L3 L5

Lesson 3: Recording Business Transactions
ACCOUNTING CYCLE
The accounting cycle refers to a series of sequential steps or procedures performed to accomplish the accounting process. The
steps in the cycle and their aims follow:
Step 1. Identification of events to be recorded Aim: To gather information about transactions or events generally through
the source documents.
Step 2. Transactions are recorded in the journal. Aim: To record the economic impact of transactions on the firm in a
journal, which is a form that facilitates transfer to the accounts.
Step 3. Journal entries are posted to the ledger. Aim: To transfer the information from the journal to the ledger for
classification.
Step 4. Preparation of a Trial Balance. Aim: To provide a listing to verify the equality of debits and credits in the ledger.
Step 5. Preparation of the Worksheet including adjusting entries. Aim: To aid in the preparation of the financial
statements.
Step 6. Preparation of the financial statements. Aim: To provide useful information to decision-makers.
Step 7. Adjusting journal entries are journalized and posted. Aim: To record the accruals, expiration of deferrals
estimation and other events from the worksheet.
Sept 8. Closing journal entries are journalized and posted. Aim: To close temporary accounts and transfer profit to
owner's equity.
Step 9. Preparation of a post-closing trial balance. Aim: To check the equality of debits and credits after the closing
entries.
Step 10. Reversing journal entries are journalized and posted. Aim: To simplify the recording of certain regular
transactions in the next accounting period. This cycle is repeated each accounting period.
Step 1. TRANSACTION ANALYSIS

The analysis of transactions should follow these four basic steps:
1.Identify the transaction from source documents.
2.Indicate the accounts--either assets, liabilities, equity, income or expenses-affected by the transaction.
3.Ascertain whether each account is increased or decreased by the transaction.
4.Using the rules of debit and credit, determine whether to debit or credit the account to record its increase or decrease.

SOURCE DOCUMENTS
Transactions and events are the starting points in the accounting cycle.
 Source documents identify and describe transactions and events entering the accounting process.
 Transactions and events are the starting points in the accounting cycle.
 Relying on source documents, transactions and events can be analyzed as to how they will affect performance and financial
position.
 Source documents identify and describe transactions and events entering the accounting process.
These original written evidences contain information about the nature and the amounts of the transactions. These are the
bases for the journal entries; some of the more common source documents are sales invoices, cash register tapes, official
receipts, bank deposit slips, bank statements, checks, purchase orders, time cards and statements of account.
THE GENERAL JOURNAL AND GENERAL LEDGER
THE JOURNAL  Relying on source documents, transactions and events can be

analyzed as to how they will affect performance and financial
position.
 Source documents identify and describe transactions and events
entering the accounting process.
 These original written evidences contain information about the
nature and the amounts of the transactions. These are the bases
for the journal entries; some of the more common source
documents are sales invoices, cash register tapes, official
receipts, bank deposit slips, bank statements, checks, purchase
orders, time cards and statements of account.
 A chronological record of the entity’s transactions.

 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.

Format.
The standard contents of the general journal are as follows:
1.Date. The year and month are not rewritten for every entry unless the year or month changes or a new page is needed.
2.Account Titles and Explanation. The account to be debited is entered at the extreme left of the first line while the account
to be credited is entered slightly indented on the next line. A brief description of the transaction is usually
made on the line below the credit. Generally, skip a line after each entry.
3.Posting Reference (PR). This will be used when the entries are posted, that is, until the amounts are transferred to the
related ledger accounts.
4.Debit. The debit amount for each account is entered in this column.
5.Credit. The credit amount for each account is entered in this column.
Illustration: Assume that Maria Concepcion Jennifer Perez-Manalo established her own wedding consultancy with an initial
investment of P250,000 on May 1. The journal entry is:
May 1 Cash (2) (3) P250,000 (4)
(1) Perez-Manalo, Capital P250,000 (5)
Initial investment of Perez-Manalo.
SIMPLE AND COMPOUND ENTRY

In a simple entry, only two accounts are affected, one account is debited and the other accounted is credited. An example of
this is the entry to record the initial investment of Perez-Manalo. However, some transactions require the use of more than two
accounts. When there are three or more accounts required in a journal entry, the entry is referred to as a compound entry.
* Corollary journals are journals made to recognize balance sheet account activities as a result of transactions
STEP 2. TRANSACTIONS ARE JOURNALIZED
After the transaction or event has been identified and measured, it is recorded in the journal. The process of recording a
transaction is called journalizing.
The following are the transactions for Weddings "R" Us during the month of May. The double-entry system will be used.
To understand the nature of the affected accounts, the letter A (for asset), L (liability) OE (owner's equity) is inserted after each
entry. In addition, owner's equity is further classified into OE:I (income) and OE:E (expenses).
Note that the rules of double-entry system are observed in each transaction:
1.Two or more accounts are affected by each transaction.
2.The sum of the debits for every transaction equals the sum of the credits.
3.The equality of the accounting equation is always maintained.
Initial Investment (Source of Assets)
May 1. Maria Concepcion Jennifer Perez-Manalo is a social entrepreneur from the South. She is into a lot of interesting causes. Her fine taste is
preeminent such that she is considered an authority in planning weddings. Upon the advice and prodding of an esteemed colleague, Bendalyn
Landicho, Perez-Manalo decided to organize her wedding consultancy. She invested P250,000 into this entity.

Analysis. Assets increased. Owner's equity increased.
Rules. Increases in assets are recorded by debits. Increases in owner's equity are recorded by credits.
Entry. Increase in assets is recorded by a debit to cash, Increase in owner's equity is recorded by a credit to Perez-Manalo, Capital.
Journal entry: May 1 Cash (A) P250,000
Perez-Manalo, Capital (OE) P250,000
To record initial investment.
Rent Paid in Advance (Exchange of Assets) Prepaid Expense / Deferred Expense or Prepayment
May 1. Rented office space and paid two months rent in advance, P8,000.

Analysis. Assets increased. Assets decreased.
Rules. Increases in assets are recorded by debits. Decreases in assets are recorded by credits.
Entry. Increase in assets is recorded by a debit to prepaid rent. Decrease in assets is recorded by a credit to cash.
Prepaid Expense / Deferred Expense or Prepayment (Current Asset) – Expenses already paid but not yet incurred or used.
Journal entry: May 1 Prepaid Rent (A) P8,000
Cash (A) P8,000
To record two months advance rent.
Note Issued for Cash (Source of Assets)
May 2. Maria Concepcion Jennifer Perez-Manalo issued a promissory note for 210,000 loan from Metrobank. This availment will be used for the
acquisition of a service vehicle. The note carries a 20% interest per annum. The arrangement with the bank is that both the interest and the
principal are payable in full in one year.

Analysis. Assets increased. Liabilities increased.
Rules. Increases in assets are recorded by debits. Increases in liabilities are recorded by credits.
Entry. Increase in assets is recorded by a debit to cash. Increase in liabilities is recorded by a credit to notes payable.
Notes Payable – Amounts or claims from clients or customers which are ezpressed in writing like promissory notes.
Notes Payable (L) P210,000
To record promissory note issued to Metrobank.
Hiring of Office Personnel
May 2. Hired an office assistant and an accountant executive each with a 7,800 monthly salary. Or each, is to receive 300 per day for the 26-
day work month.
Journal entry: No entry is necessary at this point. They started working immediately.
Service Vehicle Acquired for Cash (Exchange of Assets)
May 4. Acquired service vehicle for P420,000

Analysis. Assets increased. Assets decreased
Rules. Increases in assets are recorded by debits. Decreases by credits.
Entry. Increase in assets is recorded by a debit to service vehicle. Decrease in assets is recorded by a credit to cash.
Journal entry: May 4 Service Vehicle (A) P420,000
Cash (A) P420,000
To record acquisition of service vehicle.
Insurance Premium Paid (Exchange of Assets) Prepaid Expense / Deferred Expense or Prepayment
May 4. Paid Prudential Guarantee and Assurance, Inc. 14,400 for one-year comprehensive insurance coverage on the service vehicle.
Analysis. An asset increase. Another asset decreased
Rules. Increases in assets are recorded by debits. Decreases in assets are recorded by credits.
Entry. Increase in assets is recorded by a debit to prepaid insurance. Decrease in assets is recorded by a credit to cash.
Prepaid Expense / Deferred Expense or Prepayment (Current Asset) – Expenses already paid but not yet incurred or used.
Journal entry: May 4 Prepaid Insurance (A) P14,400
Cash (A) P14,400
To record payment of insurance.
Office Equipment Acquired on Account (Exchange and Source of Assets)
May 5. Acquired office equipment from Fair and Square Emporium for 60,000; paying 15,000 in cash and balance next month
Note. A compound entry is needed for this transaction. A compound entry is when there is more than one account listed under the debit
and/or credit column of a journal entry (as seen in the following).
Analysis. Assets increased. Assets decreased. Liabilities increased.
Rules. Increases in assets are recorded by debits. Decreases in assets are recorded by credits Increases in liabilities are recorded by credits.
Entry. Increase in assets is recorded by a debit to office equipment. Decrease in assets is recorded by a credit to cash. Increase in liabilities is
recorded by a credit to accounts payable.
Journal entry: May 5 Office Equipment (A) P60,000
Cash (A) P15,000
Accounts Payable (L) 45,000
To record purchase of equipment.
Supplies Purchased on Account (Source of Assets)
May 8. Purchased supplies on credit for 18,000 from San Jose Merchandising.
Entry. Increase in assets is recorded by a debit to supplies. Increase in liabilities is recorded by a credit to accounts payable
Journal entry: May 8 Supplies (A) P18,000
Accounts Payable (L) P18,000
To record purchase of supplies on credit.
Accounts Payable Partially Settled (Use of Assets)
May 9 Paid San Jose Merchandising P10,000 of the amount owed.

Analysis. Assets decreased. Liabilities decreased.
Rules. Decreases in assets are recorded by credits. Decreases in liabilities are recorded by debits.
Entry. Decrease in liabilities is recorded by a debit to accounts payable. Decrease in assets is recorded by a credit to cash.
Journal entry: May 9 Accounts Payable (L) P10,000
Cash (A) P10,000
To record payment of account to San Jose Merchandising.
Revenues Earned and Cash Collected (Source of Assets)

May 10. Coordinated and finalized simple bridal arrangements for three couples and collected fees of 8,800 per couple. Services include
prospecting and selecting the church and reception location, couturier, caterer, car service, flowers, souvenirs and invitations.

Analysis. Assets increased. Owner’s equity increased.
Rules. Increases in assets are recorded by debits. Increases in owner’s equity are recorded by credits.
Entry. Increase in assets is recorded by a debit to cash. Increase in owner’s equity is recorded by a credit to consulting revenues.
Consulting Revenues (OE:I) P26,400
To record revenue earned.
Salaries Paid (Use of Assets)
May 13. Paid salaries 6,600. The entity pays salaries every two Saturdays.

Analysis. Assets decreased. Owner’s equity decreased.
Rules. Decreases in assets are recorded by credits. Decreases in owner’s equity are recorded by debits.
Entry. Decrease in owner’s equity is recorded b a debit to salaries expense. Decrease in assets is recorded by a credit to cash.
Journal entry: May 13 Salaries Expense (OE:E). P6,600
Cash (A) P6,600
To record payment of salaries.
Unearned Revenues/Deferred Income Collected (Source of Assets) Unearned / Deferred Income Unearned / Deferred Revenue /
Advance Payments / Deferred Credits
May 15. The entity is earning additional revenues by referring consulting clients to friendly hotels, caterers, printers and couturiers. Received
10,000 advance fees for three clients referred.

Entry. Increase in assets is recorded by a debit to cash. Increase in liabilities is recorded by a credit to unearned referral revenues.
Unearned / Deferred Income Unearned / Deferred Revenue / Advance Payments / Deferred Credits (Current Liability)- cash received in
advanced but not yet earned/performed/rendered.
Unearned Referral Revenues (L) P10,000
To record cash received.
Revenues Earned on Account (Source of Assets) Accrued Income or Accrued Revenue
May 19. Coordinated and finalized elaborate bridal arrangements for three couples and billed fees of P12,000 per couple. Additional services
include documents preparation, consultation with a feng shui experts as to the ideal wedding date for prosperity and harmony, provision for
limousine service and honeymoon.

Analysis. Assets increased. Owner’s equity increased.
Rules. Increases in assets are recorded by debits. Increases in owner’s equity are recorded by credits.
Entry. Increase in assets is recorded by a debit to to accounts receivable. Increase in owner’s equity is recorded by a credit to consulting
revenues.
Accrued Income or Accrued Revenue (Current Asset)– Earned/performed/rendered but not yet received/recorded/paid.
Journal entry: May 19 Accounts Receivable (A) P36,000
To record services rendered on account.
Withdrawal of Cash by Owner (Use of Assets)
May 25. Perez-Manalo withdrew 14,000 for personal expenses.

Entry. Decrease in owner’s equity is recorded by a debit to Perez-Manalo, Withdrawals. Decrease in assets is recorded to cash.
Journal entry: May 25 Perez-Manalo, Withdrawals (OE) P14,000
Cash (A) P14,000
To record Perez-Manalo’s withdrawal.
Salaries Paid (Use of Assets)
May 27. Paid salaries, P7,200.

Rules. Decreases in assets are recorded by credits. Decreases owner’s equity are recorded by debits.
Entry. Decrease in owner’s equity is recorded by a debit to salaries expense. Decrease in assets is recorded by a credit to cash.
Journal entry: May 27 Salaries Expense (OE:E) P7,200
Cash (A) P7,200
To record payment of salaries.
Expenses Incurred but Unpaid (Exchange of Claims) Accrued Expense or Accrued Liability
May 30. Received the ICC-Bayante telephone bill, 1,400.
Analysis. Liabilities increased. Owner’s equity decreased.
Rules. Increases in liabilities are recorded by credits. Decreases in owner’s equity are recorded by debits.
Entry. Decrease in owner’s equity is recorded by a debit to utilities expense. Increase in liabilities is recorded by a credit to utilities payable.
Accrued Expense or Accrued Liability (Current Liability)– Expenses already incurred or used but not yet paid.
Journal entry: May 30 Utilities Expense (OE:E) P1,400
Utilities Payable (L) P1,400
To record unpaid telephone bill.
Accounts Receivable Partially Collected (Exchange of Assets)
May 30. Received 24,000 from two clients for services billed last May 19.

Analysis. An asset increased. Another asset decreased.
Rules. Increases in assets are recorded by debits. Decreases as credits.
Entry. Increase in assets is recorded by a debt to cash. Decrease in assets is recorded by a credit to accounts receivable.
by a credit to utilities payable.
Accounts Receivable (A) P24,000
To record cash received from credit clients.
Expenses Incurred and Paid (Use of Assets)
May 31. Settled the electricity bill of 3,000 for the month.

Entry. Decrease in owner’s equity is recorded by a debit to utilities expense. Decrease in assets is recorded by a credit to cash.
Journal entry: May 30 Utilities Expense (OE:E) P3,000
Cash (A) P3,000
To record payment of electricity bill.
THE LEDGER
 A grouping of the entity's accounts is referred to as a ledger.
 It is called the "reference book" of the accounting system and is
 It is used to classify and summarize transactions, and to prepare data for basic financial statements.
The accounts in the general ledger are classified into two general groups:
1. Balance sheet or permanent accounts (assets, liabilities and owner's equity).
2. Income statement or temporary accounts (income and expenses). Temporary or nominal accounts are used to
gather information for a particular accounting period. At the end of the period, the balances of these accounts are transferred to
a permanent owner's equity account.
Each account has its own record in the ledger. Every account in the ledger maintains the basic format of the T-account but
offers more information (e.g. the account number at the upper right corner and the journal reference column). Compared to a
journal, a ledger organizes information by account.
CHART OF ACCOUNTS
 A listing of all the accounts and their account numbers in the ledger is known as
the chart of accounts.
 The chart is arranged in the financial statement order, that is, assets first,
followed by liabilities, owner's equity, income and expenses.
 The accounts should be numbered in a flexible manner to permit indexing and
cross-referencing.

When analyzing transactions, the accountant refers to the chart of accounts to identify
the pertinent accounts to be increased or decreased. If an appropriate account title is
not listed in the chart, an additional account may be added. Presented below is the
chart of accounts for illustration:
Step 3. POSTING
Posting means transferring the amounts from the journal to the appropriate accounts in
the ledger. Debits in the journal are posted as debits in the ledger, and credits in the
journal as credits in the ledger.

The steps are as follows:
1. Transfer the date of the transaction from the journal to the ledger.
2. Transfer the page number from the journal to the journal reference (J.R.)
column of the ledger.
3. Post the debit figure from the journal as a debit figure in the ledger and the
credit figure from the journal as a credit figure in the ledger.
4. Enter the account number in the posting reference column of the journal once
the figure has been posted to the ledger.
LEDGER ACCOUNTS AFTER POSTING

At the end of an accounting period, the debit or credit balance of each account must be
determined to enable us to come up with a trial balance.
 Each account balance is determined by footing (adding) all the debits and
credits.
 If the sum of an account's debits is greater than the sum of its credits, that
account has a debit balance.
 If the sum of its credits is greater, that account has a credit balance.

Illustration: The ledger accounts of Weddings “R” Us after posting are shown below.
The account numbers and journal reference are purposely omitted. The balance of
each account
Step 4. TRIAL BALANCE

The trial balance is a list of all accounts with their respective debit or credit balances. It is prepared to verify the equality of debits
and credits in the ledger at the end of each accounting period or at any time the postings are updated.

The procedures in the preparation of a trial balance follow:

1.List the account titles in numerical order.
2.Obtain the account balance of each account from the ledger and enter the debit balances in the debit column and the credit
balances in the credit column.
3.Add the debit and credit columns.
4.Compare the totals.

The trial balance is a control device that helps minimize accounting errors. When the totals are equal, the trial balance is in
balance. This equality provides an interim proof of the accuracy of the records but it does not signify the absence of errors. For
example, if the bookkeeper failed to record payment of rent, the trial balance columns are equal but in reality, the accounts are
incorrect since rent expense is understated and cash overstated.

LOCATING ERRORS
An inequality in the totals of the debits and credits would automatically

signal the presence of an error. These errors include:
Error in posting a transaction to the ledger:

 an erroneous amount was posted to the account
 a debit entry was posted as a credit or vice versa.
 a debit or credit posting was omitted.
Error in determining the account balances:
 a balance was incorrectly computed.
 a balance was entered in the wrong balance column.
Error in preparing the trial balance:
 one of the columns of the trial balance was incorrectly added.
 the amount of an account balance was incorrectly recorded on the
trial balance.
 A debit balance was recorded on the trial balance as a credit or vice
versa, or a balance was omitted entirely.
What is the most efficient approach in locating an error?

The following procedures when done in sequence may save considerable time and effort in locating errors:
1. Prove the addition of the trial balance columns by adding these columns in the opposite direction.
2. If the error does not lie in addition, determine the exact amount by which the trial balance is out of balance. The amount of
the discrepancy is often a clue to the source of the error. If the discrepancy is divisible by 9, this suggests either a transposition
(reversing the order of numbers) error or a slide (moving of the decimal point).

For example, assume that the cash account balance is P21,750, but in copying the balance into the trial balance the figures are
transposed and written as P21,570. The resulting error amounted to P180 and is divisible by 9:
Another common error is the slide, or incorrect placement of the decimal point, as when P21,750.00 is copied as P2,175.00.
The resulting discrepancy in the trial balance will also be an amount divisible by 9.

Assume that the office equipment account has a debit balance of P42,000 but it is erroneously listed in the credit column of the
trial balance. This will cause a discrepancy of two times P42,000 or P84,000 in the trial balance totals. Since such errors as
recording a debit in a credit column are common, it is advisable, after determining the discrepancy in the trial balance totals, to
scan the columns for an amount equal to exactly one-half of the discrepancy.

It is also advisable to look over the transactions for an item of the exact amount of the discrepancy. An error may have been
made by recording the debit side of the transaction and forgetting to enter the credit side.

3. Compare the accounts and amounts in the trial balance with that in the ledger. Be certain that no account is omitted.
4. Recompute the balance of each ledger account.
5. Trace all postings from the journal to the ledger accounts. As this is done, place a check mark in the journal and in the ledger
after each figure is verified. When the operation is completed, look through the journal and the ledger for unchecked amounts. In
tracing postings, be alert not only for errors in amount but also for debits entered as credits, or vice versa.

Note that even when a trial balance is in balance, the accounting records may still contain errors. A balanced trial balance simply
proves that, as recorded, debits equal credits. The following errors are not detected by a trial balance:

1. Failure to record or post a transaction.
2. Recording the same transaction more than once.
3. Recording an entry but with the same erroneous debit and credit amounts.
4. Posting a part of a transaction correctly as a debit or credit but to the wrong account.
Lesson 4: Adjusting the Accounts

TWO BASIC ACCOUNTING METHODS
CASH BASIS
Transactions are not recorded until cash is received or paid. Generally, cash receipts are treated as revenues and cash
payments as expenses.
Under Cash Basis

2021
May 15 Cash P10,000
Room Revenue P10,000
Cash received for a two-day suite
accommodation on June 20, 2021.
ACCRUAL BASIS
The effects of transactions and other events are recognized when they occur and not as cash or its equivalent is received
or paid. The financial statements, except for the cash flow statement, are prepared on the accrual basis of accounting.
Financial statements prepared on the accrual basis inform users not only of past transactions involving the payment and
receipt of cash, but also of obligations to pay cash in the future, and of resources that represent cash to be received in the
future. Generally accepted accounting principles require that a business use the accrual basis.
Under Accrual Basis In contrast, if cash basis is used, the hotel will recognize revenues
2021 on May 15. Expenses related to this revenue transaction will be
May 15 Cash P10,000 incurred on June 20. Suppose a financial report is prepared at the
Unearned Revenue P10,000 end of May, under the accrual basis, no revenue or expense will
Unearned revenue. be reported. While under the cash basis, revenue of P20,000 will
be reported but the related expenses will be recognized when
June 20 Unearned Revenue 10,000 incurred on June 20. Observe that the accrual basis provided a
Room Revenues 10,000 better measure of the results of transactions.
Earned room revenue.
PERIODICITY CONCEPT

Accounting information is valued when it is communicated early enough to be used for economic decision-making. To provide
timely information, the economic life of a business is divided into artificial time period.

This assumption is referred to as the periodicity concept.
Accounting periods are generally a month, a quarter, or a year. The most basic accounting period is one year.
Entities differ in their choice of the accounting year – fiscal, calendar or natural.

 A calendar year - an annual period ending on December 31. (Example: January 1,2021-December 1,2021)
 A fiscal year - a period of any twelve consecutive months as long as it is not ending on December 31
 (Example: April 1,2021-March 31,2022)
 A natural business year - a twelve-month period that ends when business activities are at their lowest level of the annual cycle or
low point in the sales activity of a business. An accounting period ending in lax season (lowest point).
 An interim period - less than a year.

Businesses need periodic reports to assess their financial condition and performance.
The periodicity concept ensures that accounting information is reported at regular intervals. It interacts with the revenue
recognition and expense recognition principles to underlie the use of accruals. To measure profit in a fair manner, entities
update the income and expense accounts immediately before the end of the period.
REVENUE AND EXPENSE RECOGNITION PRINCIPLES

The process of measuring the performance of an entity requires that certain income and expense transactions be allocated
over several accounting periods. The adjustment process relies on the revenue recognition and expense recognition
principles.

Revenue is recognized when it is probable that economic benefits will flow to the enterprise and these economic benefits can
be measured reliably. It shall be measured at the fair value of the consideration received or receivable. In most cases,
revenue is earned in the accounting period when the services are rendered or the goods are delivered.

Expense recognition principle is the basis for recording expenses. Expenses are recognized in the income statement when it
is probable that a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen,
and that the decrease in economic benefits can be measured reliably.

RECOGNITION AND DERECOGNITION

Per 2018 Conceptual Framework, recognition is the process of capturing for inclusion in the statement of financial position or
the statement(s) of financial performance as item that meets the definition of an asset, a liability, equity, income or expenses.
The amount at which an asset, a liability or equity is recognized in the statement of financial position is referred to as its
“carrying amount’.

The statement of financial position and statement(s) of financial performance depict an entity’s recognized assets, liabilities,
equity, income and expenses in structured summaries that are designed to make financial information comparable and
understandable.

Recognition links the elements, the statement of financial position and the statement(s) of financial performance. The
statements are linked because the recognition of one item (or a change in its carrying amount) requires the recognition or
derecognition of one or more other items (or changes in the carrying amount of one or more other items). For example:

The recognition of income occurs at the same time as:
 The initial recognition of an asset, or an increase in the carrying amount of an asset; or
 The derecognition of a liability, or a decrease in the carrying amount of a liability.

The recognition of expenses occurs at the same time as:
 The initial recognition of a liability, or an increase in the carrying amount of a liability; or
 The derecognition of an asset, or a decrease in the carrying amount of an asset.

The initial recognition of assets or liabilities arising from transactions or other events may result in the simultaneous
recognition of both income and related expenses.
For example: The sale of goods for cash results in the recognition of both income (from the recognition of the one asset, the
cash); An expense (from the derecognition of another asset, the goods sold).

The simultaneous recognition of income and related expenses is sometimes referred to as the matching of costs with
income.

Recognition is appropriate if it results in both relevant information about assets, liabilities, equity, income and expenses and a
faithful representation of those items, because the aim is to provide information that is useful to investors, lenders and other
creditors.

Derecognition is the removal of all or part of a recognized asset or liability from an entity’s statement of financial position.
Derecognition normally occurs when that item no longer meets the definition of an asset or of a liability:

 For an asset, derecognition normally occurs when the entity loses control of all or part of the recognized assets; and
 For a liability, derecognition normally occurs when the entity no longer has a present obligation for all or part of the
recognized liability.
NEED FOR ADJUSTMENTS

Adjusting entries are made to reflect in the accounts information on economic activities that have occurred but have not yet
been recorded. Adjusting entries assign revenues to the period in which they are earned, and expenses to the period in which
they are incurred. These entries are needed to measure properly the profit for the period, and to bring related asset and liability
accounts to correct balances for the financial statements.

Adjustments are needed to ensure that revenue recognition and expense recognition principles are followed thus resulting to
financial statements reporting the effects of all transactions at the end of the period.

Adjusting entries involve changing account balances at the end of the period from what is the current balance of the account to
what is the correct balance for proper financial reporting. Without adjusting entries, financial statements may not fairly show
the solvency of the entity in the balance sheet and the profitability in the income statement.
There are two general types of adjustments made at the end of the accounting period:
Accrual is the recognition of “an expense already incurred Deferrals is the postponement of the recognition of “an
but unpaid”, or “revenue earned but uncollected”. This expense already paid but not yet incurred”, or of “a revenue
adjustment deals with an amount unrecorded in any already collected but not yet earned”. This adjustment
account; the entry, in effect, increases both the balance deals with an amount already recorded in the balance sheet
sheet and an income statement account. account; the entry in effect decreases the balance sheet
account and increases an income statement account.
Accruals would be required in two cases:
Deferrals would be needed in two cases:
1. Accruing expenses to reflect expenses incurred
during the accounting period that are unpaid and 1. Allocating assets to expense to reflect expenses
unrecorded. Accrued Expense or Accrued incurred during the accounting period, e. g. prepaid
Liability (Current Liability) insurance, supplies, Prepaid Expense / Deferred
2. Accruing revenues to reflect revenues earned Expense or Prepayment (Current Asset)
during the accounting period that are uncollected 2. Allocating revenues received in advance to revenue
and unrecorded. Accrued Income or Accrued to reflect revenues earned during the accounting
Revenue (Current Asset) period, e. g. subscriptions. Unearned / Deferred
Income Unearned / Deferred Revenue / Advance
- cash after Payments / Deferred Credits (Current Liability)
- cash before
ADJUSTMENTS FOR ACCRUALS (Step 5)
Accrued Expenses
An entity often incurs expenses before paying for them. Cash payments are usually made at regular intervals of time such as
weekly, monthly, quarterly or annually. If the accounting period ends on a date that does not coincide with the scheduled cash
payment date, an adjusting entry is needed to reflect the expense incurred since the last payment. This adjustment helps the
entity avoid the impractical preparation of hourly or daily journal entries just to accrue expenses. Salaries, interest, utilities, and
taxes are examples of expenses that are incurred before payment is made.

Accrued Salaries (Adjustment. g). Entities pay their employees a regular intervals. It can be weekly, semi-monthly or
monthly. Weekly payrolls are usually made on Fridays (for a five-day workweek) or Saturdays (for a six-day workweek).
Weddings “R” Us pays salaries every two Saturdays. Assume that the calendar for May appears as follows:

May
Sunday Monday Tuesday Wednesday Thursday Friday Saturday
1 2 3 4 5 6
7 8 9 10 11 12 13
14 15 16 17 18 19 20
21 22 23 24 25 26 27
28 29 30 31

The office assistant and the account executive were paid salaries on May 13 and 27. At month-end, the employees have
worked for three days (May 29, 30 and 31) beyond the last pay period. The employees have earned the salary for these days,
but it is not due to be paid until the regular payday in June. The salary for these three days is rightfully an expense for May,
and the liability should reflect that the entity owes the employees’ salaries for those days.

Each of the employee’s salary rate is P7,800 per month or P300 per day (P7,800 / 26 working days). The expense to be
accrued is P1,800 (P300 x 3 days x 2 employees). This accrued expense can be analyzed as shown:

Transaction Accrual of unrecorded expense.
Analysis Liabilities increased. Owner’s equity decreased.
Rules Increases in liabilities are recorded by credits. Decreases in owner’s equity are recorded by debits.
Entries Increase in liabilities is recorded by credit to salaries payable. Decreases in owner’s equity is recorded by a
debit to salaries expense.

Salaries Expense (OE:E) P1,800
Salaries Payable (L) P1,800

The liability of P1,800 is now correctly reflected in the salaries payable account. The actual expense incurred for salaries during
the month is P15,600 (P7,800 x 2 employees).
Accrued Interest (Adjustment h). On May 2, Perez-Manalo borrowed P210,000 from Metrobank. She issued a promissory
note that carried a 20% interest per annum. Both the interest and principal will be payable in one year. The note issued to the
bank accrues interest at 20% annually. At the end of May, Perez-Manalo owed the bank P3,500 (see computation below) for
interest in addition to the P210,000 loan. Interest is a charge for the use of money over time. Interest expense is matched to a
particular period during which the benefit, the use of borrowed money is received. The interest is a fixed obligation and
accrues regardless of the results of the entity’s operations.

Interest rates are expressed at annual rates, so if interest is being calculated for less than a year, the calculation must express
time as a portion of a year. Thus, interest expense (simple) incurred on this note during the month is determined by the
formula:

Interest = Principal x Interest Rate x Length of Time
= P210,000 x 20% per year x 1/12 of a year
= P210,000 x .20 x 1/12
= P3,500

The adjusting entry to record the interest expense incurred in May as follows:

Transaction: Accrual of unrecorded expense.
Analysis: Liabilities increased. Owner’s Equity decreased.
Rules: Increases in liabilities are recorded as credits. Decreases in owner’s equity are recorded as debits.
Entries: Increase in liabilities is recorded by a credit to interest payable. Decrease in owner’s equity is recorded by a
debit to interest expense.

Interest Expense (OE:E) P3,500
Interest Payable (L) P3,500

Note: In computing for length of time, usually exclude the day that loans occur and include the day that loans are paid off.

Accrued Revenues
An entity may provide services during the period that are neither paid for by clients nor billed at the end of the period. The
value of these services represents revenue earned by the entity. Any revenue that has been earned but not recorded during
the accounting period calls for an adjusting entry that debits an asset account and credits an income account.

Accrued Consulting Revenues (Adj. i). Suppose that Weddings “R” Us agreed to arrange a rush but simple wedding for a
madly-in-love couple in the afternoon of May 31. The entity intended to charge fees of P5,300 for the services, which is earned
but unbilled.

Transaction: Accrual of unrecorded revenue.
Analysis: Assets increased. Owner’s Equity increased.
Rules: Increases in assets are recorded as debits. Increases in owner’s equity are recorded as credits.
Entries: Increase in assets is recorded by a debit to accounts receivable. Increase in owner’s equity is recorded by a
credit to Consulting Revenues.


A total of P67,700 in consulting revenues was earned by the entity during the month.
ACCRUAL FOR UNCOLLECTIBLE ACCOUNTS

Entities often allow clients to purchase goods or avail of services on credit. Some of these accounts will never be
collected, hence, there is a need to reflect these as charges against income. In practice, an expense is recognized for the
estimated uncollectible accounts in the current period, rather than when specific accounts actually become uncollectible. This
practice produces a better matching of income and expenses.

Estimates of uncollectible accounts may be based on:

 credit sales for the period; or
 accounts receivable balance.

Illustration: Assume that an entity made credit sales of P1,100,000 for 2019 and prior experience indicates an expected 1%
average uncollectible accounts rate based on credit sales. The contra-account, Allowance for Uncollectible Accounts has
a normal credit balance and is shown as a deduction from Accounts Receivable. The allowance account needs to be
increased by P11,000 (P1,100,000 x 1%) because accounts receivable in that amount is doubtful of collection. The adjustment
will be:

Uncollectible Accounts / Bad Debts Expense (OE:E) P11,000
Allowance for Uncollectible Accounts / Bad Debts (A) P11,000

Throughout the accounting period, when there is positive evidence that a specific account is definitely uncollectible, the
appropriate account is written off against the contra account. For example, if a P1,500 receivable was considered uncollectible,
that amount would be written off as follows:

Allowance for Uncollectible Accounts (A) P1,500

No entry is made to Uncollectible Accounts Expense, since the adjusting entry has already provided for an estimated expense
based on previous experience for all receivables.
ADJUSTMENTS FOR DEFERRALS (Step 5)

Allocating Assets to Expenses
Entities often make expenditures that benefit more than one period. These expenditures are generally debited to an asset
account. At the end of each accounting period, the estimated amount that has expired during the period or that has benefited
the period is transferred from the asset account to an expense account. Two of the more important kinds of adjustments are
prepaid expenses, and depreciation of property and equipment.

Prepaid Expenses
Some expenses are customarily paid in advance. These expenditures include supplies, rent, and insurance, and they are
called prepaid expenses. Prepaid expenses are assets, not expenses. At the end of the accounting period, a portion or all of
these prepayments may have expired. The portion of an asset that has expired becomes an expense. Prepaid expenses
expire either with the passage of time or through use and consumption. The flow of costs from the balance sheet to the income
statement is illustrated below:

If adjustments for prepaid expenses are not made at the end of the period, both the
balance sheet and the income statement will be misstated. First, the assets of the
entity will be overstated; second the expenses of the company will be
understated. For this reason, the owner’s equity in the balance sheet and profit in the
income statement will both be overstated. Besides prepaid rent, Weddings “R” Us has
prepaid expenses for supplies and insurance, both accounts need adjusting entries.

Prepaid Rent (Adjustment a.) On May 1, Weddings “R” Us paid P8,000 for two months’ rent in advance. This expenditure
resulted to an asset consisting of the right to occupy the office for two months. A portion of the asset expires and becomes an
expense each day. By May 31, one-half of the asset has expired, and should be treated as an expense. The analysis of this
economic event is shown below:

Transaction Expiration of one-month’s rent.
Analysis Assets decreased. Owner’s equity decreased.
Rules Decreases in assets are recorded by credits. Decreases in owner’s equity are recorded by debits.
Entries Decrease in owner’s equity is recorded by debit to rent expense. Decrease in assets is recorded by credit to
prepaid rent.

Rent Expense (OE:E) P4,000
Prepaid Rent (A) P4,000

Computation: P8,000 (for two months covering May 1 to June 30) / 2 months = P4,000 per month

After adjustments, the prepaid rent account has a balance of P4,000 (May 1 prepayment of P8,000 less the P4,000 expired
portion); the rent expense account reflects the P4,000 expense for the month.

Prepaid Insurance (Adjustment b). Weddings “R” Us acquired a one-year comprehensive insurance coverage on the service
vehicle and paid P14,400 premiums. In a manner similar to prepaid rent, prepaid insurance offers protection that expires daily.
The adjustment is analyzed and recorded as shown below:
Transaction Expiration of one-month’s insurance.
Entries Decrease in owner’s equity is recorded by debit to insurance expense. Decrease in assets is recorded
by credit to prepaid insurance.

Insurance Expense (OE:E) P1,200
Prepaid Insurance (A) P1,200

Computation: P14,400/12 months = P1,200 per month

The prepaid insurance account has a balance of P13,200 (May 4 prepayment of P14,400 less P1,200) and insurance expense
reflects the expired cost of P1,200 for the month. As a matter of company policy, the period May 4 to 31 is considered a
month.
Supplies (Adjustment c). On May 8, Weddings “R” Us purchased supplies, P18,000. During the month, the entity used
supplies in the process of performing services for clients. There is no need to account for these supplies every day since the
financial statements will not be prepared until the end of the month. At the end of the accounting period, Perez-Manalo makes a
careful physical inventory of the supplies. The inventory count showed that supplies costing P15,000 are still on hand. This
transaction is analyzed and recorded as follows:
Transaction Consumption of supplies.
Entries Decrease in owner’s equity is recorded by debit to supplies expense. Decrease in assets is recorded by
credit to supplies.

Supplies Expense (OE:E) P3,000
Supplies (A) P3,000

The asset account supplies now reflect the adjusted amount of P15,000 (P18,000 less P3,000). In addition, the amount of
supplies expensed during the accounting period is reflected as P3,000.

Depreciation of Property and Equipment
When an entity acquires long-lived assets such as buildings, service vehicles, computers or office furniture, it is basically
buying or prepaying for the usefulness of that asset. These assets help generate profit for the entity. Therefore, a portion of
the cost of the assets should be reported as expense in each accounting period. Proper accounting requires the allocation of
the cost of asset over its estimated useful life. The estimated amount allocated to any one accounting period is called
depreciation or depreciation expense.

Three factors are involved in computing depreciation expense:

1. Asset cost is the amount an entity paid to acquire the depreciable asset.
2. Estimated salvage value is the amount that the asset can probably be sold for at
the end of its estimated useful life.
3. Estimated useful life is the estimated number of periods that an entity can make
use of the asset. Useful life is an estimate, not an exact measurement.
Accountants estimate periodic depreciation. They have developed a number of
methods for estimating depreciation. The simplest procedure is the straight-line
method. The formula for determining the amount of depreciation expense for each
period using this method is:

Service Vehicle Office Equipment
Asset cost P420,000 P60,000
Less: Estimated salvage value 84,000 0
Depreciable cost P336,000 P60,000
Divided by: Estimated useful life (7 years x 12 mos) 84 (5 years x 12 mos) 60
Monthly Depreciation Expense P 4,000 P 1,000

When recording depreciation expense, the asset account is not directly reduced. Instead, the reduction is recorded in a contra
account called accumulated depreciation. A contra account is used to record reductions in a related account and its normal
balance is opposite that of the related account. Use of the contra account, accumulated depreciation allows the disclosure of
the original cost of the related asset in the balance sheet. The balance of the contra account is deducted from the cost to obtain
the book value of the property and equipment.

Service Vehicle and Office Equipment (Adjustments d and e). Suppose that Weddings “R” Us estimated that the service
vehicle, which was brought on May 4, will last for seven years (7 years x 12 months = 84 months) and with a salvage value of
P84,000. The office equipment that was acquired on May 5 will have a useful life of five years (5 years x 12 months = 60
months) and will be worthless at that time. Substitution of the pertinent amounts into the basic formula will yield depreciation for
service vehicle and office equipment for the month as P4,000 [(P420,000 – P84,000) / 84 months] and P1,000 (P60,000 / 60
months), respectively. These amounts represent the cost allocated to the month, thus reducing the asset accounts and
increasing the expense accounts. As a matter of company policy, the period May 4 to 31 is considered a month. The analysis
follows:
Transaction Recording of depreciation expense.
Entries Decrease in owner’s equity is recorded by debit to depreciation expense-service vehicle and

depreciation expense-office equipment.
Decrease in assets is recorded by credit to accumulated depreciation-service vehicle and
accumulated depreciation-office equipment.

Depreciation Expense-Service Vehicle (OE:E) P4,000
Accumulated Depreciation-Service Vehicle (A) P4,000

Depreciation Expense-Office Equipment (OE:E) P1,000
Accumulated Depreciation-Office Equipment (A) P1,000

After adjustments, the property and equipment section of the balance sheet for Weddings “R” Us will be:

Weddings “R” Us
Partial Balance Sheet
May 31, 2019

Property and Equipment (Net):
Service Vehicle P420,000
Less: Accumulated Depreciation 4,000 P416,000

Office Equipment P 60,000
Less: Accumulated Depreciation 1,000 59,000
P475,000
Allocating Revenues Received in Advance to Revenues
There are times when an entity receives cash for services or goods even before
service is rendered or goods are delivered. When such is received in advance, the
entity has an obligation to perform services or deliver goods. The liability referred to is
unearned revenue.
For example, publishing companies usually receive payments for magazine
subscriptions in advance. These payments must be recorded in a liability account. If
the company fails to deliver the magazines for the subscription period, subscribers
are entitled to a refund. As the company delivers each issue of the magazine, it earns
a part of the advance payment. This earned portion must be transferred from the
unearned subscription revenues account to the subscription revenues account.
Unearned Referral Revenues (Adjustment f). On May 15, Weddings “R” Us received P10,000 as advance payment for
referrals made. Assume that by the end of the month, one of the three couples referred has already taken their marriage vows
and as a result the amount of P4,000 pertaining to the referred event has been realized. This transaction is analyzed as
follows:

Transaction Recognition of income where cash is received in advance.
Analysis Liabilities decreased. Owner’s equity increased.
Rules Decreases in liabilities are recorded by debits. Increases in owner’s equity are recorded by credits.
Entries Decrease in liabilities is recorded by debit to unearned referral revenues. Increases in owner’s equity is
recorded by a credit to referral revenues.

Unearned Referral Revenues (L) P4,000
Referral Revenues (OE:I) P4,000

The liability account unearned referral revenues reflect the referral revenues still to be earned P6,000. The referral revenues
account reflects the amount of referrals already completed and considered as revenues during the month, P4,000.
ALTERNATIVE METHODS OF RECORDING DEFERRALS
All transactions that required adjustments are initially recorded in the balance sheet accounts. A prepaid expense is initially recorded in a
prepaid asset account. Likewise, revenue received in advance is initially recorded in a liability account, unearned revenues. In the case of a
prepaid expense, an adjusting entry is made at the end of the period to transfer the portion of the expired asset to an expense account.
Similarly, an adjusting entry is made to transfer earned revenues from the liability account to an income account.

Entities may initially account for deferrals using income and expense accounts. The alternative approach is illustrated below.

Prepaid Expenses
On Oct. 1, 2019, Calaguas Company acquired a 3-year insurance policy for P36,000 paid in advance. Calaguas may record this transaction
depending on which of the two accounting policies it follows. The P36,000 payment may initially be recorded either as an asset or as an
expense.
At the end of the year, an adjusting entry is needed to establish the proper balances in the prepaid insurance and insurance expense
accounts. On Dec. 31, 2019, three months’ insurance has been consumed or insurance expense is equal to P3,000 (P36,000 / 36 months x 3
months). Prepaid insurance equivalent to P33,000 (P36,000 – 3,000) remain. The appropriate adjustment depends on how the initial
transaction was recorded.

Initial entry is recorded as: Adjusting entry required if initial entry is recorded as:

1. As asset 1. An asset
2019 2019
Oct. 10 Prepaid Insurance (A) P36,000 Dec. 31 Insurance Expense (OE:E) P3,000
Cash (A) P36,000 Prepaid Insurance (A) P3,000

2. As expense 2. An expense
2019 2019
Oct. 10 Insurance Expense (OE:E) P36,000 Dec. 31 Prepaid Insurance (A) P33,000
Cash (A) P36,000 Insurance Expense (OE:E) P33,000

The effect of the adjusting entries on the ledger accounts after posting is the same regardless of the initial debits as shown below:

As an Asset As an Expense
Dec. 31 Balances: Dec. 31 Balances:
Prepaid Insurance P33,000 Debit Prepaid Insurance P33,000 Debit
Insurance Expense 3,000 Debit Insurance Expense 3,000 Debit

Unearned Revenues
On July 1, 2019, Marasigan Company received P48,000 check for 2 years’ rent paid in advance. On this date, Marasigan may record a credit
in that amount either as unearned rental revenue (L) or rental revenue (OE:I), depending on its accounting policy.
At the end of the year an adjusting entry is needed to establish the proper balances in the rent revenue and unearned rent revenue accounts.
On Dec. 31, 2019, six months’ rent has been earned, or rent revenue is equal to P12,000 (P48,000 / 24 months x 6 months). Unearned rent
revenues equivalent to P36,000 (P48,000 – P12,000) remain. The appropriate adjustment depends on how the initial transaction was
recorded.
Initial entry is recorded as: Adjusting entry required if initial entry is recorded as:
1. A liability 1. A liability
2019 2019
July 1 Cash P48,000 Dec. 31 Unearned Rent Revenue (L) P12,000
Unearned Rent Revenues (L) P48,000 Rent Revenues (OE:I) P12,000
2. A revenue 2. A revenue
2019 2019
July 1 Cash P48,000 Dec. 31 Rent Revenue (OE:I) P36,000
Rent Revenues (OE:I) P48,000 Unearned Rent Revenues (L) P36,000
The effect of the adjusting entries on the ledger accounts after posting is the same regardless of the initial credits as shown below:
As a Liability As a Revenue

Dec. 31 Balances: Dec. 31 Balances:
Unearned Rent Revenue P36,000 Credit Unearned Rent Revenue P36,000 Credit
Rent Revenue 12,000 Credit Rent Revenue 12,000 Credit
Lesson 5: Worksheet, Financial Statements and Completing the Accounting Cycle

ACCOUNTING CYCLE
The accounting cycle refers to a series of sequential steps or procedures performed to accomplish the accounting process.
THE WORKSHEET
It is multi-column document which provides an efficient way to summarize the data for financial statements preparation.

Importance of the Worksheet
 It aids in the transfer of data from the unadjusted trial balance to the financial statement.
 It simplifies the adjusting and closing process.
 It reveals errors.
 It is a summary device that ease the work of the accountant in the preparation of the financial statements.

Step 5. PREPARING THE WORKSHEET
The steps in the preparation of a worksheet are:
1. Enter the account and balances in the unadjusted trial balance columns and total the amounts.
a. The account numbers, titles and balances are lifted from the general ledger to the unadjusted trial balance.
b. The accounts are listed in the worksheet in the order in the general ledger.
c. Accounts with zero balances are also presented.
d. Total debits and total credits must equal.
2. Enter the adjusting entries in the adjustments columns and total the amounts.
3. Compute each account’s adjusted balance by combining the unadjusted trial balance and the adjustment figures. Enter the
adjusted amounts in the adjusted trial balance.
The adjusted trial balance is prepared by combining horizontally, line by line, the amount of each account in the unadjusted trial
balance columns with the corresponding amounts in the adjustment columns. The procedure is called cross-footing.
4.Extend the asset, liability and owner’s equity amounts from the adjusted trial balance columns to the balance sheet
columns. Extend the income and expense amounts to the income statement columns. Total the columns.

 Every account is either a balance sheet account or an income statemen account. Asset, liability, capital, and withdrawal
accounts are extended to the balance sheet columns. Income and expense accounts are moved to the income statement
columns.
 Debits in the adjusted trial balance remain as debits in the statement columns, while credits as credits. Each account’s
adjusted balance should appear in only one statement column. At this stage, the initial totals of the income statement and
balance sheet columns are not equal.

5.Compute for profit or loss as the difference between total revenues and total expenses in the income statement. Enter profit
or loss as a balancing amount in the income statement, and in the balance sheet, and compute the final column totals.

Profit or loss is equal to the difference between the debit and credit columns of the income statement.

Revenues (Income Statement credit column total) P71,700
Expenses (Income Statement debit column total) 36,700
Profit P35,000

 The profit or loss should always be the amount by which the debit and credit columns for income statement, and the debit
and credit columns for the balance sheet differ. The profit figure is entered in debit column of the income statement and credit
column of the balance sheet. After completion, total debits and total credits in the income statement and balance sheet
columns must equal.
 The profit figure is extended to the credit column of the balance sheet because profit increases owner’s equity and increases
in owner’s equity are recorded as credits. Profit must be added and withdrawals subtracted to arrive at the ending capital
balance; this is done when the statement of changes in equity is prepared.
ESSENCE OF FINANCIAL STATEMENTS

 It is the means by which the information accumulated and
processed in financial accounting is periodically
communicated to the users.
 Sound economic decisions are based from the accounting
information embodied in the financial statement.
 It provides information about the financial position, financial
performance, and cash flows of an entity.

COMPLETE SET OF FINANCIAL STATEMENTS

Per revised Philippine Accounting Standards (PAS) No. 1,
a complete set of financial statements comprises:
1. Statement of financial position as at the end of the period;
2. Statement of comprehensive income for the period;
3. Statement of changes in equity for the period;
4. Statement of cash flows for the period;
5. Notes, comprising a summary of significant accounting
policies and other explanatory information; and
1. Statement of financial position as at the beginning of the
earlier comparative period when an entity applies an
accounting policy retrospective restatement of items in its
financial statements or when it reclassifies items in its
financial statements.
In a nutshell,
 Statement of Financial Position (or Balance Sheet) lists all the assets, liabilities and equity of an entity as at a specific date.
 Statement of Financial Performance (or Income Statement) presents a summary of revenues and expenses of an entity for a specific period.
 Statement of Changes in Equity presents a summary of the changes in capital such as investments, profit or loss, and withdrawals.
 Statement of Cash Flows reports the amount cash received and disbursed during the period.
 Notes to Financial Statements provide narrative descriptions or disaggregation of items presented in the statement and information about
them that do not qualify for recognition in the statements.
For the month ended ( DATE ) – A period in time As of ( DATE) – A point in time
Step 6. PREPARING THE FINANCIAL STATEMENTS

Statement of Financial Performance
An entity can present all items of income and expenses recognized in a period:
 In a single statement of comprehensive income, or
 In two statements:
 A statement displaying components of profit or loss (separate income statemen), and
 A second statement beginning with profit or loss and displaying components of other comprehensive income.
The 2018 Conceptual Framework does not
Weddings “R’ Us specify whether the statement(s) of financial
Income Statement performance comprise(s) a single statement
For the Month Ended May 31, 2019 or two statements.

Revenues The discussion will zero in on the separate
Consulting Revenues P67,700 income statement portion because the other
Referral Revenues 4,000 line items comprising the statement of
Total P71,700 comprehensive income will be tackled in
higher accounting because of their
Expenses complexity.
Salaries Expense P15,600
Utilities Expense 4,400 The income statement is a formal statement
Rent Expense 4,000 showing the performance of the enterprise for
Depreciation Expense-Service Vehicle 4,000 a given period of time. It summarizes the
Depreciation Expense-Office Equipment 1,000 revenues earned and expenses incurred for
Supplies Expense 3,000 that period of time.
Insurance Expense 1,200
Interest Expense 3,500 Information about the performance of an
Total 36,700 enterprise, in particular its profitability, is
required to assess potential changes in the
Profit economic resources that is likely to be
P35,000 controlled in the future. It is also useful in
predicting the capacity of the enterprise to
generate cash flows from its existing resource
base.

Statement of Changes in Equity
The statement of changes in equity summarizes the changes that occurred in owner’s equity. This statement is now a required
statement (per revised Philippine Accounting Standards (PAS) No. 1). Changes in an enterprise’s equity between two balance
sheet dates reflect the increase or decrease in its net assets during the period.
Weddings “R’ Us In the case of sole proprietorships, increases in
Statement of Changes in Equity owner’s equity arise from
For the Month Ended May 31, 2019 • additional investments by the owner, and
• profit during the period.
Perez-Manalo, Owner’s Equity, 5/1/2019 P250,000 While decreases in owner’s equity result from:
Add: Additional investments by Perez-Manalo P 0 • withdrawals of the owner, and
Profit 35,000 35,000 • loss for the period.
Total P285,000
Less: Withdrawals The beginning balance and additional
14,000 investments are taken from the owner’s capital
Perez-Manalo, Owner’s Equity, 5/31/2019 account in the general ledger. The profit or loss
P271,000 figure comes directly from the income
statement while withdrawals from the balance
sheet columns in the worksheet.
Statement of Financial Position
The statement of financial position is a statement that shows the financial position or condition of an entity by listing the assets,
liabilities and owner’s equity as at a specific date. The information needed for the balance sheet items are the net balances at
the end of the period, rather than the total for the period as in the income statement. This statement is also called the balance
sheet.

Users of financial statements analyze the balance sheet to evaluate an entity’s liquidity, its financial flexibility, and its ability to
generate profits, and its solvency.

 Liquidity refers to the availability of cash in the near future after taking into account the financial commitments over
this period.
 Financial flexibility is the ability to take effective actions to alter the amounts and timings of cash flows so that it can
respond to unexpected needs and opportunities. This includes the ability to raise new capital or tap into unused lines of credit.
 Solvency refers to the availability of cash over the longer terms to meet financial commitments as they fall due.

In preparing the balance sheet, it may be necessary to make further analysis of the data. The needed data ae the balances of
asset, liability, and owner’s equity accounts, are available from the balance sheet columns of the worksheet. However, the
interim balance for owner’s equity must be revised to include profit or loss and owner’s withdrawals for the accounting period.
The adjusted amount for ending owner’s equity is shown in the statement of changes in equity.

Format

The balance sheet can be presented in either of the following:

 Report format simply lists the assets, followed by the liabilities then by the owner’s equity in vertical sequence.
 Account format lists the assets on the left and the liabilities and owner’s equity on the right.

Either balance sheet format is acceptable.
Classification
The revised PAS No. 1 does not prescribe the order or format in which an entity presents items in the statement of financial
position; what is required is the current and non-current distinction for assets and liabilities. Assets can be presented current
then non-current or vice versa. Liabilities and equity can be presented current then non-current liabilities then equity, or vice-
versa.
It is proper to present a classified balance sheet: that is, the assets and liabilities are separated into various categories. Assets
are sub-classified as current assets and non-current assets; while liabilities as current liabilities and non-current liabilities. At
this point, it is advisable to review the definitions of the foregoing (refer to Module 2). Classifying a balance sheet aids in the
analysis of financial statements data.

When presentation based on liquidity provides accounting information
that is reliable and more relevant to decision-makers then an entity
shall present all assets and liabilities in order of liquidity. For
example,
 Assets are classified and presented in decreasing order of
liquidity. Cash is the most liquid. Assets that are least likely to be
converted to cash are listed last.
 Liabilities are generally classified and presented based on time of
maturity such that obligations which are currently due are listed first.
 It can be observed that the total assets of P546,700 in the balance
sheet does not tally with the total debits of P565,700 in the balance
sheet columns of the worksheet in Exhibit 5-4. Likewise, the total
liabilities and owner’s equity do not equal to the total credits in the
same exhibit. The reason for these differences is that accumulated
depreciation and withdrawals are subtracted from their related
accounts in the balance sheet but added in their respective columns
in the worksheet.
Statement of Cash Flows
The statement of cash flows provides information about the cash receipts and cash payments of an entity during a period. It
is a formal statement that classifies cash receipts (inflows) and cash payments (outflows) into operating, investing and
financing activities. This statement shows the net increase or decrease in cash during the period and the cash balance at the
end of the period; it also helps project the future net cash flows of the entity. Statement of Changes in Equity will be discussed
in higher accounting.
RELATIONSHIPS AMONG THE FINANCIAL STATEMENTS

The financial statements are based on the same underlying data and are fundamentally related. The following shows the basic
interrelationships among financial statements:

The income statement reports all income and expenses during the period. The profit or
loss is the final figure in this statement.
The statement of changes in equity considers the profit or loss figure from the income
statement as one of the determining factors that explain the changes in owner’s equity.
The statement of financial position reports the ending owner’s equity, taken directly from
the statement of changes in equity.
The statement of cash flows reports the net increase or decrease in cash during the
period and ends with the cash balance reported in the balance sheet. This statement is
prepared on information from the income statement and the balance sheet.
Step 7. ADJUSTMENTS ARE JOURNALIZED AND POSTED

The adjustment process is a key element of accrual basis accounting. The
worksheet helps in the identification of the accounts that need adjustments.
The adjusting entries are directly entered in the worksheet. Most accountant
prepare the financial statements immediately after completing the
worksheet. The adjustments are journalized and posted as the closing
entries are made. This step in the accounting cycle brings, the ledger into
agreement with the data reported in the financial statements.
Step 8. CLOSING ENTRIES ARE JOURNALIZED AND POSTED

Income, expense and withdrawal accounts are temporary accounts that accumulate information related to a specific
accounting period. These temporary accounts facilitate income statement preparation. At the end of each year, the balances of
these temporary accounts are transferred to the capital account. Thus, the balance of the owner’s capital account represents
the cumulative net result of income, expense and withdrawal transactions. This phase of the cycle is called the closing
procedure.

A temporary account is said to be closed when an entry is made such that its balance becomes zero. Closing simply
transfers the balance of one account to another account. In this case, the balances of the temporary accounts are transferred
to the capital account. A summary account, Income Summary is used to close the income and expense accounts. The steps
in closing the accounts of an entity will be illustrated using the Weddings “R” Us case.
1. Close the income accounts - Income accounts have credit balances before
the closing entries are posted. For this reason, an entry debits each revenue
account. The dual effect of the entry is to make the balances of the income
accounts equal to zero, and to transfer the balances in total to the credit side of the
income summary account.
2. Close the expense accounts - Expense accounts have debit balances before
the closing entries are posted. For this reason, a compound entry is needed
crediting each expense account for its balance and debiting the income summary
for the total. These data can be found in the debit side of the income statement
columns of the worksheet. The effect of posting the closing entry is to reduce the
expense account balances to zero and to transfer the total of the account balances
to the debit side of the income summary.
3. Close the income summary account - After posting the closing entries
involving income and expense accounts, the balance of the income summary
account will be equal to the profit or loss for the period. A profit is indicated by a
credit balance and a loss by the debit balance. The income summary account,
regardless of the nature of its balance, must be closed to the capital account. The
effect of posting this closing entry is to close the income summary account balance
and to transfer the balance to Perez-Manalo’s capital account for the profit.
4. Close the withdrawal account - The withdrawal account shows the amount by
which capital is reduced during the period by withdrawals of cash or other assets of
the business by the owner for personal use. For this reason, the debit balance of
the withdrawal account must be closed to the capital account as follows: The effect
of posting this closing entry is to close the withdrawal account and to transfer the
balance to the balance to the capital account.
Step 9. PREPARATION OF THE POST-CLOSING TRIAL BALANCE

It is possible to commit an error in posting the adjustments and closing
entries to the ledger accounts; thus, it is necessary to test the equality of
the accounts by preparing a new trial balance. This final trial balance
is called a post-closing trial balance.

 The post-closing trial balance verifies that all the debits equal the
credits in the trial balance.
 The trial balance contains only balance sheet items such as assets,
liabilities, and ending capital because all income and expense accounts,
as well as withdrawal account, have zero balances.
Notice that only the balance sheet accounts have balances because at
this point, all the income statement accounts have been closed.
Step 10. REVERSING ENTRIES

Preparing the post-closing trial balance may not be the last step in the accounting cycle. Some entities elect to reverse certain
end-of-period adjustments on the first day of the new period. A reversing entry is a journal entry which is the exact opposite
of a related adjusting entry made at the end of the period. It is basically a bookkeeping technique made to simplify the
recording of regular transactions in the next accounting period.

It should be emphasized that reversing entries are optional. Also, the act of reversing a previously recorded adjusting entry
should not lead us to the conclusion that the entries reversed are unnecessary or inaccurate.

Even when an entity follows the policy of making reversing entries, not all adjusting entries should be reversed. Generally, a
reversing entry should be made for any adjusting entry that increased an asset or a liability account. Therefore, all accruals are
reversed but only deferrals initially recorded in income statement, income or expenses accounts are reversed.

After analyzing the rest of the adjusting entries, the adjustments that can be reversed are as follows: prepaid expenses
(expense method), unearned revenues (income method), accrued expenses and accrued revenues.

Illustration. To show how reversing entries can be helpful, consider the
adjusting entry made in the records of Weddings “R” Us to accrue salaries
expense:

When the employees are paid on the next regular payday, the entry would
be:
Note that when the payment is made, without a prior reversing entry, the
accountant must look into the records to find out how much of the P7,200
applies to the current accounting period and how much was accrued at the
beginning of the period.

This step may appear easy in this simple case but think of the problems that may arise if the company has many employees,
especially if some of them are paid on different time schedules such as weekly or monthly. A reversing entry is an accounting
procedure that helps to solve this difficult problem. As noted above, a reversing entry is exactly what its name implies. It is a
reversal of the adjusting entry made. For example, observe the following sequence of transactions and their effects on the
ledger account, salaries expense:

These transactions had the following effects on salaries expense:
1. Adjusted salaries expense to accrue P1,800 in the proper accounting period.
2. Closed the P15,600 in total salaries expense for May to income summary.
3. Established a credit balance of P1,800 on June 1 in salaries expense equal to the expense recognized through the adjusting
entry on May 31. The liability account salaries payable was reduced to a zero balance.
4. Recorded the P7,200 payment of two weeks’ salaries in the usual manner. The reversing entry has the effect of leaving a
balance of P5,400 (7,200 – P1,800) in the salaries expense account. This P5,400 balance represented the salaries for the nine
workdays in June. Making the payment entry was simplified by the reversing entry. Reversing entries apply to all accrued
expenses or revenues.
1. Adjusting Entry 3. Reversing Entry

2. Closing Entry 4. Payment Entry

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Lesson 3: Recording Business Transactions

Step 1. TRANSACTION ANALYSIS

THE GENERAL JOURNAL AND GENERAL LEDGER

THE JOURNAL  Relying on source documents, transactions and events can be

 A chronological record of the entity’s transactions.

SIMPLE AND COMPOUND ENTRY

Revenues Earned and Cash Collected (Source of Assets)

LEDGER ACCOUNTS AFTER POSTING

Step 4. TRIAL BALANCE

An inequality in the totals of the debits and credits would automatically

Error in posting a transaction to the ledger:

Lesson 4: Adjusting the Accounts

Under Cash Basis

ACCRUAL FOR UNCOLLECTIBLE ACCOUNTS

Entries Decrease in owner’s equity is recorded by debit to depreciation expense-service vehicle and

As a Liability As a Revenue

Lesson 5: Worksheet, Financial Statements and Completing the Accounting Cycle

ESSENCE OF FINANCIAL STATEMENTS

RELATIONSHIPS AMONG THE FINANCIAL STATEMENTS

Step 7. ADJUSTMENTS ARE JOURNALIZED AND POSTED

Step 8. CLOSING ENTRIES ARE JOURNALIZED AND POSTED

Step 9. PREPARATION OF THE POST-CLOSING TRIAL BALANCE

Step 10. REVERSING ENTRIES

1. Adjusting Entry 3. Reversing Entry

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