Fundamentals of

Accounting
Course Material No. 5

EJ Blanco, CPA
Course Instructor
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The Accounting Cycle (Part 1)

1
LEARNING OUTCOMES

Here’s what I will teach you in this course material:

LESSON OUTLINE
 Understand the first four steps of the accounting cycle

 Understand
The Accounting Cycle the criteria for recording transactions
(first four steps)

Unit Outline  Analyze the effect of transactions in the accounting equation

RESOURCES NEEDED

For this lesson, you would need the following resources:

Accounting books and other references as uploaded in the

files section in MS Teams.
Powerpoint materials
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TABLE OF CONTENTS

Pretest Word Search

4
Before you start, try answering the following
questions. The Accounting Cycle
5
1. Can you recall what the Accounting Equation is?

Lesson Summary
2. Recall the rules of debit and credit. What would 12
happen if there is an increase or decrease to Assets,
Liabilities or Equity?

12 Key Terms

3. How would you know if a transaction should be

recorded in the company books?
Post Test
13

13 References
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Fundamentals
of Accounting

Key Point
This topic will introduce you
to the accounting cycle
and its first four steps
namely: Analysis of
Transactions, Journal
Entries, Posting to the
Ledger and Trial
Balance.

WORD SEARCH
Find all 12 words relevant to our topic!
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Accounting Cycle

The accounting cycle is a continuous process of accumulating, summarizing and reporting

financial information.

Step 1. Transactions
 Identification and measurement of external transactions and internal events. At this
stage, the documents used by the business are analyzed whether it has financial impact
or effect.
 Recall the rule that only financial transactions are recorded and that the amount can
be measured. These two conditions must exist in order that a particular transaction is
recognized or recorded.
Examples of financial transactions:
 Purchase of supplies from a vendor on credit is a financial transaction. In this case asset
(supplies) will increase. At the same time, liabilities (accounts payable) will increase
because the business has the obligation to pay the vendor in the future.
 Receipt of cash from a customer for the payment of receivables is a financial transaction.
This will both increase and decrease assets at the same time. Upon receipt of cash, cash
will increase while accounts receivable will decrease.
 Receipt of electric bills to be paid on a particular date is a financial transaction. This will
increase the liabilities (utilities payable) and increase the expenses (utilities expense).
Once the bills are settled or paid, this is also a financial transaction as this will decrease
the cash (asset) while decrease the liabilities (utilities payable) of the business at the
same time.
Examples of non-financial transactions:
 Hiring and termination of employees
 Recognition from the government as most outstanding business
 Death of owner
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Source Documents
Transactions and events are the starting points in the accounting cycle. By relying on the source
documents can be analyzed as to how they will affect the company’s financial performance and
financial position. Source documents identify and describe transactions and events entering the
accounting process. In a typical service business, the following are the business documents
used:
1. Official Receipt or Cash Receipt – This document is used when a business receives
money or a check. An Official Receipt or Cash Receipt is a document that acknowledges
that money or a check have been received.

2. Charge Invoice or Sales Invoice – A charge invoice is a document used when a service
has been rendered, but the client will be billed only after a certain number of days from
the date of service. For example: in a laundry business, a customer may avail of the
services of the business. However, that customer and the owner of the business had a
prior agreement that all services availed by the customer will be paid only after 30 days.
In this case, a charge invoice is issued on the day the client availed of the services.
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3. Check or Cash Voucher. The check voucher is a document used when a check is issued to
pay a certain supplier or vendor. For example, in a laundry business, for the payment of
monthly electricity bills, the business may pay either in cash or check. But the company
must prepare a cash or check voucher to support this payment. This document will serve
as a record of payment and, at the same time, as proof that payment has been made by
the company.

Step 2. Preparation of Journal Entries

 The journal is a chronological record of the entity’s transactions. A journal entry shows
all the effects of a business transaction in terms of debits and credits. Each transaction is
initially recorded in a journal rather than directly in the ledger. A journal is called the
book of original entry.
 Debits and Credits are an integral part of the journalization process. In accounting,
debits or credits are abbreviated as DR and CR respectively.
 When to Debit and when to Credit: An increase in an asset account is called a debit and
an increase in a liability or equity account is called a credit. Likewise, if we decrease an
asset account we credit that account. On the other side of the equation, if we decrease a
liability or equity account we debit those accounts.
 Rules on Debits and Credits
o The name of the account to be debited is always listed first. The debited account
is listed on the first line with the amount in the left side of the register.
o The credited account is listed on the second line and is usually indented. The
credited amount is recorded on the right side of the register.
o The total amount of debit should always equal the total amount of credit.
 Recall the discussion on the Chart of Accounts
o The Chart of Accounts is a listing of all account titles used in the business to
record all the transactions. It is arranged according to the order of their
appearance in the financial statements.
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Let us take the case of Mirabel Madrigal, a former flight attendant. Maribel decided to open her
travel agency on February 14, 2021, naming it Encanto Travel and Tours. Maribel knows that
business transactions should be separated from personal finances. Thus, she decided to invest
PHP200,000 in the business. She deposited the amount with Banco de Bruno.

Analysis: Assets increased. Owner’s Equity increased.

Rules: Increases in assets are recorded by debits. Increased in owner’s equity are recorded by credits.
Entry:
General Journal
Date Account Title and Explanation Ref Debit Credit
2/14/21 Cash P200,000
Madrigal, Capital P200,000
To record the initial investment of owner, M. Madrigal

February 15, 2021 - Mirabel purchased one computer unit from Isabela Computer Store to be
used in the business. She issued check number 001 amounting to PHP25,000.
Analysis: One asset increased. Another asset increased. Net effect is zero.
Rules: Increases in assets are recorded by debits. Decreases in assets are recorded by credits.
Entry:
General Journal
Date Account Title and Explanation Ref Debit Credit
2/15/21 Office Equipment P25,000
Cash P25,000
To record purchase of one computer unit
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February 16, 2021 - Mirabel hired Isabela, an experienced
Analysis/Rules: This is not a financial transaction as there is no financial effect to the business.
Entry: No entry

February 17, 2021 – Rendered services to Luisa and collected PHP10,000 cash.
Analysis: Assets increased. Income increased.
Rules: Increases in assets are recorded by debits. Increased in income are recorded by credits.
Entry:
General Journal
Date Account Title and Explanation Ref Debit Credit
2/17/21 Cash P10,000
Service Revenue P10,000
To record receipt of cash from customer

February 18, 2021 – Sold airline tickets to Antonio. Antonio will pay PHP15,000 on March 18, 2021.
Analysis: Assets increased. Income increased.
Rules: Increases in assets are recorded by debits. Increased in income are recorded by credits.
Entry:
General Journal
Date Account Title and Explanation Ref Debit Credit
2/18/21 Accounts Receivable P15,000
Service Revenue P15,000
To record services rendered to a customer on account

February 19, 2021 – Mirabel purchased office supplies from Abuela Merchandise amounting
to PHP5,000 on account. Mirabel will pay this on March 30, 2021.
Analysis: Assets increased. Liabilities increased.
Rules: Increases in assets are recorded by debits. Increases in liabilities are recorded by credits.
Entry:
General Journal
Date Account Title and Explanation Ref Debit Credit
2/19/21 Office Supplies P5,000
Accounts Payable P5,000
To record purchase of office supplies on account

February 25, 2021 – Paid the salary of Isabela amounting to PHP4,000

Analysis: Assets decreased. Expense increased.
Rules: Decreases in assets are recorded by credits. Increases in expenses are recorded by debits.
Entry:
General Journal
Date Account Title and Explanation Ref Debit Credit
2/25/21 Salaries Expense P4,000
Cash P4,000
To record payment of salary
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Step 3. Posting
Posting means transferring the amounts from the general journal to the appropriate accounts in
the general ledger. The general ledger is a grouping of the business’ accounts. The individual
transactions (in the general journal) are then posted from the journals to the general ledger.
Nothing should ever get posted to the ledgers without first being entered in a journal. Recall the
lesson on the general ledger (Course Material 4). We will now post the previous transactions of
Mirabel to the general ledger. For purposes of discussion, we will be using the three-column
ledger.

General Ledger
Account: Cash Account No.: 1000
Date Item Ref Debit Credit Balance
2/14/2021 Investment of Owner 200,000 200,000
2/15/2021 Purchase of Computer 25,000 175,000
2/17/2021 Service Revenue - Luisa 10,000 185,000
2/25/2021 Payment of Isabela salary 4,000 181,000

General Ledger
Account: Accounts Receivable Account No.: 1200
Date Item Ref Debit Credit Balance
2/18/2021 Service Revenue - Antonio 15,000 15,000

General Ledger
Account: Office Equipment Account No.: 1600
Date Item Ref Debit Credit Balance
2/15/2021 Purchase of Computer 25,000 25,000

General Ledger
Account: Accounts Payable Account No.: 2000
Date Item Ref Debit Credit Balance
2/19/2021 Purchase - office supplies 5,000 5,000

General Ledger
Account: Madrigal, Capital Account No.: 3000
Date Item Ref Debit Credit Balance
2/14/2021 Investment of Owner 200,000 200,000
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General Ledger
Account: Service Revenue Account No.: 4000
Date Item Ref Debit Credit Balance
2/17/2021 Service Revenue – Luisa 10,000 10,000
2/18/2021 Service Revenue - Antonio 15,000 25,000

General Ledger
Account: Supplies Expense Account No.: 6150
Date Item Ref Debit Credit Balance
2/19/2021 Purchase - office supplies 5,000 5,000

General Ledger
Account: Salaries Expense Account No.: 6100
Date Item Ref Debit Credit Balance
2/25/16 Payment of Isabela’s salary 4,000 4,000

Step 4. Unadjusted Trial Balance

At the end of an accounting period (for example, one month or one year) the working trial
balance is prepared. This involves copying each account name and account balance to a
worksheet (working trial balance). The resulting first two columns of the worksheet are called
the unadjusted trial balance. In the preparation of the unadjusted trial balance, the balances in
all the general ledgers at the end of the reporting date are forwarded to the appropriate
column. The unadjusted trial balance for the transactions in our example from Step 3 is the
following:
ENCANTO TRAVEL AND TOURS
Unadjusted Trial Balance February 28, 2021
Account Title Debit Credit
Balance Sheet Accounts
Cash P181,000
Accounts Receivable 15,000
Office Equipment 25,000
Accounts Payable P5,000
Madrigal, Capital 200,000

Income Statement Accounts

Service Revenue 25,000
Supplies Expense 5,000
Salaries Expense 4,000

P230,000 P230,000
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Notice that all asset accounts are presented first, followed by liabilities, equity (or capital
account), income accounts and lastly, expense accounts.

Review of the Accounting Equation

The basic accounting equation is what drives double-entry bookkeeping. The equation reflects
the accounts reported in the balance sheet. The basic accounting equation is as follows:

ASSETS = LIABILITIES + OWNERS' EQUITY

This is a very simple algebraic equation that reflects how the assets of an entity must be
supported by either debt or equity. As in algebra, if we add or subtract something from one
side of the equation we must add or subtract the same amount from the other side. For
example, if we were to increase cash (an asset) we might have to increase note payable (a
liability account) so that the basic accounting equation remains in balance.
ASSETS = LIABILITIES + OWNERS' EQUITY
PHP 500 = PHP 500
Applying the formula to our transactions in Step 3 above, the effects of these transactions to the
equation are shown below:

DATE TRANSACTIONS ASSETS = LIABILITIES + EQUITY

2/14/2021 Investment of Owner, Mirabel Madrigal +200,000 +200,000
2/15/2021 Purchase of computer +25,000
-25,000
2/17/2021 Rendered services to Jean and collected the payment +10,000 10,000
2/18/2021 Sold tickets to Antonio on account +15,000 15,000
2/19/2021 Purchase of office supplies on account 5,000 -5,000
2/25/2021 Payment of salary of Isabela -4,000 -4,000

LESSON SUMMARY

In this, you were introduced to the first four steps of the accounting cycle
namely: Transactions, Journalizing, Posting and Unadjusted Trial Balance.
KEY TERMS

Asset Chart of Accounts Debit

Liabilities Accounting Cycle Credit
Equity Transaction Posting
Income Journal Ledger
Expense Source Document Trial Balance
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POSTTEST

I. Indicate in each independent case whether the amount is to be DEBITED or CREDITED.

1. Increase in Accounts Payable
CREDITED 9. Increase in Owner’s Drawing credited
2. Decrease in Capital account 10. Increase in Interest Income credited
debited 11. Decrease in Accounts Payable Debited
3. Increase in Service Revenue 12. Increase in Accounts Receivable DEBITED
CREDITED 13. Decrease in Cash CREDITED
14. Increase in Loans Payable CREDITED
4. Increase in Cash DEBITED
15. Increase in Utilities Payable CREDITED
5. Decrease in Accounts Receivable
credit
6. Increase in Salaries Expense
DEBITED
7. Increase in Office Equipment
DEBITED
8. Increase in Salaries Payable
CREDITED

II. Determine whether the following transaction is financial or not.

1. Payment of salaries
9. Purchase of company car to be used in the
2. Investment of cash by owner
business
3. Hiring of new personnel
10. Employee resignation
4. Death of employee
11. Owner withdrew assets from the business
5. Receipt of MERALCO bill to be paid
12. Company was recognized as the best
next week
company in their barangay
6. Owner borrowed the company car for
13. Purchase of office equipment on account
personal use
14. Company acquired business permits and
7. Sold inventories for credit
paid the related fees
8. Payment of PLDT bill
15. Company wrote a promissory note upon
purchase of supplies from vendor

III. Fill out the missing amount in the accounting equation.

ASSET LIABILITIES EQUITY
1. P100,000 P50,000 Minus 50,000
2. 95,000 plus P20,000 P75,000
3. P800,000 300,000 minus P500,000
4. P70,000 P25,000 45,000 minus
5. P1,000,000 600,000 minus……… P400,000

REFERENCES
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Ballada, W. et al (2021). Basic Financial Accounting and Reporting
LAGUNAMade Easy (23rd edition).
Manila: DomDane Publishers & Made Easy Books
Label, W. (2016). Accounting for Non-Accountants (3rd ed.). Naperville: Sourcebooks.4

Assets increase debit , decrease credit

Cash
Accounts receivable
Notes receivable
Supplies
Inventories
Prepaid insurance
Service vehicle
Office equipment

Liabilities increased credits, decrease debit

Accounts payable
Notes payable
Unearned revenue
Accrued expense ( salaries and utilities payable )

Equity increased credits, decrease debit

Owner’s capital
Owner’s drawing

Income increased credits , decrease debit

Service fee
Sales
Interest income
gains

Expense increased debits , decrease credits

Salaries expense
Utilities expense
Rent expense
Depreciation expense
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