NCBI Modules

COVERAGE:
1. Basic Concepts
2. Accounting Cycle
3. Adjusting Journal Entries
4. Financial Statements
5. Closing Entries and Post Closing Trial Balance
6. Service Business
7. Merchandising Business

WEEK 1
BASIC CONCEPTS

1. Business Types, Forms, and its Requirements Introduction

A business entity is an organization that uses economic resources to provide goods or services to
customers in exchange for money or other goods and services.

It is a person or organization engaged in the regular conduct of commercial, industrial or

professional activities, whether for profit or not, in order to fulfill a purpose, goal, mission or
cause.

It is the regular conduct or pursuit of a commercial activity or an economic activity, including

transactions incidental thereto, by any person regardless of whether or not the person is engaged
therein is a non-stock, non-profit private organization or government entity. (Sec 105, NIRC)

Key Notes
Business:

• Person or organization Business

• Regular conduct
• Commercial, industrial or professional activities
• Conducted in the Philippines
• Lawful transactions
• Whether for profit or not
• To fulfill a purpose, goal, mission or cause

Types of Business
There are four major types of businesses:

1. Service Business
A service type of business provides intangible products (products with no physical form) for a
fee. Service type entities offers professional skills, expertise, advice, and other similar products.
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Examples of service businesses are:

o Business services, such as accounting, advisory, taxation, legal, auditing firms,

etc.
o Automotive repairs, car rental, car wash, parking spaces
o Personal services, such as laundry, beauty salon, photography
o Recreation facilities, amusement parks, bowling centers, golf courses, theatres
o Hospitals and clinics, schools, museums, banks
o Hotel and lodging

2. Merchandising Business
A merchandising business buys products and sells the same at prices higher than their purchase
costs. They are known as "buy and sell" businesses. A merchandising business buys a product
and sells it without changing its form.

Examples of this type of business are grocery stores, convenience stores, distributors, and other
resellers.

3. Manufacturing Business
A manufacturing business buys materials and converts them into a new product.

A manufacturing business combines raw materials, labor, and overhead costs in its production
process. The goods produced will then be sold to customers.

Examples of manufacturing businesses are:

o Automobile manufacturing, Aerospace and Shipbuilding

o Paper industry for producing paper, cardboard and related products
o Fashion Industry for producing textiles, clothing, footwear, accessories and
cosmetics
o Consumer Goods production such as foods, beverages and toiletries
o Printing & Publishing materials and books

4. Mixed/Hybrid Business
These are companies that can be classified in more than one type of business. They run different
departments or divisions for different purposes.

An example of this is a restaurant, combines ingredients in making a fine meal (manufacturing),

sells a cold bottle of wine (merchandising), and fills customer orders (service).

Forms of Business Organization

These are the basic forms of business ownership:

1. Sole Proprietorship
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The sole proprietorship is the simplest business form under which one can operate a business. It
is a business owned by only one person and is personally responsible for its debts. The sole
proprietorship is usually adopted by small business entities due to its simplicity, ease of setup,
and nominal cost. The owner faces unlimited liability; meaning, the creditors of the business may
go after the personal assets of the owner if the business cannot pay them.

The advantages of a sole proprietorship include:

•
o Owners can establish a sole proprietorship instantly, easily and inexpensively.
o Owner has full control over business decisions

The disadvantages of a sole proprietorship include:

•
o Owners are subject to liability for the debts, losses and liabilities of the business
o Limited source of funds

2. Partnership
A partnership is a business owned by two or more persons who contribute resources into the
entity, and divide the profits among themselves.

Generally, all partners have unlimited liability. In limited partnerships, creditors cannot go after
the personal assets of the limited partners.

The advantages of a partnership include:

o Relatively easy to establish compared to a corporation

o Talents and strengths of each partner can best be utilized
o Minimal paperwork and legal restrictions

The disadvantages of a partnership include:

o Partners have unlimited liability with regard to the liabilities and debts of the
business
o Limited ability to raise capital
o Divided authority

3. Corporation
Corporation is a business organization that has a separate legal personality from its owners. It is
usually adopted by large business organizations. Ownership is usually represented by shares of
stock.

The advantages of a corporation include:

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o Can generate large amounts of capital from investments

o easy to transfer ownership

The disadvantages of a corporation include:

o not easy to set-up and organize

o owners (stockholders) enjoy limited liability but have limited involvement in the
company's operations.

Not considered engaged in business:

• Government agencies and instrumentalities

• Pure compensation employment (local or abroad, private or government)
• Directorship in a corporation
• Gratuitous transfer of properties by succession or donation
• Isolated or casual transactions by persons not engaged in trade or business

Also considered engaged in business:

• Freelancers, agents and consultants

• Broadcast media talents and artists

Legal Requirements
1. Business Name and Entity Registration:
Depending on the form of the business, it must register with the following government agencies:

1. Sole Proprietorship - Department of Trade and Industry (Business Name

Registration)
2. Partnership or Corporation - Securities and Exchange Commission (Registration
System)

2. Secure Business Permits and Licenses

Depending on the nature of its activities, the business must secure its permits and licenses in the
city or municipality where it conducts its business. Generally the following will be obtained:

1. Business Permit - from the Mayor's Office

2. Fire Safety Inspection Certificate - from the Bureau of Fire Protection
3. Barangay Clearance and Community Tax Certificate - from the barangay where
the business is operating
4. Employer Registration - SSS, HDMF, PHIC, DOLE (if applicable)

3. Comply with BIR Requirements:

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The business entity must also comply with the following requirements of the Bureau of Internal
Revenue:

1. Business registration
2. Issuance of receipts and invoices
3. Keeping of tax and accounting records
4. Withholding of taxes on certain payments
5. Filing and payment of taxes

However profitable or noble the purpose of the business may be, the failure of the business entity
to comply with any of these requirements might lead to penalties, fines, surcharges or, at worst,
closure of the business.

After the registration and securing all the necessary certificates and permits, the company needs
to maintain its accounting records.

Summary: Business Types, Forms, and its Requirements

Summary Notes
Business - organization that uses economic resources to provide goods or services to customers
in exchange for money or other goods and services.

Types of Business:

1. Service Business - provides intangible products for a fee.

2. Merchandising Business - buy and sell merchandise
3. Manufacturing Business - buys materials and converts to a new product
4. Mix/Hybrid Business - more than one type of business

Forms of Business:

1. Sole proprietorship - owned and controlled by only one person

2. Partnership - owned by partners who agree to undertake business to make profit
3. Corporation - a legal entity owned by shareholders

Legal Requirements

1. Business Name and Entity Registration

2. Secure Business Permits and Licenses
3. Comply with BIR requirements

2. Introduction to Accounting
Accounting is commonly known as the "language of business". It provides financial information
about the organization through financial reports to different users to help them in making
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decisions. By learning this language you can communicate and understand the financial
operations of any and all types of organizations. It means that accounting allows us to see things
like how much money the business is earning, how much money the business spend and more.

Definition

• Accounting is a service activity. Its function is to provide quantitative information,

primarily financial in nature, about economic entities that is intended to be useful in
making economic decisions (Accounting Standards Council).
• Accounting is an information system that measures, processes and communicates
financial information about an identifiable economic entity.
• Accounting is the process of identifying, measuring and communicating economic
information to permit informed judgment and decision by users of the information
(American Accounting Association).
• Accounting is the art of recording, classifying, and summarizing in a significant manner
and in terms of money, transactions and events which are, in part at least of financial
character, and interpreting the results thereof (American Institute of Certified Public
Accountants).

Purpose of Accounting
The purpose of Accounting is to provide financial information about the business that will be
useful in making economic decisions of the users of the information.

Let's have a simple illustration:

Mr. Juan Dela Cruz started a Repair Service Shop. Initially, he invested Php 25,000 to open a
mini repair shop. There are many customers and the business went well. One day, one of his
primary equipment was broken and decided to buy a more advanced equipment. He then applies
for a loan in a bank to buy a new equipment. The bank officer asked Mr. Juan how much profit
did he made for the year, how much his assets are worth, how much debt he have, what his cash
flow is each month. With no recording of transactions, Mr. Juan wasn't able to answer the
questions and consequently, the bank officer did not approved Mr. Juan's loan application.

We can easily answer the bank officer's questions if we kept track of the company's transactions.
If we used Php 15,000 to buy equipment and Php 2,000 to pay rents, then we'd have Php 8,000
cash left. If we collected Php 10,000 from our customers, then we would have Php 18,000.

Accounting is important to keep track of business transactions. It is clear that the ultimate
purpose of accounting is to provide information to different users. The users utilize the
information in making economic decisions.

Financial Statements
Accounting information is data about a business entity’s transactions. Once identified and
analyzed, the information is then recorded, classified, and it eventually finds its way into various
reports commonly called Financial Statements. Financial Statements are summary accounting
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reports prepared periodically to inform interested parties as to the financial condition and
operating results of the business. The following are the Financial Statements generally prepared
to provide information to different users.

1. Statement of Financial Performance (Income Statement) - The financial statement that

summarizes revenues and expenses for a specific period of time, usually a month or a
year. Income statements are always prepared for a period of time and the term “for the period
ended” is included in the title.

2. Statement of Changes in Owner's Equity - The financial report that summarizes all the
changes in owner’s equity (capital) that occurred during a specific period.

3. Statement of Financial Position (Balance Sheet) - shows the amount and nature of business
assets, liabilities, and owner’s equity (capital) as of a specific point in time. The account balances
at the end of accounting year will carry forward to become the beginning balances of the
subsequent year

4. Statement of Cash Flow - The financial statements also show the inflows and outflows of
cash in the different activities of the business (operating, investing, and financing activities).

5. Notes to the Financial Statements -Qualitative, quantitative, and financial information that
could affect the decisions of users are included in the notes to financial statements.

Users of Accounting Information

We learned that the whole purpose of accounting is to provide information that is useful and
relevant for interested users when making decisions regarding the company and its
operations. Who are these users of financial information? What information do they need?

Key Notes
Users can be grouped into two categories namely internal users and external users

Internal Users (within the business organization)

o Owners
o Managers
o Employees
o Officers
o Internal Auditors

External Users (outside the business organization)

o Customers
o Suppliers
o Creditors
o Investors
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o External Auditors
o Government Agencies
o Industrial Organizations
o Public

Branches of Accounting
1. Financial Accounting - a systematic method of recording business transactions in accordance
to the accounting principles.

2. Management Accounting - provides information to management for better administration of

the business.

3. Cost Accounting - Cost accounting deals with evaluating the cost of a product or service
offered.

4. Tax Accounting - deals with the preparation and filing of various tax returns and dealing with
their legal implications.

5. Auditing - It is where an external certified public accountant known as an Auditor inspects

and certifies the accounts of the business for their accuracy and consistency.

Summary: Introduction to Accounting

Summary Notes
Accounting - is the art of recording, classifying, and summarizing in a significant manner and in
terms of money, transactions and events which are, in part at least of financial character, and
interpreting the results thereof (American Institute of Certified Public Accountants)

Purpose of Accounting - to provide financial information about the business that will be useful
in making economic decisions of the users of the information.

Financial Statements:

1. Statement of Financial Performance (Income Statement)

2. Statement of Changes in Owner's Equity
3. Statement of Financial Position (Balance Sheet)
4. Statement of Cash Flows
5. Notes to Financial Statements

Users of Accounting Information

1. Internal Users (Owners, Managers, Employees, Officers, Internal Auditors, etc.)

2. External Users (Customers, Suppliers, Creditors, Investors, Government Agencies, etc.)
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Branches of Accounting

1. Financial Accounting
2. Management Accounting
3. Cost Accounting
4. Tax Accounting
5. Auditing

3. Introduction to Bookkeeping
Bookkeeping is the recording of financial transactions and is part of the process of accounting in
business (Financial Accounting 2003, Weygandt; Kieso; Kimmel). It is largely concerned with
the implementation of the accounting procedures manual and maintenance of the accounting
records. Bookkeeping is the procedural implementation of Accounting.

Bookkeeper is the person who keeps and maintains the books of accounts of the business
organization. The bookkeeper is responsible for recording the transactions of the business.

Functions of a Bookkeeper

General Accounting

o Verify deposit of cash collections

o Verify petty cash disbursements
o Prepare bank reconciliation
o Post to the subsidiary and general ledgers
o Reconcile general and subsidiary ledgers
o Prepare a draft of the Trial Balance
o Assist the Accountant in the closing of the accounts and finalization of the
financial statements.
o Maintain proper filing and retrieval of accounting records
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Accounts Receivable

o Record sales invoices

o Record cash receipts from customers
o Record sales returns, account adjustments and credit memos from suppliers
o Issue Statement of Accounts to customers
o Reconcile accounts receivable ledger balance with unpaid customer invoices.
o Maintain Accounts Receivable Subsidiary Ledger
o Prepare Accounts Receivable reports

Accounts Payable

o Record purchase invoices

o Record payments to suppliers
o Record purchase returns, account adjustments and debit memos from suppliers
o Receive Statement of Accounts from suppliers
o Reconcile accounts payable ledger balance with unpaid customer invoices.
o Maintain Accounts Payable Subsidiary Ledger
o Prepare Accounts Payable reports

Inventory Accounting

o Record receipts of inventory from suppliers.

o Record release of inventory to customers
o Record inventory returns and adjustments
o Prepare purchase requests and Inventory issuance slips
o Reconcile physical count of inventory to ledger balances
o Maintain inventory subsidiary ledgers
o Prepare Inventory reports

The Bookkeeper may also be assigned to handle other functions, such as:

o Property control and monitoring

o Payroll preparation
o Remittance of statutory deductions and reports
o Tax bookkeeping
o Treasury and banking
o Audit assistance
o Managerial and administrative functions.

The scope and variety of functions depends on the nature, type, size, organization structure of the
business and other factors.
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Due to the importance of his or her functions, the Bookkeeper must possess the knowledge,
abilities and temperaments required to properly fulfill his or her duties and functions. One of the
knowledge requirements would be the basic knowledge in Accounting.

ACCOUNTING CYCLE

1. The Accounting Cycle

Introduction
The accounting cycle is a series of procedures that involves specific steps in recording,
classifying, summarizing, and interpreting transactions and events for a business entity. This is
commonly called as accounting process. It is the process of keeping track of business
transactions by recording and reporting them.

Key Notes:

Recording
1. Identification of Accountable Transactions. Business transactions or events are analyzed
and identified whether they are accountable or not.

2. Journalizing. The transactions are recorded in the book of original entry known as the
journal. The transactions are recorded chronologically with the appropriate accounts and
amounts.
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3. Posting. The transactions from the journal are classified in the book of final entry known as
the ledger. The ledger classifies the transactions effecting the increases and decreases for each
account.

Summarizing
4. Trial Balance. The summary of accounts balances from the ledger is prepared in the list of
accounts known as the trial balance. This is the proof that the ledger debit balance and credit
balances are equal and is in balance.

5. Adjusting Entries. Adjusting journal entries are made at the end of the accounting period to
assign revenues to the period in which they are earned and expenses to the period in which they
are incurred.

Reporting
6. Financial Statements. The following financial statements are prepared: statement of
financial position, statement of financial performance, statement of changes in equity, statement
of cash flows and the notes to the financial statements. These financial statements provide useful
information to interested parties for their decision-making.

7. Closing Entries. The temporary nominal accounts are eliminated from the accounts by
recording and posting the closing entries. This will prepare the accounting records for the next
accounting period.

8. Post-Closing Trial Balance. After the closing entries are posted, the post-closing trial
balance is prepared to check that the debit and credit balances of the remaining accounts are
correct.

Optional
9. Recording of Reversing Entries. At the beginning of the next accounting period, selected
adjusting journal entries made at the previous accounting period are reversed to “normalize” the
recording of the related actual transactions.

2. Identifying and Analyzing Business Transactions

Business transactions or events are analyzed whether they are accountable or not. Only
transactions which are identified to be accountable transactions are recorded in the accounting
records. A transaction or event is accountable when it meets the following criteria:

a. It affects the business entity.

b. It can be measured in terms of money.
c. It occurred on a specific date or for a specific period.
d. It affects the assets, liabilities or equity of the business.
e. It is supported by a document.
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Examples of accountable transactions:

Mr. Luca Pacioli established Pacioli General Services and had the following transactions:

• √ Investment of P100,000 capital funds by Mr. Pacioli into the business

• √ Receipt of a Charge Invoice from a supplier for the purchase of a desktop computer
amounting to P30,000.
• √ Purchase of supplies amounting to P8,000 in cash.
• √ Issuance of a Service Invoice for an amount of P40,000 to a customer for services
rendered on account.
• √ Receipt of P28,000 cash from customers in payment of their account.
• √ Payment in cash and receipt of an official receipt from supplier for payment of
accounts, P22,000.
• √ Cash payment of P12,000 for the salary of an employee.
• √ Mr. Pacioli withdrew P10,000 cash from the business.

Examples of non-accountable transactions:

• The owner of the business spent P80,000 for his wedding.

• A secretary was hired for P15,000 monthly salary.
• The company has been using the electricity for the first month of its operations but has
not yet received the electric bill.
• The company has been recognized by the local government unit as the best service
provider in the locality. It is foreseen to grow into a P10 million company in the next few
years.

Business Documents
The business documents forms serve as evidence to support the accountable transactions or
events. These documents provide the data concerning the parties involved, the exchange made,
the date and the money value of the exchange made. Some of the common business documents
include the following:

1. Sales Invoice – document issued to customer for specific materials or supplies

furnished or services rendered. It is called Purchase Invoice from the point of
view of the customer.
2. Delivery Receipt – document signifying delivery of goods and receipt of
inventory.
3. Official Receipt – document issued to acknowledge receipt of cash.
4. Deposit Slip – document used to deposit cash and cheques to a bank.
5. Purchase Invoice – a bill from a vendor for specific materials or supplies
furnished or services rendered. It is called Sales Invoice from the point of view of
the supplier.
6. Disbursement Voucher – a written, approved record of payment of cash.
7. Withdrawal Slip – document used to withdraw cash from a bank.
8. Cheque Issuance Record – a record of cheques issued by the company.
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9. Promissory Notes – a written promise to pay a certain sum of money to the payee.
It may sometimes bear an interest over a period of time.
10. Bank Statement – a document listing the bank transactions of the depositor.
11. Billing Statement or Statement of Account – document listing the unpaid
invoices of a customer. Oftentimes, it lists chronologically the invoices, payments
and adjustments to the account of the company.
12. Business Letters – correspondences to other companies, organizations or
government entities which may serve as a basis in recording an accountable
transaction or event.

3. Record transactions in the Journal

This is also known as journalizing. The transactions are chronologically recorded in

the journal. General Journal are also known as the Books of Original Entry .

The transactions are recorded through a journal entry. A Journal Entry shows the record of the
effects of a transaction or an event expressed in terms of debit and credit. An entry with one
debit and one credit is a simple journal entry, while an entry with one or more debits and credits
is a compound journal entry. A journal entry has the following elements:

1. The date of the transaction

2. The accounts debited and credited
3. The monetary values of the accounts debited and credited
4. The posting reference code of the destination ledger account
5. A brief and clear explanation of the transaction

A sample journal entries are as follows:

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Note: Throughout the course, you will notice that we always use the word “account”.
An account can be thought of as a collection of related entries. For example, every entry that
relates to our receivables from customers will be recorded in the “Accounts Receivable
account”.

The specific account titles and codes to use are maintained in a Chart of Accounts. It is a list of
the account codes and titles that must be used in recording transactions in the Journal. It shall be
maintained and updated for necessary changes, like additions of new accounts, change of titles
and codes and removal of accounts that will no longer be used.

The accounts are normally listed in the order in which they appear in the financial statements.
An account code identifies the account which will serve as its cross-reference in the journal and
ledger.

A sample is as follows:
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The accountable transactions are recorded in the general journal following the Basic Accounting
Equation:

Assets = Liabilities + Equity

This equation will guide the bookkeeper in recording the transaction. After the recording of each
transaction using a journal entry, the accounting equation will maintain its equality. This is
possible under the double-entry accounting system.

Under the Double Entry Accounting System, at least two accounts will be recorded for each
accountable transaction. The amount in every transaction must be entered in one account as
a debit (left side of the account)and in another account as a credit (right side of the account).
Because of the two-fold effect of transactions, the total effect on the left (Debit) will always be
equal to total the effect on the right (Credit).

Effect of Accounting Entries to the Accounts

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Note: It's more easy to remember the above effects when you familiarize yourself with the
increase effect on accounts. The side where the account increase its amount/value is actually
the Normal Balance of that account.

4. Posting to the Ledger

After the entries are recorded in the journal, the entries are posted into the ledger. A ledger is a
collection of all of the accounts of the company, the debits and credits under each account, and
the resulting balances. For example, the cash ledger will summarize all the transactions that
involved cash. In bookkeeping, Ledgers are important because they summarize all transactions to
show the running/ending balance of a specific account.

Posting to the ledger is the classifying phase of accounting. Posting refers to the process of
transferring entries in the journal into the accounts in the ledger. While journal is called the
Books of Original entry, because journal entries are transferred in the ledger, the general ledger
is often called the book of final entry.

Each account has an assigned account number and the individual accounts are properly arranged.
Each journal entry is posted into the related ledger account indicating the following:

• Date
• Description
• Posting Reference - serves as the cross-reference between the journal entry and the
ledger account posting.
• Debit and Credit amount
• Running Balance of the account

Sample General Ledger:

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The Posting Reference GJ-1 refers to:

GJ-General Journal
1-Page 1

5. Preparing Trial Balance

After the recording phase (Analyzing, Journalizing, and Posting), we enter the next step of the
accounting cycle, the preparation of trial balance.

Trial balance is a listing of all the balances of the different accounts as of a given date. The
account names are listed as arranged in the ledger and the balances are placed either on the debit
or credit column. The total of all accounts with debit balances must equal to the total of all
accounts with credit balances after the posting process. This trial balance is called
an unadjusted trial balance (no adjustments yet).
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There are other two types of trial balance: the adjusted trial balance which is prepared after
adjusting entries, and the post-closing trial balance which is prepared after closing entries.

Purpose of Trial Balance:

a. To check the accuracy of posting in the ledger by testing the equality of the debits and
credits.
b. It aids in locating errors in posting.
c. It serves as the basis in the preparation of the financial statements.

Errors in the Accounting Process

When the total debits and total credits are not equal, this automatically signifies that there is an
error in the recording or posting of entries. Some of the errors that could occur are the following:

o Journal entry with unequal debit and credit.

o Posting to the incorrect debit or credit of an account.
o Incorrectly footing the account balance, or trial balance.
o Forwarding the wrong amount from the ledger to the trial balance.
o Listing the account balance to the wrong side of the trial balance.

The trial balance does not guarantee that the records are accurate even if the total of debits and
total of credits are equal. The following errors will not be detected by the preparation of a trial
balance:

o Failing to record a transaction or event.

o Multiple recording and posting of a transaction or event.
o Entries or posting to the wrong account.
o Recording and posting of amounts with transposition and trans-placement errors.

Here is an example of a Trial Balance:

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ADJUSTING JOURNAL ENTRIES

1. Introduction to Adjusting Entries

Adjusting entries are made to update the accounts and bring them to their correct balances. The
purpose of adjusting entries is to match costs against revenues. The expenses incurred during the
period, whether paid or not, are matched against the revenue earned for the same period, whether
collected or not, for the correct determination of the profit for the period.

Key Notes

Types of Adjusting Entries

o Deferrals
▪ Prepaid Expense - expenses paid but not yet incurred
▪ Deferred/Unearned Revenue - income received but not yet earned
o Accruals
▪ Accrued Expense - expenses incurred but not yet paid
▪ Accrued Revenue - income earned but not yet received
o Other Adjustments:
▪ Unused supplies at the end of the period
▪ Depreciation Expense
▪ Doubtful Account/Bad Debt Expense

Steps for Recording Adjusting Entries

1. Identify what type of Adjusting Entries is involved

2. Identify what method is used (for Deferrals)
3. Calculate the amounts for the adjustments:
▪ Take note of the start date and end date
4. Designate what accounts to be debited and credited

All adjusting entries include at least a nominal account and a real account. In the next pages, we
will illustrate how to prepare adjusting journal entries for each type and provide example.
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Examples:
1. Of the purchased P8,000 supplies, P6,000 worth of supplies remains on hand at the end of
the period.
2. The equipment purchased for P30,000 has an estimated useful life of five (5) years and a
salvage value of P3,000.

2. Prepaid Expense
Prepaid expenses (Prepayments) represent payments made for expenses which have not yet
been incurred or used. It is a future expense that a company has paid for in advance.

Expenses are recognized when they are incurred regardless of when paid. Expenses are
considered incurred when they are used, consumed, utilized or has expired. Since prepayments
are not yet incurred, they should not be classified as expenses. Rather, they are classified
as current assets, since they relate to expenditures which have some future economic benefit to
the company.

Some examples are the following:

• Rent paid in advance is a prepaid expense which allows the company to utilize a
premises for many months into the future.
• Insurance policies are typically paid in advance and can be enforced for many months
into the future.
• Advertising subscriptions
• Unused supplies.

There are two method in recording prepaid expenses: (1) the asset method, and (2) the expense
method. The adjusting entry for prepaid expense will depend upon the initial journal entry based
on what method is used.

Asset Method
Under the asset method, a prepaid expense account (an asset) is recorded when the amount is
paid. (e.g. Supplies, Prepaid Rent, Prepaid Insurance, Prepaid Interest, etc.)

Original Entry:
Prepaid Expense xx
Cash xx

Adjusting Entry Should be:

Expense xx
Prepaid Expense xx

Example:
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Mr. Pacioli started his general service business. On the start of the operation, Mr. Pacioli,
purchase supplies amounting to P8,000 in cash. At the end of the period, 70% of the
supplies has been used.

On the start of the operation, the supplies bought are not yet incurred ( used ). Under Asset
Method, it is proper to record it as current asset.

Original Entry:

Supplies 8,000
Cash 8,000
At the end of the period, since 70% has been used, under asset method, the incurred expense
should be recognized.

Supplies Used: 8,000 x 70% = 5,600

Adjusting Entry:

Supplies Expense 5,600

Prepaid Supplies 5,600

Expense Method
Under the expense method, an expense account is recorded when the amount is paid. (e.g.
Supplies Expense, Rent Expense, Insurance Expense, Interest Expense, etc.)

Original Entry
Expense xx
Cash xx

Adjusting Entry Should be:

Prepaid Expense xx
Expense xx

Example:
Mr. Pacioli started his general service business. On the start of the operation, Mr. Pacioli,
purchase supplies amounting to P8,000 in cash. At the end of the period, 70% of the
supplies has been used.

On the start of the operation, under Expense Method, the entire amount is recorded as expense.

Original Entry:

Supplies Expense 8,000

Cash 8,000
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At the end of the period, since only 70% has been used, under expense method, the unused
supplies (30%) should be recognized as asset.

Unused Supplies: 8,000 x 30% = 2,400

Adjusting Entry:

Prepaid Supplies 2,400

Supplies Expense 2,400

The purpose of this adjusting entry is to make sure that the incurred (used/expired) portion is
treated as expense and the unused part is in assets. The adjusting entry will always depend upon
the method used when the initial entry was made.

3. Unearned Revenue
Unearned revenue represents revenue already collected but not yet earned. Since cash is
received by the company but have not yet performed its duties, it creates an obligation to render
service or deliver goods to its customers. (Other terms: unearned income, deferred revenue, or
deferred income)

Income is recognized when earned regardless of when it is collected. Income is considered

earned when goods or services have been received by the customer. Since unearned revenue are
not yet earned, they should not be classified as income rather, they are classified as current
liability, since they relate to an obligation of the company. It will be recognized as income only
when the goods or services have been delivered or rendered.

Some examples are the following:

• Advance rental from customers

• A services contract collected in advance
• A legal retainer collected in advance
• Insurance collected for period-coverage

There are two method in recording unearned revenue: (1) the liability method, and (2) the
income method. The adjusting entry for unearned revenue will depend upon the initial journal
entry based on what method is used.

Liability Method
Under the liability method, an unearned revenue account (a liability) is recorded when the
amount is collected. (e.g. Unearned Rent Revenue, Unearned Interest, etc.)
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Original Entry:
Cash xx
Unearned Revenue xx

Adjusting Entry Should be:

Unearned Revenue xx
Revenue Account xx

Example:
Mr. Pacioli started his general service business. During the operation, Mr. Pacioli, received
8,000 advance collection from customers. At the end of the period, 70% of the unearned
revenue has been rendered.

Upon collection of the amount, service is not yet rendered( earned ). Under Liability Method, it
is proper to record it as current liability.

Original Entry:

Cash 8,000
Unearned Service Revenue 8,000

At the end of the period, since 70% has been rendered, under liability method, the revenue
earned should be recognized.

Revenue earned: 8,000 x 70% = 5,600

Adjusting Entry:

Unearned Service Revenue 5,600

Service Revenue 5,600

Income Method
Under the income method, an income account is recorded when the amount is collected. (e.g.
Rent Revenue, Interest Income, etc.)

Original Entry
Cash xx
Revenue Account xx

Adjusting Entry Should be:

Revenue Account xx
Unearned Revenue xx
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Example:
Mr. Pacioli started his general service business. During the operation, Mr. Pacioli, received
8,000 advance collection from customers. At the end of the period, 70% of the unearned
revenue has been rendered.

Upon collection of the amount, under Income Method, the entire amount is recorded as Income.

Original Entry:

Cash 8,000
Service Revenue 8,000

At the end of the period, since only 70% has been rendered, under income method, service not
yet rendered (30%) should be recognized as liability.

Unearned Revenue: 8,000 x 30% = 2,400

Adjusting Entry:

Service Revenue 2,400

Unearned Service Revenue 2,400

The purpose of this adjusting entry is to make sure that the earned
(rendered/delivered/performed) portion is treated as income and the unearned part is in liability.
The adjusting entry will always depend upon the method used when the initial entry was made.

4. Accruals (Accrued Expense and Accrued Income)

Accrued Expense
Accrued Expense (also called accrued liabilities) refers to an expense that the company has
already incurred but not yet paid. Since expense accruals represent a company's obligation to
make future cash payments, they are shown on a company's balance sheet as
a liability (payable) .

At the end of the period, an adjusting entry is necessary if expenses incurred are not recognized.

Some examples are the following:

o Interest expense that are owed but unpaid.

o Utilities used for the month but an invoice has not yet been received before the
end of the period
o Wages that are incurred but payments have yet to be made to employees
o Services received, for which no supplier invoice has yet been received
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Adjusting Entry Should be:

Expense Account xx
Liability Account xx

Example:
Mr. Pacioli borrows a 1,000,000 loan on July 1 for business purpose from the bank. The
loan agreement requires Mr. Pacioli to to repay the 1,000,000 loan on July 1 next year
along with a 12,000 interest for 12 months.

At the end of the period, it is necessary to adjust for the interest incurred for the current period

Interest Incurred: 12,000x 6/12 = 6,000

Adjusting Entry:

Interest Expense 6,000

Accrued Interest Payable 6,000

The purpose of this adjusting entry is to make sure that the incurred expense is recognized at the
end of the period even if it is not yet paid.

Accrued Income
Accrued Income (also called accrued revenue) refers to income that the company has already
earned but not yet collected. Since income accruals represent a company's right to make future
cash inflows, they are shown on a company's balance sheet as an asset (receivable) .

At the end of the period, an adjusting entry is necessary if income earned are not recognized.

Some examples are the following:

o Interest Income that are earned but uncollected.

o Rent/Royalties not yet collected
o Services rendered, for which customers are not yet billed

Adjusting Entry Should be:

Receivable Account xx
Income Account xx

Example:
Mr. Pacioli lend 1,000,000 on September 1 to one of his customers, Mr. Luca. The loan
agreement requires Mr. Luca to to repay the 1,000,000 loan on September 1 next year
along with a 12,000 interest for 12 months.
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At the end of the period, it is necessary to adjust for the interest earned for the current period

Interest earned: 12,000x 4/12 = 4,000

Adjusting Entry:
Accrued Interest Receivable 4,000
Interest Income 4,000

The purpose of this adjusting entry is to make sure that the earned
(rendered/delivered/performed) income is recognized at the end of the period even if it is not yet
received.

5. Depreciation & Doubtful Accounts

Depreciation Expense
Introduction
Fixed Assets are economic resources owned by a business, which cannot be quickly converted
into cash. When a fixed asset is acquired by a company, it is recorded at initial cost (generally,
the purchase price of the asset). This cost is recognized as an asset and not expense. In relation
to matching principle, company must report expenses at the same time as the revenues they are
related to. Depreciation expense is recorded to allocate costs to the periods in which an asset is
used.

Depreciation Expense
Depreciation is the gradual charging to expense of an asset's cost over its expected useful life.
Depreciation recognize a portion of the asset as expense as the company records the revenue that
was generated by the fixed asset. This is mandatory under the matching principle as revenues
are recorded with their associated expenses in the accounting period when the asset is in use.

Three main inputs in computing depreciation:

Historical Cost: Purchase price and all incidental cost of the asset
Residual Value or Scrap Value: Estimated value of the fixed asset at the end of its useful life
Useful Life: Amount of time the fixed asset can be used (in months or years)

There are several methods in depreciating fixed assets. The most common and simplest is the
straight-line depreciation method. It involves simple allocation of an even rate of depreciation
every year over the useful life of the asset. The formula for straight line depreciation is:

Annual Depreciation = (Cost – Residual Value) / Useful life

Example:
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Mr. Pacioli General Services purchased an equipment for P120,000 on January 1 and the
useful life of the equipment are 10 years and the residual value of the machinery is
P20,000.

Annual Depreciation = (120,000-20,000)/10

Annual Depreciation = 10,000

Adjusting Entry:

Depreciation Expense 10,000

Accumulated Depreciation 10,000

Within the period

Example:
Mr. Pacioli General Services purchased an equipment for P120,000 on Julyl 1 and the
useful life of the equipment are 10 years and the residual value of the machinery is P20,000.

*The total annual depreciation cannot be applied on the current period because the equipment
was used only for 6 months (July to December) on the current period.

Annual Depreciation = (120,000-20,000)/10

Annual Depreciation = 10,000

Depreciation for the current period = 10,000 x 6/12

Depreciation for the current period = 5,000

Adjusting Entry:

Depreciation Expense 5,000

Accumulated Depreciation 5,000

Note:

▪ Depreciation Expense is shown in the Income Statement as part of

expense.
▪ Accumulated Depreciation is shown in the Balance Sheet as a
contra-asset account to specific non-current asset.

Doubtful Accounts

Introduction
Providing service or delivering goods to customers may be made on credit. It is likely to increase
sales when companies start offering credit on its customers. It will also create a trust between the
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parties that leads to better customer loyalty. However, businesses that provides credit are faced
with the risk of failure to receive payment from customers.

Doubtful Accounts
A doubtful account is an accounts receivable that may not be collected in the future. A doubtful
account expense is recognize to estimate the uncollectible accounts for credit sales made during
the current period. The adjusting entry for doubtful accounts is:

Doubtful Account Expense xx

Allowance for Doubtful Accounts xx

An allowance for doubtful accounts is recognized to estimate the percentage of accounts

receivable that are expected to be uncollectible.

There are several methods in estimating doubtful accounts. The most common is the percentage
of sales method. It applies a flat percentage, based on estimate, to the total amount of sales for
the period. The formula for computing doubtful accounts using percentage of sales method is
simply:

Doubtful Account Expense = Total Credit Sales x % of estimated uncollectible

Example:
Based on previous experience, Mr. Pacioli General Services estimated that 5% of the total
credit sales are not collectible. The total credit sales for the period is P100,000.

Doubtful Account Expense = 100,000 x 5%

Annual Depreciation = 5,000

Adjusting Entry:

Doubtful Account Expense 5,000

Allowance for Doubtful Accounts 5,000

Note:

▪ Doubtful Account Expense is shown in the Income Statement as

part of expense.
▪ Allowance for Doubtful Account is shown in the Balance Sheet as
a contra-asset account to Account Receivable.

WEEK 2
FINANCIAL STATEMENTS

1. Financial Statements
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The financial statements are the financial reports of the business entity in order to provide
information that is useful for the decision-making of its users.

As different groups of users will use the financial statements, it should be useful and
understandable to someone who has a reasonable understanding of accounting and business and
who is willing to study and analyze the information presented. The financial statements must be
relevant, reliable and comparable. Most of all, it must follow the applicable Philippine Financial
Reporting Standards.

The financial statements are prepared at least once a year and can be presented as frequent as
monthly or quarterly. A complete set of Financial Statements comprises the following:

1. Income Statement or Statement of Financial Performance

2. Statement of Changes in Equity
3. Balance Sheet or Statement of Financial Position
4. Statement of Cash Flows
5. Notes to the Financial Statements

2. Income Statement
The Income Statement, also called Statement of Financial Performance, presents the financial
results of a business for a given period of time. The statement presents the amount of revenue
generated and expenses incurred by the business during a reporting period, as well as the
resulting net income or net loss.

Revenues are increases in economic benefits during the accounting period in the form of inflows
or enhancements of assets or decreases of liabilities (or a combination of both) from the delivery
or production of goods, rendering of services, or other activities that constitute the entity’s
ongoing major or central operations.

Examples of revenues are as follows:

• Sales
• Professional fees earned
• Service revenues
• Interest revenue

Expenses are decreases in economic benefits during the accounting period in the form of
outflows or using up of assets or incurrences of liabilities (or a combination of both) from the
delivery or production of goods, rendering of services, or other activities that constitute the
entity’s ongoing major or central operations.

Examples of expenses are as follows:

• Cost of sales
• Depreciation expense
• Salaries and wages
• Utility costs
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3. Statement of Changes in Equity

The statement of changes in equity presents a reconciliation of the beginning and ending
balances in a company’s equity during a reporting period. The statement starts with the
beginning equity balance, and then adds or subtracts such items as profits, capital investments or
reductions, and dividend payments to arrive at the ending balance.

4. Balance Sheet
A Balance Sheet, also referred to as Statement of Financial Position, presents a company’s
financial position as of a given date. It shows the assets, liabilities and equity of the business
entity.

An asset is a resource controlled by the entity as a result of past events and from which future
economic benefits are expected to flow to the entity (IASB Framework). Examples of assets
include the following:

• Cash – includes coins, currencies, checks, bank deposits and other cash items ready for
use in the operations of the business.
• Accounts Receivable – amounts collectible from customers for goods provided and
services rendered on credit.
• Merchandise Inventory – unsold goods for sale to customers.
• Prepaid Expenses – expenses paid but not yet used.
• Property, Plant and Equipment – tangible assets used in the production or supply of
goods and services, or for business administration purposes.

A liability is a present obligation of the enterprise arising from past events, the settlement of
which is expected to result in an outflow from the enterprise of resources embodying economic
benefits (IASB Framework). Examples of liabilities include the following

• Accounts Payable – obligations due to suppliers of goods and services purchased on

credit.
• Utilities Payable - obligations due to utility companies for services rendered.
• Accrued liabilities - obligations due to others for expenses already incurred but not yet
paid.
• Unearned Revenues - obligations due to customers for goods and services paid but not
yet delivered.

Equity is the residual interest in the assets of the entity after deducting all the liabilities (IASB
Framework). It represents the capital investments, net of the capital withdrawals of the owner in
the entity, and the net income or loss in the operation of the business. Equity accounts include
the following:

• Capital account –the equity investment of the owner (in a single proprietorship) or for
each partner (in a partnership), and the cumulative effect of the withdrawals of capital
and business net profits and losses.
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• Retained Earnings – the cumulative balance of the net income or losses of the
corporation, investments of the owners, less the distribution to the owners.

CLOSING ENTRIES AND POST CLOSING TRIAL BALANCE

1. Closing Entries
Types of Accounts

1. Permanent or Real Accounts

a. Asset accounts
b. Liability accounts
c. Equity accounts

2. Temporary or Nominal Accounts

a. Revenue accounts
b. Expense accounts
c. Gains and Losses accounts
d. Equity drawing accounts
e. Income and Expense summary account

3. Mixed Accounts

For Pacioli General Services, the closing entries are as follows:

2. Post-Closing Trial Balance

A Post-Closing Trial Balance is prepared after the recording and posting of the closing entries.
The remaining Permanent/Real accounts of assets, liabilities and equity are presented with their
balances. This provides the starting balances for the next accounting period.

The post-closing trial balance of Pacioli General Services is as follows:

SERVICE BUSINESS

1. Bookkeeping for Service Businesses

A service business provides services to clients for a fee. Typically, the business provides
intangible products such as

• repairing
• beauty care
• health and recreation
• transportation
• professional
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• medical, and
• other services.

The accounting for a service business is simpler, in contrast to a merchandising business,

because the business do not involve accounting for inventories.

In rendering services, the business earns revenues, which it eventually collects. The focus of the
bookkeeping is on recording the revenues and collections.

Major activities involved in a service business

1. Rendering of services
2. Collection of payments
3. Incurrence and payment of expenses

Sample Journal entries:

Cash/Accounts Receivable xxx

Service Revenue xxx

Cash xxx

Accounts Receivable xxx

Expenses xxx

Cash/Accounts Payable xxx

We will review the bookkeeping for basic transactions of a service business by using the exercise
on the next activity.

MERCHANDISING BUSINESS

1. Concept of Merchandising Business

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The focus of this chapter is bookkeeping for the transactions of merchandising businesses. The
business purchases products from its suppliers which it sells to its customers for a profit.
Businesses in this type includes the following:

• Sari-sari stores, groceries and market stalls

• Hardware
• Appliance store
• Gadgets and electronics store
• Online product sellers

In contrast to a service business, a merchandising business is more complex due to the presence
of inventory. The inventory items needed to be purchased, transported, kept and then sold to the
customers.
In purchasing merchandise inventory, the company pays for the purchase price of the goods.
There could be an agreement for credit terms between the buyer and seller. The buyer might be
offered discounts within a certain period to encourage early or prompt payments. This is also true
in selling the merchandise inventory. The company might also offer credit terms and discounts to
its customers.

In the next pages, we will study the bookkeeping for purchases, freight charges, credit terms and
discounts, and the periodic and perpetual inventory systems.

2. Periodic and Perpetual Inventory Methods

There are two methods of accounting for the inventory of merchandising businesses, namely
periodic inventory method and perpetual inventory method.

Periodic Inventory Method

The Periodic Inventory Method is generally used when the individual inventory items have small
peso values.

Under this method, the business maintains temporary accounts like purchases, purchase returns,
and sales returns. At the end of the accounting period, these temporary accounts are used to
determine the amount of inventory available for sale.

Perpetual Inventory Method

Under this method, the inventory account is continually updated for each inventory transaction.
For every journal entry of sales, a corollary journal entry for the cost of inventory sold is also
recorded. Purchases and returns are recorded in directly in the Merchandise Inventory account.
Physical count of inventory is conducted to confirm the balances in the stock cards.
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PERIODIC INVENTORY SYSTEM

Typical Journal Entries
PURCHASES

1. To record purchase goods from a supplier:

Purchases xxxx

Cash/Accounts Payable xxxxx

2. To record purchase freight costs:

Freight-in xxxx

Cash xxxx

3. To record purchase discount:

Accounts Payable xxxx

Purchase Discounts xxxx

4. To record purchase return:

Accounts Payable xxxx

Purchase Returns and Allowances xxxx

SALES

1. To record sales to customer:

Cash/Accounts Receivables xxxx

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Sales xxxx

2. To record freight costs:

Freight Out xxxx

Cash xxxx

3. To record sales discount:

Sales Discount xxxx

Accounts Receivable xxxx

4. To record sales return:

Sales Returns and Allowances xxxx

Cash/Accounts Receivable xxxx

PERPETUAL INVENTORY SYSTEM

Typical Journal Entries
PURCHASES

1. To record purchase goods from a supplier:

Merchandise Inventory xxxx

Cash/Accounts Payable xxxxx

2. To record purchase freight costs:

Merchandise Inventory xxxx

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Cash xxxx

3. To record purchase discount:

Accounts Payable xxxx

Merchandise Inventory xxxx

4. To record purchase return:

Accounts Payable xxxx

Merchandise Inventory xxxx

SALES

1. To record sales to customer:

Cash/Accounts Receivables xxxx

Sales xxxx

Cost of Goods Sold xxxx

Merchandise Inventory xxxx

2. To record freight costs:

Freight Out xxxx

Cash xxxx
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3. To record sales discount:

Sales Discount xxxx

Accounts Receivable xxxx

4. To record sales return:

Sales Returns and Allowances xxxx

Cash/Accounts Receivable xxxx

Merchandise Inventory xxxx

Cost of Goods Sold xxxx

3. Freight Charges and Credit Term

In purchasing and selling, merchandise inventory needs to be shipped from the seller to the
buyer. The costs of shipping the goods may be charged to the buyer or the seller depending on
their agreement. There are two most common freight charge agreement:

1. Free on board, Shipping point (FOB-SP), and

2. Free on board, Destination (FOB-D)

Credit Terms:

2/10, n/30

means:

• 2% cash discount if paid within 10 days