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INSTRUCTIONAL MATERIAL FOR

ACCO 01BC

FUNDAMENTALS OF ACCOUNTING
PART 1

Compiled by:

MELINDA S. BALBARINO
LEONARDO COQUILLA
MARIA TERESA M. CORRALES
MARIETTA M. DOQUENIA
JULIETA G. FONTE
FRANCIA PEÑAFLOR
EDITHA A. PERALTA
ANDREA ROSE E. RIMORIN
CATHERINE D. SOTTO

2020
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GENERAL INFORMATION ABOUT THE COURSE

Course Code and Title : ACCO 01BC – FUNDAMENTALS OF ACCOUNTING PART 1

Semester and Academic :

Year

Course Credit : 3 Units

Pre-Requisite : None

Course Description : This course provides an introduction to accounting, within the

context of business and business decisions. Students obtain basic
understanding of the principles and concepts of accounting as well
as their applicability and relevance in the national context and learn
how to use various types of accounting information found in
financial statements and annual reports. Emphasis is placed on
understanding the reasons underlying basic accounting concepts
and providing students with an adequate background on the
recording, classification, and summarization functions of
accounting to enable them to appreciate the varied uses of
accounting data of a sole-proprietorship for service type of
business.

Course Outcomes : Upon completion of the course, the students will be able to:
a. Have detailed knowledge and understanding of the
accounting process of a Single Proprietorship for service
business
b. Produce the required entries and financial records of a
Single Proprietorship
c. Competence and honesty in the performance of
accountancy service
d. Demonstrate the qualities of a future accountant
e. Skilled in the use of a calculator, computer and other
business equipment
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GENERAL INSTRUCTIONS FOR STUDENTS

This instructional material is composed of five (5) modules that will introduce you to the
world of accounting and its reporting. Faculty members who prepared this instructional material
purposively chose only five (5) topics which are the most relevant topics when learning about
accounting.

FOR STUDENTS WITH INTERNET CONNECTIVITY, you are tasked to answer the
activities or performance tasks in accordance with the instruction of your instructor.

FOR STUDENTS WHO DO NOT HAVE INTERNET CONNECTIVITY AND RECEIVED

THIS INSTRUCTIONAL MATERIAL VIA COURIER SERVICES, you are tasked to accomplish
the activities or performance tasks at your own space. If the sheets provided are not enough, use
another sheet of paper for your answers. You may have your answers handwritten OR
computerized and printed.

House Rules

The following guides and house rules will help you further to be on track and to say at the
end of the module, “Yes! I conquered Accounting!”.

1. Schedule and manage your time to read and understand every part of the of the
module. Peruse it over until you decipher the undertakings.

2. Study how you can manage to do the activities of the course in consideration of your
modules from other courses. Be very conscious with the study schedule. Post it on
a conspicuous place so that you can always see. Do not ask you your course
facilitator about questions that are already answered in the guide.

3. Do not procrastinate. Remember, it is not others who will be short- changed if you
will do your work on time.

4. Before you start doing your tasks, read and understand the assessment tools
provided. Do not settle with the low standards, target the highest standards in doing
your assigned tasks. I know that you can! :)

5. You are free to browse and read the different materials even prior to doing the tasks
in each until the module. However, you need to ensure that you will not miss any
part of the module and you will submit course activities in the prescribed due date.
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Table of Contents
Topic Pages

Module 1 – Introduction to Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 – 29

Module 2 – The Accounting Equation And Analyzing Business Transactions. . . . .30 – 41

Module 3 – Recording and Posting the Business Transactions . . . . . . . . . . . 42 – 66

Module 4 – Adjusting Entries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 – 84

Module 5 – Completion of the Accounting Process . . . . . . . . . . . . . . . . . . . . . . 85 – 107

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Module I

INTRODUCTION TO ACCOUNTING

Overview:

Accounting is one of the key functions for almost any business. It may be handled by a
bookkeeper or an accountant at a small firm, or by sizable finance departments with dozens of
employees at larger companies. A bookkeeper can handle basic accounting needs, but a Certified
Public Accountant (CPA) should be utilized for larger or more advanced accounting tasks.
The reports generated by various streams of accounting, such as cost accounting and
managerial accounting, are invaluable in helping management make informed business
decisions. Regardless of the size of a business, accounting is a necessary function for decision
making, cost planning, and measurement of economic performance measurement.
It is therefore important to know and understand the definition of accounting and its
branches, its history, principles and standards.

Learning Objectives:

1. The learner should be able to know the history of accounting, its origin and the people
who first use the system and how the system evolved into its present condition.
2. The Learners should be able to define Accounting and understand every word used in its
definition and relate these words with the ultimate purpose or purposes of accounting
information system and to identify the primary uses of the financial information.
3. The learner should understand the basic principles in accounting to be able to understand
how the system works and how the information should be recorded and presented in the
financial reports.
4. The learner should be able to understand the different types of business and the different
forms of business organization and should be able to identify each and distinguish it from
the others.
5. The learner should be able to understand the basic accounting equation and all the
elements in it as well as the account titles that would be used in recording the transactions.

History of Accounting

The first name that might come to mind when referencing early accounting history is Fra
Luca Bartolomeo de Pacioli , an Italian mathematician, Franciscan friar, collaborator with
Leonardo da Vinci, who described double-entry bookkeeping in his “Summa de Arithmetica,
Geometria, Proportioni et Proportionalita” in 1494. While that may sound like a long time ago,
accounting may have roots that trace back even earlier. Accounting has been around for
centuries. It’s a critical part of the business, record-keeping, and life in general.

The earliest accounting records were found over 7,000 years ago among the ruins of
Ancient Mesopotamia. At the time, people relied on accounting to keep a record of crop and herd
growth. They used accounting techniques that are still used today to determine if there was a
surplus or shortage after crops were harvested each season. The first record of accounting that
occurred thousands of years ago in Mesopotamia has evolved into the intricate element of
business and life that it is today.

Accounting History During the Roman Empire

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During the reign of the Roman Empire, accounting continued to evolve much further. “The
Deeds of the Divine Augustus” is an account of Emperor Augustus’ financial dealings. It listed
such quantities as distributions to the people, grants of land, building of temples, money to military
veterans, religious offerings, and money spent on theatrical shows and gladiator events. This
discovery hints at the scope of accounting information available to the emperor, which he then
probably used for planning and decision-making purposes. Roman historians also recorded public
revenues, the amount of money in the state treasury, taxes, slaves, freedmen, and more.
Fra. Luca Pacioli’s Contribution to the Accounting Profession

In 1494, Pacioli wrote Summa de Arithmetica, Geometria, Proportioni et Proportionalita,

which included a twenty-seven-page treatise on bookkeeping titled, Particularis de Computis et
Scripturis (Details of Calculation and Recording) on the subjects of record keeping and double-
entry accounting. Pacioli’s book became the reference text and teaching tool on the subjects of
bookkeeping and accounting for the next several hundred years. This was the first time that
symbols for plus and minus appeared in a printed book. This book was the first known published
work on the topic of double-entry bookkeeping.

Accounting During the Middle Ages

During the Middle Ages, bartering was the primary form of money-changing, but when
Europe changed to a monetary economy is the 13th Century, merchants began relying on
bookkeeping to keep a record of multiple transactions. This is when double-entry bookkeeping
got its start, which is when a debit and credit value is entered for each transaction by the
accountant. Merchants at the time used accounting as a new recording system. It provided them
with constant information about their businesses that they could use in decision-making to grow
their business as they saw fit. This laid the foundation of how we use and understand accounting
today.

Accounting Systems in Today’s Generation

Nowadays, there are accounting standards, auditing regulations, and ethical standards for
accountants to follow. Along with this standard is the advancement in technology and accounting
has gone through many changes throughout the ages. Through all the changes, accounting
technology has always played a part in making the accountant’s job just a little easier. As people’s
knowledge of technology increased so has the accountant’s ability to analyze statistical values.
Technology advancements have enhanced the accountant’s ability to interpret data efficiently and
effectively. He/she now has the ability to interpret the language of business with such ease that
the accountant has become a business’ most trusted business advisor.

Accountants were pushed towards acquiring new skills due to the advancements that
information technology has made on the accounting industry. Accountants now have to have a
high level of computer and technical skills. These skills have become part of the knowledge, and
abilities of the accounting professionals. In its report the American Institute of Certified Public
Accounts (AICPA) cites that, “The knowledge, skills and abilities necessary for the entry-level
accountant now include the application and integration of information technology into the
accounting process, as well as financial and managerial accounting principles” (Dillon, Kruck,
2004). From this research, not only does an accountant need to have a broad range of accounting
knowledge and a strong ability to apply accounting principles, government regulations and
interpret tax laws; they must also have strong skills in information technology, to be able to merge
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accounting with information systems. These accountants will be in greater demand by the
profession (Dillon, et al, 2004).

Definition of Accounting

What Is Accounting?

Accounting is the process of recording financial transactions pertaining to a business. The

accounting process includes analyzing, recording, summarizing, financial transactions or events
over an accounting period, and reporting these transactions in the form of financial statements
(Income Statement, Balance Sheet, Capital Statement and Statement of Cash Flows) to
government’s regulatory, and tax collecting agencies.

In simple explanation, Accounting is how the business records, organizes, and

understands its financial information. Accounting can be thought of as a big machine where raw
financial information are put into, such as records of all business transactions, taxes, estimates
and allowance, etc., that then spits out an easy to understand reports or statements about the
financial state of the business. These financial statements tell its reader whether the business is
making a profit or not, where the cash came from and where it was put, what the current amount
of the assets and liabilities of the business and how much remained as capital of the business
owner or owners.

Technical definitions of accounting have been published by different accounting bodies.

The American Institute of Certified Public Accountants (AICPA) defines 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 financial character, and interpreting the
results thereof."

The American Accounting Association on the other hand defines accounting as “the
process of identifying, measuring and communicating economic information to permit informed
judgment and decision by users of the information”.

According to the Accounting Standards Council, “accounting is a service activity. Its

function is to provide quantitative information, primarily financial in nature, about economic
entities, that is intended to be useful in making economic decisions, in making reasoned choices
among alternative courses of action.”

Branches of Accounting

As a result of economic, industrial, and technological developments, different specialized

fields in accounting have emerged. The most commonly known branches or types of accounting
include: financial accounting, cost accounting, auditing, managerial accounting, AIS ,taxation,
forensic, and fiduciary accounting.

1. Financial Accounting- Financial accounting involves recording and categorizing

transactions for business. This data is generally historical, meaning it’s from the past. It
also involves generating financial statements based on these transactions. All financial
statements, such a balance sheet and income statement, must be prepared according to
the generally accepting accounting principles (GAAP). Financial accounting is performed
to conform to external regulations and requirements.
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2. Cost Accounting - Cost accounting is considered a type of managerial accounting. Cost

accounting is most commonly used in the manufacturing industry, an industry that has a
lot of resources and costs to manage. It is a type of accounting used internally to assess
a company’s operations. Cost accounting concerns itself with recording and analyzing
manufacturing costs. It looks at a company’s fixed (unchanging and constant costs, like
rent) and variable costs (changing costs, like shipping charges) and how they affect a
business and how these costs can be better managed, according to Accounting Tools.

3. Auditing - There are two types of auditing: external and internal auditing. In external
auditing, an independent third party reviews a company’s financial statements to make
sure they are presented correctly and comply with GAAP and IFRS. Internal auditing
involves evaluating how a business divides up accounting duties, who is authorized to do
what accounting task and what procedures and policies are in place. Internal auditing
helps a business to zero in fraud, mismanagement and waste or identify and control any
potential weaknesses in its policies or procedures.

4. Managerial Accounting -Also known as management accounting, this type of accounting

provides data about a company’s operations to managers. The focus of managerial
accounting is to provide data that managers need to make decisions about a business’s
operations, not comply strictly with GAAP. Managerial accounting includes budgeting and
forecasting, cost analysis, financial analysis, reviewing past business decisions and more.
Cost accounting is a type of managerial accounting.

5. 5. Accounting Information Systems - Known as AIS for short, accounting information

systems concerns itself with everything to do with accounting systems and processes and
their construction, installation, application and observation. This can include accounting
software management and the management of bookkeeping and accounting employees.

6. 6. Tax Accounting- Tax accounting involves planning for tax diminution, payment scheme
and the preparation of tax returns. This branch of accounting helps businesses to comply
with regulations of the Philippine Taxing Authorities, more particularly the Local
Government Units for the Mayor’s Permits, BIR for the Internal Taxes and Bureau of
Customs for taxes on importation and exportation. Tax accounting also helps businesses
figure out their income tax and other taxes and how to legally reduce their amount of tax
owing. Tax accounting also analyzes tax-related business decisions and any other issues
related to taxes.

7. Forensic Accounting -This specialized accounting service is trending in accounting and is

becoming increasingly popular. Forensic accounting focuses on legal affairs such as
inquiry into fraud, legal cases and dispute and claims resolution. Forensic accountants
need to reconstruct financial data when the records are incomplete. This could be to
decode fraudulent data or convert a cash accounting system to accrual accounting.
Forensic accountants are usually consultants who work on a project basis.

8. 8. Fiduciary Accounting - This branch of accounting centers around the management of

property for another person or business. The fiduciary accountant manages any account
and activities related to the administration and guardianship of property. Fiduciary
accounting covers estate accounting, trust accounting and receivership (the appointing of
a custodian of a business’s assets during events such as bankruptcy).
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Purposes and Uses of Accounting Information

The purpose of accounting is to accumulate and report on financial information about the
performance, financial position, and cash flows of a business. Accounting provides people
interested in the business or company with various pieces of information regarding business
operations, this information is then used to reach decisions about how to manage the business,
or invest in it, or lend money to it.

Uses of Accounting Information

1. A common use of accounting information is measuring the performance of various

business operations. While financial statements are the classic accounting information
tool used to assess business operations, business owners may conduct a more thorough
analysis of this information when reviewing business operations. Financial ratios use the
accounting information reported on financial statements and break it down into leading
indicators. These indicators can be compared to other companies in the business
environment or an industry standard. This helps business owners understand how well
their companies operate compared to other established businesses.

2. Business owners often use accounting information to create budgets for their companies.
Historical financial accounting information provides business owners with a detailed
analysis of how their companies have spent money on certain business functions.
Business owners often take this accounting information and develop future budgets to
ensure they have a financial road map for their businesses. These budgets can also be
adjusted based on current accounting information to ensure a business owner does not
restrict spending on critical economic resources.

3. Accounting information is commonly used to make business decisions. For financial

management, an income statement and accounting of expenses provides an important
overview of the business. Decisions may include expanding current operations, using
different economic resources, purchasing new equipment or facilities, estimating future
sales or reviewing new business opportunities.

4. Accounting information usually provides business owners information about the cost of
various resources or business operations. These costs can be compared to the potential
income of new opportunities during the financial analysis process. This process helps
business owners understand how current business operations will be affected when
expanding or growing their businesses. Opportunities with low income potential and high
costs are often rejected by business owners.

5. External business stakeholders often use accounting information to make investment

decisions. Banks, lenders, venture capitalists or private investors often review a
company's accounting information to review its financial health and operational
profitability. This provides information about whether or not a small business is a wise
investment decision. Many small businesses need external financing to start up or grow.
The inability to provide outside lenders or investors with accounting information can
severely limit financing opportunities for a small business.
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ACCOUNTING PRINCIPLES

The phrase "generally accepted accounting principles" (or "GAAP") consists of three
important sets of rules: (1) the basic accounting principles and guidelines, (2) the detailed rules
and standards issued by FASB and its predecessor the Accounting Principles Board (APB), and
(3) the generally accepted industry practices.

If a company distributes its financial statements to the public, it is required to follow

generally accepted accounting principles in the preparation of those statements. Further, if a
company's stock is publicly traded, Philippine law requires the company's financial statements be
audited by independent public accountants. Both the company's management and the
independent accountants must certify that the financial statements and the related notes to the
financial statements have been prepared in accordance with GAAP.

Since GAAP is founded on the basic accounting principles and guidelines, we can better
understand GAAP if we understand those accounting principles.

The following is a list of the ten main accounting principles and guidelines with a highly
condensed explanation of each.

1. Economic Entity Assumption

The accountant keeps all of the business transactions of a sole proprietorship separate
from the business owner's personal transactions. For legal purposes, a sole proprietorship and
its owner are considered to be one entity, but for accounting purposes they are considered to be
two separate entities.

2. Monetary Unit Assumption

In the Philippines economic activity is measured in Philippine pesos, and only transactions
that can be expressed in Philippine pesos are recorded.
Because of this basic accounting principle, it is assumed that the peso's purchasing power
has not changed over time. As a result, accountants ignore the effect of inflation on recorded
amounts. For example, pesos from a 1960 transaction are combined (or shown) with pesos from
a 2019 transaction.

3. Time Period Assumption

This accounting principle assumes that it is possible to report the complex and ongoing
activities of a business in relatively short, distinct time intervals such as the five months ended
May 31, 2019, or the 5 weeks ended May 1, 2019. The shorter the time interval, the more likely
the need for the accountant to estimate amounts relevant to that period. For example, the property
tax bill is received on December 15 of each year. On the income statement for the year ended
December 31, 2018, the amount is known; but for the income statement for the three months
ended March 31, 2019, the amount was not known and an estimate had to be used.
It is imperative that the time interval (or period of time) be shown in the heading of each
income statement, statement of owner’s/stockholders' equity, and statement of cash flows.
Labeling one of these financial statements with "December 31" is not good enough–the reader
needs to know if the statement covers the one week ended December 31, 2019 the month ended
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December 31, 2019 the three months ended December 31, 2019 or the year ended December
31, 2019

4. Cost Principle

From an accountant's point of view, the term "cost" refers to the amount spent (cash or
the cash equivalent) when an item was originally obtained, whether that purchase happened last
year or thirty years ago. For this reason, the amounts shown on financial statements are referred
to as historical cost amounts.

Because of this accounting principle asset amounts are not adjusted upward for inflation.
In fact, as a general rule, asset amounts are not adjusted to reflect any type of increase in value.
Hence, an asset amount does not reflect the amount of money a company would receive if it were
to sell the asset at today's market value. (An exception is certain investments in stocks and bonds
that are actively traded on a stock exchange.) If you want to know the current value of a company's
long-term assets, you will not get this information from a company's financial statements–you
need to look elsewhere, perhaps to a third-party appraiser.

5. Full Disclosure Principle

If certain information is important to an investor or lender using the financial statements,

that information should be disclosed within the statement or in the notes to the statement. It is
because of this basic accounting principle that numerous pages of "footnotes" are often attached
to financial statements.

For example, the company is named in a lawsuit that demands a significant amount of
money. When the financial statements are prepared it is not clear whether the company will be
able to defend itself or whether it might lose the case. As a result of these conditions and because
of the full disclosure principle the lawsuit will be described in the notes to the financial statements.

In compliance with this full disclosure principle, a business usually lists its significant
accounting policies as the first note to its financial statements.

6. Going Concern Principle

This accounting principle assumes that a business will continue to exist long enough to
carry out its objectives and commitments and will not liquidate in the foreseeable future. If the
business' financial situation is such that the accountant believes that it will not be able to continue
on, the accountant is required to disclose this assessment.

The going concern principle allows the business to defer some of its prepaid expenses
until future accounting periods.

7. Matching Principle

This accounting principle requires companies to use the accrual basis of accounting. The
matching principle requires that expenses be matched with revenues. For example, sales
commissions expense should be reported in the period when the sales were made (and not
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reported in the period when the commissions were paid). Wages to employees are reported as
an expense in the week when the employees worked and not in the week when the employees
are paid. If a company agrees to give its employees 1% of its 2019 revenues as a bonus on
January 15, 2020, the company should report the bonus as an expense in 2019 and the amount
unpaid at December 31, 2019 as a liability. The expense is recorded as the sales or revenue are
recorded.

8. Revenue Recognition Principle

Under the accrual basis of accounting (as opposed to the cash basis of accounting),
revenues are recognized as soon as a product has been sold or a service has been performed,
regardless of when the money is actually received. Under this basic accounting principle, a
company could earn and report P1,000,000 of revenue in its first month of operation but receive
P0 in actual cash in that month.

For example, if ABC Company completes its service at an agreed price of P50,000, ABC
should recognize P50,000 of revenue as soon as its work is done—it does not matter whether the
client pays the P50,000 immediately or in 30 days. Do not confuse revenue with a cash receipt.

9. Materiality

Because of this basic accounting principle or guideline, an accountant might be allowed

to violate another accounting principle if an amount is insignificant. Professional judgement is
needed to decide whether an amount is insignificant or immaterial.

An example of an obviously immaterial item is the purchase of a 7,500 printer by a highly

profitable multi-million-peso company. Because the printer will be used for five years, the
matching principle directs the accountant to expense the cost over the five-year period. The
materiality guideline allows this company to violate the matching principle and to expense the
entire cost of 7,500 in the year it is purchased. The justification is that no one would consider it
misleading if 7,500 is expensed in the first year instead of 1,500 being expensed in each of the
five years that it is used.

Because of materiality, financial statements usually show amounts rounded to the nearest
hundred, to the nearest thousand, or to the nearest million pesos depending on the size of the
company.

10. Conservatism

If a situation arises where there are two acceptable alternatives for reporting an item,
conservatism directs the accountant to choose the alternative that will result in less net income
and/or less asset amount. Conservatism helps the accountant to "break a tie." It does not direct
accountants to be conservative. Accountants are expected to be unbiased and objective.

The basic accounting principle of conservatism leads accountants to anticipate or disclose

losses, but it does not allow a similar action for gains. For example, potential losses from lawsuits
will be reported on the financial statements or in the notes, but potential gains will not be reported.
Also, an accountant may write inventory down to an amount that is lower than the original cost,
but will not write inventory up to an amount higher than the original cost.
Accounting Standards in the World and in the Philippines
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Financial statements have incredible importance for both internal and external
stakeholders. They basically are a report card for the company; hence, it is important that they
are regulated and do not report misleading information.

Accounting standards are exceedingly useful because they attempt to standardize and
regulate accounting definitions, assumptions, and methods. Because of generally accepted
accounting standards we are able to assume that there is consistency from year to year in the
methods used to prepare a company's financial statements. And although variations may exist,
we can make reasonably confident conclusions when comparing one company to another, or
comparing one company's financial statistics to the statistics for its industry. Over the years the
accounting standards have become more complex because financial transactions have become
more complex.

• The International Financial Reporting Standards (IFRS) Foundation is a not-for-profit

international organization responsible for developing a single set of high-quality, global
accounting standards, known as IFRS Standards. IFRS Standards are set by the IFRS
Foundation’s standard-setting body, the IASB.
• The Monitoring Board is a group of capital market authorities and provides formal link
between the Trustees and public authorities in order to enhance the public accountability
of the IFRS Foundation.
• The International Accounting Standards Board (IASB) is the independent standard-
setting body of IFRS Foundation responsible for the development and publication of IFRS
and for approving Interpretations of IFRS as developed by the IFRS Interpretations
Committee.
• The Trustees of the IFRS Foundation are responsible for the governance and oversight
of the IASB, including the due process for the development of the accounting standards.
• The IFRS Advisory Council provides advice and counsel to the Trustees and the Board,
whilst the Board also consults extensively with a range of other standing advisory bodies
and consultative groups.
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• The Accounting Standards Advisory Forum (ASAF) provides an advisory forum in which
members can constructively contribute towards the achievement of the IASB’s goal of
developing globally accepted high-quality accounting standards.
• The IFRS Interpretations Committee is the interpretative body of the International
Accounting Standards Board, which reviews implementation issues.

The first accounting standards used in the Philippines were the Generally Accepted
Accounting Principles of the US. However, with the convergence of reporting standards, the
Philippine Financial Reporting Standards (PFRS)/Philippine Accounting Standards (PAS) the new
set of accounting standards issued by the Accounting Standards Council (ASC) are adopted to
govern the preparation of financial statements. These standards are patterned after the revised
International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS)
issued by the International Accounting Standards Board (IASB).

The IFRS is a set of accounting standards that are recognized by at least 120 countries
(including the Philippines) and provides a guide on how particular types of transactions and other
events should be reported in financial statements. The rationale for using the IFRS is to ensure
consistency in recording, recognizing and measuring financial transactions, which, if followed
properly, will ensure stability and transparency throughout the financial reporting process of the
company. These standards are not enforceable and compliance is voluntary.

The International Accounting Standards (IAS) were an older set of standards stating how
particular types of transactions and other events should be reflected in financial statements.

The PFRS, the Philippine version of the IFRS with some minor modifications, and the
Philippine Accounting Standards are issued by the PFRS Council (formerly the Accounting
Standards Council [ASC]), under the oversight of the Board of Accountancy (BOA).

The Bangko Sentral ng Pilipinas (BSP) pronounced its adoption of the PFRS/PAS
effective the annual financial statements beginning 1 January 2005 in its Memorandum to All
Banks and Other BSP Supervised Financial Institutions (BSFIs) dated 11 January 2005.

Forms of Business Organization

A business entity is a group of people organized for some profitable or charitable purpose.
The source of capital of the business determines the form of business organization. Business
entities include organizations such as corporations, partnerships, charities, trusts, and other forms
of organization. Business entities, just like individual persons, are subject to taxation and must file
a tax return.

In Philippines the most common forms of businesses are sole proprietorships,

partnerships and corporation.

1. Sole Proprietorship - Sole Proprietorship is a business entity owned by an individual who

has full control/authority of its business and owns all the assets, personally owes answers
to all liabilities or suffers all losses but enjoys all the profits to the exclusion of others. A
sole proprietorship must apply for a business name and be registered with the Department
of Trade and Industry (DTI) - National Capital Region (NCR). In the provinces, application
may be filed with the DTI regional/provincial offices.
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2. Partnership - Under the Civil Code of the Philippines, a partnership is treated as juridical
person, having a separate legal personality from that of its members. Partnerships may
either be general partnerships, where the partners have unlimited liability for the debts
and obligation of the partnership, or limited partnerships, where one or more general
partners have unlimited liability and the limited partners have liability only up to the amount
of their capital contributions. It consists of two or more partners. A partnership with more
than Peso 3,000 capital must register with the Securities and Exchange Commission
(SEC).

3. Corporation - Corporation is composed of juridical persons established under the

Corporation Code and regulated by the SEC with a personality separate and distinct from
that of its stockholders. The liability of the shareholders of a corporation is limited to the
amount of their share capital. It consists of at least five to 15 incorporators, each of whom
must hold at least one share and must be registered with the SEC. Minimum paid up
capital is Peso 5,000. A corporation can either be stock or non-stock company regardless
of nationality. Such company, if 60% Filipino - 40% foreign-owned is considered a Filipino
corporation; if more than 40% foreign-owned, it is considered a domestic foreign-owned
corporation.
a. Stock Corporation- Stock Corporation is a corporation with capital stock divided into
shares and authorized to distribute to the holders of such share’s dividends or allotments
of the surplus profits on the basis of the shares held.
b. One Person Corporation- A One-Person Corporation (OPC) is a corporation with a
single stockholder, who can only be a natural person (who must be of legal age), trust or
estate. As an incorporator, the “trust” does not refer to a trust entity but rather pertains to
the subject being managed by a trustee.
c. Non-Stock Corporation- Non-Stock Corporation is a corporation organized principally
for public purposes such as charitable, educational, cultural, or similar purposes and does
not issue shares of stock to its members.

Types of Business Activity

A business entity is an organization that uses economic resources to provide goods or

services to customers in exchange for money or other goods and services.

There are three major types of businesses:

1. Service Business - A service type of business provides intangible products (products with
no physical form). Service type firms offer professional skills, expertise, advice, and other
similar products. Examples of service businesses are: salons, repair shops, schools,
banks, accounting firms, and law firms.

2. Merchandising Business - This type of business buys products at wholesale price and
sells the same at retail price. They are known as "buy and sell" businesses. They make
profit by selling the products at prices higher than their purchase costs. A merchandising
business sells a product without changing its form. Examples are: grocery stores,
convenience stores, distributors, and other resellers.

3. Manufacturing Business - Unlike a merchandising business, a manufacturing business

buys products with the intention of using them as materials in making a new product. Thus,
16

there is a transformation of the products purchased. A manufacturing business combines

raw materials, labor, and overhead costs in its production process. The manufactured
goods will then be sold to customers.

Reports or Financial Statements Generated from the Accounting System

Financial statements are written reports prepared by business’ management to present its
financial affairs in a given period (monthly, quarterly, six monthly or yearly). These statements
include Balance Sheet, Income Statement, Cash Flows and Statement of Owner/s’ Equity (for
sole proprietorship and partnership) or Shareholders’ Equity (in case of corporation).
Balance Sheet.

A balance sheet is a financial statement that reports a company's assets, liabilities and
shareholders' equity at a specific point in time, and provides a basis for computing rates of return
and evaluating its capital structure. It is a financial statement that provides a snapshot of what a
company owns and owes, as well as the amount invested by owner/s’ or shareholders. The
equation that you need to remember when you prepare a balance sheet is this –

Assets = Liabilities + Shareholders Equity.

Assets. The International Financial Reporting Standards (IFRS) framework defines an asset as
follows: “An asset is a resource controlled by the enterprise as a result of past events and from
which future economic benefits are expected to flow to the enterprise.”
Properties of an Asset
There are three key properties of an asset:
 Ownership: Assets represent ownership that can be eventually turned into cash and cash
equivalents
 Economic Value: Assets have economic value and can be exchanged or sold
 Resource: Assets are resources that can be used to generate future economic benefits

Classification of Assets
 17

Importance of Asset Classification

Classifying assets is important to a business. For example, understanding which assets
are current assets and which are fixed assets is important in understanding the net working capital
of a company. In the scenario of a company in a high-risk industry, understanding which assets
are tangible and intangible helps to assess its solvency and risk. Determining which assets are
operating assets and which assets are non-operating assets is important to understanding the
contribution of revenue from each asset, as well as in determining what percentage of a
company’s revenues comes from its core business activities.
Assets are generally classified in three ways:
1. Convertibility: Classifying assets based on how easy it is to convert them into cash.
2. Physical Existence: Classifying assets based on their physical existence (in other words,
tangible vs. intangible assets).
3. Usage: Classifying assets based on their business operation usage/purpose.

1. Classification of asset as to Convertibility - If assets are classified based on their

convertibility into cash, assets are classified as either current assets or fixed assets. An
alternative expression of this concept is short-term vs. long-term assets.

a. Current Assets - Current assets are assets that can be easily converted into cash and
cash equivalents (typically within a year). Current assets are also termed liquid assets and
examples of such are:
o Cash
o Cash equivalents
o Short-term deposits
o Stock
o Marketable securities
18

o Office supplies

b. Non-Current Assets or Fixed Assets - Non-current assets are assets that cannot be easily
and readily converted into cash and cash equivalents. Non-current assets are also termed
fixed assets, long-term assets, or hard assets. Examples of non-current or fixed assets
include:
o Land
o Building
o Machinery
o Equipment
o Patents
o Trademarks

2. Classification of asset as to Physical Existence - If assets are classified based on their

physical existence, assets are classified as either tangible assets or intangible assets.

a. Tangible Assets - Tangible assets are assets that have a physical existence (we can
touch, feel, and see them). Examples of tangible assets include:
o Land
o Building
o Machinery
o Equipment
o Cash
o Office supplies
o Stock
o Marketable securities

b. Intangible Assets - Intangible assets are assets that do not have a physical existence.
Examples of intangible assets include:
o Goodwill
o Patents
o Brand
o Copyrights
o Trademarks
o Trade secrets
o Permits
o Corporate intellectual property

3. Classification of assets as to Usage - If assets are classified based on their usage or

purpose, assets are classified as either operating assets or non-operating assets.

a. Operating Assets - Operating assets are assets that are required in the daily operation of
a business. In other words, operating assets are used to generate revenue from a
company’s core business activities. Examples of operating assets include:
o Cash
 19

o Stock
o Building
o Machinery
o Equipment
o Patents
o Copyrights
o Goodwill

b. Non-Operating Assets - Non-operating assets are assets that are not required for daily
business operations but can still generate revenue. Examples of non-operating assets
include:
o Short-term investments
o Marketable securities
o Vacant land
o Interest income from a fixed or time deposit

Liabilities -Defined by the International Financial Reporting Standards (IFRS) Framework: “A liability is a
present obligation of the enterprise arising from past events, the settlement of which is expected to result
in an outflow from the enterprise of resources embodying economic benefits.”

Classification of Liabilities
These are the three main classifications of liabilities:
1. Current liabilities (short-term liabilities) are liabilities that are due and payable within one year.
2. Non-current liabilities (long-term liabilities) are liabilities that are due after a year or more.
3. Contingent liabilities are liabilities that may or may not arise, depending on a certain event.

1. Current Liabilities also known as short-term liabilities, are debts or obligations that need to be
paid within a year. Current liabilities should be closely watched by management to make sure that
the company possesses enough liquidity from current assets to guarantee that the debts or
obligations can be met.
Examples of current liabilities:
Accounts payable
Interest payable
Income taxes payable
Bills payable
Bank account overdrafts
Accrued expenses
Short-term loans

Current liabilities are used as a key component in several short-term liquidity measures. Below
are examples of metrics that management teams and investors look at when performing financial
analysis of a company.

Examples of key ratios that use current liabilities are:

 The current ratio: Current assets divided by current liabilities
 The quick ratio: Current assets, minus inventory, divided by current liabilities
 The cash ratio: Cash and cash equivalents divided by current liabilities
20

2. Non-current liabilities, also known as long-term liabilities, are debts or obligations that are due in
over a year’s time. Long-term liabilities are an important part of a company’s long-term financing.
Companies take on long-term debt to acquire immediate capital to fund the purchase of capital
assets or invest in new capital projects.

Long-term liabilities are crucial in determining a company’s long-term solvency. If companies are
unable to repay their long-term liabilities as they become due, then the company will face a
solvency crisis.
List of non-current liabilities:
Bonds payable
Long-term notes payable
Deferred tax liabilities
Mortgage payable
Capital leases

3. Contingent Liabilities are liabilities that may occur, depending on the outcome of a future event.
Therefore, contingent liabilities are potential liabilities. For example, when a company is facing a
lawsuit of P100,000, the company will incur a liability if the lawsuit proves successful. However, if
the lawsuit is not successful, then no liability would arise.

In accounting standards, a contingent liability is only recorded if the liability is probable (defined
as more than 50% likely to happen) and the amount of the resulting liability can be reasonably
estimated.
Examples of contingent liabilities:
Lawsuits
Product warranties

Capital also known as net assets or equity; capital refers to what is left to the owners after all liabilities
are settled. Simply stated, capital is equal to total assets minus total liabilities. Capital is affected by the
following:
1. Initial and additional contributions of owner/s (investments),
2. Withdrawals made by owner/s (dividends for corporations),
3. Income, and
4. Expenses.

Owner contributions and income increase capital. Withdrawals and expenses decrease it. The terms
used to refer to a company's capital portion varies according to the form of ownership. In a sole
proprietorship business, the capital is called Owner's Equity or Owner's Capital; in partnerships, it is
called Partners' Equity or Partners' Capital; and in corporations, Stockholders' Equity.

In addition to the three elements mentioned above, Assets, Liabilities and Capital, there are two items
that are also considered as key elements in accounting equation. They are income and expenses; these
items are ultimately included as part of capital.

Income refers to an increase in economic benefit during the accounting period in the form of an
increase in asset or a decrease in liability that results in increase in equity, other than contribution from
owners. Income encompasses revenues and gains.
 21

Revenues refer to the amounts earned from the company’s ordinary course of business such
as professional fees or service revenue for service companies and sales for merchandising and
manufacturing concerns.

Gains come from other activities, such as gain on sale of equipment, gain on sale of short-term
investments, and other gains.

Income is measured every period and is ultimately included in the capital account. Examples of income
accounts are: Service Revenue, Professional Fees, Rent Income, Commission Income, Interest Income,
Royalty Income, and Sales.

Expenses are decreases in economic benefit during the accounting period in the form of a decrease in
asset or an increase in liability that result in decrease in equity, other than distribution to owners.
Expenses include ordinary expenses such as Cost of Sales, Advertising Expense, Rent Expense, Salaries
Expense, Income Tax, Repairs Expense, etc.; and losses such as Loss from Fire, Typhoon Loss, and Loss
from Theft. Like income, expenses are also measured every period and then closed as part of capital.
Net income refers to all income minus all expenses.

Income Statement
The income statement is the next financial statement everyone should look at. It looks quite
different than the balance sheet. In the income statement, it’s about the revenue and the expenses.
It starts with the gross sales or revenue. Then we deduct any sales return or sales discount from the gross
sales to get the net sales. From net sales, we deduct the costs of goods sold, and we get the gross profit.
From gross profit, we deduct the operating expenses like the expenses required for daily administrative
and selling expenses. By deducting the operating expenses, we get the operating income.

From the operating income we add, if there is any, interest and other non-operating income
received during the period and deduct the interest charges paid and other non-operating losses sustained
during the period, by this we get the EBT, meaning Earnings Before Taxes. From EBT, we deduct the
income taxes for the period, and we get the Net Income or Net Profit, meaning profit after tax.

Cash Flow Statement

Cash Flow Statement is the third most important statement every investor should look at. There are three
separate segments of a cash flow statement. These are cash flow from the operating activities, cash flow
from investing activities, and cash flow from finance activities.
1. Cash Flow from Operations is the cash generated from the core operations of the business.
2. Cash Flow from Investing Activities relates to the cash inflows and outflows related to investment
in the company like buying of property, plant, and equipment or other investments.
3. Cash Flow from Financing Activities relates to the cash inflows or outflows related to debt or
equity of the company. It includes raising of equity or capital, debt, loan repayments, buyback of
shares, and similar financing activities.

Statement of Owner/Partners’ Equity (for sole proprietorship and partnership) or Statement of

Changes in Shareholders’ Equity (for corporation)
Statement of Owner/Partners’ Equity or Statement of Changes in Shareholders’ Equity is
a financial statement that provides a summary of changes in the owner/partners’ or shareholders’
equity in a given period.
22

Illustration of Income Statement for the Different Forms of Business Organization:

Sole Proprietorship’s Income Statement
Terimacor Bicycle Rental Services
Statement of Owner's Equity
For the year ended December 31, 2019

Teresa Corrales, capital Jan. 1, 2019 90,000

Add: additional capital by Teresa Corrales
net income from Jan.1-Dec. 31, 2019
Total
Less: withdrawals or drawings from Jan. 1-92,000
Dec. 31, 2019
Teresa Corrales, capital Dec. 31, 2019 182,000

Partnership’s Income Statement

Terimacor Bicycle Rental Services Ltd.
Statement of Partner's Equity
For the year ended December 31, 2019
Teresa Anita Total
Balances Jan. 1, 2019 90,000 160,000 250,000
Add: additional capital by partners 82,000 10,000 92,000
net income from Jan.1-Dec. 31, 201928,000 28,000 56,000
Total 200,000 198,000 398,000
Less: withdrawals or drawings from Jan. 1- 18,000
Dec. 31, 2019
24,000 42,000
Capital balances Dec. 31, 2019 182,000 174,000 356,000
Elements of Statement of Changes in Owner/Partners’ Equity/Capital
Capital or investment- A capital or investment is a sum of cash acquired by a business to pursue
its objectives, such as continuing or growing operations. It also can refer to permanent fixed
assets such as property, plant, & equipment which ownership has been transferred to the
business.
Net income - For a business, net income equals is the amount remaining after subtracting all
costs and expenses from revenue. If the costs and expenses exceed revenue, it is called net loss
and this is subtracted from the capital or investment.
Drawings or withdrawals- represent an amount of cash or non-cash items removed by the owner
or partners from the business for personal use or expenditure.

Corporation’s Income Statement

 23

Terimacor Bicycle Rental Services Co.

Statement of Stockholders' Equity
For the year ended December 31, 2019
Additional
Common paid-in Retained
Stock capital earnings
Balance Jan. 1, 2019 80,000 160,000 130,000
Issuance of Stock 20,000 65,000
Net income 69,000
Cash dvidends -21,000
Stock dividend- 8% 8,000 26,000 -34,000
Purchase of treasury stock
Sale of treasury stock 13,000
Balance Dec. 31, 2019 108,000 264,000 144,000

Elements of Statement of Changes in Stockholders’ Equity

Common Stock is the first and most important component of shareholders’ equity. Common
stockholders are the owners of the company, however there are corporations which issue
preference shares which holders are also owners of the company but with limited rights.
Additional Paid in Capital means when the company receives a premium on the shares. Premium
results when the shares of stock are issued above par value.
Retained earnings or losses are accumulated from the previous period. In simple terms, retained
earnings are the amount the company keeps after paying the dividend from net income.
Treasury shares are the sum total of all the common shares that have been purchased back by
the company.
Dividend is the distribution of some of a company's earnings to a class of its shareholders, as
determined by the company's board of directors.

ACTIVITIES AND ASSESSMENT

A. Identifying the applicable Accounting Principle
1. The personal assets of the owner of a company will not appear on the company's balance
sheet because of which principle/guideline? _________________
2. Which principle/guideline requires a company's balance sheet to report its land at the amount
the company paid to acquire the land, even if the land could be sold today at a significantly higher
amount?_________________________
3. Which principle/guideline allows a company to ignore the change in the purchasing power of
the peso over time? __________________________________
4. Which principle/guideline requires the company's financial statements to have footnotes
containing information that is important to users of the financial statements?
__________________________________
5. Which principle/guideline justifies a company violating an accounting principle because the
amounts are immaterial? __________________________________
6. Which principle/guideline is associated with the assumption that the company will continue on
long enough to carry out its objectives and commitments?
7. A very large corporation's financial statements have the peso amounts rounded to the nearest
P1,000. Which accounting principle/guideline justifies not reporting the amounts to the penny?
24

8. Accountants might recognize losses but not gains in certain situations. For example, the
company might write-down the cost of inventory, but will not write-up the cost of inventory. Which
principle/guideline is associated with this action?
9. Which principle/guideline directs a company to show all the expenses related to its revenues
of a specified period even if the expenses were not paid in that period?
10. When the accountant has to choose between two acceptable alternatives, the accountant
should select the alternative that will report less profit, less asset amount, or a greater liability
amount. This is based upon which principle/guideline? ______________________________

B. Define or discuss the following:

1. Accounting
2. Generally Accepted Accounting Principles (GAPP)
3. International Accounting Standards (IAS)
4. International Financial Reporting Standards (IFRS)
5. Evolution of accounting standards in the Philippines

C. Enumerate and Discuss the following:

1. Forms of Business Organization
2. Types of Business Activity
3. 10 Generally Accepted Accounting Principles
4. Give some of the important uses of Accounting information
5. 8 Branches of Accounting
 25

WRITE YOUR ANSWERS HERE:

EXERCISE 1-1- Instructions: For each of the business listed below indicate the type of the firm for
which each belongs. Write “X” on the line provided.

SERVICE MERCHANDISING MANUFACTURING

1. car assembler ________________ ________________ __________________

2. newsstand ________________ ________________ __________________
3. paper mills ________________ ________________ __________________
4. laundry shop ________________ ________________ __________________
26

5. pharmaceutical ________________ ________________ __________________

6. dental clinic ________________ ________________ __________________
7. barber shop ________________ ________________ __________________
8. gift shop ________________ ________________ __________________
9. eal estate broker ________________ ________________ __________________
10. bookstore ________________ ________________ __________________
11. battery maker ________________ ________________ __________________
12. movie houses ________________ ________________ __________________
13. driving school ________________ ________________ __________________
14. hardware ________________ ________________ __________________
15. furniture maker ________________ ________________ __________________
16. law offices ________________ ________________ __________________
17. department store ________________ ________________ __________________
18. accounting firm ________________ ________________ __________________
19. boutique ________________ ________________ __________________
20. groceries ________________ ________________ __________________
21. supermarkets ________________ ________________ __________________
22. textiles ________________ ________________ __________________
23. shoe maker ________________ ________________ __________________
24. sari-sari store ________________ ________________ __________________
25. laundry shop ________________ ________________ __________________

EXERCISE1- 2- INSTRUCTION - After the statement given below, make a “check” on the line
Provided. Indicate the type of organization being referred to:

SOLE PARTNERSHIP CORPORATION

1. Easy to form __________ ___________ ___________
2. Life is continuous __________ ___________ ___________
3. More expensive
to organize. ____________ ______________ _____________
4. Better credit standing. __________ ___________ ___________
 27

5. Unlimited liability. __________ ___________ ___________

6. Few legal restrictions. __________ ___________ ___________
7. It is subject to more taxes. __________ ___________ ___________
8. Owner has more freedom __________ ___________ ___________
9. Owned by the government. __________ ___________ ___________
10. Centralized management. __________ ___________ ___________
11. Unlimited life __________ ___________ ___________
12. Easy to dissolve __________ ___________ ___________
13. Better credit standing
than sole proprietorship __________ ___________ ___________
14. Subject to governmental
Controls. __________ ___________ ___________
15. Large scale business
Undertakings. __________ ___________ ___________
16. Limited liability __________ ___________ ___________
17. Divided authority __________ ___________ ___________
18. Difficult of raising capital __________ ___________ ___________
19. Restricted transfer of
capital __________ ___________ ___________
20. Greater source of capital
than sole __________ ___________ ___________

PROBLEM 1-1
INSTRUCTIONS: On the space provided, indicate a CHECK MARK as to the Effect balances of
the following accounts:

INCREASED DECREASED
1. Notes payable was debited. _____________ ___________
2. Accounts receivable was credited. _____________ ___________
3. Cash was debited. _____________ ___________
28

4. Salary expense was debited _____________ ___________

5. Service income was credited. _____________ ___________
6. Accounts payable was credited _____________ ___________
7. Owner’s equity was credited. _____________ ___________
8. Cash was credited. _____________ ___________
9. Prepaid rent was debited _____________ ___________
10. Accounts payable was debited. _____________ ___________
11. Notes receivable was debited _____________ ___________
12. Salaries payable was debited _____________ ___________
13. Service revenue was debited _____________ ___________
14. Capital was debited _____________ ___________
15. Rent expense was debited _____________ ___________
16. Supplies was credited _____________ ___________
17. Utilities expense was debited _____________ ___________
18. Equipment was debited _____________ ___________
19. Unearned commission was debited _____________ ___________
20. Marlon drawing was debited _____________ ___________

PROBLEM 1-2
INSTRUCTION: Compute the new balances of the following items. Consider each item
separately:

ORIGINAL NEW
BALANCE BALANCE

SAMPLE: Cash was debited by P300 P 1, 500 P 1,800

1. Irene, Capital was debited by P10, 000 50,000 __________
2. Prepaid rent was debited by P6, 000 12,000 __________
3. Notes receivable was debited by P 3,500 14,000 __________
4. Accounts payable was debited by P 5,000 26,000 __________
5. Service income was credited by P 9,000 34,000 __________
6. Salary expense was debited by P 8,200 22,000 __________
7. Notes payable was credited by P20, 000 5,000 __________
8. Accounts receivable was debited by P18, 000 3,000 __________
9. Irene, Drawing was debited by P 2,000 8,000 __________
10. Supplies Expense was debited by P2,200 --- __________
11. Accounts receivable was credited by ,P7,500 32,000 __________
12. Utilities expense was debited by P3,200 1,000 __________
 29

13. Cash was credited by P 21,000 46,000 __________

14. Mortgage payable was debited by P30,000 75,000 __________
15. Rental Income was credited by P 15,000 9,000 __________
16. Commission income was credited by P 25,000 4,000 __________
17. Interest receivable was credited by P800 2,800 __________
18. Taxes & licenses was debited by P3,000 5,200 __________
19. Furniture & fixtures was credited by P400 10,000 __________
20. Land was debited by P45, 000 60,000 __________
21. Interest expense was debited by P750 6,800 __________
22. Equipment was debited by P 6,900 3,700 __________
23. Interest receivable was debited by P650 1,300 __________
24. Tools was debited by P2, 000 4,000 __________
25. Wages expense was debited by P 14,000 15,000 __________
30

Module 2

THE ACCOUNTING EQUATION AND ANALYZING BUSINESS TRANSACTIONS

Learning objectives
1. Discuss the basic accounting equation.
2. Understand the concept of increase/decrease in an amount.
3. Identify the effects of transactions on the accounting equation.
4. Analyze the effects of different business transactions to the accounting equation.

The purpose of accounting is to provide a means of recording, reporting, summarizing, and

interpreting economic data. At the end of the period, a trustworthy and competently financial reports
are prepared and provided on a regular basis. To do this, an accounting system must be designed.

Accounting information system is vital for keeping the data to become a document and later a
record. Once a system has been designed, reports can be issued, and decisions based upon these
reports are made for various departments and other users.

Occurrence of business transactions must be substantiated by the source documents like an

invoice, official receipts, purchase order, payroll and the like. Then it will be analyzed and processed
for recording aided by the accounting equation. The accounting equation represents the relationship
between assets, liabilities, and owner’s equity of a business. Finally, the summary of transactions in
the form of financial statements are provided to users.

What is the Accounting Equation Used for?

The basis of accounting is the principle of balance. To carry out economic activities, the
company needs funds and that these funds should be given to the company by owner/ sole
proprietor. The funds owned by the company are called assets. The total amount of funds
contributed by them is called capital. If the owner is the only one who contributed, then the
equation is

Assets = Owner’s Equity

 31

However, assets may be contributed by someone else who is not the owner. The debt of
the company for these assets is called liabilities. Therefore, now the equation will take the
following form:

Assets = Liabilities and Owner’s Equity.

The left and right sides of the equation must always be equal regardless of the
Number of business transactions.

Three Elements in the Accounting Equation

1. Assets are things of value owned by a business.
 Cash
 Accounts receivable
 Notes receivable
 Supplies
 Prepaid Insurance
 Prepaid Taxes
 Merchandise Inventory (for Merchandising business)
 Equipment
 Furniture & Fixtures
 Land
 Building
 Patents
 Copyrights
2. Liabilities. Obligations owed to other companies and people classified as current and
long-term liabilities.
 Accounts Payable
 Notes Payable
 Mortgage Payable
 Salaries Expense
 Taxes Payable
 Interest Payable
 Unearned revenue

3. Capital. Equity of the owner. These are the financial resources or assets owned by a
business that are useful in furthering development and generating income. It is the
residual interest in the assets after deducting the liabilities of the business. Capital is
affected by the following:

Effect in the Capital

Owner’s investment increase
Owner’s withdrawals decrease
Revenue /Income increase
Expenses decrease
32

ANALYZING BUSINESS TRANSACTIONS

In order to generate financial reports, business transactions have to be analyzed,

recorded and summarized. In analyzing transactions, the suggested procedures are as
follows:

1) Determine the accounts affected or involved in the transaction. There

are two or more accounts involved in every transaction.

2) Determine the effect of the transaction on the accounts involved in terms of

increase or decrease.

The accounts affected or involved and the effects of the transactions on the said
account are illustrated as follows: (INC - Increase; DEC – Decrease; NC - No Change)

Transactions Asset Liabil Capit Analysis

s ities al
An entity is separate and distinct from
the owner. Cash investment will both
1 Owner invests cash INC NC INC increase asset and capital.
Purchased supplies on Supplies is an asset and it was bought
2 credit INC INC NC on credit, both asset and liabilities
increase.

Equipment is an asset and since this is

an investment by the owner, both asset
3 Owner invests equipment INC NC INC and capital correspondingly increase.
Land increases the assets of the
4 Buys land paying cash INC/D business but cash as an asset
EC NC NC correspondingly decrease for cash
purchase of the land.
Cash increases the assets of the
business because of borrowed cash.
Notes Payable increases the liabilities
5 Borrows cash with note INC INC NC of the business as it represents an
obligation to pay in the future date.
6 Rendered services for Cash received increases asset and it
cash. INC NC INC was also an increase in capital due to
revenue earned.
Cash payments represent cash outflow
7 Paid utilities expense DEC NC DEC decreases assets while expenses
decrease capital as it has opposite
effect on income
Asset increased because of supplies
8 Paid supplies purchased. DEC NC DEC purchased and another asset, Cash
decreased because of payment.
Assets increased by the amount of
9 Rendered services on accounts receivable expected to be
account. INC NC INC collected from the customer and capital
increased since rendering of services
represents revenue.
Asset increased as there was cash
inflow in the amount of the collection.
10 NC NC
 33

Collection of Accounts INC/D Another asset decreased in the amount

Receivable EC of accounts receivable collected.
Cash is an asset; a cash payment
12 Paid salaries of DEC NC DEC decreases asset. Correspondingly,
employees. salaries expense decreases income
and decrease in income is a decrease
in capital.
Asset decreased because of cash and
13 Cash withdrawal of the DEC NC DEC decreased in capital because of
owner for personal use. personal use.
Cash payment decreases asset and a
14 Payment of accounts DEC DEC NC decreased in liabilities because of
payable accounts payable.

Asset increased by the amount of tables

15 Purchased office tables
and office chairs. Paid
down payment and the
balance is due after
30days.
and chairs (classified as furniture and
INC/D INC NC fixtures), Asset decreased by the
EC amount of cash payment. Liabilities
increased by the amount of unpaid
balance (accounts payable)

Illustrative Problem

The following details will include the amount and the account affected in illustrating the effects on
the accounting equation. Notice that the accounting equation is always balanced in every transaction
such that assets are always equal to liabilities and capital.

The Diaz Dry and Fold Shop, owned by Mr. Diaz, engaged in a laundry business completed the following
transactions during the first month of its operations, January 2020:

1. Mr. Diaz organized a laundry shop business owned and managed by himself. He
invested cash of P600,000 and deposited in the account of his business named Diaz Dry
& Fold Shop.

2. Purchased supplies in the amount of P30,000 cash.

3. Bought 4 units of washing machine and 4 units of dryer on account with the total amount
of P400,000.

4. Purchased office chairs and tables amounting to P50,000.

5. Paid space rental for the month, P 25,000.

6. Paid partial amount of P250,000 for the washing machine and dryers purchased in no. 3.

7. Received P75,000 from cash customer for the laundry services.

8. Paid light and water bills for the month, P35,000.

9. Charged customer for the laundry contract of hotel linens and curtains,
P 150,000.
34

10. Purchased additional supplies on account, P25,000.

11. Paid salary of laundry assistants, P40,000.

12. Mr. Diaz withdrew P10,000 cash for his personal use.

13. Collected 50% of laundry service charged in no. 9.

14. Purchased computer and printer, P40,000. Terms: Down payment of P10,000 and the
balance payable in two equal installments.

15. Paid local taxes to continue operate the business, P5,000.

Required: (1) Analyze the above transactions by using accounting equation tabulation and
indicate under the notation column why the capital of Diaz is affected.
(2) Prepare the financial statements for the month ended January 31, 2020.
ASSETS LIABILITIES CAPITAL

ACCOUNTS FURNITURE ACCOUNTS DIAZ, NOTATIONS

RECEIVABLE AND PAYABLE CAPITAL
CASH SUPPLIES EQUIP-
FIXTURES
MENT

1 600,000 600,000 Initial

investment

2 (30,000) 30,000
3 400,000 400,000
4 (50,000) 50,000
5 (25,000) (25,000) Rent Expense

6 (250,000) (250,000)
7 75,000 75,000 Service
Revenue

8 (35,000) (35,000) Utilities Exp.

9 150,000 150,000 Service

Revenue

10 25,000 25,000
11 (40,000) (40,000) Salaries Exp.

12 (10,000) (10,000) Diaz

withdrawal

13 75,000 (75,000)
14 (10,000) 40,000 30,000
15 (5,000) (5,000) Taxes Exp.
 35

Bal. 295,000 75,000 55,000 50,000 440,000 205,000 710,000

To enhance the usefulness of the financial data and its balances from the tabulation, the following are the
summary of financial reports:

1) Statement of Income and Expenses

2) Statement of Owner’s Equity
3) Statement of Financial Position
4) Statement of Cash Flows

Diaz Dry and Fold Shop

Statement of Income and Expenses
For the Month Ended January 31, 2020

Service Revenue P225,000

Less: Operating Expenses
Salaries P 40,000
Utilities 35,000
Rent 25,000
Taxes 5,000
Total Operating Expenses 105,000

Net Income P120,000

Diaz Dry and Fold Shop

Statement of Owner’s Equity
For the Month Ended January 31, 2020

Diaz Capital, January 1, 2020 P600,000

Add: Net Income 120,000
Total 720,000
Less: Withdrawals 10,000
Diaz Capital, January 31, 2020 P710,000

Note: The capital balance at the beginning in the amount of P600,000 increased to
P710,000 at the end of the month because of the net increase in capital by
P110,000 due to greater amount of net income of P120,000 than withdrawals of
P10,000.
36

Diaz Dry and Fold Shop

Statement of Financial Position
January 31, 2020

Assets Liabilities and Capital

Cash P295,000 Accounts Payable P205,000
Accounts Receivable 75,000 Diaz, Capital 710,000
Supplies 55,000
Furniture and Fixtures 50,000
Equipment 440,000
Total Assets P915,000 Total Liabilities and Capital P915,000

Diaz Dry and Fold Shop

Statement of Cash Financial Position
January 31, 2020

Cash Flows from Operations:

Service Revenues P75,000
Collection of Receivables 75,000
Purchased of Supplies (30,000)
Payments of Expenses:
Rent P25,000
Utilities 35,000
Salaries 40,000
Taxes 5,000 (105,000) P15,000

Cash Flows from Investment Activities:

Purchased of Equipment P(260,000)
Purchased of Furniture & Fixtures ( 50,000) (310,000)

Cash Flows from Financing Activities:

Investment of the Proprietor P 600,000
Withdrawals of the Proprietor ( 10,000) 590,000

Cash Balance, January 31, 2020 P295,000

Note: 1. Cash balance at the end of the Statement of Cash Flows must always be
equal to the cash indicated in the statement of Financial Position.
2. The statement of Cash Flows explained the sources and uses of cash.
 37

Activities and Assessment

EXERCISE 2-1. INSTRUCTIONS: On the space provided, indicate whether the normal
balance of each of the given account is DEBIT or CREDIT:

1. Building __________ 11. Interest Payable ___________

2. Supplies __________ 12. Land __________
3. Accounts Payable _________ 13. Drawing __________
4. Allow. for doubtful accts. ________ 14. Rent Expense _________
5. Notes Receivable __________ 15. Prepaid Insurance ___________
6. Mortgage Payable __________ 16. Equipment ___________
7. Commission Income _________ 17. Furniture & Fixtures _________
8. Cash __________ 18. Professional Fees ___________
9. Accumulated Depreciation _______ 19. Sales Salary _______________
10. Capital ___________ 20. Unearned Income ___________

EXERCISE 2-2. Write “T” if the statement is true and “F” if the statement is false.

_____1. The fundamental accounting equation is Assets = Liabilities + Capital

_____2. Revenue increases owner’s equity.
_____3. Payment of an expense increases asset.
_____4. Expenses decreases owner’s equity.
_____5. Receipt of cash decreases asset.

EXERCISE 2-3. Show the effects on the accounting equation. Write + for increase, - for
decrease, and NC for No Change.

Asset Liability Capital

1. Owner invested cash in the business
2. Owner borrowed money from the
bank
3. Purchased filing cabinets for cash.
4. Owner purchased a printer on
account
5. Bought truck paying 10% down and
balance on account.
6. Paid account to creditors
38

7. Charged customer for the service

rendered.
8. Collected an account receivable
9. Purchased reams of bond paper in cash
10. Paid utilities for the month
11. Owner withdrew cash for personal use
12. Rendered service for cash

Exercise 2-4

A medical practioner Dr. Nikolai opened his clinic with the following initial transactions:
1. Dr. Niko opened a medical clinic by investing P300,000 pesos.
2. Issued a promissory note for the P100,000 he borrowed from Banco De Uno.
3. Purchased a medical bed and its accessories worth ₱100,000
4. Bought from A Co. a table and cabinet worth ₱70,000.
5. Purchased medical supplies in the amount of ₱25,000 cash.
6. Withdrew ₱20,00 for personal use
7. Purchased chairs on account for ₱15,000.
8. Paid 50% of account to A co.
9. Bought from SM Furniture cabinet shelves worth of ₱20,000. Paid ₱5,000 cash and the
balance on account.
10. Received P75,000 from the group of patients as medical fees.
11. Paid power and water bills for the month, P8,000.
12. Paid medical assistant salary, P20,000.
13. Charged the patients for attending the medical care, P50,000.
14. Paid the balance in full to SM Furniture.
15. Collected 70% of medical fees charged to patients in no.13.
16. Paid communication bills, P3,500.
17. Paid P6,000 to Petron Station for the gasoline of Dr. Nokolai’s service vehicle.
18. Settled a partial payment of P70,000 to Banco De Uno ( refer to item no. 2)
19. Purchased additional medical equipment, P50,000. Terms: Paid P30,000 and the
balance after 30 days.
20. Returned defective medical supplies purchased in no. 5, worth P5,000.
21. By taking inventory at the end of the period, medical supplies consumed amounted to
P18,000.

Required:
1) Analyze and record the transaction using the given tabulation below:

A S S E T S LIABILITIES CAPITAL
Acct. Fur. & Accounts Mortgage Nikolai,
No. Cash Rec’ble Supplies Fixture Equipt. Payable Payable Capital Notations
 39

2) Prepare the following financial reports for the month of January 2020:
a) Income Statement
b) Statement of Owner’s Equity
c) Statement of Financial Position
d) Statement of Cash Flows
40

WRITE YOUR ANSWERS HERE:

 41

WRITE YOUR ANSWERS HERE:

42

WRITE YOUR ANSWERS HERE:

 43

Module 3

RECORDING AND POSTING THE BUSINESS TRANSACTIONS

After studying Module 3, the students should be able to:

1. Learn the 3 basic accounting values or elements

2. Distinguish between tangible assets and intangible assets.
3. State the accounting equation (in two ways) and explain the significance.
4. Know the difference between a debit and a credit.
5. Know the rules of addition and subtracticn by position
6. Know the other accounting values or elements which will affect the owner's equity.
7. Know how to compute the net profit or loss
8. Prepare a chart of accounts
9. Know the correct order of listing of the accounts in the chart of accounts.
10. Learn what, where, how and why business transactions are recorded.
11. Analyze the effects of a transaction in the accounting values.
12. Learn how to record formally in the general journal (journalizing)
13. Learn how to record formally in the general ledger (posting).
14. Learn how to prepare the different kinds of trial balance.

ANALYZING BUSINESS TRANSACTIONS

The source documents are analyzed before recording the transactions in the general journal. The
source documents include check, statement of account, official receipt, payroll, invoice, etc. Analyzing
business transaction is the first step in the accounting process.

The following are illustrated to analyze the business transactions:

Starting a business: On Feb. 1, 2020, Mr. Ramon Tan obtained the funds to start a business by
withdrawing P700,000 from his personal savings account. He deposited the money in a new bank current
account that he opened in the name of his business, RT General Services.

The financial transaction is analyzed as follows:

1. A separate and distinct entity from his personal financial affair is created. This is
an example of Business Entity Concept.

2. As a source document shown in the accounting records, you will find a deposit slip
evidencing the deposit in the current account of RT General Services in the amount
of P700,000 dated Feb. 1, 2020.

3. An economic resource which is Cash is invested in the business entity. The source
of this asset is the contribution made by the owner, which represents the owner’s
equity.

4. The dual nature of the transaction is that cash is invested and owner’s equity is
created. The effects of this transaction on the accounting equation are as follows:
44

increase in asset (Cash) from zero to P700,000 and increase in owner’s equity
from zero to P700,000.

5. At this point, the entity has no liability, and assets equal owner’s equity.
Purchasing Equipment on Account: On Feb 5, 2020, Mr. Ramon Tan bought cleaning machine from
Felix Trading at a cost P50,000. The supplier agreed to allow 60 days for the company to pay the bill.

The financial transaction is analyzed as follows:

1. The entity has established an account with a creditor. An obligation to be paid

within 60 days.

2. As a source document shown in the accounting records, you will find a sales
invoice with a term 60 days issued by Felix Trading.

3. An economic resource which is Machinery is purchased to be used in the business

entity. The source of this asset is the liability provided by the creditor, which
represents the liability.

4. The dual nature of the transaction is that machinery is invested and liability is
created. The effects of this transaction on the accounting equation are as follows:
increase in asset (Machinery) from zero to P50,000 and increase in liability from
zero to P50,000.

5. At this point, the entity has assets of P850,000 equal liability of P50,000 and
owner’s equity of P800,000.
Purchasing Supplies for Cash: On Feb. 10, 2020, Mr. Ramon Tan purchased supplies from Santos
Trading that had a total cost P3,000. He issued a check payable to Santos Trading.

The financial transaction is analyzed as follows:

1. The entity has maintained a checking account to monitor disbursement of funds.

2. As a source document shown in the accounting records, you will find a check
payable to Santos Trading and Official Receipt issued by Santos Trading
evidencing the payment of the supplies purchased.

3. An economic resource which is Supplies is purchased to be used in the business

entity. The source of this asset is another asset (Cash) provided by the owner by
issuing a check to Santos Trading.

4. The dual nature of the transaction is that Supplies is purchased and another asset
which is cash is used in exchange for the other asset. The effects of this
transaction on the accounting equation are as follows: increase in asset (Supplies)
from zero to P3,000 and decrease in another asset (Cash) from P800,000 to
P797,000.
 45

5. At this point, the entity has assets of P850,000 equal liability of P50,000 and
owner’s equity of P800,000.
Payment to a creditor: On Feb 20, 2020, Mr. Ramon Tan paid Santos Trading for the cleaning machinery
purchased on Feb. 5, 2020.

The financial transaction is analyzed as follows:

1. The entity has settled his account with a creditor.

2. As a source document shown in the accounting records, you will find a check
issued in the name of Santos Trading and an Official Receipt issued by Santos
Trading evidencing receipt of payment.

3. There is no economic resource but rather eliminated the liability of the entity. The
payment of the liability provided by the creditor has been paid.

4. The dual nature of the transaction is that machinery is invested and liability is
created. The effects of this transaction on the accounting equation are as follows:
increase in asset (Machinery) from zero to P50,000 and increase in liability from
zero to P50,000.

5. At this point, the entity has assets of P850,000 equal liability of P50,000 and
owner’s equity of P800,000.

THE RECORDING PROCESS

To be able to learn how to record formally the various business transactions in the general journal,
it is necessary to introduce fire the technical accounting terms that will be used and the effects of each
transaction. Familiarization of these terms will be understanding of the manner and procedure of recording.

In this chapter, the focus is on the analysis and recording of transactions of a service business. It
should be emphasized however, that the discussions are based on the assumption that manual
bookkeeping system is used which 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 – there are e 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, cabineis,
chairs, etc.), office equipment (such as calculators, computers, copying machines, fax machine, etc.),
machineries, delivery truck, land, building, among others. Before a property can be considered as an asset,
it is necessary that it has a value and it is owned by the business. Assets are classified as current assets
and non-current assets. Current assets are arranged according to liquidity. Non-current assets are long-
term assets and not intended to be converted to cash for a period of one year.

Examples of current assets are cash, receivables, supplies, prepaid expenses.

46

Examples of non-current assets are office equipment, land, building, truck, machineries.

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. Liabilities are classified as current liabilities
and non-current liabilities. Current liabilities are arranged according to maturity for a period of one year or
less. Non-current liabilities are long-term debts and are to be paid beyond a period of more than one year.

Examples of current liabilities are account payables, interest payable, taxes payable.

Examples of non-current liabilities are notes payable, mortgage payable, bonds payable.

3. Capital (Owner's Equity) - This is the owner's interest or claim 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.

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. 16

Equation 1

ASSETS = LIABILITIES + CAPITAL*

P 500,000 = P200,00 + P300,000

(Creditors' Equity)+ (Owner’s Equity)

*Owner's Equity

The above equation signifies that there are two parties which have financial claim or interest in the
assets of the business. They are the creditors represented by the liabilities and the owner represented by
the capital or owner’s equity

Equation 2

ASSETS – LIABILITIES = CAPITAL

P 500,000 - P 200,000 = P 300,000

The above equation signifies that in the event of liquidation, the creditors have preference over the
assets of the business which means that the claim of the creditors must be satisfied first before there can
be a return of capital of the owner.
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)

DEBIT (DR.) = CREDIT (CR)

Assets = Liabilities + Capital
 47

Based on the above positions of the 3 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 be used. What is a T ACCOUNT? It
is an accounting device that is the changes in the accounting elements. It is called T account because o
will be a convenient tool to analyze and record the effect of a transaction on the different accounting
elements.

Assets Liabilities Owner's Equity

Increase Decrease Decrease Increase Decrease Increase

Examples:

Assets____ Liabilities ___ Owner's Equity____

DR CR DR CR DR CR
P 20,000 P 5,000 P 10,000 P 40,000 P30,000 P100,000
P 15,000 P 30,000 P 70,000

Based on the above examples, the assets have a debit balance of P15,000 (P20,000 - P5,000),
the liabilities have a credit balance of P30,000 (P40,000 - P10 000) and the owner's equity has a balance
of P70,000 (P100,000-P30,000).
.
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 may withdraw money from the business for
personal use. To account for these revenues, expenses, and withdrawals, the following three additional
accounting elements or values will be introduced:

Drawing - is the withdrawal made by the owner is considered as a reduction of capital.

Revenues (Income) – is the 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.

Expenses – is the 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 can be expanded as follows:

REVENUES
48

ASSETS = LIABILITIES + OWNER'S EQUITY EXPENSES

DRAWINGS

Revenues____ Expenses ____ Drawings_____

Decrease Increase Increase Decrease Increase Decrease

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 decreases should be on the opposite side (debit). For
expenses and drawings, because they will decrease the owner's 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).

Examples:

Revenues Expenses ____ Drawings____

DR CR DR CR DR CR
P 11,000 P 22,000 P12,000

Based on the above examples, the revenues have a credit balance of P11,000 which is its normal
position, the expenses have a debit balance of P22,000 which is its normal position and the drawings have
a debit balance of P12,000, which is its normal position. In the journal entry, revenues are always on the
credit side, expenses are always on the debit side and drawings are on the debit side of the accounting
equation.

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 or a title as well as a
code 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 by the bookkeeper.
An example of a chart of accounts of a typical servicing concern is shown below:
 49

Chart of Accounts (Service Business)

100- Assets 400- Revenue

101- Cash 401- Repair Income
102- Accounts Receivable 402- Rental Income
103- Note Receivable 500- Expenses
104- Supplies 501- Office Supplies Expense
105- Furniture & Fixtures 502- Rent Expense
106- Office Equipment 503- Salaries Expense
107- Repair Equipment 504- Insurance Expense
200- Liabilities 505- Advertising Expense
201- Accounts Payable 506- Utilities Expense
202- Note Payable 507- Miscellaneous Expense
203- Loan Payable
204- Mortgage Payable
300- Owner's Equity
301- C. Cruz, Capital
302- C. Cruz, Drawing

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 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 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?

The transactions are recorded in the Book of Accounts, 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 transactions are first 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 two kinds of journals: the general journal and the special
journals.

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.
50

. It will be noted that all the business transactions are recorded first in the journal and the second is
the posting in the general ledger.

Sample of a General Journal Book

Shown below is how every page of the conventional general journal book looks like.
Page No.
Date Particular P/R DR CR

Sample of a General Ledger

Shown below is how every page of the conventional general ledger book looks like.

Account Name Account No.

Date Item P/R DR CR BALANCE

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 in a 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 recordin g 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.

To illustrate:
 51

NORMAL BUSINESS TRANSACTIONS

DEBIT (DR.) CREDIT (CR.)
Value/s received Value/s given up
Transactions or paid for or source

1. Mr. Cruz invested P 200,000 to Cash C. Cruz, Capital

start an auto repair business. (value received) (source)

2. C. Cruz invested his computer costing Office Equipment C. Cruz, Capital

P 14,000 in the business. (value received) (source)

3. Bought supplies from ABC Trading Office Supplies Cash

Company for cash, P 20,000. (value received) (value given up)

4. Bought tables and chairs from Furniture & Fixtures Accounts Payable
Fix Furniture Co. on credit, P 12,000 (value received) (in lieu of cash)

5. Issued a promissory note for Repair Equipment Note Payable

repair equipment bought, P 45,000. (value received) (in lieu of cash)

6. Borrowed money from the bank, Cash Loan Payable

P 35.000. (value received) (source)

7. Received cash for repair service Cash Repair Income

rendered, P40.000. (value received) (source)

8. Billed Mr. Tan, a customer Accounts Receivable Repair Income

for repair service rendered, P 3,600. (right to collect (source)
in lieu of cash)

9. Received a promissory note, P 4,000 Note Receivable Repair Income

for repair service rendered. (value received in (source)
lieu of cash)

10. Bought office supplies Office Supplies Cash

for cash, P800. (value paid for) (value given up)

11. Paid rent for the office space. P 3,000. Rent Expense Cash
(value paid for) (value given up)

12. Paid the salaries of the employees Salaries Expense Cash

P 12,000. (value paid for) (value given up)

13. A portion of the office space is being Cash Rental Income

sub-leased to a tenant and received (value received) (source)
P 500 as payment of the rental.

14. The owner withdrew cash for his C. Cruz, Drawing Cash
personal use, P 2,500. (value paid for) (value given up)

15. Paid FIX Furniture partially, Accounts Payable Cash

P6,000 (see transaction 4). (value paid for) (value given up)

16. Paid the promissory note Note Payable Cash

(see transaction 5). (value paid for) (value given up)
52

17. Paid the loan in full Loan Payable Cash

(see transaction 6). (value paid for) (value given up)

18. Collected partially the account Cash Account Receivable

of Mr. Tan P 2,000. (value received) (source)
(see transaction 8).

Example of Journal Entries

Jan 1 – Bought supplies on account, P10,000

Supplies 10,000
Accounts payable 10,000
Purchased supplies on account.

1 – Paid rent for the months, P3,000.

Rent Expense 3,000

Cash 3,000
Paid rent.

2 – Returned P2,000 defective supplies

Accounts Payable 2,000

Supplies 2,000
Returned supplies.

5 – Made a partial payment on the purchased supplies, P3,000

Accounts Payable 3,000

Cash 3,000
Paid supplies purchased on account.

11 – Paid supplies in full.

Accounts Payable 5,000

Cash 5,000
Paid in full.

14 – Bought equipment on cash

Equipment 9,000
Cash 9,000
Purchased equipment.

15- Bought equipment on account, P20,000

Equipment 17,000
Accounts Payable 17,000
Purchased equipment on account.
 53

The journal entries are recorded in the General Journal. The first column is the Date,
followed by the particulars, posting reference, Debit Column and Credit Column. The first row
after the Date is to put the Year then the Month and Date. The Month is to be written once while
the date is to be written in every transaction. The month will be written upon the start of
another page or start of another month.

Example of Journal Entries written in a General Journal.

EXAMPLE 2

JAN

7 – Bought tables and chairs on account, P 40,000

54

Furniture & fixtures 40,000

Accounts payable 40,000
Purchased furniture on account.

7- Paid Meralco bills for the month, P 2,000

Utilities expense 2,000

Cash 2,000
Paid utility bill.

8- Returned P 3,000 worth of defective tables

Accounts payable 3,000

Furniture and fixtures 3,000
Returned defective furniture.

10 – Made a partial payment on the purchased table and chairs, P 20,000

Accounts payable 20,000

Cash 20,000
Paid furniture purchased on account.

17- Paid the tables and chairs in full

Accounts payable 17,000

Cash 17,000
Paid in full.

Example of a Ledger

Example of a Trial Balance

 55

Name of the Company

Trial Balance
Date

Account Title P/R DR CR

Cash 189,000
Accounts receivable 7,000
Computer Supplies 40,000
Computer equipment 100,000
Accounts Payable 50,000
Notes Payable 50,000
Lopez, Capital 300,000
Lopez, Drawing 25,000
Service Income 9,000
Salaries Expense 20,000
Rent Expense 5,000
Supplies Expense 3,000
Miscellaneous Expenses 20,000
Total 409.000 409,000

EXERCISE 3-1

INSTRUCTION: Listed here are series of accounts that are numbered for identification letters of
the accounts affected by the transactions described. The same account may be used in several
answers.

COLUMN I
NOS. TRANSACTIONS DEBIT CREDIT

1. The owner invested cash in the business. ______ ______

2. Paid rent for three months. ______ ______
3. Purchased supplies on account. ______ ______
4. Purchased three years insurance policy. ______ ______
5. Rendered services on cash basis. ______ ______
6. Purchased equipment for cash. ______ ______
56

7. Paid salaries of employees. ______ ______

8. Rendered services on credit. ______ ______
9. Paid creditors on account. ______ ______
10. Paid advertising expense to manila inquirer. ______ ______
11. The owner withdrew cash for personal use. ______ ______
12. Collected cash from customers on account. ______ ______
13. Paid the note to the bank. ______ ______
14. Paid telephone and electric bill. ______ ______
15. Paid miscellaneous expenses for the month. ______ ______

COLUMN II

A. Capital J. Accounts Payable

B. Cash K. Accounts Receivable
C. Equipment L. Notes Payable
D. Salary Expense M. Advertising Expense
E. Service income N. Salaries Payable
F. Rent Expense O. Utilities Expense
G. Supplies P. Misc. Expense
H. Prepaid Insurance Q. Taxes Expense
I. Prepaid Interest R. Drawing

EXERCISE 3-2

INSTRUCTION: For each of the transactions below fill in the spaces to answer the questions.

a. Received P450,000 cash from clients for services rendered.

b. Paid P58,000 for salaries of employees.
c. Collected P90,000 from clients on account.
d. Billed clients P20,000 for services rendered.
e. Paid insurance expense for the year P6,000
f. The owner Cora Daza, a sole proprietorship, invested cash in business, P1,000,000.
g. Purchased P10,000 of supplies on account
h. Paid P30,000 to suppliers on account.
i. Paid rent for the month, P25,000.
 57

ACCOUNTS TYPE OF INCREASE OR

NOS. DEBIT/CREDIT
AFFECTED ACCOUNT DECREASE
a. 1.
2.
b. 1.
2.
c. 1.
2.
d. 1.
2.
e. 1.
2.
f. 1.
2.
g. 1.
2.
h. 1.
2.
i. 1.
2.

PROBLEM 3-1 JOURNALIZATION

INSTRUCTION: The following are the transactions of WINSTON ENTERPRISES during its first
month of operations.

2020
January

2. Michael Winston invested P50,000 cash in the business.

4. Paid municipal taxes and licenses, P550
7. Bought supplies P6,000 cash basis.
8. Purchased furniture and fixture from Rhea Trading for P12,500
Terms: 10% down, balance on account.
9. Paid rent P45,000 in advance for three months.
10. Receipts for the week from various services rendered amounted to P18,000
15. Billed a customer the amount of P6,000 for services rendered.
16. Paid Rhea Trading Company in full.
18. Paid salaries of employees, P46,000.
20. Purchased equipment on account P14,000.
58

25. Paid miscellaneous expense, P2,400.

27. Michael Winston withdrew cash for personal use, P7,000.
29. Paid light telephone and water for the month, P12,600
31. Paid the salaries for the second half of the month, P38,000.

INSTRUCTIONS:

1. Analyze and journalize the above transactions

2. Use the following account titles;

Cash
Accounts Receivable
Supplies
Furniture & Fixtures
Equipment
Accounts Payable
Winston, Capital
Winston Drawing
Service Revenue
Rent Expense
Taxes and Licenses
Salary Expense
Utilities Expense
Miscellaneous Expense

PROBLEM 3-2
On February 2020, Marlon Balista started his medical services in practice. During the
month the following transactions were completed:

FEBRUARY
1. Mr. Balista invested P150,000 in a new bank account in the name of Marlon Balista, M.D.
3. Purchased medical equipment costing P62.000, paying P20,000 cash and the balance on
notes payable.
4. Bought medical supplies for cash, P12,000.
7. Paid rent for the month, P6,000.
8. Received P15,000 for medical services rendered.
10. Acquired table & chairs on account, P8,500
13. Billed medical services to a client, P34,000
15. Paid salaries to employees, P26,400
17. Paid another doctor for preparing laboratory services on a patient, P3,000
20. Paid creditors on account, P2,500
22. Paid insurance premium for the quarter, P4,700.
23. Paid miscellaneous expenses, P2,200.
 59

25. Received P34,000 from patient on account.

27. Paid salaries of medical technician and other employees, P58,50
28. Received cash from cash patients, P68,500

INSTRUCTIONS:
1. Prepare jojunal entries on the above transactions.
2. Post the entries to the ledger. Use the following account titles given: Cash, 11; Accounts
receivable, 12; Medical supplies, 13; Medical equipment, 14; Furniture & Fixtures, 15;
Notes payable, 21; accounts payable, 22;Balista, Capital, 31, Balista, Drawing, 32;
Medical revenues, 41; Salary expense, 51; Rent expense, 52; Laboratory expense, 53;
Utilities Expense, 54; Insurance expense, 55; and Miscellaneous expense, 58.
3. Prepare a TRIAL BALANCE for the month.

Name: __________________________________________________
Date:_______________________
Professor:________________________________________________

QUIZ 1

Test I. Write the letter of your choice corresponding to the effects of the following business transactions:

a. Increase in assets and increase in capital

b. Increase in assets and increase in liabilities
c. Increase in one asset and decrease in another assets.
d. Decrease in assets and decrease in capital
e. Decrease in assets and decrease in liabilities
f. Decrease in capital and increase in liabilities

1. The owner invested cash into the business.

2. Purchased supplies on account.
3. Paid office rent for the month.
60

4. Rendered service on account.

5. Borrowed funds from the bank.
6. Paid suppliers for the supplies purchased on account.
7. Withdrawn cash for personal use.
8. Paid bank loan.
9. Collected cash from customer on account.
10. Received bill from MERALCO due next month.
11. Purchased office equipment for cash.
12. Purchased delivery truck on installment basis.
13. Paid salaries of the employees.
14. Additional investment made by the owner.
15. Incurred advertising expense to be paid next month.
16. Paid the utility bill incurred last month.
17. Received cash for the services rendered from cash customer.
18. Purchased supplies for cash
19. Paid advertising expense incurred last month.
20. Returned defective supplies purchased on account.

Test II. Problem Solving. The bookkeeper of MMK Service Company owned and operated by Aren Ting,
extracted the following debit and credit balances from the general ledger on December 31, 2016, the end
of the accounting period.

DEBITS
Cash P 12,800
Note Receivable 1,650
Accounts Receivable 21,600
Tools 10,000
Furniture & Fixtures 21,840
Office Equipment 38,900
Delivery Van 120,000
Photocopying Machine 50,000
Note Payable 3,400
Accounts Payable 4,000
A. Ting, Drawing 25,000
Salaries Expense 34,800
Utilities Expense 12,660
Rent Expense 18,000
Insurance Expense 16,000
 61

Advertising Expense 20,000

Repairs & Maintenance Expense 11,000
Miscellaneous Expense 9,410
Interest Expense 128

CREDITS
Cash P 6,410
Note Receivable 650
Accounts Receivable 11,450
Note Payable 6,400
Accounts Payable 18,000
Loan Payable 20,000
A. Ting, Capital ?
Service Income 233,398
Rental income 12,000
Interest Income 20

REQUIRED: Prepare the trial balance as of December 31, 2016. The accounts must be
arranged in their proper order.

Test III. Problem Solving. The bookkeeper of Mr. Go, accounting the following balances from the general
ledger on December 31, 2019, the end of the accounting period.

REQUIRED: Prepare a trial balance in good form.

62

Name: __________________________________________________
Date:_______________________
Professor:________________________________________________

QUIZ 1
 63

Test II. The following business transactions of JIT CONSULTANCY SERVICE owned by Atty. Art Nabong
during the month of June, 2020 were presented below:

1 Transferred P500,000 from his personal savings account to a checking account opened in the name of
his company.
2 Paid cash of P15,000 to Aries Rentals for rent of office space.
3 The business uses rent expense account for the rent.
5 Purchased the law books for office library for P30,000 from National
7 Book Store paying cash of P15,000, signed a promissory note of P10,000 and the balance on
account
9 Purchased office supplies from National Book Store for cash, P1,500
10 Purchase office equipment from Nick Furniture, P25,000, paying cash of P5,000 and the balance on
terms for 30 days.
11 Completed legal and consultancy services for Abraham Company on credit, P65,000
13 Received cash of P35,000 from Philippine Lawyers Association for the legal services completed.
15 Purchased office machinery from Office Machine Factory on credit, P25,000
18 Paid for the law books purchased from National Book Store, P5,000.
20 Received cash of P10,000 to apply on account from Abraham Co.
22 Cash of P15,000 was received from Burnham Company for legal work completed.
23 Paid for the salaries and wages of office staff, P19,500.
28 Paid the two months rent in advance to Aries Rentals.
29 Atty. Nabong took P5,000 cash for personal expenses.
30 Billed A. Reyes for legal services rendered, P10,000.

Use the following chart of account:

100 Cash
64

101 Notes receivable

102 Accounts receivable
103 Office supplies
104 Law Library
105 Office Machinery
106 Office Equipment
200 Accounts payable
201 Notes payable
300 A. Nabong, Capital
301 A. Nabong, Drawing
400 Legal and Consultancy Income
500 Rent expense
501 Salaries and wages expense
502 Supplies expense
503 Taxes expense

Required: 1. Journalize the above transactions.

2. Post the journal entries in the general ledger.
3. Present a trial balance for the period ended June 30, 2020.
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WRITE YOUR ANSWERS HERE:

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WRITE YOUR ANSWERS HERE:

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WRITE YOUR ANSWERS HERE:

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Module 4

ADJUSTING ENTRIES

The Need for Adjusting Entries

After the trial balance is completed, normally the financial statements cannot be prepared
yet. The reason is there are still some transactions of the business that are not yet recorded.
These transactions have to be recorded first in order to bring all the accounts up to date at the
end of the accounting period. The entries to record these transactions are called adjusting
entries.
All adjusting entries affect at least one income statement account and one balance sheet account.
Thus, an adjusting entry will always involve a revenue or an expense and an asset or a liability
account.

The entity’s life can be meaningfully subdivided into equal time periods for reporting
purposes. An accounting period can be monthly, quarterly, semi-annually or annually. This is
called the periodicity principle.
Applying this concept, a business adjusts and closes its books at the end of an accounting period
and then prepares the various financial statements at the end of each period. The most basic
accounting period is one year.

OBJECTIVES:

At the end of the lesson:

• the student will be able to differentiate cash basis and accrual basis of accounting; and
• the student will be able to recognize the different types of adjustments prepared at the end of
the accounting period.

Cash and Accrual Basis of Accounting

As mentioned earlier, the cash basis recognizes revenues and expenses only when they
are received and paid, respectively whereas the accrual basis recognizes revenues when earned
and expenses when incurred, regardless of when collected or paid.

Generally accepted accounting principles require that a business use the accrual basis of
accounting.

Types of Adjusting Entries

 Accrued Expenses – These are expenses incurred in one period but remain unrecorded and
unpaid as of the end of the period. They are also called accrued liabilities or unrecorded
expenses.

The pro-forma adjustment is:

Expense account xxxx

Liability account xxxx
70

For example: A company’s accounting period is monthly, January 1-31, 2019. All
expenses incurred during the month of January must be recorded in January. Let us say, taxes
for the month of January amounting to P 5,000 will be paid on February 5, 2019, the adjusting
entry will be:

2019
Jan 31 Taxes Expense 5,000

Taxes Payable 5,000

So, since we are using the accrual basis of accounting, the question is when did the
company incur the expense? The answer of course is for the month of January, therefore we will
record the expense in January. And since this will still be paid in February, we will record a liability
in January.

Another example is, assume a small business is paying a total of P 10,000 for the salaries
of its employees for a 5-day work week. Payday is every Friday. Accounting period is monthly.
The Salaries Expense during the month of March is shown below:
Salaries Expense
Mar. 5 10,000
12 10,000
19 10,000
26 10,000

40,000

If March 26 is a Friday, then the last day of the month (March 31) falls on a Wednesday.
Therefore the adjusting entry to be made will be:

Mar. 31 Salaries Expense 6,000

Salaries Payable 6,000

If financial statements are prepared on March 31, the Salaries Expense to be shown in
the statement of comprehensive income totaled P 46,000 and the statement of financial position
will show Salaries Payable amounting to P 6,000.

 Accrued Revenues – These are revenues earned in one period but remain unrecorded and
not received as of the end of the period. They are also called accrued assets or unrecorded
revenues.

The pro-forma adjustment is:

Asset account xxxx

Revenue account xxxx

For example: ABC Company’s accounting period is monthly, August 1-31, 2019. All
revenues earned during the month of August must be recorded in August. If the company is in
 71

the business of renting apartments and one of its tenants has not paid the August rent for P 8,000,
then the adjusting entry of ABC Company will be:

2019
Aug. 31 Rent Receivable 8,000

Rent Revenue 8,000

 Prepaid Expenses – These are expenses paid by the business in advance; or these are
expenses already paid in cash by the business but the expenses are not yet incurred or only
a portion of the amount paid was used up as expense. Prepaid expenses are also termed as
deferred expenses.

There are two methods of accounting for prepaid expenses:

1. Asset method – if at the date of payment, the business debited an asset account,
say Prepaid Rent and credited Cash.

The pro-forma adjustment is:

Expense Account used or expense

Asset Account portion

2. Expense method – if at the date of payment, the business debited an expense

account, say Rent Expense and credited Cash.

The pro-forma adjustment is:

Asset Account unused or asset

Expense Account portion

To illustrate, assume that XYZ Company is using a monthly accounting period. On

January 1, 2019, the company paid P 45,000 representing 3-month rent beginning January 1,
2019. The company adjusts and closes its books every month. The entry to record the
prepayment and the adjusting entry at the end of the month will be:

Asset Method Expense Method

2019
Jan 1 Prepaid Rent 45,000 Rent Expense 45,000
Cash 45,000 Cash 45,000

2019
Jan 31 Rent Expense 15,000 Prepaid Rent 30,000
Prepaid 15,000 Rent Expense 30,000
Rent
72

Since P 45,000 is for 3 months, the monthly rent is P 15,000. For January, the used or
expense portion is one month or P 15,000; therefore the unused or asset portion will be two
months or P 30,000 as of January 31.

The effects of these entries are shown in the following T-accounts:

Asset Method

Prepaid Rent Rent Expense

2019 2019 2019
Jan. 1 Jan. 31 Jan. 31 15,000
45,000 15,000

30,000

Expense Method

Rent Expense Prepaid Rent

2019 2019 2019
Jan. 1 Jan. 31 Jan. 31 30,000
45,000 30,000

15,000

Regardless of which method a business used in any particular case, the amount reported
as expense in the statement of comprehensive income and the amount reported as asset in the
statement of financial position will be the same.

Both methods of accounting for prepayment are acceptable although most companies
employ the expense method due to its simplicity. A business must also use a method consistently
for a particular type of prepayment, say asset method for rent while expense method for supplies.

 Unearned Revenues – These are revenues collected or received by the business in advance;
or these are revenues already collected in cash by the business but the revenues are not yet
earned or only a portion of the amount received was earned or became revenue. Unearned
revenues are also termed as deferred revenues.

There are two methods of accounting for unearned revenues:

1. Liability method – if at the date of collection, the business credited a liability account,
say Unearned Rent and debited Cash.

The pro-forma adjustment is:

Liability Account earned or income

Revenue Account portion
 73

2. Revenue method – if at the date of collection, the business credited a revenue

account, say Rent Revenue and debited Cash.

The pro-forma adjustment is:

Revenue Account unearned or liability

Liability Account portion

To illustrate, assume that ABC Company is using a monthly accounting period. On

October 1, 2019, the company collected or received P 30,000 representing 3-month rent
beginning October 1, 2016. The company adjusts and closes its books every month. The entry
to record the advance collection and the adjusting entry at the end of the month will be:

Liability Method Revenue Method

2019
Oct 1 Cash 30,000 Cash 30,000
Unearned 30,000 Rent Income 30,000
Rent

2019
Oct Unearned Rent 10,000 Rent Income 20,000
31
Rent Income 10,000 Unearned Rent 20,000

Since P 30,000 is for 3 months, the monthly rent is P 10,000. For October, the earned or
income portion is one month or P 10,000; therefore the unearned or liability portion will be two
months or P 20,000 as of October 31.

The effects of these entries are shown in the following T-accounts:

Liability Method

Unearned Rent Rent Income

2019 2019 2019
Oct 31 Oct. 1 Oct. 31
10,000 30,000 10,000

20,000

Revenue Method

Rent Income Unearned Rent

2019 2019 2019
74

Oct. 31 Oct. 1 Oct. 31

20,000 30,000 20,000

10,000

Regardless of which method a business used in any particular case, the amount reported
as income in the statement of comprehensive income and the amount reported as liability in the
statement of financial position will be the same.

Both methods of accounting for unearned or deferred revenues are acceptable although
most companies employ the revenue or income method due to its simplicity. A business must
also use a method consistently for a particular type of unearned or deferred revenue, say liability
method for rent while income or revenue method for subscription.

 Depreciation of Property, Plant and Equipment

Physical resources that are owned and used by a business which are permanent in nature
or have a long useful life are called property plant and equipment. They are also called fixed
assets or plant assets. Examples are land, building, equipment, trucks, automobiles, a computer,
store fixtures, or office furniture. These assets help generate income for the business. It is
important and proper that a portion of the asset be recorded as expense in each accounting
period.

Property, plant and equipment are recorded at their acquisition cost, which comprises:

a. The purchase price;

b. Freight, insurance, installation and other related expenses in bringing the

assets for use; and

c. The initial estimate of the costs of dismantling and removing the item at the end
of its useful life.

Fixed assets, with the exception of land have limited useful lives and as such are subject
to depreciation.

Depreciation is the systematic allocation of the cost of the fixed asset over its useful life.
Depreciation is not a process of asset valuation.

There are three factors to be considered in computing depreciation:

 Cost of the asset.

 Residual value, or the estimated amount that the fixed asset can be sold at the
end of its useful life. Other terms used are salvage value, scrap value or trade-in
value.

 Useful life or the estimated number of years or number of units or hours that the
asset can be used during its life.
 75

The pro-forma adjustment for depreciation is:

Depreciation Expense – Name of asset xxx

Accumulated Depreciation – Name of asset xxx

There are different methods of computing depreciation. We will discuss here only
the simplest and the most commonly used method which is the straight-line method. This method
will result into equal periodic charges for depreciation. Also take note that in the adjusting entry
for depreciation the account credited is the account Accumulated Depreciation. This is a contra-
asset account which will be deducted from the related fixed asset account in the balance sheet.
The credit is not made directly to the fixed asset account in order to preserve the original cost of
the fixed asset in the balance sheet.

To illustrate, assume that on January 1, 2019, Jug Company bought a delivery truck for a
total cost of P 500,000. Its estimated life is 10 years and the estimated residual value is P
50,000. The company is using the straight-line method of computing depreciation and it is using
an annual accounting period. The entries of Jug Company for the above transactions are:

2019
Jan 1 Delivery Truck 500,000
Cash 500,000
To record the purchase of delivery truck.

The adjusting entry on December 31, 2019:

2019
Dec 31 Depreciation Expense-Delivery Truck 45,000
Accumulated Depreciation-Delivery Truck 45,000

Computations will be:

Annual depreciation = Cost – Residual Value

Estimated Life

= P 500,000 – 50,000
10

= P 45,000
=======

Other computation for straight-line method is:

Annual depreciation = (Cost – Residual Value) x

76

Depreciation rate

= (P 500,000 – 50,000) x 10%

= P 45,000
=======

The depreciation rate can be computed by getting the reciprocal of the life. Example: 10
years is equal to 1/10 or 10%.

The balance of the Depreciation Expense account is shown in the statement of

comprehensive income. In the statement of financial position as of December 31, 2019, the
carrying amount or the book value of the asset is P 455,000, as shown below:

Delivery Truck P
500,000
Less Accumulated Depreciation 45,000

Carrying amount or Book value P

455,000

The depreciation of the fixed asset will be recorded at the end of each year (for ten years).
The same adjusting entry will be recorded for 10 years. Assuming a statement will be made on
December 31, 2025:

Delivery Truck P
500,000
Less Accumulated Depreciation 270,000

Carrying amount or Book value P

230,000

At the end of ten years, the Accumulated Depreciation account will have a balance of P
450,000. At this point, the book value of the asset will be equal to the residual value of P 50,000.

The other types of adjustments, bad debts and merchandise inventory, will be taken up in
the discussion of merchandising business.

EXERCISES
 77

Exercise 4-1

Quick Company paid P 25,920 premium on a three-year insurance policy on September 1, 2019.
The effectivity of the policy begins on September 1, 2019.

1. Assuming the cash basis of accounting, how much of the premium will appear as
an expense on the annual statement of comprehensive income for year 2019?
For 2020? For 2021? For 2022?

2. Assuming the cash basis, how much of the premium will appear as an asset on
each December 31 statement of financial position for the year 2019? For 2020?
For 2021? For 2022?

3. Assuming the accrual basis of accounting, how much of the premium will appear
as an expense on the annual statement of comprehensive income for the year
2019? For 2020? For 2021? For 2022?

4. Assuming the accrual basis, how much of the premium will appear as an asset
on each December 31 statement of financial position for the year 2016? For
2017? For 2018? For 2019?

Use the following table. Use the space provided for the supporting computations in good form.

2019 2020 2021 2022

1.

2.

3.

4.

Exercise 4- 2

Determine the amounts indicated by question marks in the columns below. Consider each column
a separate problem. Make the adjusting entry for column (a) assuming supplies purchased are
debited to an asset account.

(a) (b) (c) (d)

Supplies on hand, August 1 P 264 P 434 P 196 ?

Supplies purchased during the month 52 ? 174 1,928
Supplies consumed during the month 194 972 ? 1,632
Supplies remaining on August 31 ? 436 56 1,188

Exercise 4-3
78

Classify the following items as (a) deferred expense (prepaid expense), (b) deferred revenue
(unearned revenue), (c) accrued expense ( accrued liability), or (d) accrued revenue (accrued
asset). Use CAPITAL LETTERS.

____________ 1. A two-year premium paid on a fire insurance policy

____________ 2. Electric bill owed but not yet paid

____________ 3. Office Supplies on hand

____________ 4. Wages owed but not yet paid

____________ 5. Telephone bill owed but payable in the following period

____________ 6. Subscriptions collected in advance by a newspaper publisher

____________ 7. Service Revenue collected but not yet earned

____________ 8. Service Revenue already earned but not yet received

____________ 9. Interest paid in advance from a bank loan

____________ 10. Rent received in advance

____________ 11. Services rendered but not yet collected

____________ 12. Advertising contract paid in advance for one year

____________ 13. Income collected but not yet earned

____________ 14. Rent paid in advance

____________ 15. Interest collected in advance by the creditor

Exercise 4-4

The Supplies and Supplies Expense accounts at December 31, after adjusting entries have been
posted at the end of the first year of operations, are shown in the T-accounts below:

Supplies Supplies Expense

Bal. 2,090 Bal. 9,715

Determine the amount of supplies purchased during the year. ____________

Exercise 4-5
 79

At the end of the current year, P 21,780 of fees had been earned but had not been billed to clients.

a. Journalize the adjusting entry to record the accrued fees.

Post
Date Description Ref. Debit Credit

b. If the cash basis rather than the accrual basis had been used, would an adjusting
entry have been necessary? Explain.

Exercise 4-7

Prepare the adjusting entries on December 31, 2019, the end of the annual accounting period, on
the following independent data. Show your computations after each entry.

1. The Insurance Expense account had a debit balance on December 31, 2019 of
P 36,000 representing premium for a 2-year fire insurance policy effective
October 1, 2019.

2. Rent Income was credited for P 18,000 on November 1, 2019 representing nine
months rent collected in advance.

3. Equipment per general ledger on December 31, 2019 shows a balance of P

372,000. Equipment acquired during the year was P 52,000 on April 1, 2019. All
equipment is to be depreciated at the rate of 25% per annum.

4. As of December 31, 2019, commissions already earned but not yet collected
amounted to P 48,000.

5. Office Supplies costing P 9,000 bought during the period was debited to the Office
Supplies account. Of the amount, P 5,000 were consumed during the year.

6. Unearned Service Fees account showed a credit balance of P 80,000 per general
ledger on December 31. Of this, 40% had been actually earned during the period.

7. On December 31, 2019 a 90-day, 9% Notes Payable has a balance of P 120,000

per general ledger. The note was issued on December 5, 2019. No interest has
been taken on this note.

8. Unearned service revenue has a balance of P 400,000 of which 60% has been
earned.

9. Notes Receivable has a balance of P 100,000 received from a client in settlement

of an open account on November 16, 2019. The note is a 90-day, 12% note. No
interest has been taken on this note.

10. The Prepaid Insurance account has balance of P 210,000 on December 31, 2019.
The balance represented two fire insurance policies acquired during 2019. The
80

first policy, Policy I for P 120,000 was acquired on March 1, 2019 and the
second policy, Policy II was acquired on August 1, 2019 for P 90,000. Policy I is
payment for a 2-year plan while Policy II is for a one-year plan.

EXERCISE 4-8 Classification of Adjusting Entries

INSTRUCTION: Classify the following transaction as:

a. Accrued revenue c. Prepaid expenses

b. Accrued expense d. Unearned revenue

1. Interest paid in advance at the time the note was discounted at the bank.
2. Property taxes paid in advance.
3. Commission income received in advance.
4. Rent received in advance in property owned.
5. Life insurance premiums received by an Insurance company.
6. Supplies on hand.
7. Unpaid salaries to employees.
8. Portion of fee earned by CPA but not due until completion of an audit.
9. Interest earned but not yet received.
10. Taxes owed but payable in the following month.
11. Subscription collected in advance by a publisher.
12. Receipts from sale of meal tickets by a restaurant.
13. Interest owed but not yet due.
14. A three-year premium paid on fire insurance policy.
15. Salary owed but not yet due.
16. Uncollected service income.
17. Accrued interest on notes payable.
18. Paid advertising expenses for the quarter.
19. Collected two months deposit and one month advance on rental of apartment.
20. Unrecorded interest on notes receivable.
EXERCISE 4-9 Preparation of Adjusting Entries
INSTRUCTION: Only one-half of each adjusting entry has been shown in a journal form.
Complete the journal entry.
 81

2020
Nov.
1. Interest Income is credited.
2. Doubtful account expense is debited.
3. Commission income is debited.
4. Accumulated depreciation is credited.
5. Utilities expense is debited.
6. Service income is credited.
7. Prepaid rent is credited.
8. Rent receivable is debited.
9. Office supplies are debited.
10. Allowance for doubtful accounts is debited.
11. Salaries payable is credited.
12. Unearned rent is debited.
13. Depreciation expense is debited.
14. Wages expense is debited.
15. Prepaid insurance is credited.
16. Interest expense is debited.
17. Interest receivable is debited.
18. Unearned commission is credited.
19. Rent expense is credited.
20. Unearned interest is credited.

PROBLEM 4-1. INSTRUCTION: 1. Prepare the necessary adjusting entries on December

31, 2020.
82

DOMINIC DE MESA MERCHANDISING follows the policy of recording

prepayments in REVENUE and EXPENSE accounts and reverses appropriate adjusting entries
at the beginning of the new accounting period. The records of the business show the following:

A. On Sept. 1, 2020, De Mesa borrowed P 200,000 cash from PNB by issuing a 14%
notes payable due in one year. The interest is payable upon maturity of the note.
B. De Mesa purchased a three-year insurance policy for P 90,000 on July 31, 2020.
C. On September 1, 2020, De Mesa paid P 60,000 representing rental for twelve months
beginning on this date.
D. Office supplies on hand on March 1, 2020, amounted to P 900. During the year, office
supplies of P 2,200 were purchased. On December 31, there are unused supplies of
P 1,800.
E. De Mesa pays all employees every Friday. The total payroll for a five-day workweek
ending on January 2, 2021 is P40,000.
F. De Mesa purchased an office equipment on Sept 1, 2020, for P45,000. On January
1, 2020, the office equipment has a balance of P20, 000. All assets of the company
have estimated useful life of 10 years with no salvage value.
G. Dominic reports accounts receivable of P 400,000 and Allowance for doubtful
accounts of P 1,000 (debit balance); 3% of the receivables are estimated to be
uncollectible.

PROBLEM 4-2 Preparation of adjusting entries

INSTRUCTIONS: 1. Prepare adjusting entries on December 31, 2020 on the following

 83

transactions.
2. Show computation as your explanation.

The following information has been made available in connection with the closing
of the books of Minda Enterprises as of December 31 are as follows:

a. Salaries already due but not yet paid as of December 31, amounted to P 9,500.
b. The rent income has a balance of P 6,800. Of this amount, P 1,500 has already been
earned as of December 31.
c. The insurance expense account amounted to P 6,000. Of this amount, P 2,000
expired as of December 31.
d. The Subscription Income has a balance of P 9,800. Of this amount P 5,000 has
already been earned as of December 31.
e. Interest earned but not yet collected on notes receivable outstanding, p 2,400.
f. Interest due on notes payable outstanding, P 4,600.
g. Interest paid in advance on a bank loan was debited to interest expense account,
P980. The loan will run for a period of 90-day starting from December 1.
h. Interest collected and credited to interest income P 1,400. This represents interest for
a 45-day period effective December 18.
i. Store supplies debited to Store supplies expense, P 6,600. As of
December 31, P 2,250 store supplies are still unused.
j. Accounts receivable of P250,000 is only 94% is collectible.
k. Building of P300,000 have an estimated useful life of 20 years with scrap value of
P50,000 and was acquired on Jan 1.
84

WRITE YOUR ANSWERS HERE:

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WRITE YOUR ANSWERS HERE:

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WRITE YOUR ANSWERS HERE:

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Module 5

COMPLETING THE ACCOUNTING CYCLE OF A SERVICE BUSINESS

OVERVIEW

The completion of the accounting cycle of a service concern starts with the preparation of
a worksheet. This worksheet is used each time financial statements are prepared, either
monthly, quarterly, semi-annually, or annually. It is a columnar sheet of paper used to
facilitate the analysis of the effects of adjusting and closing entries on the general ledger
accounts. It is a tool by accountants to facilitate preparation of the financial statements
and is not part of the formal accounting record.

This module illustrates a ten-column work sheet that includes columns for trial balance,
adjustments, adjusted trial balance, income statement, and balance sheets. Each sheet of
the columns has a debit or credit column.

MODULE OBJECTIVES

After reading this chapter, the students should be able to:

a.) Enumerate the steps in the Accounting cycle.

b.) Prepare financial statements from the worksheet.
c.) Journalize and post adjusting and closing entries.
d.) Prepare post-closing trial balance and reversing entries.

COURSE MATERIALS

THE ACCOUNTING CYCLE

The accounting cycle is a series of steps accountants perform during an accounting

period relating to analyzing, recording, classifying, summarizing and reporting useful
financial information. Its purpose is to generate the financial statements.

The steps in the accounting cycle are:

1. The transactions are analyzed by examining source documents.

2. The transactions are journalized.
3. The journal entries are posted to the ledger.
4. A trial balance is prepared.
5. The data needed to adjust the accounts are assembled.
6. The work sheet is prepared.
7. The financial statement is prepared
8. The adjusting entries are journalized and posted to the ledger
9. The closing entries are journalized and posted to the ledger
88

10. A post-closing trial balance is prepared.

11. The reversing entries are journalized and posted to the ledger

The first three steps comprise the recording phase of accounting. The summarizing phase
starts with the preparation of the trial balance up to the closing trial balance. The last step
is performed at the beginning of the new accounting period.

WORKSHEET

A worksheet is a columnar sheet of paper used to summarize information such as

adjusting and closing entries to facilitate preparation of the financial statements.

The steps in the preparation of the work sheet are as follows:

1. Enter the title and balances of ledger accounts in the trial balance columns.

2. Enter the adjustments in the adjustment column. Identify each adjustment with
letter.
3. Enter adjusted account balance in the adjusted trial balance columns.

4. Extend adjusted balances of revenue and expense accounts from the adjusted trial
balance columns to the income statement columns.

5. Extend adjusted balances of assets, liabilities and owner’s equity accounts from
the adjusted trial balance columns to the balance sheet column.

6. Determine the total of the income statement and the balance sheet columns. Enter
the net income or net loss as a balancing figure in both pairs of columns, and again
compute column trials.

1. TRIAL BALANCE COLUMNS

Copy the trial balance in the trial balance column of the work sheet. Enter the title
of each ledger account on the description column. Usually, only those accounts with
balances as the end of the accounting period is listed. Alternatively, all account titles in
the chart of accounts, even those with zero balances are listed.

To illustrate the preparation of a work sheet, assume the following trial balance for
Marianne Reyes Information Systems Company.
 89

Marianne Reyes Information Systems Company

Trial Balance
December 31, 2020

Debits Credits

Cash P 64,000
Notes Receivable 350,000
Accounts Receivable 116,000
Supplies 42,000
Prepaid Insurance 12,000
Land 400,000
Building 590,000
Accumulated depreciation – Building P 177,000
Equipment 450,000
Accumulated depreciation – Equipment 270,000
Accounts Payable 413,000
Unearned Consulting revenues 204,000
M. Reyes, Capital 805,000
M. Reyes, Drawing 50,000
Consulting Revenues 1,108,000
Salaries Expense 770,000
Rent Expense 25,000
Repairs Expense 71,000
Miscellaneous Expense 37,000
________ __________
Total 2,977,000 2,977,000
====================

2. THE ADJUSTMENT COLUMNS

Adjusting entries bring the accounts up-to-date prior to preparing the financial statements.
Enter the adjustments in the adjustment column of the work sheet. If the account is not
included in the original trial balance, add the account title just after the totals of trial
balance. The amounts are written on the debits and credits sides of the adjustment
columns placing a reference letter to the left of each mount. This reference letter facilitates
the actual journalizing of the adjusting entries.

After entering all adjusting entries in the adjustment columns, add the two columns. The
total of the two columns should be equal if all debts and credits are entered properly.

The adjustments for Marianne Reyes Information System Company are as follows:

(a) Supplies on hand as of December 31 is P11,000

(b) One-third of the unearned revenues has been earned as at Dec 31.
(c) Depreciation for the year amounted to P59,000 for the building and P90,000 for the
equipment
(d) Salaries in the amount of P12,000 have accrued at year end
(e) The notes receivable were accepted for several customers. The notes were issued
on Sept 1, 2020 and will be settled together with a 12% interest on May 31, 2021.
90

(f) A premium of P12,000 for a one-year insurance policy was paid in Dec 1.

A worksheet is prepared for Marianne Reyes Information System Company is presented

on page ______.

3. ADJUSTED TRIAL BALANCE COLUMNS

An adjusted trial balance is the original trial balance plus or minus the adjustments. If the
item appears as a debit in the trial balance, and there is a credit in the adjustment column,
subtract the two amounts and extend the difference on the adjusted trial balance column
on the side of the larger amount. If the item appears as a debit amount, add and extend the
total on the debit side of the adjusted trial balance. Add also the account with the credit
balance in the trial balance and credit amount in the adjustments.

Extend all accounts having balances to the adjusted trial balance columns. Note
that some account balances remain the same because no adjustment has affected them.
Simply extend this account balances to the Adjusted Trial Balance columns.

Add the adjusted trial balance debit and credit columns, the two totals must be
equal. If the trial balance column and the adjustments columns do not, a mathematical
error or an error in extension more likely causes the inequality.

4. INCOME STATEMENT COLUMNS

Extend all revenue and expense account balances from the adjusted trial balance
columns to the income statement columns. Since revenues carry credit balances, extend
them to the credit column; extend the expenses to the debit column. Then subtotal each
column. If the total revenues exceed the total expenses, the difference is the net income
that is added to the debit column total in order to bring the two columns into agreement.
On the other hand, if the total expenses exceed the total revenues, the result of business
operation is a net loss which is added to the credit column total.

Note that the amount of difference is being added on the column with a lower totals..
Notice also that if the amount is on both ends of Income Statement(IS) and Balance Sheet
(BS) column (IS debit and BS credit), it is a net income, on the other hand, if the difference
is at the middle of the IS and BS column, it is a net loss (IS credit and BS debit).

5. BALANCE SHEET COLUMNS

Extend the assets, liabilities, and owner’s equity accounts from the adjusted trial balance
sheet columns. Debit the assets and credit the liabilities and owner’s equity amounts. Note
that the beginning rather than the ending balance of the owner’s capital is carried into the
credit column because the closing entries are not yet prepared.

If the income statement and balance sheet columns do not agree on the first attempt, work
backward through the process used in preparing the worksheet. Specifically, the following
steps should be taken until the error is discovered:
 91

1. Re-add the debit and credit columns to see if an error is made in addition. If the
column totals do not agree, check to see if some items are extended incorrectly from the
adjusted trial balance columns to the balance sheet and income statement.

2. Re-add the adjusted trial balance columns. If the totals agree, check whether if item
is transferred to the correct income statement and balance sheet columns. If the totals do
not agree, make sure that the each adjustment is properly added to or subtracted from the
related amount in the trial balance.

3. Re-add the adjustment columns.

4. Re-add the trial balance columns. If the totals do not agree, review the ledger
accounts to find the error.

Marianne Reyes Information Systems Company

Work Sheet
For the Year Ended December 31, 2020

Account Title Trial balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet
debit credit debit credit Debit credit debit credit debit credit
Cash 64,000 64,000 64,000
Notes Receivable 350,000 350,000 350,000
Accounts Receivable 116,000 116,000 116,000
Supplies 42,000 a)11,000 31,000 31,000
Prepaid Insurance 12,000 f)1,000 11,000 11,000
Land 400,000 400,000 400,000
Building 590,000 590,000 590,000
Accumulated 177,000 c) 59,000 236,000 236,000
depreciation-Building
Equipment 450,000 450,000 450,000
Accumulated 270,000 c) 90,000 360,000 360,000
depreciation-Equipment
Accounts Payable 413,000 413,000 413,000
Unearned consulting 204,000 b)83,000 121,000 121,000
revenues
M.Reyes, Capital 805,000 805,000 805,000
M.Reyes, Drawing 50,000 50,000 50,000
Consulting Revenue 1,108,000 b)83,000 1,191,000 1,191,000
Salaries Expense 770,000 d)12,000 782,000 782,000
Rent Expense 25,000 25,000 25,000
Repairs Expense 71,000 71,000 71,000
Miscellaneous Expense 37,000 37,000 37,000
2,977,000 2,977,000
Supplies Expense (a)11,000 11,000 11,000
Depreciation expense- c)59,000 59,000 59,000
Building
Depreciation expense- c)90,000 90,000 90,000
equipment
Salaries Payable d)12,000 12,000 12,000
Interest receivable e)14,000 14,000 14,000
Interest Income e)14,000 14,000 14,000
Insurance Expense f)1,000 1,000 1,000
270,000 270,000 3,152,000 3,152,000 1,076,000 1,205,000 2,076,000 1,947,000
Net Income 129,000 129,000
1,205,000 1,205,000 2,076,000 2076,000
92

PREPARING FINANCIAL STATEMENTS FROM THE WORK SHEET

After completing the worksheet, all information needed to prepare the income
statement, the statement of owner’s equity, the statement of financial position, and the
statement of cash flows can now be presented as follows.

THE INCOME STATEMENT

The information needed to prepare the income statement can be taken from the
income statement columns in the work sheet. The income statement for Marianne Reyes
Information Systems Company follows:

MARIANNE REYES INFORMATION SYSTEMS COMPANY

STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 2020

Consulting Revenue P 1,191,000

Less: Operating Expenses
Salaries Expense P 782,000
Depreciation expense-Equipment 90,000
Depreciation expense-Building 59,000
Repair Expense 71,000
Rent Expense 25,000
Supplies Expense 11,000
Insurance Expense 1,000
Miscellaneous Expense 37,000 1,076,000
_______ __________
Net Income P 129,000
==========

STATEMENT OF CHANGES IN OWNER’S EQUITY

The Statement of Owner’s Equity (also called Capital Statement) is a financial statement
that summarizes the activities that affects the capital account.

The four activities that affects the capital are: 1) additional investments (as addition), 2)
Revenue; 3) Expenses (The result of operations, the difference of Revenue and Expenses,
either Net income or Net loss is an addition or deduction, respectively) and 4) the
withdrawals (as deduction).

This statement is prepared by showing the beginning capital balance, adding the
additional investments and net income (or deducting net loss), and then subtracting the
owner’s withdrawal. The result is the ending capital balance that is forwarded to the
balance sheet.

Shown in the next page is the capital statement prepared for Marianne Reyes Information
Systems Company.
 93

MARIANNE REYES INFORMATION SYSTEMS COMPANY

STATEMENT OF CHANGES IN OWNER’S EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2020

Capital, January 1, 2020 P 805,000

Add: Additional investments P -0-
Net income 129,000
Total P 129,000
Less: Withdrawal 50,000
Increase in Capital 79,000
_________
Capital, December 31, 2020 P 884,000
========

THE BALANCE SHEET OR STATEMENT OF FINANCIAL POSITION

A classified statement of financial position subdivides the assets and liabilities in order to
provide more specific information for the users of financial statements. The assets are
classified into current assets and non-current assets. Liabilities are also classified either
as current or non-current (long term).

Current assets are cash and other assets that are converted into cash or used up
in a relatively short period of time, usually one year or less. Current assets commonly used
by a service-type enterprise include cash, accounts receivable, notes receivable, and
prepaid expenses. Normally, current assets are listed in the order of liquidity, or their
convertibility into cash.

Non-current assets are assets acquired for use in the business. This includes long
term investments, property, plant and equipment (Plant assets), intangible assets and
other assets. Property, plant and equipment are assets acquired for use in the business
rather than for sale. They are also called fixed assets because they are used for term-term
purposes.

Current liabilities are debts usually due within one year, the payment of which
normally requires the use of current assets. Current liabilities are usually listed in the order
of their maturity. The sooner a liability is to be paid, the earlier it is to be listed. Examples
include accounts payable, notes payable, unearned revenues, accrued expenses and
salaries payable.

Non-current liabilities are those debts that will be paid after a relatively long period
of time, usually more than one year. Normally, the ones with the earliest due dates are
listed first. Examples include notes payable, mortgage payable and bonds payable.

MARIANNE REYES INFORMATION SYSTEMS COMPANY

94

BALANCE SHEET
DECEMBER 31, 2020

ASSETS
Current Assets
Cash P 64,000
Notes Receivable 350,000
Accounts Receivable 116,000
Interest Receivable 14,000
Supplies 31,000
Prepaid Insurance 11,000 P 586,000

Non-current Assets
Land P 400,000
Building P 590,000
Less: Accumulated Depreciation 236,000 354,000
Equipment P 450,000
Less: Accumulated Depreciation 360,000 90,000 844,000

TOTAL ASSETS P1,430,000

=========

LIABILITIES AND OWNER’S EQUITY

Current Liabilities
Accounts Payable P 413,000
Salaries Payable 12,000
Unearned Consulting Revenue 121,000 P 546,000

M. Reyes, Capital 884,000

TOTAL LIABILITIES AND OWNER’S EQUITY P1,430,000

=========

JOURNALIZING AND POSTING THE ADJUSTNG ENTRIES

The adjusting entries recorded in the worksheet are also recorded in the journal and
posted in the ledger. This is to prove that the balances of the accounts in the ledger
conform with the balances shown in the financial statements. These entries are also
posted to the general ledger in the usual manner, except that the word “Adjusting” is
written on the items column to differentiate it from other posted entries.

The preparation of the worksheet does not eliminate the need to journalize and post the
adjusting entries because the worksheet is only an accounting tool and is not part of the
formal accounting records.

The adjusting entries of Marianne Reyes Information Systems Company are journalized as
follows:

GENERAL JOURNAL PAGE 3

 95

Date Description P/R Debit Credit

2020
Dec. 31 Supplies Expense 505 11,000
Supplies 105 11,000
To take up supplies used for the period..

31 Unearned Consulting Revenue 207 83,000

Consulting Revenue 401 83,000
To take up earned portion of consulting revenue.

31 Depreciation expense-Building 502 59,000

Depreciation expense-Equipment 503 90,000
Accumulated Depreciation – Building 108A 59,000
Accumulated Depreciation – Equipment 109A 90,000
To take up depreciation expense for the period.

31 Salaries Expense 501 12,000

Salaries Payable 203 12,000
To take up accrued salaries for the period.

31 Interest Receivable 104 14,000

Interest Income 402 14,000
To take up accrued interest income.
(350,000 x12%x4/12)

31 Insurance Expense 507 1,000

Prepaid Insurance 106 1,000
To take up expired portion of prepaid insurance.

THE CLOSING ENTRIES

The closing entries are entries prepared at the end of the accounting period to bring
the balances of the temporary or nominal account to zero, so that they will be ready to
receive data for the next accounting period. These accounts are closed at the end of each
period so that we may identify their balances by the year of their occurrence. Hence, we
say the sales of 2020 must not include the sales of 2021.

In the closing process, a temporary account or clearing account called “Income

Summary” is used. After all revenue and expense account balances are transferred to
income summary, its balance represents the results of the operations (net income or net
loss) for the period. The other terms that maybe used are Revenue and Expense Summary
or Profit and Loss Summary.

The steps in the closing process are as follows:

96

1. Closing the revenue account(s). The balances in the revenue account are
transferred to the income summary account by debiting each revenue account for the
amount of its balance, and crediting the income summary account for the total revenue.

2. Closing the expense accounts. The balances in the expense account are transferred
to the income summary account by debiting the income summary account for the total
expense, and crediting each expense account for the amount of its balance.

3. Closing the income summary account. The balances in the income summary
account are transferred to the owner’s capital. A credit balance in the income summary
account represents net income and is closed by debiting income summary and crediting
the owner’s capital account. A debit balance in the income summary account represents
net loss and is closed by debiting the owner’s capital account, and crediting the income
summary account.

4. Closing the owner’s drawing account. The balance of the owner’s drawing account
is transferred to the owner’s capital account by debiting the capital account for the amount
of the withdrawals, and crediting the drawing account for its balance.

The Closing entries are recorded on the next available space in the journal right
after the adjusting entries. They are also posted in the usual manner except that the word
“Closing” is written on the items column to differentiate it from other posted entries.

GENERAL JOURNAL Page 5

Date Description Post Debit Credit

2020 Ref
Dec. 31 Consulting Revenue 401 1,191,000
Interest Income 402 14,000
Income Summary 303 1,205,000
To close the revenue account.
2020
Dec 31 Income Summary 303 1,076,000
Salaries Expenses 501 782,000
Rent Expense 503 25,000
Repairs Expense 502 71,000
Miscellaneous Expenses 509 37,000
Supplies Expense 505 11,000
Depreciation Expense - Building 502 59,000
Depreciation Expense - Equipment 503 90,000
Insurance Expense 507 1,000
To close the expense accounts

31 Income Summary 303 129,000

 97

M. Reyes, Capital 301 129,000

To close the net income to capital.

31 M. Reyes, Capital 301 50,000

M. Reyes, Drawing 302 50,000
To close the owner’s drawing account

After closing, the nominal or temporary accounts in the ledger, such as service
revenue, all expense accounts and the drawing account will be zero balances, as shown
in the following T-accounts:

M. Reyes, Capital 301

Dec. 31 Closing 50,000 Jan. 1 805,000
Dec. 31 Closing 129,000
934,000
Bal.884,000

M. Reyes, Drawing 302

Jan. 1 50,000 Dec. 31 Closing 50,000

Income Summary 303

Dec. 31 Closing 1,076,000 Dec. 31 Closing 1,205,000
31 Closing 129,000
1,205,000

Consulting Revenue 401

Dec. 31 Closing 1,191,000 Jan. 7 1,108,000
Dec. 31 AJE 83,000
1,191,000

POST-CLOSING TRIAL BALANCE

After the nominal accounts (temporary accounts) have been closed, what remain is
the real accounts (permanent accounts). Thus, a post-closing trial balance is also called
a Statement of Financial Position (Balance Sheet) in a trial balance form, because the items
appearing are the elements of the Balance Sheet (Assets, Liabilities and Owner’s Equity).
The temporary accounts have been closed, so they are not included in the post-closing
trial balance. The Post-Closing Trial Balance will served as the beginning balance of the
next accounting period.
98

The post-closing trial balance of Marianne Reyes Information Systems Company as

of December 31, 2020, is shown as follows:

MARIANNE REYES INFORMATION SYSTEMS COMPANY

Post-Closing Trial Balance
December 31, 2020
Account
Code Account Name Debit Credit_

101 Cash P 64,000

102 Notes Receivable 350,000
103 Accounts Receivable 116,000
104 Interest Receivable 14,000
105 Supplies 31,000
106 Prepaid Insurance 11,000
107 Land 400,000
108 Building 590,000
108A Accumulated Depreciation – Building P 236,000
109 Equipment 450,000
109A Accumulated Depreciation – Equip. 360,000
201 Accounts Payable 413,000
203 Salaries Payable 12,000
207 Unearned Consulting Revenue 121,000
301 M. Reyes, Capital 884,000
________________________
Total P 2,206,000 P 2,206,000
=======================

THE INTERIM STATEMENTS

Interim statements are financial statements prepared for a period of less than a
year. It is considered essential in providing the investors and stakeholders with timely
information as to the progress of the enterprise. This is why most companies prepare a
monthly, quarterly or semi-annually income statement. Adjustments must be considered
in rendering interim reports.

REVERSING ENTRIES

For certain types of adjusting entries, reversing entries are prepared on the first day
of the next accounting period. They are called reversing entries because they reverse the
effects of the adjusting entry to which they relate. The purpose of reversing entry is to
simplify the first entry relating to the same item in the next accounting period.

Recall the adjusting entry made by Marianne Reyes Information Systems Company
to recognized accrued salaries of P 12,000. This adjusting entry is made to record salaries
incurred but not yet paid as of December 31, 2020.
 99

Illustrated below are the entries from December 31 through February 10, the next payday,
assuming (1) no reversing entry is prepared, and (2) reversing entry is prepared.

(1) (2)
Dec
31 Salaries Expense 12,000 Salaries Expense 12,000
Salaries Payable 12,000 Salaries Payable 12,000
To take up accrued To take up accrued
salaries salaries

Jan 1 No entry Salaries Payable 12,000

Salaries Expense 12,000
To reverse the adj. entry
on Jan. 31

Jan
10 Salaries Payable 12,000
Salaries Expense 3,000 Salaries Expense 15,000
Cash 15,000 Cash 15,000
Paid salaries of Paid salaries of
employees employees

The adjusting entries of December 31, 2020 are the same whether or not a reversing entry
is made. The reversing entry on January 1, is the exact reversed of the debit and credit
used in the adjusting entry. The use of the reversing entry simplifies the entry made on
payment date on January 10. There is no need to remember that the accrued salary of
P12,000 was already recorded. When the company paid the P15,000.00 salaries, the entry
is simply a debit to Salaries Expense and a credit to cash for P15,000.00.

The end result in the account is the same whether or not a reversing entry is used. The T-
accounts that follow will prove this. The beginning balance in Salaries Payable results from
the adjusting entry made on December 31.

(1) The T-account as they appear when no reversing entry is prepared.

Salaries Expense Salaries Payable

Feb. 10 3,000 Feb 10 12,000 Dec. 31 12,000

(2) The T-accounts as they appear when reversing entry is prepared.

Salaries Expense Salaries Payable
Feb.10 15,000 Jan 1 12,000 Jan 1 12,000 Dec. 12,000

The four adjusting entries that may be reversed at the beginning of the next
accounting period are: 1) accrued expenses 2) accrued revenue 3) prepaid expenses
using expense method 4) unearned revenue using revenue method.
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Not all adjusting entries are reversed on the first day of the next accounting period.
Entries for reversals are those relating to the situations where cash is paid or received in
an adjusting entry. Such items would include accrued expenses and accrued revenues.
We do not reverse adjustments for items that will not result in a subsequent receipt or
payment of cash, such as the adjustment for depreciation and allowance for bad debts.

Adjusting entries for prepaid expenses recorded under the expense method and
unearned revenues recorded under the revenue method are reversed. Since the closing
entries made at the end of the period affects the revenue and expense account, reversing
entries are needed to revert back the original method used; namely, the expense method
for prepaid expense and the revenue method for unearned revenue. A general rule to follow
is that all adjusting entries that increase assets or liabilities are reversed. Adjusting entries
that decrease assets and liabilities are not reversed.

EXERCISES
1.The following trial balance of Marquez Equipment Rental, as of December 31, 2020,
contains the following account balances.

MARQUEZ EQUIPMENT RENTAL

Trial Balance
December 31, 2011

Debit Credit
Cash P 55,600
Accounts Receivable 32,500
Office Supplies 8,000
Prepaid Rent 58,500
Prepaid Insurance 11,760
Equipment 192,000
Accumulated Depreciation – Equipment
Accounts Payable P 31,150
E. Marquez, Capital 262,030
E. Marquez, Drawing 22,600
Rental Service Revenue 627,100
Salaries Expense 390,000
Utilities Expense 74,800
Travel Expense 58,720
Miscellaneous Expense 19,800

Total P 920,280 P 920,280

Adjustment data at December 31 are as follows:

(a) Rent expense for the year amounts to P4,875.

(b) Unexpired insurance at December 31, amounts P10,780.
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(c) The equipment acquired on Sept. 1, is to be depreciated at P38,400 per year.

(d) Salaries incurred but unpaid at December 31, amounts to P7,500.
(e) Unused office supplies at December 31, P3200.
(f) Accrued Rental Service at December 31, P5,800.

Instructions: Prepare the following:

1) a 10-column worksheet;
2) Journalized the adjusting and closing entries
3) Income Statement; Capital Statement; and Balance Sheet
4) And Post-closing Trial Balance
5) Journalized the reversing entries

2. From the following selected accounts that Persevering Auto Repair Shop reported in
its June 30, FY end annual financial statements, prepare the entity’s closing entries.

Zeny Allen, capital 782,600 Interest expense 24,750

Service Revenue 280,500 Accounts receivable 282,000
Unearned service revenue 30,380 Salary payable 19,020
Salary expense 148,750 Depreciation expense 23,500
Accumulated Depreciation- Equip 87,500 Rent expense 22,750
Supplies Expense 3,230 Z. Allen, drawing 48,000
Interest Revenue 11,750 Supplies 20,750

GENERAL JOURNAL Page 3

Date Description P/R Debit Credit

EXERCISE 5-1 Preparation of a Worksheet

The Trial Balance of PEDRO JOSE Advertising Agency before adjustments are shown below:
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PEDRO JOSE ADVERTISING AGENCY

Trial Balance
October 31, 2020

ACCOUNT TITLES DEBIT CREDIT

Cash P 260,000
Accounts receivable 28,800
Prepaid rent 70,000
Prepaid insurance 50,000
Office supplies 19,200
Office equipment ` 96,000
Accumulated depreciation P 14,000
Notes payable 30,000
Accounts payable 120,000
Salaries payable 30,000
Interest payable 2,000
PJ Capital 200,000
PJ Drawing 32,000
Commission revenue 160,000
Total P 556,000 P 556,000

INSTRUCTIONS:
1. Prepare a worksheet.
2. Adjustment data on October 31, 2020, the end of the month:
(a) the uncollectible account is 5% of accounts receivable
(b) Prepaid rent is for six months beginning September 1.
(c) Expired insurance, P 36,000.
(d) Unearned commission, P 8,000.
(e) Unpaid salaries, P 24,000.
3. Prepare an Income Statement, Capital Statement and balance sheet.

EXERCISE 5-2
INSTRUCTION: Prepare Financial Statements, Closing entries, and Post-closing trial balance.
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The adjusted trial balance of KAREN ADVERTISING AGENCY after posting of adjusting
entries is shown below:

KAREN ADVERTISING AGENCY

Adjusted Trial Balance
September 30, 2020

ACCOUNT TITLES DEBIT CREDIT

Cash P 270,000
Commission Receivable 7,200
Prepaid rent 84,000
Office supplies 12,600
Office equipment ` 36,000
Accumulated depreciation-office P 16,400
Furniture & Fixtures 18,800
Accumulated Depreciation – Fur & Fix 6,000
Notes payable 114,000
Accounts payable 30,000
Salaries payable 4,800
Interest payable 1,200
Unearned commission 24,000
Karen Capital 200,000
Karen Drawing 32,000
Commission Earned 175,200
Salaries expense 64,800
Rent expense 36,000
Office Supplies expense 6,600
Depreciation Expense – Office Equip 2,400
Depreciation Expense – Fur & Fix 1,000
Interest Expense 200 ___
Total P 571, 600 P 571, 600

PROBLEM 5-1
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The Trial Balance of MESTIOLA LAUNDROMAT at December 31, the end of the current
fiscal year, and data needed for year-end adjustments are presented below:

MESTIOLA LAUNDROMAT
TRIAL BALANCE
December 31, 2020
ACCOUNT TITLES DEBIT CREDIT
Cash P 8,250
Laundry Supplies 10,110
Prepaid Insurance 3,120
Laundry Equipment 58,000
Accumulated Depreciation P 20,000
Office Equipment 40,000
Accumulated Depreciation 14,000
Accounts Payable 1,550
Mestiola, Capital 34,950
Mestiola, Drawing 30,000
Laundry Revenue 125,200
Wages Expense 29,500
Rent Expense 8,200
Utilities Expense 5,100
Miscellaneous Expense 3,420________________
Total P195,700 P195,700
ADJUSTMENT DATA:
a. Laundry supplies on hand, P 2,850.
b. Insurance expired, P 2,500.
c. Depreciation – Laundry Equipment, P 20,000
d. Depreciation – Office Equipment P 16,000
e. Wages accrued are December 31, ) 18,000.
Instructions:
1. Complete worksheet.
2. Prepare an income statement, Capital statement and Balance Sheet. (Report form).

PROBLEM 5-2
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INSTRUCTIONS: 1. Complete a Worksheet.

2. Prepare financial statements
3. Journalize adjusting, closing, reversing entries and Post-Closing Trial
Balance.

The account balances of YOLANDA REALTY at the end of the month April, 2020 are
presented below:
Cash P 17,420
Accounts Receivable 46,240
Prepaid Insurance 2,970
Office Supplies 850
Automobile 48,000
Accum. Depr. – Automobile P 9,650
Office Equipment 31,600
Accumulated Depreciation 7,000
Accounts Payable 1,480
Yolanda, Capital 56,070
Yolanda, Drawing 40,000
Revenue from Fees 269,120
Salary and Comm. Exp. 132,000
Rent Expense 12,000
Advertising Expense 7,650
Automobile Expense 2,830
Miscellaneous Expense 1,760_______________
Total P343,320 P343,320
DATA FOR ADJUSTMENT
a. The uncollectible account is 4%.
b. The unexpired insurance, P660.
c. Supplies used, ¼ of the amount.
d. Depreciation: automobile, P12,000; Equipment, P9,000.
e. Unpaid salary and commission, P60,000.
f. Unrecorded Revenue from fees, P85,200.
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WRITE YOUR ANSWERS HERE:

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References:

https://studyfinance.com/journal-entries/
Ballada, Win and S. Ballada. Accounting Fundamentals, 5th edition. Manila: DomDane Publishers. 2019
HF 5635 P75 2013 Baguino, Armando D. et al (2013) Principles of Accounting

https://www.cpapracticeadvisor.com/home/article/10263076/the-evolution-of-technology-for-the-
accounting-profession
https://fremont.edu/history-of-accounting/
https://www.geemiz.com/accounting/theory-of-accounts/definition-of-accounting.html
https://smallbusiness.chron.com/general-uses-accounting-information-3951.html
https://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176156304264
http://www.picpa.com.ph/attachment/1302018111735724.pdf
https://www.accountingcoach.com/accounting-principles/explanation
http://www.tradechakra.com/economy/philippines/types-of-business-entities-in-240.php
` https://www.freshbooks.com/hub/accounting/8-branches-of-accounting
https://www.wallstreetmojo.com/financial-statements/
https://corporatefinanceinstitute.com/resources/knowledge/accounting/types-of-assets/