MANILA TYTANA COLLEGES

Formerly Manila Doctors College

A Partner of the Metrobank Group
Metropolitan Park, Pres. Diosdado Macapagal Blvd., Pasay City, 1300

FUNDAMENTALS OF ACCOUNTING 1
Leonardo M. Dimatalo
Diane B. Estaris, CPA
 TABLE OF CONTENTS

INTRODUCTION TO ACCOUNTING AND ITS HISTORY…….……………………………..1

Lessson 1: Nature of Accounting…....………………………………………………………………2

Lesson 2: Business Environment.……...……………………………………………………………5

Lesson 3: Accounting Concepts and Principles...………………………………………………….17

Lesson 4: A.L.E. –Accounting Equation…………………………………………………………....22

Lesson 5: Assets…………………..…………………………………………………………………..25

Lesson 6: Liabilities and Owner’s Equity…...……………………………………………………...29

Lesson 7: Income Statement………………………………………………………………………....32

Lesson 8: Effects of Various Transactions in Accounting Equation……………………………...37

Lesson 9: Journalizing……………………………………………………………………………….45

Lesson 10: Posting to Ledger………………………………………………………………………...51

Lesson 11: Trial Balance……………………………………………………………………………..57

Lesson 12: Adjusting Entries………………………………………………………………………...61

Lesson 13: Adjusted Trial Balance………………………………………………………………….78

Lesson 14: Closing Entries…………………………………………………………………………...81

Lesson 15: Post Closing Trial Balance and Reversing Entries...…………………………………..88

Lesson 16: Transactions of Merchandising Business……………………………………………….93

Reference……………………………………………………………………………………………...107
INTRODUCTION TO ACCO UNTING AND ITS
HISTORY

Students of this discipline have to understand right from the beginning of this
course how important and practical accounting is to our lives. Almost every role in our
life involves the principles of accounting; as a mother or a father who are working
tirelessly to make ends meet – hence, the difficulty of budgeting a limited fund for
unlimited needs, as a student who is faced also with financial decisions, from variety of
school projects that they need to create to simple decision making of where to eat; we
are all confronted with financial and economic problems. There is a need for everyone
to balance their spending in accordance to their limited resources or earnings. During
these scenarios, which transcends to all walks of life, accounting will play a vital role
by equipping students with relevant information that can help them solve their financial
and economic constraints.

Accounting History
They said that accounting can be traced as early as 2000 B.C. in the civilization
of Babylonia, Greece, Egypt and Assyria. In the bible, accounting is also present,
remember Matthew, one of the 12 apostles of Jesus Christ was a tax collector.

The first accounting book was written by Cotrugli in Naples but the modern day
double entry bookkeeping could be traced from the book prepared in 1494 by an Italian
mathematician. Fr. Luca Pacioli, the author for several books in mathematics and a
writer of Summa de Arithmetica, Proportioni et Proportionalita. One section of the latter
made him famous for his works on accounting, “Particularis de Computis et Scripturis”.
It gave way to modern bookkeeping methods. Pacioli is known to be the Father of
Accounting (Cruz-Manuel, 2010).

In the Philippines, bookkeeping was introduced by the Spaniards and the

bookkeeper was called Tenedor de Libro. The first licensure examination was given for
Certified Public Accountants in 1923 and the professional association of accountants
was established in 1929(Vera Cruz- Manuel, 2010).

In the past, Accounting used to be part of the curriculum of Business

Administration major in Accounting. Today, there is already a separate curriculum for
this discipline. The Accountancy profession has already attained its status as in other
professions like law and medicine (Hugo-Macapilit, 2000 revised ed).

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 LESSON 1: NATURE OF ACCOUNTING

After this Chapter the learner must be able to:

 Define Accounting
 Describe its nature and functions in business

WHAT IS ACCOUNTING?

The Accounting Standards Council provides the following 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 decision.

American Accounting Association defines accounting as:

Accounting is the process of 1.) Identifying 2.) Measuring and 3.) Communicating
economic information to permit informed judgment and decision by users of the
information.

Another definition of accounting is that it 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 a financial character and interpreting the results
thereof.

With these given definitions, one can infer three important features of accounting. First,
accounting gathers quantitative data, second, the data is financial in nature or involves
money, lasty, the data gathered is to be used in making economic decisions.

FOUR ASPECTS OF ACCOUNTING

1. Recording

Recording in accounting is also known as “journalizing” or perhaps “debit-credit”

entries or what we call double entry bookkeeping. When recording transactions the
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 accountant should be careful, prudent and analytical. This is the first step to accounting
thus due care is necessary. Transactions should be recorded in the books chronologically
as they took place.

2. Classifying

After recording the transactions, all accounts must be posted to ledger for proper
classification so that it would be easier for the accountant to sort these accounts into five
categories such as Asset accounts, Liability, Owner’s equity, Revenue, and Expense
accounts.

3. Summarizing

After all accounts have been classified in their respective categories, preparation of the
financial statements would be the next step. These financial statements include
Statement of Financial Position-Balance Sheet, Income Statement, and Statement of
Changes in Owner’s Equity and Statement of Cash Flows.

4. Interpreting

As an accountant remember that there are many users of financial statements that you’ll
be preparing. These are the employer or the owner of the company, investors,
government agencies, and other third parties. Therefore the need for the financial
statement to be understood by these users is a must. Interpreting gives both the
qualitative and quantitative aspect of the financial statement. By giving comprehensible
interpretation to the data, users will know the economic condition of the business, its
stability and growth and users can make good economic decisions for the business.
Thus, we say that accounting is the language of business.

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 Let us do this!
1. What is accounting according to ASC?

2. What is accounting according to AAA?

3. What are the four aspects of accounting?

4. Among the four aspects of Accounting, what do you think is the most important and
why? Answer in your own words.

5. Do you agree that accounting is the language of business? Explain your answer.

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 LESSON 2: BUSINESS ENVI RONMENT

After this chapter, the learner must be able to:

 Differentiate the branches of accounting
 Explain the kind of services rendered in each of these branches
 Identify users of financial information
 Describe different business organizations
 Classify the different types of business operations.

THE DIFFERENT BRANCHES OF ACCOUNTING

1. Financial Accounting – deals with the fundamentals covering accounting principles

and concepts relative to measurement, classification and valuation as applied to the
assets, liabilities and owner’s equity. Same goes for revenues and expense accounts in
relation to the preparation and presentation of financial statements. These financial
statements is governed by GAAP or Generally Accepted Accounting Principles to make
sure they follow legal and regulatory requirements.

Generally accepted accounting principles are rules, procedures, practice and standards
followed in the preparation and presentation of financial statements.
Financial accounting, in simplest definition, involves preparation and interpretation of
Financial Statements which are to be used by external users. These external users may
include but not limited to, government, customers, potential investors, lenders, and
suppliers. One can see from the financial statements of the business historical financial
information regarding the performance of the business. One would know from there if
the business is gaining or losing, liquid or solvent, how much is its total liabilities and
equity.

2. Management Accounting – refers to the function of providing professional advisory

services for the purpose of improving the client’s use of its resources and maximize its
capabilities to achieve the objectives of the organization. Under this branch of
accounting the service being rendered by the accountant is not the making of financial
statements but he/she only assists the client in the implementation of internal controls
already set by the company and formulation of organization strategy.

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 If financial Accounting involves historical financial information, Management
accounting presents both financial and non-financial information primarily for the
management who are the internal users.

3. Government Accounting – has been defined as the process of analyzing, summarizing,

and communicating all transactions involving receipts and disposition of government
funds and property and interpreting the result thereof. A Certified Public Accountant
may be employed in any agencies of the government related to the custody of public
funds, some famous agencies where CPAs are employed are Commission on Audit
(COA), Bureau of Internal Revenue, Department of Budget Management, Bureau of
Treasury, and Securities and Exchange Commission.

4. Auditing – one of the primary service being rendered by most public accounting
practitioners which is also known as external auditing. The auditor examines and
reviews the financial statements of the client as to its reliability, fairness, proper
presentation, and its compliance with the laws and generally accepted accounting
principles. The independent auditor shall give reasonable assurance if the financial
statements have passed the examination and review.

The BIR requires every business to submit an audited Financial Statements to be

attached in the filing of annual income tax returns.

5. Tax Accounting – an independent certified public accountant may also provide for tax
services by preparing and filing income tax returns for his/her clients. It could be on a
monthly basis, quarterly or annually. Usually, businesses ask their accountants to
manage their taxes for the whole year from the filing of their monthly Value-added
taxes, monthly percentage tax returns, quarterly filing of taxes up to annual filing. The
independent CPA must be well-versed with the tax laws as for him/her to give advice
to his/her clients on how to minimize payment of taxes legally.

6. Cost Accounting – this branch of accounting most of the time is most often used by
manufacturing businesses who is much concerned with their cost of production. It has
something to do with the allocation determination, distribution, and control of cost such
as raw materials, labor, and overhead cost (supervisor’s salary, water, electricity,
telecommunication etc.) directly attributable to the conversion of raw materials to
finished goods.

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7. Accounting Education – the academicians, as a CPA you may also have the passion to
share your knowledge to the future minds that is why a CPA may choose to become a
professor in a school or university. However he/she must be able to comply with the
necessary post-graduate degree before he/she can pursue in the academe.

8. Accounting Research – Just like any other fields accounting is like unending process
of discovery, of debates and arguments of how to interpret several accounting standards,
how to account for certain activities, how to deduct or add a certain transaction.
Accounting research would deal with careful and diligent study giving light to gray
areas of accounting by using current events that may affect the profession.

Having known all these, you as a learner of this discipline perhaps must have been
thinking that these financial statements and all these financial information would be
used only by the owner of the business and the government, as being prepared by the
accountant.

There are two users of Financial Information, first are the primary users who are directly
involved in managing the business we call them internal users and second are the
secondary users who are parties outside the business but their decision may greatly
affect the business, we call them external users.

Internal users include:

1. Original Investor/Owners/Stockholders – they are concerned with the result of the

operation of the business and whether or not their investment is gaining or losing.

2. Management – a manager is responsible for good stewarding of the business. The

organizing, planning, directing and controlling the operation of the business is to be
handled by him/her/them. Most often, they are the ones being confronted with big issues
of the company like whether or not they have to shut down one product line, or to shut
down the whole company. For them to be able to decide on this they need financial
information for better decision making.

3. Employees – every employees wants higher wages/salaries, benefits, good working

conditions and, most of all, security of tenure. The financial information of the company
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would be a good basis of the actual performance of the business. The employees would
be able to know from there whether the business is stable or unstable.

External users include:

1. Financial Institutions/Creditors – lenders may use the financial statements of the

company when making assessment on the capacity of the company in paying their debts.

2. Government – primarily financial statements, specifically audited financial

statements are required by the BIR when it comes to collection of taxes. As to other
agencies, they use financial information from business to verify whether a business is
compliant with rules and regulations.

3. Potential Investors – a potential investor is a person who has interest in contributing

money or property into the business, but before that one would check first the present
performance of business to make sure that the money that they would invest won’t lose.
The only way for that person to know the performance of the business is through
financial statements of the company where financial information can be seen.

In the future after earning enough money, you would want your money earn for you.
You could invest it somewhere else and it could give you interests, dividends, royalties
etc. Let us say you decided to take on your own business, what would be necessary steps
you have to take and consider?

First, a business would start by investing your money. Now, when you already invested
your money or properties to the business it becomes business’s money or properties and
they are no longer yours, personally, in that sense. This is what we call “Business
entity” concept. The personal assets of the owner and the business are separate and
distinct from that of another.

For example, Juan Bacnang owns a sari-sari store, he gets the “baon” of his son from
the sari-sari store and he gets the payment for his cellular phone load from the revenue
of the sari-sari store at the end of the day he accounts for his total income and he found
out there was none! Was there really no income from the sari-sari store for the whole
day? Or Did Juan just fail to separate personal expense from the expense of the
business?
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 After investing, ask your self, what type of business activity would you like to engage
in?
There are three major types of business activities.

Types of Business Activities

 SERVICE – if this would be the type of activity that you would want to be involved
with, remember that businesses involve in service activities renders skills as their
service and they ask for a fee to their clients or customers. E.g. Barbershop, Salon,
Accounting Firm, Law Firm, clinic, internet café, restaurants, schools, travel agency etc.

 TRADING/MERCHANDISING – this business activity is involve in buying and

selling of goods or merchandise. E.g. Sari-sari store, Grocery, Supermarket, Bookstore.

 MANUFACTURING – It involves purchasing of raw materials and converting it into

finished goods then later on sell these produced products to the market. This involves a
lot of costs during the production. These costs include direct materials cost, direct labor
costs and overhead costs for supervisor salary, electricity, water, and factory supplies.

Now after deciding which business activity you would want to pursue, the next question
for you is, would you manage it alone? Would you want to have a partner? Or would
you like to put up your own corporation? Remember, it was discussed during your
Business Ethics and Social Responsibility course that there are four types of business
organizations.

Types of Business Organization

 Sole Proprietorship – a business organized and owned by one person who usually
act as a manager. This has to be registered with Department of Trade and Industry for
the registration and sole acquisition of rights of trade name and to make sure that it
won’t be used by anyone illegally and without the consent of the owner.

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 Advantages:

1. It only entails minimal cost to put up a sole proprietorship as well as minimal

requirements for its formation, which is why it is said to be easier to form this kind of
business organization.
2. The decision making is solely to the owner because the owner is the head
3. All profits shall be acquired by the owner.

Disadvantages:

1. Limited Resources as to capital

2. Owner has an unlimited liability
3. Limited idea and knowledge when it comes to management for it is only one person
running the business.

 Partnership – Article 1767 of the civil code of the Philippines, by the contract of
partnership two or more persons bind themselves to contribute money, property or
industry to a common fund, with the intention of dividing the profits among themselves.
Partnership is being registered with Securities and Exchange Commission.

Two or more persons may also form a partnership for the exercise of a profession.
Lawyers, CPAs, engineers and doctors usually form partnership to build a consultancy
firm and they offer variety of professional services to their clients.

Advantages of partnership are unlike sole proprietorship, two or more heads would
mean more knowledge, experience and skills to be contributed in the management of
business. Another is that it would also mean more resources for the company for there
would be contribution of funds from partners.

Disadvantages of partnership, a general partner has an unlimited liability. Death,

withdrawal, through retirement or disagreement of partners, and admission of a new
partner may dissolve the partnership.

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 Corporation – is a business organized separate and distinct from that of its owners.
A corporation is a separate legal entity and can enter into a transaction like buying and
selling. Both corporation and partnership has juridical personality. And because of this
juridical personality it acquires its own rights, duties and responsibilities of a juridical
person. Its separate personality starts only after it has been registered with and it’s
Articles of Incorporation approved by Securities and Exchange Commission.

The Board of Directors elected by the shareholders who are also from among themselves
are managing the corporation. The investor in the corporation is called shareholder and
the unit of ownership is called shares or stocks as evidenced by a certificate of stock or
share certificate.

Advantages:

1. A Stockholder has limited liability. Their liability is only up to the extent of their
subscribed share capital or up to the amount of their capital investment.
2. Corporation has permanent existence.
3. More resources as compared among all others business organizations.
4. Shares of stocks from a shareholder may be transferred, sold or be bought back by the
corporation without having to go under reorganization or dissolution.

Disadvantages:

1. When putting up a corporation, the incorporators have to secure many requirements and
establishing a corporation may be said more costly than partnership.
2. Shareholders have little or no participation at all in the management of business because
there is already a Board of Directors who is running the business.
3. Distribution of Income depends upon the declaration of the dividends by the board of
directors.

 Cooperatives – Republic Act 6938 section 3 states that a cooperative is a duly

registered association of persons, with common bond of interest, who have voluntarily
joined together to achieve a lawful common social or economic end, making equitable
contributions to the capital required and accepting fair share of the risks and benefits of
the undertaking in accordance with universally accepted cooperative principles.

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 Simplifying, the same with what you have learned from Business Ethics and Social
Responsibility subject, a cooperative is an association of group of small producers and
consumers who come together to form a business which they themselves own, manage
and patronize.

Advantages:

1. The prices of products being sold by the cooperative are cheaper because there is already
a direct purchase between the members of the cooperative and the producer or
manufacturer. In here, middleman is already eliminated.
2. They can save on management expense. The members of the cooperatives are the ones
managing the business, this is a voluntary service.

Disadvantages:

1. Because the members are small producers and consumers, they also have limited capital.
Mostly of the members of a cooperative are the financially challenged individuals.
2. The membership to the cooperative is non-transferrable.

After considering all these information you must register your business to the
appropriate government agency and pay the correct and proper taxes, licenses, and
permits fees. Always be mindful of all the necessary things needed to run your business
smoothly. Most of the time we take for granted little things, let us all be reminded that
even little things matter. And sometimes because we neglect these things big businesses
suffers great losses due this reason.

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 Let us try this!
1. What are the different branches of accounting?

MATCHING TYPE

Match Column A with the corresponding definition that can be found in column B
Write the correct answer on the space provided for.

Column A Column B
1. It has something to do with the allocation
determination, distribution, and control
of cost such as raw materials, labor, and
overhead cost directly attributable to the
conversion of raw materials to finished
goods.

Financial Accounting
2. It involves filing and payment of correct
taxes to avoid payment of unnecessary
Cost Accounting penalties.
3. It deals with the fundamentals covering
accounting principles and concepts
relative to measurement, classification
and valuation as applied to the assets,
liabilities and owner’s equity. Same goes
for revenues and expense accounts in
relation to the preparation and
Tax Accounting presentation of financial statements.
4. It involves examination and review of the
financial statements of the client as to its
reliability, fairness, proper presentation,
and its compliance with the laws and
Auditing generally accepted accounting principles.

Government Accounting 5. Would deal with careful and diligent

study giving light to gray areas of
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 accounting by using current events that
may affect the profession.

6. Process of analyzing, summarizing, and

communicating all transactions involving
receipts and disposition of government
funds and property and interpreting the
Accounting Research result thereof.

3. Enumerate the intended users for Financial Information and explain the importance
of financial information for each of these users. (You may use the back sheet of the
paper for your answer)

4. What are the types of Business Activities? Explain each and give examples.

5. Enumerate and explain each business organization.

(You may use the back page for your answer)

6. Enumerate the advantages and disadvantages of the following:

Sole Proprietorship

Partnership

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 Corporation

Cooperative

Determine the types of business organization formed in each case. Also, you must
determine which business activity is involved and where it should be registered.

1. Peter Pan just graduated from the University of Pennsylvania. Wendy, childhood friend
of Peter, just won the lottery the same day that Peter Pan went back home to the
Philippines. Peter and Wendy are both Certified Public Accountants. They decided to
build their own accounting firm named PeeWee Auditing Services.

2. Nanding, a father of a happy family, decided to have an additional source of income.

He franchised 7-eleven, hired some service crews. Most of the goods he is selling has a
mark-up of at least 10% depending on the product.

3. Haya is producing processed foods. Halina is producing bread and is delivering breads
to some bakeshops. Haya and Halina decided to have a joint business and put up
Alapaap Burgers.

Identify to which accounting profession the following careers are as described below.
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a. One who determines the cost of producing a product or service, determine its
profitability and monitors its performance in the market._________________
b. A CPA or a lawyer in charge of preparing reports to be submitted to the BIR and who
advises the clients on financial and economic decisions made and the impact of taxes
on them.______________________
c. A CPA who examines and records reports of the accounting department ensuring that
these are fairly presented in accordance with the generally accepted accounting
principles. ______________________
d. A licensed professional who makes a study and gives recommendations to management
regarding decision making problems such as feasibility study of a new project, retain or
drop a product line, process further or sell the product._______________

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 LESSON 3: ACCOUNTING CONCEPTS AND
PRINCIPLES

At the end of this lesson, learner must be able to:

 Explain generally accepted accounting principles ( GAAP )
 Explain the varied accounting concepts and principles

What is Generally Accepted Accounting Principles or GAAP?

As discussed from the last chapter, it was already mentioned that GAAP or generally
accepted accounting principles are rules and procedures that defines what are
“accepted” accounting practices.
It is like the standards of the accounting profession or more likely, laws, where everyone
in the profession must conform. These principles or standards have developed on the
basis of day-to-day experience, real situation, events, reason, custom, usage and
practical necessity. These standards are to be followed when preparing financial
statements.
In the Philippines, it is the Accounting Standards Council who spearheads the
development of these gaap. The approved statements being released by the ASC that
contains accounting standards were formerly known as “Statement of Financial
Accounting Standards or SFAS”. Now, we do not call it as such but Philippine
Accounting Standards or PAS and Philippine Financial Reporting Standards or
PFRS.
To properly serve the purpose of the financial statements, that is to provide financial
information to its users who most of the time are not degree holder in accounting, it is
a must that accountants must comply with the PAS and PFRS. In this case, the financial
information is understandable, reliable and consistent. With all these the intended users
can make economic decisions.

Underlying Assumptions

 Going Concern Assumption – it is also known as “continuity assumption”. With this

concept the accountant and especially the owner/owners of business assumes that the

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 business will continue its operation indefinitely. Therefore any acquisition of assets are
normally recorded at cost. In other words, financial statements are prepared as is.

 Accounting Entity / Entity Concept – under this assumption, the entity (business) is
separate and distinct from the owners, managers and employees who constitute the
entity. Meaning, whatever transaction the business has, it should not be comingled with
the personal transactions of the owner.
Ex. Mr. X owns a department store. Beside his department store is also his restaurant.
These two entities shall have separate books of account, one for the department store
and one books of account for the restaurant. They should be treated separately to be able
to identify which between the two is giving larger profit or losing. The same goes with
the personal money of Mr. X. the personal money of Mr. X should not be mixed with
the money of any of his two businesses.
 Time Period / Periodicity – This states that the “indefinite life” of the business must
be subdivided into time periods or what we call “accounting periods” which are usually
of equal length for the purpose of reporting the financial position, performance, and
cash flows of the business for a specific length of time. The length of accounting period
is usually twelve months.

o Accounting Period may either be:

 Calendar year – the calendar operation of the business starts on January 1 and ends on
December 31 of the same year, exactly twelve months.

 Fiscal year – the calendar operation of the business starts at any month of the year and
ends on the twelfth month after the starting period.
Example: Mang Bok opened his Angboks Manok business on June 1, 2016. He is
following fiscal calendar year, it means from June 1, 2016 the end of one accounting
period for Mang Bok’s business would be on May 31, 2017.
Why do we have to subdivide the indefinite life of a business into twelve months? For
simple reason that we need to prepare annual reports. It means to say that only the
transactions within same accounting period should be presented in the financial
statement for that year. If you are preparing financial statements for the year 2017 and
your company is using calendar year, only those transactions that happened from
January 1, 2017 up to December 31, 2017 shall be included in the presentation of
financial statement.

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 QUALITATIVE CHARACTERISTICS / BASIC ACCOUNTING PRINCIPLES

 Accrual principle – Accrual accounting means that income is recognized when earned
regardless of when received and expense is recognized when incurred regardless of
when paid. With this concept, we recognized immediately the effects of these
transactions and other events. When we say we “recognized immediately” we valuate
or measure it outright and record it in the accounting book by making a journal entry of
“debit and credit”.

Example: Susan’s cellphone intended for her business is under post paid plan. She used
up the plan for the month of April. The billing from her service provider has not come
until July. Does this mean that Susan would only recognize the utility expense on July
after she received the billing? The answer is no. Susan should recognize immediately
the expense for the month of April and record it on the first day of the next month, which
is May, and not on the month of July. This is what we mean by “expense is recognized
when incurred regardless of when paid”
Pro-forma entry:
May 1 Utility expense P***
Utility Payable P***
To record the communication
Expense for the month of April

 Objectivity principle – the financial statements are verifiable or objective in the sense
that they are supported by evidence so that an accountant that would look into the same
evidence would arrive at the same economic decision or conclusion.

 Materiality – this concept is also known as the “doctrine of convenience”. An

information is said to be material if its omission or misstatement could influence the
economic decision of the users taken on thee basis of the financial statements.

This concept also dictates that strict adherence to GAAP is not required when the items
are not significant enough to affect economic decisions of users. Eg. Sai owns a
warehouse where there are hundreds of tons of bond papers. He later found out that one
realm of bond paper is missing. This missing one realm of paper can be expensed
immediately for convenience.

 Adequate disclosure – means that all relevant or important information, transactions,

and events should be clearly reported in the financial statements. This is to avoid
misleading and misrepresentation.

 Consistency – is the uniform application of accounting method from period to period.

A business cannot use one accounting method for the year and then changed it the next
year and then another year after that.

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Mang Ben uses First in First out method of inventory valuation for the year 2017, Mang
Ben will use average method next year, 2018 and again FIFO method in the succeeding
year. This should not be the case.
However, as cliché goes “there is no permanent thing in this world except change”. For
every business change is a necessity so it means that accounting method can be changed
too. Especially if the change would yield better result and performance of the business,
then we must embrace change. Only that there must be full disclosure of the change
and its monetary effect.

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 Let us try this!

1. Discussed briefly the meaning of generally accepted accounting principles.

2. What is going concern assumption?

3. Explain in a concise manner the meaning of Entity concept assumption

4. What is the usual accounting period?

a. Six Months b. Twelve months’ c. Three months d. Two years

5. Which user need financial information to enable them to evaluate the ability of the
business to pay loans?
a. Suppliers b. Lenders c. Employees d. Investors

6. From the following situations, explain why the accounting practices are not in
conformity with the Accounting concepts and cite what concept/s is/are violated.

a. The owner-manager bought a laptop for personal use. The invoice was given to the
accountant who recorded it as asset of the business._________________

b. No financial statements were prepared by Tina Mad for her business. She said that she’ll
prepare the statement when she closes the business which she predicts to take place after
30 years._________________________________

c. Allan Dimo operates a restaurant besides the department store owned by him. The assets
of the restaurant are reported in the statement of financial position of the department
store._____________________________________

d. Purchased an equipment at a cost of P1, 000.00. The new equipment was charged to
expense although it has a useful life of 3 years. _________________

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 LESSON 4: A.L.E -THE ACCOUNTING
EQUATION

At the end of this lesson, learner must be able to:

 Know the basic elements of Accounting

 Perform operations involving simple cases with the use of accounting equation
 Learn the effects of the business transactions on the accounting equation.

This lesson will teach you the heart of accounting. If for once you have thought
accounting is hard or difficult, you may want to revisit your belief after this lesson.
Accounting is combination of very simple mathematics and common sense. When we
say common sense it includes understanding and analysis. So, it is simple mathematics
plus analysis.

The accounting equation is as simple as this: A, L, E. Where “A” stands for assets, “L”
stands for liability and “E” stands for equity or owner’s equity. Simple as that.

Now let us place the necessary operations to make it look like a mathematical formula;

Assets = Liability + Equity or A = L + E.

Assets, Liability and Owner’s Equity are the three basic elements of accounting. These
accounts can be found in the statement of financial position or Balance Sheet.
From this simple equation some other more formula may be derived. Always remember
that this equation always has two sides, the left side and the right side. We call the left
side the debit side and the right side as the credit side.

Debit Credit
Assets = Liabilities + Equities

What if you are given the amount of Assets and Equity and you are to look for the
amount of the Liability? The formula would be; Liability=Assets-Equity.
Assets are resources owned by a business. Common assets accounts are: cash and cash
equivalents, accounts receivable (or any receivables), equipment, building, land,
furniture & Fixtures, inventory and prepaid expenses.

22
Liabilities are amounts the business owes. Liability accounts often have the word
“payable” in the title. Examples of liabilities are: accounts payables, notes payable and
mortgage payable.

Owner’s equity or stockholder’s equity is the net worth of a business. It is also the
amount left over after the liabilities are deducted from assets.

Any changes on one side of the equation must be balanced by an equal change on the
other side of equation. See examples below for illustration:

Sena Thor invested P5, 000,000 cash in her dental clinic. The accounting equation will
show:

Assets = Owner’s Equity

Cash P5, 000,000 Thor, Capital P5, 000,000

Assume that Sena Thor borrowed cash of P2, 000,000 from the bank for use in the
business. The accounting equation will change both sides.

Assets = Liabilities + Equity

Cash P7, 000,000 P2, 000,000 + P5, 000,000

Another illustrations:
If the assets are valued Php100, 000 and the owner’s equity at Php50, 000, how much
is the value of liabilities?

Solution:
A=L+E
100,000 = L + 50,000
L = 100,000 – 50,000
L = 50,000

The owner invest personal cash worth Php25, 000 in the business. What is the effect of
this transaction to the assets, liabilities and owner’s equity account?

Solution:
A=L+E
25,000 = 0 + E
E = 25,000

23
 Let us try this!

A. Using the accounting equation, compute for the missing financial statement amounts:
Company Assets = Liabilities + Equity
F P 300, 000 ________ P 250, 000
G _______ 450,000 350,000
H P900, 000 150,000 ________
I P1, 000,000 _________ 2/5
J __________ 20% or 800,000 __________

B. At the beginning of 2017, a proprietor’s assets are valued at Php 250, 000 and liabilities
are Php 150, 000. If the revenues and expenses for 2017 are Php 95, 000 and Php 55,
000 respectively and owner’s withdrawals are Php 40, 000, what is the owner’s equity
of the business at the end of year 2017?

Solution:

C. Total liabilities of Alberts Bakeshop amounts to P400, 000 which is 40% of the total
assets. How much is owner’s equity?
Solution:

D. Total liabilities amounts to P500, 000. Total owner’s equity is thrice the liabilities. How
much is the total assets?
Solution:

E. Total assets of XYZ Corp amounts to P1, 400,000 and owner has a 60% interest over it.
How much is its liabilities?
Solution:

24
 LESSON 5: ASSETS

At the end of this lesson, learner must be able to:

 Define what are assets
 Identify current and non-current assets
 Give examples of assets

ASSETS

Assets are defined as “resources controlled by the business as a result of past

transactions and events and from which future economic benefits are expected to flow
to the business”.

Assets are being used by the business in its operation and are expected to benefit the
business over a number of years. For example, the school’s assets to name a few, are:
land, building, cash, furniture & fixtures such as tables, chairs, whiteboards, filing
cabinets, ceiling fans, air-conditioners, equipment such as fax machine, telephones,
computers, printers etc. These will all give economic benefit to the school over a number
of years.

Economic benefit is the ability of the asset to produce future cash flows for the business
whether directly or indirectly. If you sold the computer of the school then it would give
additional cash for the school and that is an example of direct economic benefit.

If the school use their printers to print flyers for promotion, then, the printers of the
school are giving economic benefit to the school indirectly because it is use to create
another asset such as additional enrollees.

Assets are being classified into two (2) categories. Current Assets and Non-current
assets.

Current Assets – are easily converted into cash or usually consumed during the
accounting period which is usually one year.

a. Cash and Cash equivalents

A.1 Cash on hand – cash or money not yet deposited in the bank. May include petty
cash.

A.2 Cash in bank – money deposited in the bank

25
 A.3 Cash equivalents – are short term investments that are readily convertible to known
amounts of cash which are subject to an insignificant risk to changes in value.

b. Trading securities or Marketable securities – company securities, usually stocks that

are sold for cash. Held only for a short span of time.

c. Trade and other receivables

C.1 Notes receivable – claims of the business evidenced by a note.

C.2 Accounts receivable – claims of business from customers for sales made or services
rendered on account.

C.3 Interest receivable – interest earned by the business on an interest-bearing note, not
yet collected.

C.4 Advances to employees – certain amount of money loaned to employees payable in

cash but most of the time through salary deductions.

C.5 Accrued income - income already earned but not yet received.

d. Inventories / merchandise inventories – goods unsold at the end of the accounting

period or on hand at the beginning of the year.

e. Prepaid expense – are expenses paid in advance or items that are bought which will be
used during the accounting period. This includes office supplies.

Non-Current assets

a. Long-term Investments
b. Property, plant and equipment – permanent in nature, possess physical existence, not
for sale, intended for use in the operation
c. Furniture & fixtures – term used to include tables, chairs, and counters, cabinets and
other pieces of furniture used in the business.
d. Land
e. Building
f. Machineries
g. Intangible assets
h. Other non-current assets

26
 There are also contra-assets accounts that decreases the value of a certain asset.

Allowance for Doubtful Accounts – this is a provision for accounts that may not be
collected by the business from its customers or clients in the future. This is to be
deducted from the accounts receivable.

Accumulated depreciation – is another contra-asset account. It is a deduction from a

particular fixed asset account. Property, plant, equipment, machineries, and building
have their own depreciation accounts, all these assets are depreciating except for land
asset which appreciates.

The normal side of assets is the debit side. Meaning if there is an increase on any of
the asset of the business an automatic debit for that asset should be recorded and an
equivalent credit with the appropriate account should be recorded.

Example: Allan Dimo invested cash worth P200, 000 to his barber shop.

The asset of the company was increased, and it is the cash of the company that increased.
The entry for this is

Cash (ASSET) P200, 000

Dimo, Capital 200,000
To record investment by Allan

Points to remember:

International Accounting Standards 1. One must classify an asset when;

1. Expected to be realized (sold, liquidated) in, or is intended for sale or consumption in

the entity’s normal operating cycle. (Normal operating cycle of a business is one
accounting period which is normally twelve months)
2. Held primarily for the purpose of being traded
3. Expected to be realized within twelve months of the balance sheet date
4. Cash or a cash equivalent unless it is restricted from being exchanged or used to settle
a liability for at least twelve months after the balance sheet date.

27
Let us try this!

Classify the following assets whether they are current asset or non-current asset.

Items Current Non-Current

Cash on hand
Building
Photocopy machines
Paper clips
Office Desk
Cash in bank
Merchandise inventory
Prepaid interest
Petty cash fund
Accounts Receivable
Notes Receivable
Supplies
Land
Backhoe
Prepaid insurance

B. Explain based on your own understanding the difference between current assets and
non-current assets.

C. Compute for the following:

How much is the total current assets?

Land P 1,000,000
Cash 500, 000
Three-month treasury bill 80,000
Goods unsold 20,000
Unused Supplies 25,000
Building 800,000
Office Tables & Chairs 10,000
Three-year Treasury bill 90,000
Total Current Assets ____________

28
 LESSON 6: LIABILITIE S AND OWNER’S
EQUITY

At the end of this lesson, learner must be able to:

 Define what are liabilities and owner’s equity
 Identify current and non-current liabilities
 Give examples of liabilities

Liabilities

“Present obligations of an entity arising from past transactions or events, the settlement
of which is expected to result in an outflow from the entity of resources embodying
economic benefits”
Liabilities are also classified as current and noncurrent. Philippines Accounting
Standards 1, paragraph 69, provides that an entity shall classify a liability as current
when:
1. The entity expects to settle the liability within the entity’s normal operating cycle.
2. The business holds the liability primarily for the purpose of trading.
3. The liability is due to be settled within twelve months after the balance sheet date.
4. The business does not have an unconditional right to defer settlement of the liability for
at least twelve months after the balance sheet date.
Current liabilities are obligations or debts of the business which will be paid within
the normal operating cycle of the business which is usually within twelve months by
means of payment using current assets or a creation of another current liability.
Examples of current liabilities are
Accounts Payable – current liability. It is an obligation that may have arise from
purchase of goods, supplies, furniture, or equipment for the business or if the business
availed services on account.
Notes Payable – it is classified as current liability if the note is payable within one year
if not, then it should be classified as noncurrent liability.
Interest Payable – an interest due to an interest bearing note. It is also called as accrued
interest expense.
Salaries Payable – are salaries not yet paid by the company to its employees.

29
Unearned income – these are advance collection of the business before goods are
delivered of before any service is rendered.
Utilities Payable - obligations of the business to utility companies such as MERALCO,
Maynilad, Manila Water for utilities used by the company. These includes water,
electricity, telephone bills
Withholding taxes payable – these are taxes withheld by the business from the salaries
of the employees which should be remitted to the BIR.

NON-CURRENT LIABILITIES
Mortgage payable – long-term liability of a company that may refer to a secured debt.
The liability of the business is said to be secured because there is a collateral for the
debt. The collateral would be any real estate property of the company.
Bonds Payable – these obligations are usually long-term in nature. Corporations
usually issue bonds when lending money from people aside from its shareholders.
Bonds bears interest most of the time.

OWNER’S EQUITY OR CAPITAL

Capital - It is the residual right or interest of the owner in the business net assets. It is
the difference between the assets and liabilities of the business. It also represents the
original investment and is increased whenever there is an additional investments made
by the owner. If the business profits, the capital would also increase otherwise if there
is a loss.
Owner’s drawing – whenever the owner withdraws cash or other items from the
business, such withdrawal should be charged in this account. This account is temporary
account for temporary withdrawals being made by the owner. This later on is to be
closed to capital account.
Income and Expense Summary – temporary account opened at the end of the
accounting period to absorb income and expense accounts before finally closing it to
capital.

The three accounts that were discussed namely; Assets, Liabilities and Owner’s equity
form part of the Statement of Financial position or Balance Sheet.

30
 Let us try this!
Classify the following liabilities into current and noncurrent liabilities:
Current Non-current
1. Accounts Payable
2. Interest Payable
3. Unearned Commission
4. Bonds Payable
5. Notes Payable due in 6 months
6. Mortgage payable
7. Notes Payable due in 2 years
8. Withholding taxes payable
9. SSS premium payable
10. Phil health premium payable
11. Utilities payable
12. Unearned interest income

Compute for the owner’s capital.

Tina, Pina and Gina decided to put up their own business. Tina invested cash worth 500,
000 to the business, Pina invested an equipment worth 350, 000 while Gina invested a
car to be used as a business service. The car is worth 800, 000. After a month the three
loaned from a bank 200, 000 as an additional investment for their business. Gina
withdrew 10,000 from the capital. 80,000 and 35,000 were the income and expense
respectively of the company during the year.
Solution: (You may use the back sheet of the paper)
Compute for Current Liabilities:
Mortgage payable P 500, 000
Salaries Payable 100,000
Interest Payable 15,500
Deferred Income 22,500
Utilities Payable 25,000
Bonds Payable 12,500
Accounts Payable 600,000

Solution:

31
 LESSON 7: INCOME STATEMENT

At the end of this lesson, learner will be able to:

 Classify income and expenses as basic elements of accounting
 Identify sources of income
 Prepare a single-step income statement

Income Statement
Income statement will show the financial performance of a business. One indicator that
will show us whether a business has performed positively for a certain period is the level
or amount of income earned for that specific period. How does a company earn? We
have mentioned assets before this lesson, through effective and efficient utilization of
its resources a business could earn money with a given period of time.
Income statement is one of the financial statements that we are going prepare. The
accounts involve and are included in the income statement are: Revenue and Expense
accounts.

Sources of Income/ Revenue for Business:

Revenue represents the inflow of cash to the business.
If the business is involve in merchandising or trading, where there is buying and selling,
the source of income for that business is from Sale of merchandise to customers. The
income from such sales would be reflected to income statement. Such account would be
called as “Sales”. If ever there are returned goods or discounts, there will be accounts
for that; we call it Sales returns and allowances and Sales Discount. These accounts
are to be deducted to Sales revenue to arrive at net sales. Sales is the revenue title being
used by manufacturing and merchandising industries.
But what if your business is a service industry? Then you would not expect to see the
term “sales” in your income statement but rather “Service fee” or “Professional fee”
or simple “Income” from services.
If one owns a dental clinic, one must set-up among other terms; “service fee”, “dental
fee” or “service income” account. If you are a lawyer and you have rendered your
service to a client, you may use “Legal fees” and use it in your income statement.

32
Expense
Expense represents the outflow of cash or any other assets from the business. The
business consume or use up its assets as necessity in its operation.
Another basic element of accounting that is included in your Income statement is the
expense account. These expenses are to be deducted to the total income of the company
to arrive at the net income.
There are many expenses to be paid by the business during its operations. To wit:
Salaries expense – expense paid by the company to its employees or workers for the
service rendered to the company. These includes salary, wages, 13th month pay and
other benefits of an employee or worker.
Utilities expense – utilities necessary for the operation of the company such as water,
electricity and telecommunication.
Supplies expense – office supplies used
Insurance expense – companies are paying premium for several insurances, perhaps
for health insurance of its employees. Insurance expense will represent the expired
portion of the insurance premium.
Depreciation expense – Some portions of the assets of company are being charged to
expense every year this is because of depreciation. Depreciation happens due to wear
and tear of an asset or sometimes because of obsolescence of the asset. Every asset
depreciates except for Land which appreciates.
Bad Debts – if some portion of the receivable of the company are estimated to be
uncollectible this expense account would be the catch basin for uncollectible receivables
which will then be expensed for the period.
Interest expense – the amount of money being charged for borrowed money or cash.
Taxes and licenses – the expenses being paid by the business to government, such as
VAT, income taxes, licenses and fees, Mayor’s Permit and others.

There are a lot of expenses being shouldered by business but are necessary in the
operation of his/her/their business. If the business is a manufacturing company – there
is Cost of goods sold. These are other expenses: Repairs and maintenance, salesman
salaries, cost of sales, rent expense, delivery expense, advertising expense and many
more.

33
The Single-step Income Statement
The Income statement is dated for a certain period. It may cover one whole year, one
month, or a quarter regardless of the year when the business started.
Under single-step Income statement you must group all income accounts and then group
all expenses.
The heading of the Income statement is placed at the center of the statement. The name
of the company or owner should be written of the first line, the name “Income
statement” should be next and for third line, the period covered.

Example:

Bob Uy Travel and Tours

Income Statement
For the month ended August 30, 2017

Service Income P150, 000

Other Income 50,000
Total Income P200,000

Less Expense:
Rent Expense P 10, 000
Salaries Expense 10, 000
Repair Expense 5, 000
Utilities Expense 12, 000
Supplies Expense 2, 000 (39,000)
Net Income P 161,000

34
 Let us try this!

Place a check mark opposite the account title where they should be reported:
Income Statement Balance
Sheet
1. Utilities expense
2. Unused supplies
3. Service Income
4. Interest receivable
5. Professional fees
6. Bad Debts
7. Unearned interest income
8. Accrued Interest income
9. Prepaid interest
10. Supplies Inventory
11. SSS premium expense
12. Withholding taxes payable
13. Repairs and maintenance
14. Allowance for bad debts
15. Cash in Bank
16. Accounts Payable
17. Salaries payable
18. Unexpired insurance

Prepare a single-step income statement for the following:

1. ABC CORPORATION, for the month ended August 30, 2017
Service Income 200,000, depreciation expense 20,000, bad debts 5,000, utilities
expense 10,000, rent expense 5,000, interest expense 4,500. Miscellaneous 8,000.
2. Venomancer Co. for the period year ended December 31, 2017, Service income
100,000, taxes and licenses 20,000, salaries expense 35,000, rent expense 5,000, utilities
expense 5,200, and supplies expense 800, other income 10,000.
3. Vina & Tog Auditing Services for the six-month period ended August 30, 2017, salary
expense 3,000, Rent expense 1,350, supplies expense 5,700, taxes and licenses 2,550,
utilities expense 6,750, Auditing fee 50, 000.

Compute for the missing amounts:

1. Service Income 40,000
Other Income 10,000
Total Expense ?
Net Income 20,000

35
2. Service Income ?
Other Income 20,000
Total expense 10,000
Net Income 30,000

3. Service Income 150,000

Less Expense:
Rent Expense ?
Supplies Expense 4,000
Taxes and licenses 10,000
Salaries expense 50,000
Utilities expense 12,500
Net Income 67,500

What is an Income Statement?

What financial statement do you report income and expenses?

36
 LESSON 8: EFFECTS OF VARIOUS
TRANSACTIONS IN THE ACCOUNTING
EQUATION

At the end of this lesson, learner must be able to:

 Solve exercises on accounting principles as applied in various cases
 Illustrate the accounting equation

Now that we have discussed the five basic accounting elements; assets, liabilities,
owner’s equity, revenue and expense, the next step is for you to apply the accounting
equation on varied transactions involving the aforementioned accounts.
The accounting equation, which is Assets = Liabilities + Equity, has two sides. One for
the debit side which is on the left side and the other is the credit side which is on the
right side.
Assets = Liabilities + Owner’s Equity

Debit Side Credit Side

The normal side for Assets is the debit side. It is said to be normal for assets because
the usual balance for assets should be seen on the Debit side. Also, every increase in
the assets of the business has a corresponding debit entry for such asset.
While the normal side for Liabilities and Owner’s equity is the Credit side. Meaning,
one should normally see the balances for this account on the credit side. And, any
increase in the liabilities of the company would mean an additional credit entry. If there
is also an increase in the owner’s equity it also means an additional credit entry.

The rule for debit and credit in summary:

Debit Credit
1. Increase in Assets (+ Asset) 1. Decrease in Assets ( - Asset)
2. Decrease in Liabilities (- Liabilities) 2. Increase in Liabilities ( + Liab)
3. If company incurs loss 3. If company earned profit
4. Expenses 4. Additional Investment

37
 Assets Liabilities
Debit to increase Credit to decrease Debit to decrease Credit to increase
(+) (-) (-) (+)

Owner’s Equity
Debit to decrease Credit to increase
(-) (+)

Remember that under double entry bookkeeping, for every debit there should be a
corresponding credit. You must always maintain the equilibrium of two sides - debit
and credit sides.

Illustration:

Assets as initial investment of the owner

June 1 Allan Dimo opened a restaurant by investing cash of P 100, 000. He also
invested his car with a value of 500, 000.
Analysis: The assets of the business will increase, initially, in the form of Cash, P100,
000 and car, 500, 000 with a corresponding increase in owner’s equity in the amount of
P 600, 000.
Assets = Liabilities + Owner’s Equity Explanation/Accounts
+ 100,000 Initial Investment
+ 500, 000 0 + 600, 000 Accounts involved:
cash, cars and owner’s
equity
Bal. 600,000 0 600, 000

38
Asset purchased on account
June 10 Allan Dimo purchased equipment worth 50, 000 on account.
Analysis: The business purchased an equipment, this would be an increase in the assets
of the business in the amount of 50, 000. The equipment was actually bought on account,
therefore it is also an increase of P 50, 000 to the liabilities of the business
Assets = Liabilities + Owner’s Equity Explanation/Accounts
+ 50,000 + 50, 000 0 Bought equipment on
account. Equipment
and Accounts Payable
Bal. 50,000 50, 000 0

Asset purchased for cash

June 11 Bought an additional equipment for cash. The equipment is worth
P100,000
Analysis: There is an increase in asset in the amount of 100,000 for the additional
equipment. And because it was bought for cash the asset of the business will also
decrease in the amount of 100, 000.
Assets = Liabilities + Owner’s Equity Explanation/Accounts
+ 100,000 0 Bought equipment on
cash. Equipment and
-100,000 Cash
Bal. 0 0 0

Cash borrowed from bank

June 20 Borrowed P100, 000 from bank for use in the business
Analysis: Increase in cash – asset
Increase in accounts payable- liability

Assets = Liabilities + Owner’s Equity Explanation/Accounts

+ 100,000 +100,000 0 Borrowed cash for
business. Cash and
Accounts payable
Bal. 100,000 100,000 0

39
Cash withdrawn by owner

June 22 Allan Dimo made a cash withdrawal for P 10, 000 for personal use.
Analysis: The asset of the business will decrease in the form of cash, P
10,000 with corresponding decrease in the owner’s equity since owner
recovered part of his investment by withdrawing cash.

Assets = Liabilities + Owner’s Equity Explanation/Accounts

-10,000 0 -10,000 Cash withdrawal from
capital. Cash, Dimo,
Drawing.
Bal. (10,000) 0 (10,000)

Let us summarize all the transactions and see whether the total balance of the asset is
still equal to the sum of liabilities and equity accounts.

Assets = Liabilities + Owner’s Equity

June 1 P 100,000 P 600,000
500,000
June 10 50,000 50,000
June 11 100,000
(100,000)
June 20 100,000 100,000
June 22 (10,000) (10,000)
Balance P 740,000 = 150,000 + 590,000
740, 000 740,000

Now, let us have transactions that involves revenue and expenses.

July 2 Received cash for catering services rendered. P 80,000

Analysis: Increase in the assets of the business in the form of cash

And increase in owner’s equity for income.

Assets = Liabilities + Owner’s Equity Explanation/Accounts

+ 80,000 0 + 80,000 Cash received for
service rendered.
Bal. 80,000 0 80,000

40
July 12 Cash was paid for the utilities. Electricity expense P5, 000, water bill
2,000 and telephone 3,000

Analysis: Decrease in asset in the form of Cash, 10,000

Decrease in owner’s equity.

Assets = Liabilities + Owner’s Equity Explanation/Accounts

-10,000 0 -5,000 Payment of utilities.
-2,000 Cash and Utilities
-3,000 expense
Bal. (10,000) 0 (10,000)

Revenue rendered on account

July 20 Sue Sy hired your service for her debut on July 23, 2017 and promised
to pay P 40,000 on September 1, 2017

Analysis: Increase in assets in the form of Accounts receivable, P 40,000

Increase in owner’s equity for income

Assets = Liabilities + Owner’s Equity Explanation/Accounts

+ 40, 000 0 + 40,000 Rendered service on
account. Accounts
Receivable, Service
Income.
Bal. 40,000 0 40,000

41
 Let us try this!

1. Enumerate the rule for debit and credit

2. Make a table and analyze the following transactions indicating the increase or decrease
in the following accounts: Assets, Liabilities and owner’s equity.

Anne Yare established a coffee shop near Taft Avenue – Vito Cruz. The business started
operations on January 2017. Anne Yare invested cash of P 20, 000 and equipment of P
48, 000. The following are the additional transactions for January:

Jan 6 Bought furniture and fixtures worth P 10,000 on account

7 Bought a coffee maker for P 20,000. Terms: 50% down, balance on
account
8 Anne withdrew P2, 000 cash for personal use
10 Bought supplies costing P 2,000 and paid cash
15 The account of January 6 is due, Anne paid the account from her personal
cash
30 The account of January 7 is due. Issued a 60-day promissory note for
this.

Solution:

3. Make another table. Analyze also the following transactions, this time, with specific
account titles. Use the following accounts for assets: Cash, Supplies, Prepaid rent,
Furniture and Fixtures, Equipment, Leasehold Improvement. And for liabilities: Notes
Payable. Sy, Capital for the owner’s equity.

Sue Sy, a fresh graduate student who was working as a mere employee in a company in
Makati, decided to become an entrepreneur and put up her own internet shop. The
following are the transactions for the month of June:

June 1 Sue Sy started an internet shop and named it “Playmate.com” by

investing P 350,000 cash.
5 Sue Sy hired two workers to assist her in her shop
10 Two month rent deposit was paid in cash, P 10,000
42
 15 Paid P 15,000 for building materials to fix the shop, P 8,000 for furniture,
P 45,000 for one unit of air con and two units of electric fans.
20 Purchased supplies for cash, P 1,500
25 The shop was ready for the installation of the computer units. Angel
purchased 12 units of computer hardware from Dell. She paid 50% in
cash P125, 000 and a note for the balance payable in 12 monthly
installments starting July 1.
Solution:

4. Answer the following questions:

A. Bong Go medical clinic has assets equal to P 6, 150,000 and liabilities equal
to P 2, 650,000. Before the year ended cash was borrowed from the bank
amounting to P 1,500,000 half of which was used to buy equipment and the
other half to pay for the liabilities which were past due. What is the total
equity at the year-end?

Solution:

B. At the beginning of the year, Mildred’s Lechon’s assets are P 2,200,000 and
its equity is P 1,150,000. During the year, assets increase by P 700,000 and
liabilities increase by P 300,000. What is the equity at the end of the year?

Solution:

C. At the beginning of the year, Bhor Logs Co. liabilities equal P 860,000.
During the year assets increase by P 800,000, and at the end of the year assets

43
 are equal to P 2,180,000. Liabilities decrease by P100, 000 during the year.
What are the beginning and the ending amounts of equity?

Solution:

Below are list of transactions. Indicate which accounting elements of the

business are affected by placing the amount and the (+) increase or (-) decrease
sign or NA, if accounts are not affected, in the respective columns. Jack is the
owner-manager of the business. Unless otherwise stated, these are all business
transactions.

Transactions Assets Liabilities Owner’s equity

Jack Invested P
500,000 in a
restaurant and
bought a car worth
500,000 for his
personal use.
He hired a cook, a
cashier and a
server. Salary on
commission basis.
He bought
cooking
equipment and
paid P300,000
He bought office
equipment
P150,000 on
account
He took home P5,
000 for his own
use.

44
 LESSON 9: JOURNALIZI NG

At the end of this lesson, learner must be able to:

 know the complete accounting cycle
 enumerate the accounting cycle
 understand the use of Chart of Accounts
 record accounting transactions
 apply to various transactions the rules for debit and credit

The Accounting cycle

The following steps are followed in the accounting cycle:

Gather the
Analyze and Record Post to Ledger
documents

Prepare a Worksheet
Prepare a Trial Journalize and Post
for adjustments and
Balance the Adjusting entries
Financial Statements

Prepare and adjusted Prepare Financial Journalize and post

Trial Balance Statements the Closing entries

Prepare a post Journalize and post

closing Trial Balance the reversing entries

45
The first step in accounting is not recording the transaction immediately but the
gathering of necessary documents. It is a must for every bookkeeper or accountant to
keep safe all documents because he/she cannot just record transactions in the books of
accounts without basis.

After gathering the document needed, one must analyze whether the transaction is an
accounting transaction. If a transaction does not hold any economic activity to the
business one must not record or journalize it.

For example: An owner hires two employees for his restaurant.

This transaction cannot be journalized.

This is not an accounting transaction for it did not redound any economic benefit to the
company or it did not even triggered an outflow of economic resources from the
company.

Therefore, bookkeeping or journalization requires critical and analytical skills.

Journalization is the process of recording accounting transactions in the journal or

books of account of the business.

The next step after journalization is posting. Posting to the ledger every transactions
that have been journalized is simple that you are only going to transfer information
recorded from the journal to the ledger. After that, we are going to take all open accounts
from the ledger and prepare an unadjusted trial balance. Not all transactions have
been recorded, there are still accounts to be adjusted and there are nominal accounts that
have to be closed. And for us to do this, we need to prepare adjusting entries. These
adjusting entries, which will also be discussed in detail in the preceding lesson of this
book, are needed to update the accounts that were left open.

Remember that we must not proceed to the next accounting period if our financial
statements still bears erroneous entries and transactions. After the adjusting entries we
are now going to prepare the adjusted trial balance. From there, after we have taken
into account all necessary adjustments we can now start preparing our financial
statements such as: Income Statement, Balance Sheet, Statement of Cash Flows and
Statement of Changes in Owner’s Equity.

We are closing the books every end of the accounting period. Closing the books refers
to the process where we are going to bring the income and expense accounts to zero
balance. The income and expense accounts are nominal accounts. These accounts
have to be closed at the end of the accounting period. The reason for doing this is to
determine and distinguish the income and expense for each accounting period.

Later on the accrual basis and cash basis as a method of accounting will be discussed.
Because of these accounting methods some adjustments were made to reflect on the
46
balances of some balance sheet accounts. There are transactions that should be included
in the accounting period but were recorded only at the end of the accounting period.
These were adjustments made. However, some of these adjusting entries have to be
reversed at the beginning of the next accounting period. That is why we have reversing
entries at the end of the accounting cycle.

Chart of Accounts
Chart of Accounts will be the guide of the bookkeeper in recording business
transactions. These are literally chart of account titles that the accountant or bookkeeper
must use. If there is a chart of account, which is available most of time. The bookkeeper
cannot use any other account titles when recording or journalizing. The account titles
under the chart are organized in such a way that assets, liabilities, owner’s equity,
income and expense accounts have their own series and are sorted accordingly.

Chart of Accounts- Service Industry

100 Series – Assets 300 Series – Owner’s Equity

Current Assets 301 – A. Dimo, Capital
101 – Cash on hand 302 – A. Dimo, Drawing
102 – Cash in bank 303 – Income and Expense Summary
103 – Accounts Receivable
103.1 - Allowance for doubtful accounts Income Statement Accounts
104 – Office supplies
105 – Prepaid Insurance 400 Series – Income
401 – Service Income
Noncurrent Assets 402 – Interest Income
106 – Land 403 – Rent Income
107 – Buildings
107.1 – Accumulated Depreciation –
500 Series – Expense
Buildings
108 – Furniture & Fixtures 501 – Rent Expense
108.1 – Office Equipment 502 – Utilities Expense
503 – Salaries Expense
200 Series- Liabilities 504 – Taxes and Licenses
Current Liabilities 505 – Supplies expense
201 – Accounts Payable 506 – Repairs Expense
202 – Notes Payable 507 – Depreciation Expense
508 – Bad debt expense
Long-term Liabilities
210 – Long-term notes Payable
211 – Mortgage Payable

47
This is an example of a chart of accounts. If the company of Allan Dimo has this chart
of accounts then the company cannot use any account titles when recording transactions
aside from the accounts listed above.

Same goes for other businesses, if they have Chart of Accounts they must use the
accounts that are listed in there.

Journalization
Now that we have discussed the accounting cycle and chart of accounts, we can now
proceed to the “bookkeeping” process. Below is an illustration of a portion of a journal.
Each part will be explained.

Illustration: On June 10, 2017 Allan Dimo initially invested P300, 000 to his
restaurant business.

Date Explanation F Debit Credit

2017
June 10 Cash on hand P 300,000

A.Dimo, Capital P 300,000

To record initial investment

Enter year and month on the first date column. And the day on the
nd
2 date column.

The debit and credit entry is written in the “Explanation

column” The debit is written in the first line. The credit entry is written immediately
on the next line after the debit entry, take note that the credit entry should be indented
about half-inch when written.

On the third line is the brief explanation of the transaction. The explanation should be
indented too.

The amounts are entered in the debit and credit column.

48
Let us try this!

Enumerate the accounting cycle.

Prepare journal entries for the transactions enumerated below using the given Chart of
Accounts:

Account Title

Cash On hand Professional Fee

Accounts Receivable Taxes and Licenses
Furniture and Fixtures Rent Expense
Office Equipment Salaries Expense
Accounts Payable
Goo, Capital
Goo, Drawing

Kim Bong Goo established his Spa Skin Clinic on July 1, 2017. His transactions for
the month of July are as follows:

July 1 – K.Goo invested P 300,000 in a skin clinic

2 – Paid taxes and licenses to the City government of Pasay, P 3,500
4 – Paid rent of P 5,000
7 – Bought office computer P 20,000, cash
8 – Bought furniture on account P 5,000
10 – Rendered service for cash, P 5,000
11 – Rendered service on account, P 7,000
15 – Paid salaries, P 10, 000
20 – Kim Bong Goo made an additional investment of P 50,000
24 – Collection of account of July 11 transaction
28 – Paid account of July 8
30 – Paid salaries, P 10,000

49
Analyze the following transactions and record using these account titles: Cash,
Accounts Receivable, Office Supplies, Furniture and Fixtures, Office
equipment,Car,Notes Payable, Utilities Payable, Don Facundo,Capital, Don Facundo,
Drawings, Professional Fees, Rent expense, Salaries expense, Supplies Expense,
Utilities expense.

The following are the transactions of Don Facundo Accounting Firm for the month of
August:
1 Facundo invested 250,000 cash and 100,000 office equipment
2 Signed a lease contract for a monthly rental of P 10,000
2 Bought furniture & fixtures for P10, 000 and paid for cash
2 Bought office supplies worth P 5,000
4 Received P 50,000 for feasibility conducted for a client
14 Paid salary of one secretary and two accounting staffs for the first half of
August, P 30,000
16 Billed a client, Miniwide, for audit work rendered, P 50,000
17 Nena’s Foodhaus was billed P20, 000 for accounting service rendered.
20 Miniwide paid half of its account
21 Bought a car for business service, P 600,000. Gave a down payment of
50% and issued a note for the balance
22 Nena’s Foodhaus paid P 10,000 for its account
23 Facundo took P10, 000 for personal use.
25 Paid rent and salaries
30 Received utility bills, P 5,000
31 Supplies worth 5,000 were used up for the month.

50
 LESSON 10: POSTING T O LEDGER

At the end of this lesson, learners must be able to:

 Analyze transactions with the use of debit and credit using T-accounts
 Post the journal entries in the general ledger

The “T-account”

Let us recall our previous lesson regarding the rules for debit and the credit.

Assets Liabilities
Debit to increase Credit to decrease Debit to decrease Credit to increase
(+) (-) (-) (+)

Owner’s Equity
Debit to decrease Credit to increase
(-) (+)

Remember that under double entry bookkeeping, for every debit there should be a
corresponding credit. You must always maintain the equilibrium of two sides - debit
and credit sides.
Can you notice something from each account? Do these accounting equations look like
forming letter “T”? A T-account is used to easily analyze the effect of each
transactions in the assets, liabilities, owner’s equity, revenue and expenses. The T-
account has two sides, one for recording an increase in an account and the other is for
recording the decrease.
When we journalize transactions we write account titles in a pro-forma entry. Under T-
account, we are not going to need any pro-forma entries. T-account is the simplest way
to analyze every transaction.

51
Sample:

Cash
Debit side Credit side
increase in the amount of cash decrease in the amount of cash
(+) (-)

For a sample transaction:

On June 20, 2017 Mang Ben invested cash to his poultry business, P 50,000.

Instead of making a journal entry, one may simply use the “T-account” for faster
analysis. In this case you must have two T-Accounts. One for Cash and the other for
Capital account.

Cash Ben. Capital

June 20 P 50,000 June 20 P 50,000

June 21 Received cash from chicken eggs sold 10,000

Cash Sales
June 20 P 50,000 June 21 P 10,000
21 10,000
Bal P 60,000

Using T-account one can easily see the balances for each account every after each
transaction. However this is just a preliminary tool for analysis of transactions. In actual
practice there is a formal book of accounts being used containing not only the account
title, date and amount but also the following:

page reference,
account number and
balance of each accounts.

52
All accounts are compiled in one book called general ledger wherein a separate page
is maintained for each account. A cash ledger is illustrated below.

CASH ACCOUNT NO. 101

Date Particular F Debit Date Particulars F Credit

August 1 J1 50,000 August 7 J1 45,000

3 J1 100,000 18 J1 5,000
21 J2 15,000 20 J2 55,000
30 J2 8,000 22 J2 1,500
Bal 66,500

Notice that there is an account number indicated for the cash ledger. This account
number is the assigned number for “cash” in the chart of accounts. Next, notice that
using this format there are still two sides, one for debit and the other is the credit side.
Actually the general ledger is like a summary of all transactions for one account. What
you are seeing above is the Cash ledger and all the transactions recorded in the journal
are now summarized or compiled in one ledger. The “F” stands for folio. It is the source
of the transaction.

Like in our example “J1” and “J2” is written under folio column. It only means that
transactions for August 1, 3 7, and 18 can be found in Journal book/page number 1.
While the transactions involving cash for August 20, 21, 22 and 30 can be found from
Journal book/page number 2.

The general ledger is also known as the book of final entry. Remember that while a
journal provides complete details for every transaction in sequence according to dates;
a ledger on the other hand summarizes all changes that took place for one particular
account. If a business has 30 different account titles then the business will be needing
30 ledgers to be compiled in the general ledger.

If you are transferring the debits and credits from journal to the ledger, you call that
process as posting.

53
Illustration:

General Journal Journal 1

Date Particulars F Debit Credit

2009 Cash 101 300,000
September 1 Dimo, Capital 301 300,000
To record Initial
Investment

GENERAL LEDGER
CASH
Date Particular F Debit Date Particulars F Credit
2009 J1 300,000
Sept 1

Recall that the first step we have done is we journalized the accounting transactions.
After we record the transaction we now transfer these recorded transactions from the
journal to the ledger. Now we are done with the second step of accounting cycle which
is posting.

54
Let us try this!

A.

1. Prepare journal entries for the transactions enumerated below using the given
Chart of Accounts:

Account Title

Cash On hand Professional Fee

Accounts Receivable Taxes and Licenses
Furniture and Fixtures Rent Expense
Office Equipment Salaries Expense
Accounts Payable
Rosel, Capital
Rosel, Drawing

2. Jack Rosel established his Diagnostic clinic on August 1, 2017. His transactions
for the month of July are as follows:

July 1 – Jack invested P 500,000 in his clinic

2 – Paid taxes and licenses to the City government of Pasay, P 3,500
4 – Paid rent of P 5,000
7 – Bought office computer P 20,000, cash
8 – Bought furniture on account P 5,000
10 – Rendered service for cash, P 5,000
11 – Rendered service on account, P 7,000
15 – Paid salaries, P 10, 000
20 – Jack Rosel made an additional investment of P 100,000
24 – Collection of account of July 11 transaction
28 – Paid account of July 8
30 – Paid salaries, P 10,000

Required:
a. Make a T-account
b. Post the journal entries to the ledger

55
B.

1. Analyze the following transactions and record using these account titles: Cash,
Accounts Receivable, Office Supplies, Furniture and Fixtures, Office
equipment,Car,Notes Payable, Utilities Payable, Don Quixote, Capital, Don
Quixote, Drawings, Professional Fees, Rent expense, Salaries expense, Supplies
Expense, Utilities expense.
2. Record also these transactions using T-account
3. Make a simultaneous postings in the general ledger.

The following are the transactions of Don Quixote Accounting Firm for the month of
August:
1 Quixote invested 150,000 cash and 10,000 office equipment
2 Signed a lease contract for a monthly rental of P 20,000
2 Bought furniture & fixtures for P20, 000 and paid for cash
2 Bought office supplies worth P 15,000
4 Received P 30,000 for feasibility conducted for a client
14 Paid salary of one secretary and two accounting staffs for the first half of
August, P 20,000
16 Billed a client, Ultrawide, for service rendered, P 40,000
17 Lita’s Foodhaus was billed P20, 000 for accounting service rendered.
20 Ultrawide paid half of its account
21 Bought a car for business service, P 600,000. Gave a down payment of
50% and issued a note for the balance
22 Lita’s Foodhaus paid P 10,000 for its account
23 Quixote took P10, 000 for personal use.
25 Paid rent and salaries
30 Received utility bills, P 5,000
31 Supplies worth 5,000 were used up for the month

56
 LESSON 11: TRIAL BAL ANCE

At the end of this lesson, learner must be able to

 Define a Trial Balance
 Prepare a trial balance and appreciate its use

Trial balance is an accounting report that lists the balances of each general ledger
account wherein total debits shall equal to total credits for a given period. The trial
balance is prepared after all the transactions for the period have been journalized and
posted to the general ledger.
How to prepare a trial balance:
a. Heading of trial balance should consist of:
 Name of the business
 Title of the report
 Date
b. It should appear in the following sequence : assets, liabilities, owner’s equity,
revenues, and expenses
Sue Sy Repair Services
Unadjusted Trial Balance
December 31, 2017

Account Title Debit Credit

Cash P7, 480,000
Account Receivables 3,400,000
Service Supplies 1,500,000
Furniture and Fixtures 3,000,000
Service Equipment 16,000,000
Account Payable P9,
000,000
Mortgage Payable 12,000,000
Sy, Capital 13,200,000
Sy, Drawing 7,000,000
Service Revenue 9,550,000
Rent Expense 1,500,000
Salaries Expense 3,500,000
Taxes and Licenses 370,000
TOTAL P43, 750,000 P43, 750,000

57
The above report is called unadjusted trial balance since adjustments are not yet
included. There are other types of trial balances namely adjusted trial balance
(adjustments are considered) and post-closing trial balance (prepared after closing
entries).
Take note that the trial balance only checks that the total debits are equal to total credits
and not a guaranteed proof of the accuracy of the ledgers. These are instances when
this happens:
a. Error of omission where a transaction was not recorded (no debit and credit)
b. When a transaction was recorded twice (both debit and credit are overstated by
the same amount)
c. When an account recorded instead of another account of the same classification
(the total debits would still the same but may construed as misclassification)

In double-entry accounting system, trial balance is one way of detection any

mathematical errors. However, when the total debits are not equal to total credit, then
this would be due to the following:
a. Transposition Error – happens when the two numbers are interchanged or
reversed when posting a transaction

Example:
Wrong amount: P7, 840,000
Correct amount: 7,480,000
Difference: 90,000

Note that the difference is divisible by 9.

b. Transplacement Error – happens when there is an error in placing a decimal

point

Example:
Wrong amount: P3, 400,000
Correct amount: P 340,000.00

58
Let us try this!

Exercise 1: Prepare a trial balance from the following information:

 Name of business: Bob Uy Janitorial Services, Inc.

 Period: March 31, 2017

Account Titles Amount

Cash on hand 20,000

Telephone Expense 5,000

Interest Payable 2,000

Withholding Taxes Payables 5,000

Accounts Payables 10,000

Furniture and Fixtures 50,000

Machinery and Equipment 50,000

Accounts Receivables 25,000

Mortgage Payable 15,000

Rent Income 15,000

Petty Cash Fund 7,000

Service Revenue 185,000

Salary Expense 40,000

Bob Uy, Capital 90,000

Utilities expense 15,000

Bob Uy, Drawings 5,000

Exercise 2: On January 1, 2017, Domingo Dimaunahan launched a My Doming’s

Laundry Shop. Upon examination of ledger balances as of December 31, 2017 below
contains the following error:
a. A debit of P75, 000 Laundry Machine was posted twice.
b. A credit to cash of P20,000 was erroneously posted as P2,000
c. A debit of P10,000 to Utilities Expense was charged as Salaries Expense
d. A credit of P40,000 to Accounts Payable was posted on the debit side
e. Cash receipt of P22,500 on laundry fee earned was not posted
f. Consultant’s Fees Expense of P50, 000 was posted twice.
59
 g. Footings for cash on the debit side was understated by P45,000
h. Supplies Used was copied in the trial balance on the wrong side.

Particulars Debit Credit

Depreciation Expense P 180,000
Laundry Machine 750,000
Accounts Payable P92, 500
Accounts Receivable 626,000
Cash 527,000
Laundry Fees Earned 1,344,000
Supplies Used 24,000
Accumulated Depreciation-Laundry Machine 80,000

Utilities Expense 870,000

Miscellaneous Expense 154,000
Rent Expense 936,800
Salaries Expense 348,000
Consultant’s Fees Expense 242,400
Furniture and Fixtures 707,000
Dimaunahan, Capital 3,496,200
Dimaunahan, Drawings 84,500
Notes Payable 159,000
Accumulated Depreciation- Furniture and Fixtures 100,000
Total P5, 425,700 P5, 203,200

Required:

a. Prepare a correct trial balance

b. Which of the above errors would not cause the trial balance to be out of balance?

60
 LESSON 12: ADJUSTIN G ENTRIES

At the end of this lesson, learner must be able to:

 Define adjusting entries and know their importance
 Define prepayments, deferrals, accrued expense, accrued income, bad debts,
depreciation expense
 Understand alternative methods in recording prepayments and deferrals
 Make the required journal entries for the adjustments.

Adjusting journal entries are accounting journal entries needed to convert the
accounting records to the accrual basis of accounting which is based on Accrual
Principle also known as Revenue Recognition Principle and the Expense Recognition
Principle.
Under the Revenue Recognition Principle, revenue is recognized when it is earned or
realized / realizable regardless of when the cash is collected. On the other hand, under
the Expense Recognition Principle or Matching Principle, expense is recognized as
incurred at the time service is received or used up regardless of when the cash is paid
and should be matched against income.
Reasons for making adjustments on trial balance prior to financial statements
preparation:
a. Part of income are already earned but not included in the trial balance
b. Part of expenses are already expired but not included in the trial balance
c. Part of assets should be expired or used up
d. Part of liabilities should be recognized as earned
e. Part of income reported are not yet earned
f. Part of expenses are not yet expired
Items that are usually adjusted:
a. Accrued Income
b. Accrued Expenses
c. Deferred or Unearned Income
d. Prepaid Expenses
e. Bad Debts or Doubtful Accounts
f. Depreciation Expenses

61
  ACCRUED INCOME AND EXPENSES
Accrued Income is income already earned but not yet received. It is classified as
receivable (asset). Some examples are accrued rental receivable and accrued interest
receivable.
Pro-forma Entry:

Income Receivable xx
Income xx
Recognition of income earned

Accrued Expenses are expenses already incurred but not yet paid. These are classified
as liabilities. Some examples are accrued salaries payable and accrued interest
payable.

Pro-forma Entry:

Expenses xx
Expenses Payable xx
To record unpaid expenses

Illustration 1: Assume that Healthy Clinic referred a patient for laboratory examination
to Maria Laboratory and for which it is entitled to a commission or referral fee of P500.
This amount was not yet collected as December 31, 2017, the end of its accounting
period.

Viewpoint of Healthy Clinic:

Dec 31, 2017 Referral Fee Receivable 500

Referral Fee Income 500
To adjust referrals due from MariaLaboratory

Viewpoint of Maria Laboratory:

Dec 31, 2017 Referral Fee Expense 500

Referral Fee Payable 500
To adjust referral fee due to Healthy Clinic

Illustration 2: On December 1, 2017, Alpha Company issued a 45-day note, 18% note
for a P100, and 000 cash loan received from Beta Finance. As of December 31, 2017,
30 days has lapsed. Required: Journal entries as of December 31, 2017

62
Viewpoint of Alpha Company:

Dec 31, 2017 Interest Expense 1,500

Interest Payable 1,500
To accrue interest for 30 days due to Beta Finance

Viewpoint of Beta Finance:

Dec 31, 2017 Interest Receivable 1,500

Interest Income 1,500
To accrue interest for 30 days due from Alpha Company

Computation: Get the period that has transpired from date of note to the end of
accounting period. (December 1, 2017 – December 31, 2017 = 30 days) Then apply
the I = PRT for computation of interest.

Interest = Principal x Rate x Time

1,500 = 100,000 x .18 x 30/360

Effect on the financial statements if the accrual has not been recognized:

Viewpoint of Alpha Company:

Affected Accounting Statement of Financial Statement of

Accounts Position Comprehensive Income
Current Liabilities Understated
Owner’s Equity Overstated
Expenses Understated
Net Income Overstated

Viewpoint of Beta Finance:

Affected Accounting Statement of Financial Statement of

Accounts Position Comprehensive Income
Current Assets Understated
Owner’s Equity Understated
Revenue Understated
Net Income Understated

63
 Illustration 3: ABC, Inc. has unpaid rent to Kim Bam Corp. amounting to P20, 000 at
the end of December 31, 2017.

Viewpoint of Kim Bam Corp.:

Dec 31, 2017 Rent Receivable 20,000

Rent Income 20,000
To adjust unpaid rent from ABC, Inc.

Viewpoint of ABC, Inc.:

Dec 31, 2017 Rent Expenses 20,000

Rent Payable 20,000
To adjust unpaid rent to Kim Bam Corp.

 DEFERRED INCOME – this refers to unearned income or pre-collected income. It is

income already received but not yet earned; therefore, it is a liability account. Some
examples are: unearned rental income and unearned interest income.

Two methods for the adjustment of deferred income:

a. Liability Method – used in recording the advance collections since it was

immediately credited to an unearned or deferred income account.

Pro-forma Entries:

Cash xx
Unearned Income xx
To record advanced collection of cash

Unearned Income xx
Income xx
To adjust the income or record the earned portion

b. Income Method – records advanced collection with a credit immediately to an

income account.

Pro-forma Entries:

Cash xx
Income xx
To record advanced collection of cash

Rent Income xx
Unearned Income xx
To adjust the unearned portion
64
Illustration: On September 1, 2017, DEF Corporation has received an advance
collection of rental for building for six months amounting to P60, 000.

Under Liability Method:

Journal Entries:

Sep 1, 2017 Cash on hand 60,000

Unearned Rent Income 60,000
To record advance collection for six months

Dec 31, 2017 Unearned Rent Income 40,000

Rent Income 40,000
To adjust the four months rent earned

Analysis:
Month Amount per month* Status as of December 31, 2017**
Sept 2017 10,000 Earned
Oct 2017 10,000 Earned
Nov 2017 10,000 Earned
Dec 2017 10,000 Earned
Jan 2018 10,000 Unearned
Feb 2018 10,000 Unearned

Notes:
*amount per month = total amount of collection / no. of terms
P10, 000 = P60, 000 / 6

**December 31, 2017 is the cut-off period or end of accounting period. This must be
considered when making any kind of adjustment.

The entries posted in T-accounts will appear as follows:

Cash on hand
Sept 1 60,000

Unearned Rent Income Rent Income

Dec 31 40,000 Sept 1 60,000 Dec 31 40,000

Balance P 20,000 Balance P 40,000

65
Under Income Method:

Journal Entries:

Sep 1, 2017 Cash on hand 60,000

Rent Income 60,000
To record advance collection for six months

Dec 31, 2017 Rent Income 20,000

Unearned Rent Income 20,000
To adjust the two months unearned rent

Analysis:
Month Amount per month* Status as of December 31, 2017**
Sept 2017 10,000 Earned
Oct 2017 10,000 Earned
Nov 2017 10,000 Earned
Dec 2017 10,000 Earned
Jan 2018 10,000 Unearned
Feb 2018 10,000 Unearned

Notes:
*amount per month = total amount of collection / no. of terms
P10, 000 = P60, 000 / 6

**December 31, 2017 is the cut-off period or end of accounting period. This must be
considered when making any kind of adjustment.

The entries posted in T-accounts will appear as follows:

Cash on hand
Sept 1 60,000

Unearned Rent Income Rent Income

Dec 31 20,000 Dec 31 20,000 Sept 1 60,000
Balance 20,000 Balance 40,000

Note that regardless of method to be used, the balances for income and unearned
income should be the same and the cash account should not be adjusted.

66
 PREPAID EXPENSE – this refers to expenses already paid but yet incurred or used
up, thus, classified as assets. Some examples are: prepaid rent, prepaid insurance and
prepaid interest.

Two methods for the adjustment of prepayments:

a. Asset Method – used in recording the advance payment and immediately debited
to prepaid expense (asset) account.

Pro-forma Entries:

Prepaid Expenses xx
Cash xx
To record advanced payment of expenses

Expense xx
Prepaid Expenses xx
To adjust for the expired or used up portion

b. Expense Method – records the advance payment and immediately debited to

expense account

Pro-forma Entries:

Expenses xx
Cash xx
To record advanced payment of expenses

Prepaid Expense xx
Expenses xx
To adjust for unexpired portion

Illustration: On June 1, 2017, GHI Corporation paid an insurance premium worth

P120, 000 for one year.

Under Asset Method:

June 1, 2017 Prepaid Insurance 120,000

Cash on hand 120,000
To record advance payment of insurance premium for one year

Dec 31, 2017 Insurance Expense 70,000

Prepaid Insurance 70,000
To adjust for seven months expired insurance premium

67
Analysis:
Month Amount per month* Status as of December 31, 2017**
June 2017 10,000 Expired
July 2017 10,000 Expired
Aug 2017 10,000 Expired
Sept 2017 10,000 Expired
Oct 2017 10,000 Expired
Nov 2017 10,000 Expired
Dec 2017 10,000 Expired
Jan 2018 10,000 Unexpired
Feb 2018 10,000 Unexpired
Mar 2018 10,000 Unexpired
April 2018 10,000 Unexpired
May 2018 10,000 Unexpired

Notes:
*amount per month = total amount of payment / no. of terms
P10, 000 = P120, 000 / 12

**December 31, 2017 is the cut-off period or end of accounting period. This must be
considered when making any kind of adjustment.

The entries posted in T-accounts will appear as follows:

Cash on hand
June 1 120,000

Prepaid Insurance Insurance Expense

June 1 120,000 Dec 31 70,000 Dec 31 70,000
Balance 50,000 Balance 70,000

Under Expense Method:

June 1, 2017 Insurance Expense 120,000

Cash on hand 120,000
To record advance payment of insurance premium for one year

Dec 31, 2017 Prepaid Insurance 50,000

Insurance Expense 50,000
To adjust for five months unexpired insurance premium

68
 Analysis:

Month Amount per month* Status as of December 31, 2017**

June 2017 10,000 Expired
July 2017 10,000 Expired
Aug 2017 10,000 Expired
Sept 2017 10,000 Expired
Oct 2017 10,000 Expired
Nov 2017 10,000 Expired
Dec 2017 10,000 Expired
Jan 2018 10,000 Unexpired
Feb 2018 10,000 Unexpired
Mar 2018 10,000 Unexpired
April 2018 10,000 Unexpired
May 2018 10,000 Unexpired

Notes:
*amount per month = total amount of payment / no. of terms
P10, 000 = P120, 000 / 12

**December 31, 2017 is the cut-off period or end of accounting period. This must be
considered when making any kind of adjustment.

The entries posted in T-accounts will appear as follows:

Cash on hand
June 1 120,000

Prepaid Insurance Insurance Expense

Dec 31 50,000 June 1 120,000 Dec 31 50,000
Balance 50,000 Balance 70,000

Again, note that whatever method is used, the balances for prepaid expense and expense
account should be the same and the cash account should not be adjusted.

 BAD DEBTS – are expense incurred by the business due to non-collectability of some
receivables. Bad debts are considered part of operating expenses of the company and
will be shown in the Statement of Comprehensive Income.

Two methods for recognition of bad debts:

a. Direct Write Off Method – used in recording bad debts expenses only when the
company is assured that the receivable will not be collected anymore.
69
 Pro-forma Entry:

Bad Debts Expense xx

Accounts Receivable xx
To write off the receivable

No entry is necessary if the accounts receivable are only doubtful of collection

b. Allowance Method – used in recording bad debt expenses even if the accounts are
doubtful of collection.

Pro-forma Entries:

Doubtful Accounts xx
Allowance for Doubtful Accounts xx
To adjust receivable as doubtful accounts

Allowance for Doubtful Accounts xx

Accounts Receivables xx
To record or write off the uncollectible accounts receivable

Allowance for doubtful accounts is contra asset account which can be derived as
follows:

Allowance for doubtful account, beginning xx

Add: Bad debt expense xx
Collection of accounts previously written off xx
Less: Accounts written off (xx)
Allowance for doubtful accounts, ending xx

The allowance for doubtful accounts is deducted the principal amount of accounts
receivables to derive the Net Realizable Value as expressed through formula below:

Account Receivable
Less: Allowance for Doubtful Account
Net Realizable Value

Furthermore, doubtful accounts are derived through estimation. There are three methods
in estimating the doubtful accounts:

a. Aging of accounts receivable – the allowance for doubtful accounts is derived

through multiplying the total each classification of account receivables by the
percent of non-collectability.

70
 Formula:

Amount based on classification x Percent of Loss = Required Allowance, End

Illustration:

Percent of Required
Balance
Classification Uncollectability Allowance
(a)
(b) (a x b)
1-30 days 500,000 1% 5,000
31-60 days 100,000 5% 5,000
61-90 days 200,000 10% 20,000
Total 800,000 30,000

b. Percent of accounts receivable – the allowance of doubtful accounts is derived

through multiplying the balance of accounts receivables by the estimated percent
usually based from past experience of the business

Formula:

Balance of Accounts Receivable x Estimated Percent = Required Allowance,

End

Illustration:
Given: Accounts Receivables, End = 100,000
Estimated % of doubtful accounts = 3%

Solution = 100,000 x 3%
Required Allowance, End = 3,000

c. Percent of Sales – the bad debt expense or doubt accounts expense is derived
by multiplying the net credit sales by a certain rate

Formula:

Net Credit Sales x Rate = Bad Debt Expense

Illustration:
Given: Sales = 100,000
Sales Returns = 20,000
Percent of Sales = 3%

Solution = (100,000 -20,000) x 3%

Bad Debt Expense = 2,400

71
Recovery of accounts previously written off

Sometimes, accounts previously written off due to non-collectability can be possibly

recovered. This happens when the customer would like to restore the credit with the
company.

Pro-forma Entry for both Direct Write Off and Allowance Method:

Accounts Receivable xx
Allowance for Doubtful Accounts xx
To record the reversal of original entry of write off

Cash xx
Accounts Receivables xx
To record the recovery of accounts previously written off

Illustration:

1. ABC Corporation has accounts receivable of P50, 000 which are considered as
doubtful in collection.

Under Direct Write off Method:

No entry is necessary.

Under Allowance Method:

Doubtful Accounts 50,000
Allowance for Doubtful Accounts 50,000
To adjust receivable as doubtful accounts

2. Subsequently, the above accounts are found out to be worthless or cannot be

collected anymore and should be written off

Under Direct Write off Method:

Bad Debt Expense 50,000
Accounts Receivable 50,000
To record or write off the uncollectible accounts receivable

Under Allowance Method:

Allowance for Doubtful Accounts 50,000
Accounts Receivable 50,000
To record or write off the uncollectible accounts receivable

72
 3. However, the same accounts that are previously written-off are recovered or
collected

Under both Direct Write off and Allowance Method:

Accounts Receivable 50,000
Allowance for Doubtful Accounts 50,000
To record the reversal of original entry of write off

Cash 50,000
Accounts Receivables 50,000
To record the collection of accounts previously written off

 DEPRECIATION is defined as “the systematic allocation of the depreciable amount

of an asset over its useful life”. It is an expense account, therefore, part of Statement of
Comprehensive Income. Depreciation is applicable to property, plant and equipment,
except land.

Formula for computation of depreciation using straight line method:

Cost of Asset xx
Less: Scrap value / residual value, if any (xx)
Depreciable Amount xx
Divided by: Useful life (in years) xx
Depreciation xx

Factors to be considered in computation of depreciation:

a. Cost of asset – includes acquisition cost and any incidental expenses necessary to
acquire and make the asset available for use.
b. Scrap value – also known as residual value and disposal value. This the estimated
selling price of the asset after disposal which occurs at the end of its useful life
c. Depreciable Amount – the difference after deducting the scrap value from the cost
of asset
d. Useful life – refers to number of years, number of machines hours or numbers of
units produced which represents the productive life of the asset.

Formula to derive carrying value of asset or net book value:

Cost of Asset xx
Less: Accumulated Depreciation (xx)
Net Book Value or Carrying Value of Asset xx

Accumulated depreciation is the sum of depreciation of property and classified as

contra asset account, thus, presented in the Statement of Financial Position. Net
Book Value (NBV) or Carrying Value is the net amount of asset being presented in the
73
Statement of Financial Position is computed by deducting the accumulated
depreciation from cost of asset.

Illustration: As of December 31, 2017, ABC Company has the following balances in
its trial balance:

Account Title Debit Credit

Machinery & Equipment P750, 000
Building 1,000,000

Additional Information:

Acquisition / Estimated
Account Scrap Value
Construction Date Useful Life
Machinery and Equipment Jan. 1, 2016 6 0
Building March 1, 2017 10 100,000

Computation:

1. Machinery and Equipment:

Cost 750,000
Less: Scrap value 0
Depreciable Amount 750,000
Divided by: Useful Life 6 years
Depreciation for 2017 125,000

2. Building:

Cost 1,000,000
Less: Scrap value 100,000
Depreciable Amount 900,000
Divided by: Useful Life 10 years
Depreciation per year 90,000
Multiply by: 10/12
Depreciation during 2017 75,000

74
Worksheet

All these adjustments would be presented in one worksheet. Usually a 10 column

worksheet is required when making a worksheet. Worksheet includes the following:
1. the first two columns will present the unadjusted Trial balance
2. third and fourth columns are dedicated for the adjustments
3. fifth and sixth columns are for the Adjusted Trial Balance
4. seventh and eight columns are for the Income statement
5. And the ninth and tenth column are for Balance Sheet accounts.

Sample Format:

Adjusted Trial Income

Trial Balance Adjustments Balance Sheet
Balance Statement
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit

75
Let us try this!

Exercise 1: A trial balance is given together with its adjustments. You are required to
make the all necessary adjusting entries.

BABY JOSH AIRCON REPAIR SERVICE

TRIAL BALANCE
December 31, 2017

Debit Credit

Cash on Hand P 125,000

Cash in Bank 145,000
Accounts Receivable 49,000
Notes Receivable 30,000
Prepaid Insurance 45,000
Machinery & Equipment 200,000
Furniture & Fixtures 25,000
Accounts Payable P 56,000
Notes Payable 50,000
Josh, Capital 245,000
Josh, Drawing 5,000
Repair Income 370,250
Salaries Expense 45,000
Supplies Expense 1,000
Rent Expense 20,000
Taxes & Licenses 6,000
Utilities Expense 25,000
Interest Expense 250
Totals P 721, 250 721,250

Adjusting events:

1. 5% of the accounts receivable should be recognized as doubtful collection.

2. Insurance premium recorded as Prepaid Insurance was for six months starting Sept.
1, 2017.
3. Supplies still on hand, P 300
4. The note receivable represents a 60-day 12% note received from the customer on
November 16, 2017
5. Machinery and Equipment were acquired April 1, 2017 with an estimated useful life
of 10 years and scrap value of P 50,000
6. The furniture and fixtures were acquired January 1, 2017 with estimated useful life
of 10 years and a scrap value of 2,500.
7. The notes payable is for 60 days at 18% due to ABC Bank dated December 1, 2017.
8. December gross receipts is one third of gross revenue of P 13,000 subject to 3%
percentage tax.
76
Exercise 2: The unadjusted trial balance of Love Spa showed, among others, Medical
Supplies P 75,500 and Medical Supplies expense P 0. On December 31, 2017, end of
the accounting period, P 5,500 medical supplies are still on hand.

Required: Make an adjusting entry on December 31 to adjust for the medical supplies
used.

Exercise 3: Leonardo Company purchased a delivery van on July 1, 2017 for P

2,500,000 plus prepaid insurance for one year P 10,000. The van had an estimated useful
life of ten years and zero residual value.

Required:
1. Give the entry for the purchase of the van.
2. Give the entry to record the payment of prepaid insurance
3. Give the entry to adjust for depreciation on December 31, 2017
4. Give the entry to adjust for the expired insurance on December 31, 2017

77
 LESSON 13: ADJUSTED TRIAL BALAN CE

At the end of this lesson, learners must be able to

 Prepare an adjusted trial balance
 Apply the learning from adjusting entries to come up with an adjusted Trial balance

Adjusted trial balance is prepared subsequent to posting of adjusting entries to the

ledger. Just like unadjusted trial balance, the main purpose of preparation of adjusted
trial balance is to test and ensure that the total debits are equal to total credits for a given
period.
Illustration:
ABC Corporation
Adjusted Trial Balance
As of December 31, 2017

Unadjusted Trial Balance Adjustments Adjusted Trial Balance

Account Title
Debit Credit Debit Credit Debit Credit
Cash P 60,000.00 P 60,000.00
Accounts Receivable 30,000.00 P 5,000.00 35,000.00
Service Supplies 15,000.00 P 1,000.00 14,000.00
Furniture and Fixtures 30,000.00 30,000.00
Equipment 150,000.00 150,000.00
Accumulated Depreciation 50,000.00 50,000.00
Accounts Payable 55,000.00 55,000.00
Notes Payable 10,000.00 10,000.00
ABC, Capital 191,000.00 191,000.00
ABC, Drawing 7,000.00 7,000.00
Service Revenue 90,000.00 5,000.00 95,000.00
Rent Expense 15,000.00 15,000.00
Salaries Expense 35,000.00 35,000.00
Taxes and License 4,000.00 4,000.00
Service Supplies Expenses 1,000.00 1,000.00
Depreciation Expense 50,000.00 50,000.00

Total P 346,000.00 P 346,000.00 P 56,000.00 P 56,000.00 P 401,000.00 P 401,000.00

78
Let us try this!

Exercise 1: The worksheet data of JKL Repair Services are presented below:

Trial Balance Adjustments Adjusted Trial Balance

Account Titles
Debit Credit Debit Credit Debit Credit
Accounts Receivables __________ __________ 330,000
Prepaid Insurance 270,000 __________ 200,000
Prepaid Rent 80,000 __________ __________
Accumulated Depreciation 150,000 __________ __________
Salaries Payable __________ 60,000
Service Revenue 880,000 __________ 980,000
Depreciation Expense __________ 90,000
Insurance Expense __________ __________
Rent Expense __________ 30,000
Salaries Expense __________ 510,000
TOTAL 1,090,000 1,090,000 290,000 290,000 1,280,000 1,280,000

Requirements:
a. Fill in the missing amounts.
b. Make the necessary adjusting entries.

Write your entries below:

79
Exercise 2: The unadjusted trial balance of Diane Company at June 30, 2017 is shown
below:

Diane Company
Worksheet
For the month ended June 30, 2017

Unadjusted Trial Balance

Account Titles Debit Credit
Cash P 5,000
Account Receivables 4,500
Supplies 7,500
Accounts Payable P 2,500
Unearned Service Revenue 300
Diane, Capital 7,700
Service Revenue 10,000
Salaries Expenses 2,400
Utilities Expenses 1,100
Total P 20,500 P 20,500

Other data:
a. Count of supplies reveals P7, 000 on hand.
b. Remaining unearned revenue at month-end is P100
c. Accrued utilities expenses are P200

Requirement:
a. Prepare an adjusted trial balance for the month-end June 30, 2017.
b. Prepare the necessary adjusting entries.

80
 LESSON 14: CLOSING ENTRIES

At the end of this lesson, learners must be able to:

 Prepare closing entries
 Explain the purpose of closing entries

In accounting cycle, recording of closing entries is the next step after preparation of
financial statements for the accounting year. Closing of entries is applicable to
temporary or nominal accounts such as revenue and expense accounts, as well as to
withdrawal accounts of owners in case of sole proprietorships and partnerships.
Take note that the real or permanent accounts are never closed wherein balances of
assets, liabilities and owner’s equity will be carried forward in the next accounting
period. Closing of entries is applicable only to nominal accounts which will bring such
accounts to a zero balance.
Income summary account is a ledger account used to close the nominal accounts. The
net amount of this account represents the net income or net loss of the business during
the period.

Four closing entries are below:

1. Close all income accounts / credit balances (normally revenues and gains) of
Statement of Comprehensive Income to Income Summary Account

[Income Accounts Income Summary Account]

Pro-forma entry:

Revenue xx
Income Summary xx
To close the income accounts to income summary

2. Close all expense accounts / debit balances (normally expenses and losses) of
Statement of Comprehensive Income to Income Summary Account

[Expense Accounts Income Summary Account]

81
 Pro-forma entry:

Income Summary xx
Expenses xx
To close the expense accounts to income summary

3. Close Income Summary Account to capital account for sole proprietorship or to

retained earnings for corporation

[Income Summary Account Capital or Retained Earnings Account]

Prior to closing of Income Summary to appropriate account, its ending balance must
be determined first which should match the net income / loss for the period.

 If the Income Summary has a credit ending balance, it shows that the business
has net income for the period.
Income Summary
Closing Entry # 1 Closing Entry # 2

Balance xxxx

Pro-forma entry:

Income Summary xx
Capital / Retained Earnings xx
To close the income summary to capital or retained earnings account

 If the Income Summary has a debit ending balance, it shows that the business
has net loss for the period.
Income Summary
Closing Entry # 1 Closing Entry # 2

Balance xxxx

Pro-forma entry:

Capital / Retained Earnings xx

Income Summary xx
To close the income summary to capital or retained earnings account

82
4. Close drawing account to capital account for sole proprietorship or dividend
accounts to retained earnings account.
Pro-forma entry:
For sole proprietorship:

Capital xx
Drawing Account xx
To close the withdrawals to capital account
For corporation:

Retained Earnings xx
Dividends xx
To close the dividends to retained earnings account
To simply remember the required closing entries, just recall the REID: Revenues –
Expenses – Income Summary – Drawings / dividends
To illustrate the procedure for closing entries, let us use the example for the adjusted
trial balance lesson as shown below:
ABC Corporation
Adjusted Trial Balance
As of December 31, 2017

Adjusted Trial Balance

Account Titles Debit Credit
Cash P 60,000
Accounts Receivable 35,000
Service Supplies 14,000
Furniture and Fixtures 30,000
Transportation Equipment 150,000
Accumulated Depreciation P 50,000
Accounts Payable 55,000
Notes Payable 10,000
ABC, Capital 191,000
ABC, Drawing 7,000
Service Revenue 95,000
Rent Expense 15,000
Salaries Expense 35,000
Taxes and License 4,000
Service Supplies Expenses 1,000
Depreciation Expense 50,000
Total P 401,000 P 401,000
83
The following are the closing entries:

1. Service Revenue 95,000

Income Summary 95,000
To close the income accounts to income summary

2. Income Summary 105,000

Rent Expense 15,000
Salaries Expense 35,000
Taxes and License 4,000
Service Supplies Expenses 1,000
Depreciation Expense 50,000
To close the expenses accounts to income summary

3. ABC, Capital 10,000

Income Summary 10,000
To close the income summary to capital account

4. ABC, Capital 7,000

ABC, Drawing 7,000
To close the withdrawal to capital account

84
Let us try this!

1. Identify which of following accounts are nominal and which are real by putting
them in their respective columns:
Accounts Nominal Accounts Real Accounts
Deferred Rent
Prepaid Insurance
Interest Income
Wages Payable
Advertising expense
Unused Supplies
Doubtful Accounts
Depreciation Expense
Owner’s Drawing
Service Fee Income

2. The following were taken from the worksheet adjusted trial balance columns of
PinsanKo Painter Company, the company is being owned by Cardo Dalisay:

Account Titles Debit Credit

Cash P 22,800
Accounts Receivable 15,400
Supplies 2,300
Prepaid Insurance 4,800
Office Equipment 44,000
Accumulated Depreciation-Equipment 18,000
Notes Payable (Issued December 15) 15,000
Accounts Payable 8,000
SSS & EC Premiums Payable 322
Pag-ibig Premiums Payable 100
Phil Health Premiums Payable 120
Withholding taxes Payable 92
Interest Payable 100
Dalisay, Capital 40,250
Dalisay, Drawing 12,000
Service Revenue 79,900
Advertising expense 12,900
SS & EC Premiums expense 106
Pag-ibig premiums expense 50
Phil Health Premiums expense 60
Supplies Expense 3,700
Depreciation expense 6,000
Insurance Expense 4,000
Salaries Expense 33,668
Interest Expense 100
Total P 161,884 P 161, 884
85
Required:

1. Prepare closing entries as of December 31, 2017.

2. Is the performance of the company a profit or a loss?

3. Prepare the closing entries of Heart Repair Services of the following general
ledger account as of March 31, 2017 as presented below:

Service Revenue Salaries Expense

(Mar 1) 25,000 (Mar 15) 20,000
(Mar 7) 35,000 (Mar 30) 20,000
(Mar 18) 20,000
(Mar 25) 40,000

Utilities Expense Heart, Capital

(Mar 7) 1000 (Mar 1) 25,000
(Mar 23) 3000 (Mar 15) 50,000

Heart, Drawing
(Mar 10) 5,000

Entries:

86
 4. Prepare the closing entries for Words Services as of August 30, 2017. The
adjusted trial balance is given below:
Words Services
Adjusted Trial Balance
As of August 30, 2017

Adjusted Trial Balance

Account Titles Debit Credit
Cash P 13,000
Supplies 6,000
Accounts Payable P 2,000
Word, Capital 10,000
Word, Drawings 3,000
Service Revenue 30,000
Salaries Expense 17,000
Utilities Expense 3,000
Total P 45,400 P 45,400

Entries:

5. The adjusted trial balance of Brain Company as of May 31, 2017 has the
balances as shown below:
Brain Company
Adjusted Trial Balance
As of May 31, 2017

Adjusted Trial Balance

Account Titles Debit Credit
Cash P 45,000
Supplies 20,000
Machinery 20,000
Accounts Payable P 14,000
Mortgage Payable 16,900
Brain, Capital 9,000
Retained Earnings 2,000
Service Revenue 3,500
Salaries Expense 3,000
Insurance Expense 2,000
Utilities Expense 400
Total P 45,400 P 45,400

Required: Prepare all necessary closing entries.

87
 LESSON 15: POST-CLOSING TRIAL
BALANCE AND REVERSIN G ENTRIES

At the end of this lesson, learner must be able to:

 Prepare Post-closing Trial Balance
 Prepare reversing entries

The preparation of post-closing trial balance is the last step for accounting cycle. This
serves as a check on the accuracy of the closing process and ensures that the books are
in a balance state at the start of the next accounting period. As the name suggests, the
total debits and total credit must be equal. It differs from the adjusted trial balance in
two reasons follows:
 Excludes all nominal accounts
 Updates the capital account (for sole proprietorship) and retained earnings
account (for corporation) to its correct ending balance
Illustration: Using the example in the previous lesson, the post-closing trial balance of
ABC Corporation would be as follows after incorporating all closing entries:

ABC Corporation
Adjusted Trial Balance
As of December 31, 2017

Adjusted Trial Balance

Account Titles Debit Credit
Cash P 60,000
Accounts Receivable 35,000
Service Supplies 14,000
Furniture and Fixtures 30,000
Transportation Equipment 150,000
Accumulated Depreciation P 50,000
Accounts Payable 55,000
Notes Payable 10,000
ABC, Capital 174,000
Total P 289,000 P 289,000

88
As you’ve noticed, the balances of all nominal/temporary accounts (Revenue –
Expenses – Income Summary - Drawings) have been absorbed by capital account.

REVERSING ENTRIES
Reversing entries are prepared at the beginning of the next accounting period. This is
an optional step in accounting cycle.

The following four accounts are qualified for reversal:

a. Accrued Income

Pro-forma reversing entry:

Income xx
Accrued Income xx
To reverse the accrued income
b. Accrued Expenses

Pro-forma reversing entry:

Accrued Expense xx
Expense xx
To reverse the accrued expense

c. Unearned Income under Income Method

Pro-forma reversing entry:

Unearned Income xx
Income xx
To reverse the unearned income
d. Prepaid Expense under Expense Method

Pro-forma reversing entry:

Expense xx
Prepaid Expense xx
To reverse the unearned income

89
Illustration 1 – Accrued Income and Accrued Expenses: Assume that Healthy Clinic
referred a patient for laboratory examination to Maria Laboratory and for which it is
entitled to a commission or referral fee of P500. This amount was not yet collected as
December 31, 2017, the end of its accounting period.

Viewpoint of Healthy Clinic:

Adjusting entry:

Dec 31, 2017 Referral Fee Receivable 500

Referral Fee Income 500
To adjust referrals due from Maria Laboratory

Reversing entry:

Jan 1, 2018 Referral Fee Income 500

Referral Fee Receivable 500
To reverse the accrued income

Viewpoint of Maria Laboratory:

Adjusting entry:

Dec 31, 2017 Referral Fee Expense 500

Referral Fee Payable 500
To adjust referral fee due to Healthy Clinic

Reversing entry:

Jan 1, 2018 Referral Fee Payable 500

Referral Fee Expense 500
To reverse the accrued expense

Illustration 2 – Unearned Income under Income Method: December 1, 2017, DEF

Corporation has received an advance collection of service revenue amounting to P60,
000.

Dec 1, 2017 Cash on hand 60,000

Service Revenue 60,000
To record advance collection for service revenue
Adjusting entry:

Dec 1, 2017 Service Revenue 60,000

Unearned Service Revenue 60,000
To adjust the service revenue
90
Reversing entry:

Jan 1, 2018 Unearned Service Revenue 60,000

Service Revenue 60,000
To reverse the service revenue

Illustration 3 – Prepaid Expense under Expense Method: On June 1, 2017, GHI

Corporation paid an insurance premium worth P120, 000 for one year.

June 1, 2017 Insurance Expense 120,000

Cash on hand 120,000
To record advance payment of insurance premium for
one year

Adjusting entry:

Dec 31, 2017 Prepaid Insurance 50,000

Insurance Expense 50,000
To adjust for five months unexpired insurance premium

Reversing entry:

Jan 1, 2017 Prepaid Insurance 50,000

Insurance Expense 50,000
To reverse the prepaid insurance expense

91
Let us try this!

Exercise 1: The following were taken from the worksheet adjusted trial balance
columns of PinsanKo Painter Company, the company is being owned by Cardo
Dalisay:

Account Titles Debit Credit

Cash P 22,800
Accounts Receivable 15,400
Supplies 2,300
Prepaid Insurance 4,800
Office Equipment 44,000
Accumulated Depreciation-Equipment 18,000
Notes Payable (Issued December 15) 15,000
Accounts Payable 8,000
SSS & EC Premiums Payable 322
Pag-ibig Premiums Payable 100
Phil Health Premiums Payable 120
Withholding taxes Payable 92
Interest Payable 100
Dalisay, Capital 40,250
Dalisay, Drawing 12,000
Service Revenue 79,900
Advertising expense 12,900
SS & EC Premiums expense 106
Pag-ibig premiums expense 50
Phil Health Premiums expense 60
Supplies Expense 3,700
Depreciation expense 6,000
Insurance Expense 4,000
Salaries Expense 33,668
Interest Expense 100
Total P 161,884 P 161, 884

Required:

A. Prepare closing entries as of December 31, 2017.

B. Is the performance of the company a profit or a loss?
C. Open T accounts for Dalisay, Capital, Dalisay Drawings and Income Summary
Post your closing entries. Determine the balance to be presented as Dalisay,
Capital
D. Prepare reversing entries assuming company uses the expense method in recording
prepayments and the income method in recording pre-collections.

92
 LESSON 16: TRANSACTI ONS OF
MERCHANDISING BUSINE SS

At the end of this lesson, learner must be able to:

 Understand the difference in computing profit for a service provider and merchandiser
 Account for sales and compute for net sales revenue
 Account for purchases and compute for cost of purchases.
 Determine cost of sales.
 Compute for VAT exclusive and VAT inclusive goods
 Know the two Inventory system being used by merchandisers

After dealing with service provider transactions, you will learn during this lesson some
important transactions for a merchandising business. Let us all take a look at the
difference of these two, the service provider business and a merchandiser.

The main difference of these two businesses can be found in the sales and cost of sales
section. Both can be found in their respective Income statements/Statement of
Comprehensive Income.

Illustration:

Service Provider Merchandising

Service Fees Revenue P xxx Sales P xxx
Other Income xxx Less: Cost of Sales (xxx)
Total Income xxx Gross Income xxxx
Less: Operating Expense (xxx) Less: Operating Expense (xxx)
Other operating exp (xxx) other operating exp (xxx)
Net Income/Loss P xxx Net Income/loss P xxx

The source of revenue for a service provider is called Service Fee Revenue. This comes
from rendering services to customers for a fee. On the other hand, the source of revenue
for a merchandising is called Sales which comes from selling of goods or merchandise.

Cost of Sales as one major deduction to the Sales Revenue item. This represents the
expense incurred or cost of buying the merchandise which were sold at a higher price
to obtain a revenue. The Gross Income on sales represent the mark-up or margin of
profit in selling goods to the customers. This would also state whether the business’
pricing policy was correctly made, adequate or not.

93
 Inventory System

The cost of sales or also known as the cost of goods sold as mentioned earlier is
considered to be one of the major expense of the business being deducted to the Sales
revenue item.

According to Zenaida Vera Cruz-Manuel in her book 21st Century Accounting Process,
2009, “merchandiser’s balance sheet is practically the same as that of a service provider
except that its current assets include Merchandise Inventory which is not found in the
current assets of a service provider. Merchandise inventory refers to goods purchased
for resale to customers. The cost of goods sold, which is found in the Income Statement
and the cost of merchandise inventory, which is found in the Balance Sheet, are
determined and recorded using either the Perpetual Method or Periodic Method.”

1. Perpetual Method

Under this method, every movement of merchandise is recorded directly to the

“merchandise inventory” account. The reason for its name is because of the
“continuous” recording and control of the merchandise from the date it was purchased
to the time that is sold. Usually, business who sells high priced products but low volume
of goods, like car dealers, use this method of inventory system.

Pro forma entries under Perpetual Method- Buyer’s Perspective:

1. Purchased merchandise for cash or on account

Merchandise Inventory xxx

Cash/Accounts Payable xxx

2. Incurred transportation expense in buying of merchandise

Merchandise Inventory xxx

Cash/ Accounts Payable xxx

3. Returned defective merchandise

4. Granted allowances to the buyer for the account purchases
5. Issued a debit memo to the seller for returned merchandise

Accounts Payable xxx

Merchandise Inventory xxx

6. Paid account within the discount period

Accounts Payable xxx
Merchandise Inventory xxx
Cash xxx
7. Paid account beyond the discount period
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 Accounts Payable xxx
Cash xxx

Under the perspective of Seller, the Pro Forma entries would be as follows:

1. Sold merchandise for cash or on account

Cash/Accounts Receivable xxx

Sales xxx

Cost of Sales xxx

Merchandise Inventory xxx

2. Received defective merchandise sold on account

3. Granted allowances to the buyer for the account sales
4. Issued a credit memo to the buyer for merchandise returns

Sales Returns and Allowances xxx

Accounts Receivable xxx

Merchandise Inventory xxx

Cost of Sales xxx

Take note that the perpetual method of inventory system is to be discussed in details in
higher accounting.

2. Periodic Method

Under this method, a merchandise when bought is being recorded using the “Purchases”
account which represents goods available for sale. When goods are sold, only the sales
revenue, with the actual amount obtained from the customers, is recorded.

Under periodic method, cost of sales and merchandise inventory accounts are to be
determined at the end of the accounting period. Another thing, periodic method is
adapted by businesses who are selling goods with low price but high volume of goods
such as grocery stores and supermarkets.

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The Pro-forma entries under Periodic Method would be as follows:

1. Purchase goods for cash or on account

Purchases xxx
Cash/Accounts Payable xxx

2. Sold goods to customers for cash or on account

Cash xxx
Sales xxx

3. To record at the end of the year the merchandise inventory still on hand

Merchandise Inventory xxx

Income Summary xxx
To record goods on hand

Illustration:

Assume that during the year the total purchases of the company amounted to 100,000
Representing 400 executive chairs bought at P 250.00 each. At the end of the year,
physical count of chairs showed 140 are still on hand. Cost of goods sold is computed
as follows:

Purchases (400 x P250) P 100,000

Less: Merchandise Inventory, end (140 x P 250.00) (35,000)
Cost of Goods Sold (260 x P 250.00) 65,000

At the end of the year, P 65,000 out of the merchandise purchased of P 50,000 will be
the cost of goods sold or cost of sales to be presented in the Income Statement. The
merchandise inventory, end amounting to P 35,000 will be presented in the Balance
Sheet representing the amount of goods still on hand.

If the executive chairs bought at P250 were sold at 50% above-cost or mark-up of 125.00
per chair, then sales price would be:

Purchase Price P 250.00

Mark-up (50% of 250) 125.00
Selling Price P 375.00

From there, we can now compute for gross income on Sales:

Sales (400-140=260) (260 x P375) P 97,500

Cost of Sales (65,000)
Gross Income P 32, 500
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To record the transactions under Periodic Method:

Purchases 100,000
Cash 100,000

Cash 97,500
Sales 97,500

End of accounting period:

Merchandise Inventory 35,000

Income Summary 35,000
To record goods on hand

 NET SALES
Things to be considered when computing for Net Sales

1. Gross Sales - is earned when the seller of the goods sells the merchandise to the
customers.

2. Sales Discounts – there are two common discounts being granted to the customers,
these are TRADE DISCOUNTS and CASH DISCOUNTS.

Trade discounts are given to customers usually buying large quantities of goods or for
regularly patronizing customers. It is important to remember that trade discounts are
being deducted immediately from the LIST PRICE or original price of the goods at the
point of sale. So, a business if given trade discount should record only the gross invoice
price.

3. The gross invoice price is the amount of list price less trade discounts.

Trade discounts could be given one after another.

Illustration:

TRADE DISCOUNTS
Assuming that an office furniture with a list price of 10,000 was given a trade discount
of 4% and 2%. The gross invoice price will be computed as follows:

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List Price P 10,000
Less; 4% of P 10,000 400
9,600
Less: 2% of P 9,600 192
Gross Invoice Price P 9,408

To record the purchase of merchandise with a trade discount, following the illustration
above:

Seller’s point of view:

Cash on hand P 9, 408

Sales P 9,408

CASH DISCOUNTS

A cash discount is given to buyer who bought goods on account. This encourages buyers on
account to pay their liabilities on time or before the due date of collection. This system allows
the business to have an early collection of their receivables. Also, the accounts receivable of the
company is being minimized because customers tend to pay their liabilities within the credit
terms to avail of the discount.

Some examples of credit terms:

2/10, 1/30,
5/15, 2/eom, n/60

2/10, 1/30 credit terms would mean that the liability is payable within 30 days with a 2% cash
discount if the customer pays within 10 days or 1% cash discount if he/she pays within 30 days.

5/15, 2/eom, n/60 would mean that the credit term is payable within 60 days with 5% cash
discount if paid within 15 days from date of sale but only 2% if paid after 15 days but before
the end of the month, eom stands for “end of the month”, and no cash discount available for the
customers beyond the end of the month of sale within 60 days.

Sales Discounts account should be debited since this would decrease the revenue.

Illustration:

On June 1, 2017 Lion Company sold goods to Pusa Company for P 25,000 with P 5,000
down payment and the balance on term of 2/10, n/30. Pusa Company paid on June 8,
2017.

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Entries would be:

June 1 Accounts Receivable 20,000

Cash 5,000
Sales 25,000

June 8 Cash on hand 19,600

Sales Discount 400
Accounts Receivable 20,000

SALES RETURNS AND ALLOWANCES

Sales returns and allowances are used in recording returned merchandise for the reason
that the goods sold were defective, broken, if it in excess of the actual order, or if it was
not ordered at all. It could also be the case that a customer may simply ask for a reduction
or allowance in the price for similar reasons without actually returning the merchandise
bought.

Like sales discounts, SRA should be debited since it is also a deduction to the revenue
account.

To illustrate:

Pusa Company returned the purchased goods to Lion Company because of the defect in
the products. The returned goods are worth P 3,000. The total merchandise bought by
Pusa Company to Lion Company is P 20,000. Lion Company acknowledged the
returned goods and refunded Pusa Company for the worth of the defective products.

Entries

Cash on Hand 20,000

Sales 20,000

Sales Returns and Allowances 3,000

Cash on hand 3,000

Now that we have discussed things that you have to consider for computing Net Sales,
let us have the pro forma computation as shown below as a summary:

Sales Revenue P xxxx

Less: Sales Discounts xxxx
Sales Returns and Allowances xxxx xxxxx
Net Sales P xxxx

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 Net Purchases
Things to be considered for computation of Net Purchases

1. Gross Purchases – the amount that appears in the invoice.

2. Freight In – an additional cost when buying merchandise is the transportation cost.
This transportation cost may be paid by the buyer or the seller depending on the
terms of sale. If the transportation expense is to be paid by the buyer then perhaps
the term is FOB Shipping point. If it is to be paid by the seller, the term could be
FOB Destination.

FOB SHIPPING POINT

This means free on board at shipping point. If this is the term of shipment of the goods,
then the title of ownership for the goods passes to the buyer as soon as seller turns over
the goods to the common carrier such as cargo ship for the delivery of goods to the
buyer. It also means that the buyer shall shoulder the transportation expense as the
owner of the goods under shipment.

Seller Cargo ship/common carrier Buyer

The moment that the seller delivers the goods to the area of the common carrier, the
ownership of the goods are now passed to the buyer. Therefore, the goods are now the
responsibility of the buyer. The transportation expense should be shouldered by the
buyer.

FOB SHIPPING POINT, Freight Collect

FOB Shipping point, Freight Collect means that the transportation expense were paid
by the buyer. The common carrier shall collect from the buyer.

Illustration:

On September 1, 2017, Lion Company bought from Davao Furniture Shop goods worth
P 200,000 to be transported by a ferry at a cost of P 5,500 under terms: 2/10, n/30, FOB
Shipping Point, Freight Collect. The goods were received Sept. 3, freight were paid
accordingly.

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Entries:

Sept 3, 2017 Purchases P 200,000

Accounts Payable P 200,000

Freight In 5,500
Cash on Hand 5,500

FOB SHIPPING POINT, Freight Prepaid

- FOB SHIPPING POINT, freight prepaid is a term were the buyer should be
paying for the transportation expense but the seller advances the payment for the
freight. The accounts payable of the buyer would increase, if the sale were made
on account. But for the seller, only the accounts receivable shall increase and
not the amount of actual sales.

Illustration:

Using the example above, assume that the term of shipment is FOB Shipping Point,
Freight prepaid and the sale was made on account.

Entries:

Buyer’s:

Purchases 200,000
Freight in 1,000
Accounts Payable 201,000

Seller’s:

Accounts Receivable 201,000

Sales 200,000
Cash on hand 1,000

Note that the accounts receivable increase because the freight is collectible by the seller
from the buyer who is liable for the freight under FOB shipping point. However the
sales revenue account did not increase.

FOB DESTINATION

Freight is not always the liability of the buyer. The seller may also be held liable for the
freight. The term FOB Destination means that the title of ownership of goods bought
shall pass to the buyer only until it reaches the place of the buyer. If the goods have not
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reached the place of the buyer, the seller remains the owner of the goods during its
transit. This time the seller is the one responsible for the freight charges. This is called
Freight out. Freight out is considered to be part of selling expense.

Entries:

Given the above illustration, assume that the term of shipping is FOB Destination,
freight prepaid.

Seller’s entry

Accounts Receivable 200,000

Sales 200,000

Freight out 5,000

Cash on hand 5,000

Buyer’s entry:

Purchases 200,000
Accounts Payable 200,000

PURCHASE RETURNS AND ALLOWANCES

Purchase returns and allowances are deduction from the amount of the gross purchase
made. Some goods bought may be returned to the buyer for reasons that some goods are
defective, broken, spoiled or not actually ordered. Like the definition of Sales Returns
and Allowances only in this case it is at the perspective of the buyer. Because this is a
decrease in the amount of the purchases, this account is to be credited.

From the illustration of the Lion Company and Davao Furniture Shop, assume that some
goods bought by Lion Company were defective. The amount of defective products that
were returned to Davao Furniture Shop is P 10,000.

Entries would be:

Purchases 200,000
Accounts Payable 200,000

Accounts Payable 10,000

Purchase Returns and Allowances 10,000
To record returned defective furnitures

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PURCHASE DISCOUNTS

Recall discussion with trade discounts and cash discounts. Purchase discounts have
similar concept with sales discount. Trade discounts are discounts given to the buyer
and is immediately deducted from the list price. Cash discounts are given if the buyer
were able to pay the liability within the discount period.

Illustration:

Assume that on September 1, 2017 Duncan Shoes of Marikina bought goods from
Masinag Shoe Supplies for 20,000. A 2% trade discount was granted and the term of
purchase was 2/15, n/30. FOB Shipping Point, Freight Prepaid, P 1,500. Duncan paid
for the account on Sept. 14.

Computation:

List Price P 20,000

Less: 2% trade discount 400
Gross Invoice Price P 19,600
Freight Prepaid 1,500
Accounts Payable 21, 100
Less: Cash Discount of 2% of P 19,600 392
Net Invoice Price to be paid within
the discount period P 20, 708

Entries:

Purchases 19,600
Accounts Payable 19,600

Freight In 1,500
Accounts Payable 1,500

Accounts Payable 20,600

Purchase discount 392
Cash 20, 708

Summary computation for NET PURCHASES:

Purchases P xxx
Add: Freight In xxx
Total cost of goods delivered xxxx
Less: Purchase Returns and Allowances Pxxx
Purchase Discount xxx xxx
Net Purchases P xxx

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 VALUE ADDED TAX

Under the National Internal Revenue Code of the Philippines, any person who, the
course of trade or business, sells, barters, exchanges, leases goods or properties, renders
services, and any person who imports goods shall be subject to value-added tax (VAT).

The value added tax is an indirect tax and the amount of the tax may be shifted or passed
on to the buyer, transferee or lessee of the goods, services, or properties.

Therefore for every business transaction a 12% vat is included increasing the amount to
be paid by the buyer. For merchandising business, purchases made is subject to 12%
VAT.

Take note that business whose gross receipt for the whole year exceeds One Million
Nine Hundred Nineteen Thousand Five Hundred Pesos (P 1,919,500.00) is required to
file VAT returns. IF the business’s annual gross sales did not exceed the said amount,
the business is only subject to file Percentage tax returns.

The entry of business for VAT would be a debit to “Input tax” for every purchase made
including VAT. And credit to “Output tax” for sales made by the company. For the
filing of tax returns the Input tax and output tax are closed every month. Total Input tax
is to be offset by the total Output tax, if the output tax is higher than input tax there
would be a taxes payable to the government.

Value added tax is to be paid on or before the 20th day of the following month. Those
businesses who are VAT payable must present to their invoices the word “VAT
Registered Sales” or “Vatable sales” or “VAT inclusive” and present the computation
of prices plus the additional 12% VAT.

Illustration:

Lion Company, is a vat-registered company, bought goods on account for P 33,600 from
Masinag Shoe Supplies which is also vat-registered company. After 15 days, Lion
Company sold goods to customer worth P 56, 000 for cash.

Invoice are VAT Inclusive

Entries would be:

Purchase (33, 600 / 1.12) 30,000

Input Tax (30,000 x .12) 3,600
Accounts Payable 33,600

Cash 56,000
Sales (56,000/ 1.12) 50,000
Output Tax (50,000 x .12) 6,000
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Output Tax 6,000
Input tax 3,600
VAT payable 2,400
To record tax liability

VAT payable 2,400

Cash in Bank 2,400
Tax remitted to BIR

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Let us try this!

1. On June 4, 2017 Harry’s Potteries sold ceramic potteries to Dumbledore’s

Towers at a list price of P 25,000. Terms: 50% down payment, balance 2/10,
n/30. A 5% trade discount was given to Dumbledore. Bernie’s paid cash for
freight on goods sold, P 1,000. Dumbledore paid after eight days from the date
of sales. SELLER IS VAT exempt.

Required:

Make all necessary entries in the books of Harry.

2. International Bookstore, distributor of textbooks used in elementary schools,

sold to Rudy D. Terti on July 1, 2017 goods listed at a price of P 7,500. Trade
discounts of 2% and 1%. Terms: 2/10, n/30. Rudy paid P 5,000 on July 5 and
the balance on July 10. Seller is VAT exempt.

Required:

Make all necessary entries in the books of Seller.

3. Bimbo Company, importer of cellphones, sold goods to Bokia Market on August

1, 2017 at an invoice price of P 20,000. The sale was made on account with
terms 2/10, n/30. Bokia gave 30% down payment, got an allowance approved
for two defective cellphones, worth P 2,000 on August 4, 2017. Bokia paid its
account within 10 days after the date of sale.

Required: Make all the entries in the books of Bimbo. Seller is a non VAT
registered.

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 REFERENCES

Cruz-Manuel, Zenaida (2010), 21st Century Accounting Process: Basic Concepts and
Procedures, (16th edition), Zenaida Vera Cruz-Manuel, San Andres Bukid, Manila

Macapilit, Cecilia, (2009), Worktext in Basic Accounting (Service/ Merchandising),

Rex Book Store, Inc. Manila, Philippines

Valix C., Peralta J., & Valix, C., ( 2010 ), Financial Accounting 1, 2010 revised
edition, GIC Enterprise & Co. Inc., C.M. Recto, Manila

Valix C., Peralta J., & Valix, C., ( 2010 ), Financial Accounting 3, 2010 revised
edition, GIC Enterprise & Co. Inc., C.M. Recto, Manila

Website:

http://www.accountingverse.com/accounting-basics/adjusted-trial-balance.html

Others:

Philippine Financial Reporting Standards

The National Internal Revenue Code of 1997, Republic Act 8424, the Tax Reform Act
of 1997

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