CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS

(ACCO 103)
Topic 3: Review of The Accounting Process
Learning Outcomes:
After successful completion of this module, you should be able to:
❖review the phases of accounting process;
❖acquire mastery in preparing year-end adjusting entries; and
❖understand the nature of reversing entries.

The steps in accounting process:

1. Documenting Transactions - The accounting cycle starts with a business event or

simply transactions. Verifiability of transactions must be supported by underlying
business documents such as receipts, sales invoice, purchase invoice, check vouchers
among others. These source documents will be the basis for recording transactions.
2. Analysis of Transactions and Recording in the Journal
 Accounting journals are often called the book of original entry.
 Accounting journals are a record of business transactions and events for a specific
account in chronological order.
 For the transactions to be recorded, it must influence the elements of financial
statements and be governed by the qualitative characteristic of relevance and
faithful representation.
 An item is recognized in the financial statements if:
a) It meets the definition of an asset, liability, equity, income or expense;
b) It provides useful information that is relevant and faithfully represented;
c) The benefits of the information provided to the users justify the costs of
obtaining, providing and using information;
d) It is measurable.
  Double entry accounting system - The accounting system that requires every business
transaction or event to be recorded in at least two accounts. This is the same concept
behind the accounting equation.
General classification of journals:
1. General Journal - often used by small entity with only few transactions and also called
two column journals.
2. Special Journal - For an entity with numerous transactions, special journals are being
used in addition to general journal that are used to help divide and organize business
transactions.
Special Journals
 Cash Receipts Journal
 Cash Disbursements Journal
 Purchases Journal
 Sales Journal
Each of the journals has a specific purpose and are used for recording specific types of
transactions. For example:
 The cash receipts journal contains all of the cash sale transactions.
 The accounts receivable or credit sales journal contains all the transactions for credit
sales.
 Purchases Journal are used for all credit purchase
 Cash purchases transactions are recorded in cash disbursement journal.
 All other transactions such as adjusting and closing, and reversing entries are recorded in
the general journal. The use of special journal the help management organize and analyze
accounting information.

3. Post Journal Entries to Applicable Ledger Accounts

 Ledger is a complete listing of all the accounts use in the chart of accounts.
 The entries from the journals are transferred to this ledger accounts.
 Each journal entry is transferred from the journal to the corresponding ledger accounts.
The debits are always transferred to the left side and the credits are always transferred to
the right side of the ledger.
 Since most accounts will be affected by multiple journal entries and transactions, there
are usually several numbers in both the debit and credit columns.
 The account balances of each account are calculated at the bottom and get its total. This
process is called pencil footing. Notice that these are account balances—not column
balances.
 The total difference between the debit and credit columns will be displayed on the bottom
of the corresponding side. The purpose of this process is to show the effects of
transactions on the elements of financial statements.
 The use of special journals facilitates the posting process and only the total is entered in
the ledger. However, the general journal is posted individually.
 For controlling accounts in the ledger, the entity has subsidiary ledger for accounts with
various details. For instance, the customer’s account serves as subsidiary ledger for
accounts receivable, creditors accounts for accounts payable, raw materials inventory
accounts and different property items for property and equipment accounts.
  Most entities have computerized accounting systems that update ledger accounts as
soon as the journal entries are input into the accounting system.
 Manual accounting systems are usually posted weekly or monthly. Just like journalizing,
posting entries is done throughout each accounting period.

4. Trial Balance is Prepared

 The preparation of Trial Balance determines the equality of debits and credits in the
ledger but does not give assurance of balances being error-free during journalizing and
posting process.
 The total amount indicated in the Trial Balance summarizes the effect of the transactions
on each account of the ledger for an accounting period.
 Accounts are usually listed in order of their account number.
 Most charts of accounts are numbered and presented in the order starting with the assets,
liabilities, equity accounts and ending with income and expense accounts.
 The total balances of the accounts are not yet updated and may require adjustments.
Adjusting entries are journalized and posted.

5. Adjusting Entries are Journalized and Posted

 Adjusting entries or Adjusting Journal Entries (AJE’s) are made at the end of accounting
period before the financial statements are prepared. •
 Adjusting entries are mostly for adjustment of the following:
o To match revenue and expenses in the period in which they occur, i.e., Matching
Principle
o For revenues from which cash are not yet collected
o For expenses incurred but not yet paid (accruals)
o For accounts recorded cash receipts from which revenue have not yet been earned
o For recorded cash payments for which expenses that are not yet incurred
(deferrals)
o Adjustments for impairment of financial assets like receivables
The adjusting entries affects:
1. Real accounts - assets, liabilities and equity whose balances are carried forward to the
next accounting period.
2. Nominal accounts - income, expenses, income summary and drawings are brought to
zero at the end of the accounting period.

Three (3) different types of adjusting journal entries:

1. Prepayments
2. Accruals
3. Non-cash expenses (Asset Depreciation and amortization, Impairment of Asset)

Each one of these entries adjusts income or expenses to match the current accounting period
usage. This concept is based on the time period principles which states that accounting records
and activities can be divided into separate time periods. In this process, we are separating the
income and expenses into the amounts that were used in the current accounting period and
deferring the amounts that are going to be used in future periods.
PREPAYMENTS
 Prepaid expenses are goods or services used in the operations of the entity that have
been paid for but have not been consumed at the end of accounting period.
 Upon purchase the amount is initially recorded either asset or expense account.
 As the time passes its operations, it is necessary to determine the portion of used up
during the current period and the unused portion for use to subsequent period.
 If the prepayment was originally recorded to expense account, the year-end adjustment
recognizes the asset portion or the unused balance. While if the prepayment was
originally recorded as an asset, the year-end adjustment recognizes the expense and
recognizes the expenses or used portion. Both instances needed adjusting entries for the
asset account would represent the unused portion while the expense account reports the
balance representing the used portion during the accounting period.

Example of Journalizing Prepaid Expenses

Assume that on October 1, 2021, Ace Company paid insurance premiums on its property
covering a period of two years from Oct 1, 2021 to Sep 30, 2023 for a total amount of P48,000.
Assume further that Ace Company’s accounting period ends on Dec 31. The journal entries to
record the payment and the related adjustment at year-end is as follows:

 Unearned revenues consist of income received from customers, but no goods or services
have yet been provided to them. In this case, the entity owes the customers a good or
service and must record the liability in the current period until the goods or services are
provided. The entity that received cash before the sale of goods and services may record
the collection with the option of recording using the revenue method or the liability
method.
 At the end of accounting period, the portion of amount collected that is not yet earned
and for delivery on future date, the account originally credited represents mixed account
revenue and liability.
 Needed adjustment before preparing the financial statements is to adjust the mixed
account and identify revenue earned in the current period and the amount deferred for
future period.
Example of Journalizing Unearned Revenues
ACCRUALS
 Accrued expenses are expenses incurred but are not yet paid at the end of the fiscal
period.
o They are both an expense and a liability. Hence, they are referred to as accrued
liability, accrued payable, or accrued expense.
 Accrued revenues are revenues earned but not yet received at the end of the period.
o Example is an adjustment for services that have been performed but have not been
billed or collected. To present an accurate picture of the affairs of the business, the
revenue earned must be recognized on the income statement and the asset on the
balance sheet.
Example of Journalizing Accrued Expenses
Assume that a company, with a five-day work week, pays wages of its daily-wage
workers every Friday. The average weekly payroll amounts to P15,000 and the last wage
payment for the company’s fiscal year ending June 30 was Friday, June 25. The adjusting entry
on June 30 to record wages incurred but not yet paid for the three (3) remaining working days of
June (June 28, 29, 30) is:

Example of Journalizing Accrued Revenues

On May 1, 2021, a company received a 15% 90-day note for P50,000 from a customer on
an overdue account. Interest on such note will be collected together with the principal on
maturity date. Because interest accrues with the passage of time, an interest has already been
earned from May 1, 2021 through June 30, 2021. Thus, on June 30, 2021, the end of the
company’s fiscal year, prior to the preparation of financial statements, the adjusting entry is
(assume a 360-day year)

NON-CASH EXPENSES
 Adjusting journal entries are also used to record expenses like
o Depreciation
o Amortization
o Depletion
These expenses are often recorded at the end of accounting period because they are usually
calculated on a period basis.
For example, depreciation is usually calculated on an annual basis. Thus, it is recorded at the end
of the year.
Property Plant and Equipment (PPE) and Intangible asset (IA) accounts are assets of the entities
that are being used for its operations and recorded that must be also adjusted to reflect its value.
The recognition of depreciation for PPE and amortization of IA applies the recognition principle
of systematic and rational allocation.
Depreciation is the systematic allocation of expense on the life or usefulness of the asset. The
adjustment recognizes the Depreciation expense and the decrease is recorded by crediting the
contra asset account – Accumulated Depreciation
 For intangible assets (IA), the charge to operation for its utilization is recorded by
crediting Accumulated Amortization.
o Amortization is the systematic and rational allocation of cost of the intangible
assets over its economic benefits. The cost of these assets is initially recognized as
an asset and systematically spread the expense portion over its period of benefit or
usefulness. •
 For impairment of asset, accounts such as loans and receivables should be appropriately
reported at net realizable value. The significant portion of credit sales regardless the
entities effort of its collection, there is always a probability of not being collected at its
full amount.
o At the end of accounting period the unrecoverable amount is recognized as
impairment loss or also known as Bad debts or Uncollectibles.
o Based on this, an adjusting entry is made by debit to Uncollectible Accounts
Expense and credit the contra asset account Allowance for Uncollectible (if using
the allowance method).
Example of Journalizing Asset Depreciation and Amortization
Assume that a company acquired an office equipment on May 1, 2021 for P250,000. The
equipment has an estimated salvage value of P10,000 at the end of its estimated useful life of
five (5) years. The company uses straight-line method and computes depreciation to the nearest
month. If the company reports on a calendar year basis, the adjusting entry on Dec 21, 2021, is

INVENTORIES
Two methods of inventory systems 1.
1. Perpetual Inventory - The Inventory and the Cost of Goods Sold balance that appears in
the ledger reflects the updated amounts and does not require further adjusting entry
2. Periodic Inventory (physical) - Adjustment is needed to set-up the ending inventory and
recognize Cost of Goods Sold. Before year-end adjustments, the inventory account still
reflects the beginning inventory balance because all purchases of merchandise during the
period are recorded in the Purchases account. The amount of ending inventory is
determined by means of a physical count and an adjustment is made to reflect this among
of ending inventory.
 Inventories are required to be stated at lower of cost or market and reduced to net
realizable value.
Proforma entry for inventory and cost of goods sold (periodic):
  Provision for income tax
o Normally the adjusting entries for income taxes is prepared after all the accounts
have been adjusted and the profit and loss are computed. ▫
o Entry: Dr. Income Tax Expense (or Provision for Income Tax)
Cr. Income Tax Payable.
 Recognition of deferred tax asset and deferred tax liability coming from the existence
of taxable temporary differences and deductible temporary differences.
Three Steps in Recording Adjusting Journal Entries:
1. Determine current account balance
2. Determine what current balance should be
3. Record adjusting entry The adjustments are then made in journals and carried over to the
account ledgers and accounting worksheet

6. Preparation of Adjusted Trial balance

 Adjusted trial balance is a listing of all company accounts that will appear on the
financial statements after year-end adjusting journal entries have been made.
 Both the debit and credit column totals are calculated at the bottom of a trial balance and
these debit and credit totals must always be equal. If they aren’t equal, the trial balance
was prepared incorrectly, or the journal entries weren’t transferred to the ledger accounts
accurately.
 Accounting worksheet is a spreadsheet that tracks each step of the accounting cycle.
This typically has five sets of columns that start with the unadjusted trial balance
accounts and end with the financial statements. In other words, an accounting worksheet
is basically a spreadsheet that shows all of the major steps in the accounting cycle side by
side.

7. Preparation of Financial Statements

 The financial statements are the end results of the accounting process. These presents
the effects of transactions completed by the entity during the accounting period.
 The concept financial reporting and the process of the accounting cycle are focused
on providing external users with useful information in the form of financial
statements.
The financial statements prepared by the entity include:
1. Statement of financial position as at the end of the period;
2. Statement of profit or loss and other 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 significant accounting policies and other explanatory information

 IAS 1 sets out framework and overall requirements for the preparation and presentation
of financial statements. These guidelines are for their structure and minimum
requirements of the content of financial statements. The requirement for an entity to
present a complete set of financial statements Summary, Profit and Loss Summary, or
Expenses and Revenue Summary which summarizes the net effect of total income and
expenses. The balance of these accounts represents the profit or loss for the period. If the
result is credit balance there is profit, if debit balance there is loss.
 8. Preparation of Closing Entries
In the closing process:
 Each account that affects the computation of the profit or loss for the period is to be
debited or credited for the amount that will result in zero balance, with corresponding
entry to Income Summary account.
 The Income Summary account and the Dividends account are transferred to Retained
Earnings account.
 At the end of the year, all the nominal or temporary accounts are closed. Only balances of
real accounts are carried to the next accounting period.

9. Preparation of Post Closing Trial Balance

The post-closing trial balance is a list of all accounts and their balances after the closing entries
have been journalized and posted to the ledger. •
 The purpose of preparing the post-closing trial balance is to verify that all temporary
accounts have been closed properly. •
 The only accounts in the post-closing trial balance are the accounts that are found in the
statement of financial position. These accounts are the real (permanent) accounts which
represent the asset, liabilities and equity accounts for the next accounting period.

10. Preparation of Reversing Entries

Reversing entries, or reversing journal entries, are journal entries made at the beginning
of the next accounting period to reverse or cancel out adjusting journal entries made at the end of
the previous accounting period. This is the last step in the accounting cycle.
Reversing entries are made because previous year accruals and prepayments will be paid off
or used during the new accounting period and no longer needed to be recorded as liabilities and
assets.
These entries are optional depending on whether or not there are adjusting entries that need
to be reversed. Not all adjusting entries need to be reversed.
Entries that need reversing entries: •
 For accruals – Accrued Income, Accrued Expenses •
 For deferrals– Only that create and asset or liability and are originally entered in nominal
accounts such as: o
o Prepaid Expenses using the expense method
o Unearned income using the income method

When adjusting entries are made for accrued income or expense account, a reversing entry must
be made to eliminate the need for monitoring their respected balances of the receivable and
payable which are created during the adjusting entries. The collection and payment in the
ensuing period are recorded in the usual revenue and expense account.