FABM

Week 6: Accounting Cycle of a Service Business (Part II-B)

There are questions that the owner of a business periodically asks – How much did the business entity earn?
What is the financial condition of the business? How much is the owner’s interest in the entity today? What
happened to the cash receipts? Where did cash go? Investors, creditors, taxing authorities and other users have
their own questions about the business which need to be answered.
Those are just the typical questions commonly raised in the business and as an ABM student, it also triggers your
mind and curiosity to look into and analyze what is really happening in the business entity. That is what we are
going to learn about in this week’s lesson as we are going to dwell on the preparation of financial statements and
the remaining steps to complete the accounting cycle of a service business.

What is the Worksheet?

Accountants often use a worksheet to help transfer data from the unadjusted trial balance to the financial
statements. This multi-column document provides an efficient way to summarize the data for financial statements.
The accountant generally prepares a worksheet when it is time to adjust the accounts and prepare financial
statements. Note, however, that it is possible to prepare financial statements directly from the adjusted trial
balance at the end of the accounting period if the business has relatively few accounts.
 
The worksheet simplifies the adjusting and closing process. It can also reveal errors. The worksheet is not part of
the ledger or the journal, nor is it a financial statement. It is a summary device used by the accountant for his/her
convenience.
 
The structure of the worksheet of Del Mundo Landscape Specialist is presented as follows:
 
(See the attached worksheet)
/files/4997531/FABM_Week_6_Worksheet.docx

What is the complete set of financial statements?

An entity shall present with equal prominence all of the financial statements in a complete set of financial
statements. Per revised International Accounting Standards (IAS) No. 1, a complete set of financial statements
comprises:
1. A statement of financial position at the end of the period;
2. A statement of comprehensive income for the period;
3. A statement of changes in equity for the period;
4. A statement of cash flows for the period;
5. Notes, comprising a summary of significant accounting policies and other explanatory information; and
6. A statement of financial position as at the beginning of the earliest comparative period when an entity
applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial
statements or when it reclassifies items in its financial statements.
What is the essence of Financial Statements?
The financial statements are the means by which the information accumulated and processed in financial
accounting is periodically communicated to the users. Without accounting information embodied in the financial
statements, users may not be able to arrive at a sound economic-decisions. The objective of financial statements
is to provide information about the financial position, financial performance, and cash flows of an entity that is
useful to a wide range of users in making economic decisions.

How to prepare the financial statements?

Once the worksheet is completed, it is easy to prepare the financial statements for the account balances have
been extended to the appropriate income statement and balance sheet columns. Most of the information needed
to prepare the income statement, statement of changes in equity and balance sheet are available from the
worksheet. The statements presented are those of Del Mundo Landscape Specialist. Note that financial
statements shall be presented at least annually.

INCOME STATEMENT
The income statement is a formal statement showing the performance of the enterprise for a given period of time.
It summarizes the revenues earned and expenses incurred for that period of time. The income statement for Del
Mundo Landscape Specialist is prepared directly from the income statement columns of the worksheet.

Del Mundo Landscape Specialist

Income Statement
For the Month Ended November 30, 2020

     

Revenues    

Service Income   ₱42,250

     

Expenses    

Salaries Expense ₱5,600  

Supplies Expense 500  

Rent Expense 7,000  

Insurance Expense 2,000  

Utilities Expense 1,500  

Advertising Expense 1,750  

Depreciation Expense – Vehicles 4,500  

Depreciation Expense – Equipment 1,000  

 Interest Expense 1,400  

Total   (25,250)

Profit   ₱17,000

Information about the performance of an enterprise, in particular its profitability, is required in order to assess
potential charges in the economic resources that is likely to control 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. Changes in an enterprise’s equity between two balance sheet dates reflect the
increase or decrease in its net assets during the period.

In the case of sole proprietorship, increases in owner’s equity arise from additional investments by the owner and
profit during the period. Decreases result from withdrawals by the owner and from loss for the period.
 

Del Mundo Landscape Specialist

Statement of Changes in Equity
For the Month Ended November 30, 2020

     

Del Mundo, Owner’s Equity, 11/1/2020   ₱450,000

Add: Additional Investments by Del Mundo ₱-0-  

Profit 17,000 17,000

Total   ₱467,000

Less: Withdrawals   (5,000)

Del Mundo, Owner’s Equity, 11/30/2020   ₱462,000

BALANCE SHEET
The balance sheet is a statement that shows the financial position or condition of an entity by listing the assets,
liabilities and owner’s equity as at a specific date. The information needed for the balance sheet items ae 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 statement of financial position.
 
Format
 
The balance sheet can be presented in either the report format or the account format. The report format simply
lists the assets, followed by the liabilities then by the owner’s equity in vertical sequence. The 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
 
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.
 
To make accounting information useful to decision-makers, the items in the balance sheet may be grouped and
arranged in accordance with the following guidelines:
 
 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.

The classified balance sheet of Del Mundo Landscape Specialist in report format is:

Del Mundo Landscape Specialist

Balance Sheet
November 30, 2020

Assets

Current Assets      

Cash   ₱182,250  

Accounts Receivable   10,000  

Supplies   500  

Prepaid Rent   14,000  

Prepaid Insurance   22,000  

Total Current Assets     ₱228,750

Property and Equipment (Net)      

Vehicles ₱300,000    

Less: Accumulated Depreciation (4,500) ₱295,500  

Equipment ₱54,000    
 Less: Accumulated Depreciation (1,000) 53,000 348,500

Total Assets     ₱577,250

Liabilities

Current Liabilities      

Accounts Payable   ₱1,000  

Notes Payable   100,000  

Salaries Payable   1,600  

Interest Payable   1,400  

Unearned Revenues   11,250  

Total Current Liabilities     ₱115,250

Owner’s Equity

Del Mundo, Capital, 11/30/2020     462,000

Total Liabilities and Owner’s Equity     ₱577,250

 

What are the remaining steps in the accounting cycle?

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, expenses, 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 closed the
income and expense accounts. The steps in closing the accounts of an entity will be illustrated using Del Mundo
Landscape Specialist case.
 
 Close the Income Account
 
Income accounts have credit balances before the closing entries are posted. For this reason, an entry debiting
each revenue account in the amount of its balance is needed to close the account. The credit is made to the
income summary account. The entry to close the income accounts for the Del Mundo Landscape Specialist is
as follows:
 2020        

November 30 Service Income 410 ₱42,250  

  Income Summary 330   ₱42,250

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. Note that the data for closing the income
accounts can be found in the credit side of the income statement columns of the worksheet.

 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.

2020        

November 30 Income Summary 330 ₱25,250  

  Salaries Expense 510   ₱5,600

  Supplies Expense 520   500

  Rent Expense 530   7,000

  Insurance Expense 540   2,000

  Utilities Expense 550   1,500

  Advertising Expense 560   1,750

  Interest Expense 570   1,400

  Depreciation Expense – Vehicles 580   4,500

  Depreciation Expense – Equipment 590   1,000

 

The dual 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 account.
 

 Close the Income Summary Account

 
After posting the closing entries involving the 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 a debit balance. The income summary account, regardless of the nature of its balance, must be closed
to the capital account. For the Del Mundo Landscape Specialist, the entry is as follows:
 2020        

November 30 Income Summary 330 ₱17,000  

  Del Mundo, Capital 310   ₱17,000

The effect of posting this closing entry is to close the income summary account balance and to transfer the
balance to Del Mundo’s capital account for the profit.
 
 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:

2020        

November 30 Del Mundo, Capital 310 ₱5,000  

  Del Mundo, Withdrawal 320   ₱5,000

 

The effect of posting this closing entry is to close the withdrawal account and to transfer the balance to the
capital account.

PREPARATION OF A 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 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 the 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.

Del Mundo Landscape Specialist

Post-Closing Trial Balance
November 30, 2020

Cash ₱182,250  

Accounts Receivable 10,000  

Supplies 500  

Prepaid Rent 14,000  

 Prepaid Insurance 22,000  

Vehicles 300,000  

Accumulated Depreciation - Vehicles   ₱4,500

Equipment 54,000  

Accumulated Depreciation - Equipment   1,000

Accounts Payable   1,000

Notes Payable   100,000

Salaries Payable   1,600

Interest Payable   1,400

Unearned Revenues   11,250

Del Mundo, Capital   462,000

  ₱582,750 ₱582,750
 

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 expense
– accounts are reversed.
SAMPLE EXERCISE
Worksheet Preparation

The June 30, 2016 trial balance for Rosalina Besario Surveyors is presented as follows:

Rosalina Besario Surveyors

Trial Balance
June 30, 2016

Cash ₱210,000  

Accounts Receivable 930,000  

Prepaid Advertising 360,000  

Engineering Supplies 270,000  

Survey Equipment 1,890,000  

Accumulated Depreciation – Survey Equipment   ₱640,000

Accounts Payable   190,000

Unearned Survey Revenues   120,000

Noted Payable   500,000,

Besario, Capital   1,120,000

Besario, Withdrawal 700,000  

Survey Revenues   6,510,000

Salaries Expense 3,270,000  

Rent Expense 960,000  

Insurance Expense 250,000  

Utilities Expense 160,000  

Miscellaneous Expense 80,000  

Totals ₱9,080,000 ₱9,080,000

 The following information pertaining to the year-end adjustment is available:
 
a. Account of the engineering supplies at June 30, 2016 amounted to ₱90,000.
b. The ₱360,000 prepaid advertising represents expenditure made on December 1, 2015 for monthly
advertising over the next 18 months.
c. Depreciation on the survey equipment amounted to ₱160,000.
d. One-third of the unearned survey revenues has been earned at year-end.
e. At year-end, salaries in the amount of ₱140,000 have accrued.
f. Interest of ₱60,000 on the notes payable have accrued at year-end.

Required: Prepare the adjustments on the worksheet and complete the worksheet.

GENERALIZATION
The adjusted trial balance is simply the unadjusted trial balance plus the effects of the adjusting entries. Closing
entries reduce the balances of the temporary accounts to zero to prepare them for accumulating amounts for
another accounting period. The post-closing trial balance proves the equality of debits and credits after the
preparation of closing entries.