by the
amount of profit earned during the year or is decreased by a loss. Cash or
other assets that the owner may withdraw from the business ultimately
reduce it. This account title bears the name of the owner.

Withdrawals. When the owner of a business entity withdraws cash or

other assets, such as are recorded in the drawing account rather than
directly reducing the owner’s equity account.
Income Summary. It is temporary account used at the end of the
accounting period to close income and expenses. This account shows the
profit or loss for the period before closing to the capital account.

INCOME STATEMENT
INCOME
Service Income. Revenues earned by performing services for a
customer or client; for example, accounting services by a CPA firm,
laundry services by a laundry shop.

11
Sales. Revenues earned as a result of sale of merchandise; for example,
sale of building materials by a construction supplies firm.

EXPENSES
Cost of sales. The cost incurred to purchase or to produce the product
sold to customers during the period; also called cost of goods sold.
Salaries and Wages Expense. Includes all payments as a result of an
employer – employee relationship such as salaries or wages, 13 th month
pay, cost of living allowances and other related benefits.
Telecommunications, Electricity, Fuel and Water Expenses.
Expenses related to use of telecommunications facilities, consumption of
electricity, fuel and water.
Rent Expense. Expense for space, equipment or other asset rentals.
Supplies expense. Expense of using supplies (e.g. office supplies) in the
conduct of daily business.
Insurance Expense. Portion of premiums paid on insurance coverage
(e.g. on motor vehicle, health, life, fire, typhoon or flood) which has
expired.
Depreciation Expense. The portion of the cost of a tangible asset (e.g.
buildings and equipment) allocated or charged as expense during an
accounting period.
Uncollectible Accounts Expense. The amount of receivables
estimated to be doubtful of collection and charged as expense during an
accounting period.
Interest Expense. An expense related to use of borrowed funds.

Preparation of the chart of accounts:

Sure Repair Shop

Chart of Accounts

Account No. Account Title

111 Cash
112 Account Receivable-R. Gil
113 Account Receivable- M. Soriano

12
 114 Repair Tools
115 Repair Supplies
116 Furniture’s and Fixtures
117 Service Truck
211 Accounts Payable- Cruz Furniture
212 Notes Payable
311 G. Alajar, Capital
312 G. Alajar, Personal
411 Service Income
511 Advertising Expense
512 Salaries and Wages
513 Utilities Expense
514 Rent Expense

Chart of Accounts – these are the listing of the account title use by a
particular entity in the course of their business operation.

Account No. – The Number assigned for each account for easy reference.
The business entity may assign their Account No. based on the company
practices. Account titles are listed based on their normal or kinds of
business operation.

Financial Statements

Financial statements are the means by which the information

accumulated and processed in financial accounting is periodically
communicated to the users of the financial information.

COMPLETE SET OF FINANCIAL STATEMENTS

INCOME STATEMENT
A formal statement showing the performance of the enterprise for
a given period of time. Summarizes the revenues earned and expenses
incurred for that period of time
Proforma Income Statement:

SURE REPAIR SHOP

Income Statement
For the month ended December 31,2014

13
Service Income xx
x
Less: Advertising x
x
Salaries and Wages x
x
Utilities Expense x
x
Rent Expense x
x
Repair Supplies Used x
x
Depreciation-Repair Tools x
x
Depreciation- Furniture and Fixtures x
x
Depreciation-Service Truck x
x
Interest Expense x xx
Px
Net Profit x

Statement of Changes in Owner’s Equity

- summarizes the changes that occurred in owner’s equity. This
statement is now a required statement (per Philippine Accounting
Standards (PAS) No. 1)

Proforma Statement of Changes in Equity

SURE REPAIR SHOP

Statement of Changes in Owner's Equity
For the month ended December 31,2014

G. Alajar, Capital xx
x
Add: Additional Investment x
x
Net Profit x xx
Total xx
(xx
Less: Personal )
Px
G. Alajar, Capital as of 12/31/2014 x

14
Balance Sheet is a statement that shows the financial position or
condition of an entity by listing the assets, liabilities and owner’s equity as
at specific dates.

Proforma Balance Sheet

SURE REPAIR SHOP
Balance Sheet
As of December 31, 2014

Asset
Current:
x
Cash x
x
Accounts Receivable x
x
Repair Supplies x
x
Prepaid Advertising x
x
Total Current Assets x

Non-Current:
x
Repair Tools x
x x
Less: Accumulated Depreciation x x
x
Furniture’s and Fixtures x
x x
Less: Accumulated Depreciation x x
x
Service Truck x
x x
Less: Accumulated Depreciation x x
x
Total Non-Current Assets x
x
Total Assets x

Liabilities
x
Notes Payable x
x
Accrued Interest Payable x
Accrued Salaries and Wages x

15
 x
x
Accrued Rent Expense x
x
Unearned Service Income x
x
Total Liabilities x

Owner's Equity
x
G. Alajar, Capital x
x
Less: G. Alajar, Personal x
x
Net Capital x
x x
Add: Net Profit x x
x
Total Liabilities and Owner's Equity x

Statement of Cash Flows

Provides information about the cash receipts and cash payments
of an entity during a period. This statement shows the net increase or
decrease in cash during the period and the cash balance during the
period.

Proforma Statement of Cash Flows

SURE REPAIR SHOP
Statement of Cash Flows
For the month ended December 31,2014

Cash Inflows
Cash from Cash Sales xx
Collections of Receivables xx
Cash from Bank Loans xx
Total Cash Inflows xx

Cash Outflows
Payment of Liabilities xx
Purchases xx
Payment of Expenses xx
(xx
Total Cash Outflows )
Net Cash Inflows/Cash Outflows xx
Add: Cash Balance Beginning xx

16
 Px
Cash Balance as of 12/31/2015 x

Debit and Credit

The T-Account

Business transactions cause increases and decreases in the accounting

values. To record these changes; a business firm make use of accounts. An
accounts is an accounting device use to summarize the increases and decreases
in the assets, liabilities, and owner’s equity of the business.

A simple form of accounts look like a big letter “T”, thus it is called a “T-
account”. It has a left side and a right side. It appears as follows:

Name of the firm

Left side right side

The left side of a T-account is the debit (abbreviated Dr.) side and the
right side is a credit (abbreviated Cr.) side.

“To debit” is to enter the amount on the left side of a T-account

and “to credit” is to enter on the right side of a T-account. The amount entered
in the left side of a T-account are “debits” and those on the right side are
“credits”.

“To debit” and “to credit”, however, should not be confused with “to
increase” and “to decrease”. To debit and to credit may mean either a decrease
or an increase depending on the accounts affected. Thus, the rule of debit and
credit is as follows:

Debit to: Credit to:

1. Increase asset 1. Decrease asset

2. Decrease Liabilities 2. Increase Liabilities
3. Decrease in owners’ equity due to: 3. Increase in owners’ equity
due to:
a. Withdrawal of assets by the owner a. investment by the owner
b. Increase in expenses and losses b. decrease in expenses and
losses
c. Decrease in income c. increase in income

17
Illustrations:

Transaction 1

Nov.1 – M. Rogers opened a catering service he called “McRogers”. He invested

P32,000 cash and equipment, P85,000.

Debit Credit

Cash P32,000 M. Capital P117,000

Equipment 85,000

Analysis:

1. The assets and the equity are affected.

2. The owner put in the business cash and equipment, thus increasing
the assets and increasing the equity.
Transaction 2

Nov.3 – He purchased kitchen utensils, tools and additional equipment from Kent
Trading on credit, P20,000.

Debit Credit

Tools and equipment P20,000 Accounts Payable -

P20,000

Kent Trading

Analysis:

1. The assets and liabilities are affected

2. Assets, tools, and equipment, are bought by the owner on credit
basis, thus increasing the assets and liabilities of the business.

Transaction 3

Nov. 7 – Paid for advertisement announcing the opening of his business, P1,500.

Debit Credit

18
Advertising expense P1,500 Cash P1,500

Analysis:

1. The asset and equity are affected.

2. The equity is decreased due to the advertising expense incurred and
the asset, cash, is decreased for payment of the said expense.

Transaction 4

Nov. 9 – Paid one-half of the account due to Kent trading.

Debit Credit

Accounts payable P10,000 Cash P10,000

Analysis:

1. Assets and liabilities are affected.

2. There is a decrease in liability due to the partial payment of the
account to Kent Trading and also a decrease in asset, cash, for the
amount paid for this liability.
Transaction 5

Nov. 11 – Rendered a catering service to N. San Juan for his son’s wedding and
received cash P52,000.

Debit Credit

Cash P52,000 Service Income P52,000

Analysis:

1. The assets and equity are affected.

19
 2. Cash is received from customer, thus increasing the asset of the
business and the proprietorship is increased due to the revenue
derived from rendering of services.
Transaction 6

Nov. 13 – Paid for the food supplies used in San Juan’s wedding party, P25,000.

Debit Credit

Food Supplies P25,000 Cash P25,000

Analysis:

1. The asset and the equity are affected.

2. The equity is decreased due to the cost of food supplies and the
asset, cash is also decreased for payment of the supplies.
Transaction 7

Nov. 17 – billed J. Estrada, P25,000 for catering service rendered in his birthday
party.

Debit Credit

Accounts Receivable - P25,000 Service Income

P25,000

Estrada

Analysis:

1. The asset and equity are affected.

2. Equity is increased due to the revenue from services rendered and
asset is increased for the claims from the customer for this service.

Transaction 8

Nov. 20 – Paid the salary of the assistant cook, P5,000.

Debit Credit

Salary P5,000 Cash P5,000

20
Analysis:

1. The asset and equity are affected.

2. The equity is decreased due to the salary expense incurred by the
business and the assets, cash, is decreased for payment of such
expense.

Transaction 9

Nov. 22 – Received from J. Estrada the amount of P10,000 as partial payment of

the account due from him.

Debit Credit

Cash P10,000 Accounts Receivable

P10,000

Analysis:

1. Only assets are affected. Liabilities and equity are not affected.
2. Cash is received from a customer to apply to his account, thus
increasing the assets, cash, and decreasing the receivable from the
said customer.

Transaction 10

Nov. 25 – Withdrew P5,000 for his personal use.

Debit Credit

M. Rogers, Personal P5,000 Cash P5,000

Analysis:

1. The asset and equity are affected.

2. The equity is decreased due to the drawings made by the owner.
The asset, cash, is decreased for such drawing made.

21
JOURNALIZING

Chart of Accounts

A chart of accounts is a list of account titles used by business. It serves as a

guide to the bookkeeper. Such accounts are divided into sections and each title
has a given code number.

Illustration:

ABC Trading
Chart of Accounts

Assets Cost

111 Cash on Hand 511 Purchases

511 Purchase Return and
112 Cash in Bank a Allowances
511
113 Notes Receivable b Purchase Discounts
114 Interest Receivable 412 Freight In
115 Accounts Receivable
115
a Allowance for Bad Dedts Expenses
116 Merchandise Inventory
117 Supplies Unused 611 Salary Expense
118 Prepaid Insurance 611 Supply Expense
119 Furnitures and Fixtures 611 Rent Expense
119
a Accumulated Depreciation- 611 Advertising Expense
Furnitures and Fixtures 611 Freight Out
120 Equipment 611 Bad Debts
120
a Accumulated Depreciation- 611 Depreciation
Equipment 611 Light, Water, And Telephone
121 Land 611 Taxes and Licenses
122 Building 611 Miscellaneous Expense
122
a Accumulated Depreciation-
Building Other Income

Liabilities 711 Interest Income

712 Commission Income
211 Notes Payable
212 Accounts Payable Other Expenses

22
213 Interest Payable 811 Interest Expense
214 Taxes Payable
215 Salaries Payable

Capital

311 Virgil, Capital

312 Virgil, Drawing
Revenue and Expense
313 Summary

Income

411 Sales
411
a Sales Return and Allowances
411
b Sales Discounts

Assets, Liability, and capita accounts are also called real accounts, balance sheet
accounts, or permanent accounts. Income and expense accounts are sometimes
called nominal accounts, profit and loss accounts, or temporary accounts.

Accounting Period and Accounting Cycle

Accounting period or fiscal period is each segment of time, usually a year, in

which statements are prepared in order to know the results of the business
operation during that particular period of time. The length of each accounting
period depends on the nature of the business. An accounting period may be
annual, semi-annual, quarterly, or monthly. Usually, most firms use such period
of time when the business is slow as the end of their accounting period and the
beginning of the next period.

Accounting cycle consists of successive steps starting with the recording of

transactions in the books of accounts and ending with post-closing trial balance.
The following successive steps consist one accounting cycle which will be
discussed in the subsequent chapters.

1. Journalizing
2. Posting
3. Preparation of Trial Balance
4. Adjusting Entries
5. Preparation of the worksheet
6. Preparation of the financial statements
7. Closing the Entries
8. Post-Closing Trial Balance
Journalizing

23
Journalizing is the first step in the accounting cycle. It is the process of recording
business transactions in a journal.

A journal is a book of accounts wherein business transactions are recorded for

the first time. It is also called the book of original entry. There are two kinds of
journal – the general journal and the special journals. Cash receipts journals,
cash payments journals, sales journals, purchase journals, and some other forms
of combination journals are special journals. The type of journal to be used
depends on the size and need of the business. In our lesson, we will only be
using general journal.

General journal is the simplest form of journal wherein the two-column form may
be used.

Illustration:

General Journal
Account Titles and
Date Explanation F Debit Credit

A general journal contains the following columns:

Date – the date of the transaction is entered in this column; transactions are
recorded ia a systematic manner and in chronological order.

Account Titles and Explanation – this column contains the debit and credit
accounts and a brief explanation of the entries

Folio – this contains the post reference number or the ledger page in which the
accounts are transferred.

Debit – contains the amounts debited.

Credit – contains the amounts credited

Procedures in Journalizing

A. Under the date column

1. The year is written in small figures at the top of the first
column.

24
 2. The month of the transaction is written on the first line of the
column. The year and the month are not repeated except at
the top of a new page or when there is a change in the month.
3. The day of each transaction is written in the right sub-column
of the date column. The date of the transaction occurring on
the same day is repeated.
B. Under the account titles and explanation
1. The name of the account debited is written first at the left
margin of the account titles and explanation column
2. The name of the account credited is written on the following
line, indented about one-half inch from the left margin.
3. The explanation is placed on the next line, indented about one
inch from the left margin. The explanation should be short but
sufficient enough to explain the entry.

C. Under the debit column

1. The debit amount is written on the debit column opposite the
debit account
D. Under the credit column
1. The credit amount is written on the credit column opposite the
credit account.
E. Under the folio column
1. The folio or reference column is used to indicate the page
number of the ledger in which the entry is transferred. There
is no entry yet in the folio column when transactions are
recorded in the general journal. However, when the entries
are copied from the journal to the ledger, the account number
of the ledger accounts in which the debits and credits are
copied are entered in the folio column.
2. A single-space should be left blank after each entry.
A journal entry is a record of business transaction in the journal. There are two
types of journal entry: Simple journal entry which contains only one debit and
one credit accounts, and the compound journal entry which contains either one
debit and two or more credits; or two or more debits and one credit; or two or
more debits and two or more credits.

Illustration:

Transaction

On January 1 of the current year, Mr. P. Rodriguez opened a tailoring shop which
he named “PR Tailoring’. He invested cash, P25,000 and sewing equipment,
P100,000 in the business.

Simple Journal

Date Account Titles and Explanation F Debit Credit

25
201 1 Cash 25,000
5
P. Rodriguez, Capital 25,000
Jan
To record the initial investment of P.
Rodriguez

1 100,000
Sewing Equipment
100,000
P. Rodriguez, Capital

To record the initial investment of P.

Rodriguez

Compound Journal Entry

Date Account Titles and Explanation F Debit Credit

201 1 Cash 25,000

5
Sewing Equipment 100,000
Jan
P. Rodriguez, Capital 125,000

To record the initial investment of P.

Rodriguez

Need for Journal

1. To provide in one place a complete record of each transaction. Such

will link together the debits and credits of the transactions.
2. The records make it possible to trace the debits and credits of the
accounts when errors are committed
Bookkeeping Techniques

When recording transactions in the journal or ledger, commas and periods are no
longer written because the ruled lines in the forms accomplished this purpose.
Each column in the journal and ledger represents a digits.

However, when reports are prepared in unruled paper, commas and periods are
necessary.

26
Dash instead of zeros may be used in writing centavos because it is easier to
write than two zeros. This, however, is optional on the part of the bookkeeper.
When preparing reports, however, two zeros are preferred because they are
neater in appearance.

POSTING AND TRIAL BALANCE

Posting

Posting is the process of transferring the records from the journal to the
ledger. A ledger constitutes a group of accounts. It is also called the book
of final entry. The simpler form of a ledger is the “T-account”.

Illustration:

General Ledger

Name of the item Account No.

Date Explanation F Debit Dat Explanation F Credit

e

The illustration shown above is the most commonly used form of a ledger.
The two vertical lines in the middle divide the left side or the debit side
and right side or the credit side of the form. Each side has column for
date, explanation, cross-reference number or folio, and amounts.

Need for a ledger

1. Items of similar nature are grouped together.

2. It is easier to locate the item if an information about it is needed.
Procedure of posting

1. Locate the corresponding account title in the ledger.

2. Transfer to the ledger the following information from the journal
a. Date
b. Explanation

27
 c. Amount
Debit accounts from the journal are posted on the debit side of the ledger
and credit accounts are posted on the credit side of the ledger.

3. Place the page number of the journal in which the information was
taken to the folio column of the ledger.
4. Place in the folio column of the journal of the page number of the
ledger in which the information was posted.
Inserting the account number in the journal folio column serves two
purposes:

a. It serves as a cross-reference when it is desired to trace the amount

from one record to another.
b. Writing the account number in the journal indicates that posting is
completed.
Footing the accounts

Before the preparation of trial balance, the accounts should be footed

first. The following procedure is followed:

1. Foot or add the debit side of the account using pencil.

2. Foot or add the credit side of the account using pencil.
3. Take the difference between the totals of the debits and credits. If
the debit total is more than the credit total, the difference is placed
on the explanation column of the debit side. If the difference is a
credit, the amount is written on the explanation column of the credit
side.
Trial Balance

A trial balance is a list of account with open balances in the general

ledger. It proves the equality of the debits and the credits in the general
ledger.

There are two types of trial balance: the trial balance of balances and the
trial balance of totals. The trial balance of balances contains accounts with
open balances. Accounts with open balances either have a debit balance
or credit balance. An account is said to have a debit balance if the debit
total is more than the credit total and is said to have a credit balance if
the credit total is more than the debit total. If the debit side and credit
side are equal, the account is a zero balance or closed account.

The other form of trial balance is the trial balance of totals. In this form,
the total of the debits and the total of the credits of each accounts are
listed.

28
Procedure in trial balance preparation

1. Write the heading of the trial balance. The heading of the trial
balance includes the following:
a. The name of the business or the owner
b. Title of the list of trial balance
c. Date of the trial balance
2. Provide a column for the accounts and two money columns-----a
debit and a credit.
3. The accounts should be written in just one column arranged in the
following sequence;
a. Assets
b. Liabilities
c. Capital
d. Income
e. Expenses
4. Write the amounts opposite the corresponding accounts under the
debit money column if the account is a debit balance and under the
credit money column if the account is a credit balance.
5. Foot the money columns. Double rule the totals.
Errors in Trial Balance

If the total of the debit and credit sides of a trial balance are not equal, an
existence of error or more is possible. The causes of errors are the
following:

1. Posting an item twice.

2. Posting to the wrong side of the account
3. Omission of posting
4. Wrong footing of the ledger
5. Wrong transferring of account from the ledger t the trial balance.
The following procedure may be followed to locate errors:

1. Re-add the debits and credits of the trial balance.

2. Get the difference between the two totals.
a. If the difference is a digit of one, i.e., P10, P100, P1,000, etc.
the error may be in the addition or subtraction. Check the
footings of the debit and credit in that case. If the error is not
located, the posting in the ledger should be verified.
b. If the difference is an even number, divide the number by 2.
The quotient arrived at may be omitted in the trial balance or
an account may be erroneously transferred on the wrong side
of the trial balance. For this type of trial balance, scan the
posting in the general ledger. If the amount is found, verify if
the posting is correct or not.

29
 c. If the difference is multiple by 9, the error may be due to
transposition, that is, the order of the figure is reversed. Such
as 57 is written 75, or 119 as 191.
d. If the difference is divisible by 9, this indicates misplacements.
For example P100 is written as P10 or P2,500 as P250.
Correction of Errors

Erasures in the records are not advisable because they destroy the
neatness of work. Instead the following ways may be applied to correct
errors committed:

1. Using correcting journal entries; or

Drawing a single straight line through the wrong item or amount and
writing immediately above the cancelled item or amount the correct one.

Adjusting Entries, Adjusted Trial Balance, Preparation of Worksheet

Introduction

Accounting period is any length of time which the life of the business is
divided. Such time may either be a monthly period, quarterly period, or a year.

At the end of each accounting period, financial reports are prepared to

show the results of the business operations. Such reports which always include
the income statement and balance sheet should reflect the revenues realized
and expenses incurred, and a fairly measure of the assets, liabilities, and owner’s
equity.

Normally, at the end of each accounting period, there are several accounts
that need to be adjusted.

Need for adjustment

1. To reflect the proper amounts revenues realized and expenses

incurred during a period.
2. To show a fair a fairly measure of the assets, liabilities, and owner’s
equity.
Accounts that need to be adjusted

1. Adjustment for the expiration of prepayments of expenses.

2. Adjustment for the realization of income collected in advance.
3. Adjustment for the accrual of expenses.
4. Adjustment for the accrual of income.
5. Provision for bad debts.
6. Provision for depreciation.
Adjustment for the Expiration of Prepayments of Expenses

30
 Prepaid expenses are expenses paid in advance. At the time of payment,
the account is an asset and as it is used it becomes an expense. The adjusting
entry for this account depends on the original entries made when it was paid.

There are two methods to be used:

1. Asset Method. Under this method, the original entry made is

charged to an asset.
Example:

On November 1 of the current year, C Santos paid ₱30,000 for a three-

month rental of the office space.

Original Entry Adjusting Entry

Nov. 1 Prepaid Rent Dec. 31 Rent Expense

₱30,000 ₱20,000

Cash Prepaid Rent

₱30,000 ₱20,000

Prapid Rent Rent Expense

Nov.1 ₱30,000 Dec. 31 ₱20,000 Dec. 31 ₱20,000

Analysis

The ₱30,000 which was paid in November 1 is for a three-month rental of

the space i.e., for November, December, and January. As of December 31, the
end of the accounting period, only ₱20,000 or rental for two months have been
incurred, so that portion is an expense and the remaining ₱10,000 is still prepaid
until January 31 of the following accounting period.

2. Expense Method. Under this method, expense account is charged

when payment is made. Using the same example, the following are
the entries made:

Original Entry Adjusting Entry

Nov. 1 Rent Expense Dec. 31 Prepaid Rent ₱10,000

₱30,000

Cash Rent Expense

₱30,000 ₱10,000

31
 Rent Expense Prepaid Rent
Nov.1 ₱30,000 Dec. 31 ₱10,000 Dec. 31 ₱10,000

Analysis:

The rental payment of ₱30,000 is paid for the months of November,

December, and January. As of December 31, only ₱20,000 or for two months
rental have been incurred. The remaining ₱10,000 is still prepaid until January 31
of the next accounting period.

Adjustment for the realization of Income Collected in Advance or

Unearned Income

Unearned income arises when payment is received before goods are

delivered or before services are rendered.

There are two methods to be used: The income method and the liability
method.

Again, the method to be used depends on the original entries made.

1. Income Method. Under this method, income account is credited

when cash is received.

Example:

On November 1 of the current year, the business received ₱30,000 cash

from the tenant of the vacant space of the store.

Original Entry Adjusting Entry

Nov. 1 Cash ₱30,000 Dec. 31 Rent Income ₱10,000

Rent Income Unearned Rent

₱30,000 ₱10,000

Rent Income Unearned Rent

Dec.31 ₱10,000 Nov. 1 ₱30,000 Dec. 31 ₱10,000

Analysis:

32
 The business received from a tenant a ₱30,000 cash advance rentals for
the months of November, December, and January. As of December 31, only two
months rental or ₱20,000 are already earned. The remaining ₱10,000 is still
unearned until January 31 of the following accounting period.

2. Liability Method. Under this method, a liability account is credited

upon receipt of cash.
Original Entry Adjusting Entry

Nov. 1 Cash ₱30,000 Dec. 31 Unearned Rent

₱20,000

Unearned Rent Rent Income

₱30,000 ₱20,000

Unearned Rent Rent Income

Dec.31 ₱20,000 Nov. 1 ₱30,000 Dec. 31 ₱20,000

Analysis:

As of December 31, the two-month rentals or ₱20,000 are already earned.

Only ₱10,000 or the rental for the month of January is still unearned.

Accrual of Expenses

Accrued expenses are those expenses already incurred during the period
but are not yet paid or recorded.

At the end of the accounting period, the income statement should reflect
such expense and the balance sheet should reflect a liability account. The
adjusting entry to record accrual of expenses is debit the expense account and
credit the liability account.

Example:

Office employees are prepaid every two weeks. On December 31, five
days’ salaries of an office employee for ₱300 per day have accrued.

Adjusting Entry:

Date Account Titles and Explanation F Debit Credit

33
Dec.3 Salaries ₱1,500
1

Accrued Salaries ₱1,50

0

To record five-day accrued salaries of an

employee for

₱20/day.

Accrual of Income

Accrued income arises when goods have been delivered or services have
been rendered but no amount of payment have been collected or if there is
payment, such collection is not yet recorded.

In order to avoid understatement of income and asset, an adjusting entry

is needed at the end of the period.

The entry to adjust accrual of income is to debit the assets account and
credit the income account.

Example:

A tenant who occupies the right side of the shop space, is two months in
debts as of the balance sheet date. His monthly rental is ₱2,500 per month.

Adjusting Entry:

Date Account Titles and Explanation F Debit Credit

Dec.3 Accrued Rent Income ₱5,000

1

Rent Income ₱5,00

0

Provision for Bad Debts

Usually most business firms extend credits to attract more customers and
sell more goods. However, not all credits extended are good or collectible. For a
reason or another, a certain percentage of these collectibles are not collected.
For this reason, the business should provide for such losses for non-collection of
credits. This loss from uncollectible accounts is called bad debts. Bad debts is a
nominal account which must be shown in the income statement at the end of the
accounting period.

The entry to adjust bad debts is as follows:

Date Account Titles and Explanation F Debit Credit

34
Dec.3 Bad Debts ₱xxx
1

Allowance for bad debts ₱xxx

Bad debts or loss for bad debts is debited to show a decrease in

proprietorship account due to estimated loss.

Estimated Uncollectible Accounts or Allowance for bad debts which is a

valuation account is credited because it is a deduction from an asset account,
Account Receivable. In the balance sheet presentation, Estimated Uncollectible
Account is deducted from Accounts Receivable to show the net book value or the
net realizable value of the accounts receivable.

Illustration:

Accounts Receivable ₱xxx

Less: Allowance for bad debts ₱xxx

Net Realizable Value ₱xxx

There are several methods of estimating the probable losses from bad debts.

1. Increasing the accumulated allowance for bad debts by a certain

percentage of the accounts receivable.
2. Increasing the accumulated allowance for bad debts to a certain
percentage of accounts receivable.
Illustration:

Debit Credit

Accounts Receivable ₱7,000

Allowance for Bad Debts ₱500

1. Increasing the allowance for bad debts by a certain percentage of the

accounts receivable.
What is the adjusting entry to increase the allowance for bad debts by
10% of accounts receivable?

Computation:

Bad debts estimate = ₱7,000 x.10 = ₱700

35
Adjusting Entry:

Debit Credit

Bad Debts ₱700

Allowance for Bad Debts ₱700

To record increase of allowance

for bad

debts by 10% of accounts

receivable

Balance Sheet presentation:

Accounts Receivable ₱7,000

Less: Allowance for bad debts ₱1,200

Net Realizable Value ₱5,800

2. Increasing the allowance for bad debts to a certain percentage of

accounts receivable.
Using the same information in the pre-adjusted trial balance, what is
the adjusting entry to increase the allowance for bad debts to 10% of
the accounts receivable?

Computation:
Bad debt estimate = ₱7,000 x .10 = ₱700
₱700 – 500 = ₱200

Adjusting Entry:

Debit Credit

Bad Debts ₱200

Allowance for Bad Debts ₱200

To record increase of allowance

for bad

debts by 10% of accounts

receivable

Balance Sheet presentation:

36
 Accounts Receivable ₱7,000

Less: Allowance for bad debts ₱700

Net Realizable Value ₱6,300

Provision for Depreciation

Assets which are relatively permanent in nature are fixed assets. They are
used by the business in its operation and are not intended for sale. The value of
these assets, except land decrease as times passes by due to the following
reasons:

1. Wear and tear from operation

2. Inadequacy and obsolescence

An asset is said to be inadequate for the business if there is business

expansion and the asset can no longer fulfill the needs of the business.

It is said to be obsolete in the introduction of new models or inventions and

the business desires to replace the old asset with the new one.

The cost of the fixed asset is allocated to the number of its useful life.
Depreciation is the portion of the cost of the asset which is already used or
consumed.

The following formula is used to compute for depreciation:

C – SV
D=
n

Where: D = is the depreciation

C = is the original cost which includes the invoice price less discount plus
other costs incurred

before the use of the asset such as freight and installation.

S = is the salvage or scrap value. This is the amount wherein the asset
can be sold after its

useful life.

n = is the number of estimated useful life

Example:

A delivery truck was purchased for ₱250,000. It is estimated to last 10

years after which it shall have a value of ₱50,000. Compute for the depreciation.

37
 C – SV
D=
n

= ₱250,000 - ₱50,000

10 years

= ₱20,000/year

Adjusting Entry:

Debit Credit

Depreciation, delivery truck ₱20,000

Accumulated Depreciation, delivery ₱20,00

truck 0

Depreciation is an expense account. Accumulated depreciation is a contra

asset account. A contra asset account is an account the balance of which is
deducted from a related asset to show the proper amount of such asset. The
asset account is not credited to preserve the historical cost of the asset. Instead,
a contra asset account is credited because depreciation is merely an estimate
and to preserve the original cost of the asset.

Depreciation for a Fractional Period

If the purchase date of the asset does not coincide with the beginning of
the accounting period, such asset should be depreciated on a fraction of a
period. Suppose the accounting starts at January 1 and ends on December 31.
On May 1 of the current year, some pieces of furniture were purchased for
₱4,800. The asset is estimated to have 10 years of useful life. To compute for the
depreciation on December 31 is:

C – SV
D=
n
= ₱4,800 – 0

10 years

= ₱480/year

The annual depreciation of the furniture is ₱480. To compute for the

depreciation from May 1 to December 31, divide ₱480 by 12months to get the

38
monthly depreciation. Then multiply the monthly depreciation by 8 months, i.e.,
from May to December.

₱480 / 12 mos = ₱40/mo.

₱40 x 8 mos = ₱320

Adjusting Entry on the year of purchase:

Date Account Titles and Explanation F Debit Credit

Dec.3 Depreciation, Furniture ₱320

1

Accumulated Depreciation, Furniture ₱320

In the following years the depreciation of the asset will be on a one whole
year that is ₱480/year.

Posting the Adjusting Entries

After the adjusting entries have been recorded in the general journal, they
should be posted to the ledger to adjust the accounts. After accounts have been
posted, an adjusted trial balance should be prepared to prove the accuracy of
the posting to the ledger.

The Worksheet

A worksheet is prepared to facilitate the preparation of adjusting entries,

financial statements, and closing entries. It is prepared before the construction of
financial statements and before the adjusting entries are entered in the journal
and posted.

The following steps are taken in preparing a worksheet:

1. Write the heading of the worksheet at the top of the paper with the
following information
Name of the business

Worksheet

For the Period of __________,20__

2. Provide the following column in the worksheet:

Adjusted
Trial Adjustmen Income Balance
Trial
Balance ts Statement Sheet
Balance

39
Account Deb Cred Deb Cred Deb Cred Deb Credi
Title it it it it it it Debit Credit it t

3. Copy the trial balance on the first two money columns.

4. Enter in the adjustments columns the adjusting entries. Before each
corresponding debit and credit amounts, write in parenthesis the
same index number or letter. Those accounts which are not found in
the trial balance should be written below the pre-adjusted trial
balance.
5. Total the adjustment columns.
6. The adjusted trail balance columns is the total of the pre-adjusted
trial balance and the adjustment columns. If the amount are both
debit, add. Then extend the amount to the debit column. Same
procedure will be followed if the amounts are both credits, only it
will be extended to the credit column. If the amount is on debit and
one credit, subtract the smaller amount from the bigger amount,
then extend on the column of the bigger amount.
7. Add the adjusted trial balance columns to prove the equality of the
debits and credits.
8. The adjusted trial balances are extended to the balance sheet at
income statement columns. Assets, liabilities, and capital to the
balance sheet columns and income and expense to the income
statement columns. Add these last four columns. Get the difference
of the debit and credit sides of the income statement and the
difference of the debit and credit sides of the balance sheet. The
difference of both should be equal, otherwise, an error or errors are
committed.
If the credit total of the income statement is more than the debit total, the
difference is a net income. If the debit side is more than credit side, the
difference is a net loss. Write the difference below the smaller sides.

9. Write in the column for account titles “Net Income” if the difference
is a net income or “Net Loss” if the difference is net loss.
10. Write the final total and double rule.

40
 SURE REPAIR SHOP
Trial Balance
December 31, 2014

Accounts Debit Credit

Cash 900
Accounts Receivable-M. Soraino 1,200
Repair Supplies 1,500
Repair Tools 1,200
Furniture and Fixtures 6,500
Service Truck 20,000
Notes Payable 3,250
G. Alajar, Capital 25,200
G. Alajar, Personal 750
Service Income 5,900
Advertising 250
Salaries and Wages 900
Utility Expense 150
Rent Expense 1,000
Total 34,350 34,350

On December 31, the end of the accounting period, the following data were
taken.

1. An actual count of repair supplies showed a balance of ₱850.

________
2. Repair tools are depreciated at 10% per annum. ________
3. Furniture and fixture are estimated to have a useful life of 5 years
while service truck has a useful life of 10 year. Both assets were
bought on September of the current year. ________
4. A 10% interest has accrued on the payable. _________
5. Of the income received. ₱900 is applicable to the next accounting
period.
6. Accrual of expenses: Salaries and wages ₱250; Rent ₱500 __________
7. The balance of the advertising expense account represents payment
for five months. Paid on September 1 of the current year.
________________.
Financial Statements are report prepared by businesses. Business
owners keep records of expenses and income and the overall status of
their businesses. They do this for a number of reasons, to name a few:

41
 1. To help them manage a business
2. To inform other owners of current operations
3. To provide required information to lenders from whom they
wish to borrow money
4. For tax purposes
Two most commonly prepared financial statements are:

1. The Income Statement

2. The Balance Sheet
1. The Income Statement
The Income Statement provides a financial summary of the firm’s
operating results during a specific period. Most common are
statements covering one-year period of operations, ordinarily
December 31.

Usually, an income statement has the following items:

a. Sales Revenue – the total peso amount of sales during the
period
b. Sales Return and Allowances – goods returned by the buyers
are called sales return while reduction in selling price are sales
allowances
c. Cost of goods sold – the amount paid by the business for the
items sold to customers
d. Gross profits – profits earned from producing and selling the
goods
e. Operating expenses – amount paid by the firm in selling its
goods
f. Net income – income after taxes

Note: Be sure to check the results of your income statement by adding

the cost of goods sold, expenses, net income, and income taxes. They
should be equal to net sales

2. The Balance Sheet

The Balance Sheet describes the financial condition of a firm at one
point in time. It shows the worth of a business at a particular time by
listing its assets, liabilities, and owner’s equity.

Assets:

Current Assets:----cash or items that can be converted into cash within a

short period of time

42
 Cash – in checking and savings accounts

Accounts Receivable – funds owed by customers of the firm

Notes Receivable – value of all notes owed to the firm

Inventory – cost of merchandise that the firm has for sale

Fixed Assets------assets that are expected to be used for more than

a year

Land – book value of any land owned by the firm

Buildings – book value of any building

Equipment – book value of any equipment

Furniture & Fixture – book value of any fixture, furniture owned

Liabilities:

Current Liabilities----items that must be paid by the firm within a short

period of time, usually one year

Accounts Payable – amount that must be paid to other firms

Notes Payable – value of all notes owed by the firm

Long-term Liabilities----- items that will be paid after a year

Loans Payable – total due on all loans, mortgages

Long-term notes payable – total of all other debts of the firm

Owner’s Equity---- The difference between the total of all assets and of
all liabilities. Also referred to as capital, net worth or in case of
corporation, stockholder’s equity

The relationship between assets, liabilities and owner’s equity expressed

by the following:

Asset = Liabilities + Owner’s Equity

43
CLOSING ENTRIES AND POST-CLOSING TRIAL
BALANCE
Introduction

After the income statement has been prepared, the nominal accounts have
served its purpose, that is, they have been used to measure and show the nature
and causes of changes in the financial condition of the business. They have
provided the source of income and nature of expenses and losses. These
expense accounts are not accumulated. They are computed for each accounting
period. Therefore these accounts should be closed.

To close the nominal accounts:

1. Debit the income account and credit the Revenue and Expense
Summary account.
2. Credit the expense accounts and debit the Revenue and Expense
Summary account.
3. Get the difference of the Revenue and Expense Summary account.
The difference should be closed to the capital account. If there is a
drawing account, the difference of the Revenue and Expense
Summary should be closed to this account. The drawing account
then is closed to the capital account.

Illustration

1. Service Income ₱5,900

Revenue and Expense Summary ₱5,900
To close the income account to the
Revenue and expense summary

2. Revenue and Expense Summary ₱5,195

Advertising ₱200
Salaries and Wages 1,150
Utility Expense 150
Rent Expense 1,500
Repair Supplies Used 650
Depreciation – repair tools 120
Depreciation – furniture and fixtures 433.33
Depreciation – Service Truck 666.67
Interest Expense 325
To close the expense accounts to the
revenue and expense summary accounts

3. Revenue and Expense Summary ₱706

G. Alajar, Personal 706
To close the Revenue and Expense
Summary account to the drawing account
4. G. Alajar, Capital ₱44
44
 G. Alajar, Personal ₱44
To close the drawing account
to the capital account

Ruling the Closed Nominal Accounts

After the closing entries have been posted to the ledger, the debit and
credit sides of nominal accounts are already in balance. They are therefore,
double ruled.

Illustration:

Service Income Advertising Salaries and Wages

CJE (1) BAL. BAL. CJE (2)
5,900 5,900 BAL. 250 AJE (7) 50 900 1,150
AJE (6a)
CJE (2) 200 250

250 250 1,150 1,150

Utilities Expense Rent Expense Repair Supplies Used

CJE (2) BAL. CJE (2) CJE (2)
BAL. 150 150 1,000 1,500 AJE (1) 650 650
AJE (6a)
500

1,500 1,500

Depreciation- Repair Depreciation- Furniture and

tools Fixtures Depreciation- Service Truck
AJE (2) CJE (2) AJE (3a) CJE (2) AJE (3b) CJE (2)
120 120 433.33 433.33 666.67 666.67

Revenue and Expense

Interest Expense Summary G. Alajar, Personal
AJE (4) CJE (2) CJE (2) CJE (1) CJE (3)
325 325 5,194 5,900 BAL. 750 706
CJE (4)
CJE (3) 706 44

5,900 5,900 750 750

45
G. Alajar, Capital
CJE (4) BAL. beg.
44 25,000
BAL. ending
25,156

25,200 25,200
Post-closing Trial Balance

To test that the general ledger accounts are in balance before the
transactions of the next accounting period are posted, a post-closing trial
balance should be prepared.

Summary of Accounting Cycle

The life of the business is divided into accounting periods. In each

accounting period, there is one recurring accounting cycle which consists of the
following successive steps:

1. Journalizing – the process of recording business transactions in a

journal.
2. Posting – copying the information recorded in the journal to the
ledger.
3. Preparing a trial balance – summarizing the ledger accounts and
testing the correctness of the debits and credits
4. Adjusting the entries – adjusting the accounts that need to be
adjusted at the end of the period to bring the accounts up to date.
5. Preparing worksheets – sorting out the accounts as to nominal
and real accounts and grouping them in their respective columns
and then taking the results of the business operations.
6. Preparing the financial statements – preparing the income
statement and balance sheet from the information in the worksheet.
7. Closing the nominal accounts – preparing and posting the
entries to revenue and expense summary account and closing this
account to capital account.
8. Preparing the post-closing trial balance – checking the accuracy
of the adjusting and closing entries made.

46
47