Accounting 4.
4. Equipment and devices used in the system to
• “The process of identifying, measuring, and
communicating economic information to permit
informed judgements and decisions by users of the
information.” - (American Association of Accountants)
• The accounting process of identifying, measuring,
and communicating economic information is
effected through an entity’s accounting information
system.
Accounting information system – the system f
collecting and processing transaction data and
disseminating financial information to interested parties.
Accounting information system is a subsystem of
Management Information System (MIS).
Management information system - a set of data
gathering, analyzing, and reporting functions designed to
provide management with the information it needs to
carry out its functions. The major components of an
MIS include the following:
1. Accounting Information System or Financial
Information System
2. Personnel Information System
3. Logistic Information System
Components of accounting information system
1. Personnel directly involved in accounting work.
2. Accounting policies and standard
 Accounting policies are the specific principles,
bases, conventions, rules and practices applied
by an entity in preparing and presenting
financial statements.
 Not all the PFRSs that are applicable to an
entity. An entity adopts and applies only the
PFRSs that are relevant to its operations.
Moreover, some PFRSs provide a choice of
measurement or presentation methods. The
relevant PFRSs and the methods chosen are
the entity’s accounting policies which are the
entity’s accounting policies which are disclosed
in the notes to financial statements.
3. Procedures or set of interrelated activities
involving the originating, processing and reporting
of financial and related information.
 Steps (4), (6), (9) and (10) are optional, meaning
expedite work, to provide controls, and prevent
fraud and errors.
5. Records and reports necessary to gather, process,
store and transmit financial and other information.
Accounting Cycle - represents the steps or accounting
procedures normally used by entities to record
transactions and prepare financial statements.
Steps in the Accounting Cycle
1. Identifying and analyzing transactions – the
accountants gather information form source
documents and determines the effect of the
transactions on the accounts.
2. Journalizing – the identified accountable events
are recorded in the journals.
3. Posting – information from the journal are
transferred to the ledger.
4. Preparing the unadjusted trial balance – the
balances of the general ledger accounts are proved
as to the equality of debits and credits. The
unadjusted trial balance serves for adjusting entries.
5. Preparing the adjusting entries – the accounts are
updated as of the reporting date on an accrual basis
by recording accruals, expiration of deferrals,
estimations, and other events often not signaled by
new source documents.
6. Preparing the adjusted trial balance – the equality
of debits and credits are rechecked after
adjustments are made. The adjusted trial balance
serves as basis for the preparation of the financial
statements.
7. Preparing the financial statements – these are the
means by which the information processed is
communicated to users.
8. Closing the books – this involves journalizing and
posting closing entries and ruling the ledger.
Temporary accounts (or nominal accounts) are
closed and the resulting profit or loss is transferred
to an equity account.
9. Preparing the post-closing trial balance – the
equality of debits and credits are again rechecked
after the closing process.
10. Preparing the reversing entries – reversing entries
are usually made at the beginning of the next
accounting period to simplify the recording of
certain transactions in the next accounting period.
they are not required in the preparation of financial
statements. However, for best internal control
purposes, trial balances should be prepared.
Accounting records of a business entity
1. Business or source documents – these are the
original source materials evidencing a transaction.
Examples: sales invoices, official receipts, vouchers,
statements of account, etc.
2. Book of accounts
a. Journal
b. Ledger
Systems of recording transaction
1. Double-Entry System - each transaction is
recorded in two parts – debit and credit. The
double-entry system makes use of the following
concepts:
• Duality – this concept views each transaction
as having a two-fold effect on values – a value
received and a value parted with, and each
transaction is recorded using at least two
accounts.
• Equilibrium – the concept requires each
transaction to be recorded in terms of equal
debits and credits.
 This type of recording is in line with the PFRSs
because profit or loss is determined through the
“transaction approach.” Under the transaction
approach, profit or loss is computed as the
difference between income and expenses.
 The accounts recognized under the double-entry
system are: Assets, Liabilities, Equity, Income and
Expense.
 The books of accounts used under the double-
entry system are: Journal, Special Journal, Ledger,
Subsidiary Ledger and other important books.
2. Single-entry system – each transaction is recorded
through simple narrative. Transactions are not
analyzed in terms of debits and credits. Profit or loss
for the period determined though the “capital
maintenance approach” or by comparing the
beginning and ending balances of equity.
 This type of recording is not in line with PFRSs
because profit or loss is not determined using
 the transaction approach. Moreover, internal
control is not enhanced under this type of
recording because records are usually
inadequate.
 The accounts recognized under the single-
entry system include: Cash, Accounts
Receivable, Accounts Payable and Equity.
 The books of accounts used under the single-
entry system include: Cash books and
subsidiary ledgers (personal accounts).
 Journals are used under the double-entry system
because only this system utilizes debits and credits.
However, subsidiary ledgers are used under both
the double-entry and single-entry systems.
 Accrual basis and cash basis of accounting can be
applied under both the double-entry and single-
entry systems.
 Under accrual basis, income and expenses are
recognized when earned or incurred, regardless of
when cash is received or paid. Under cash basis,
income and expenses are recognized when received
or paid, regardless of when earned or incurred.
Accounting Records
• Journal – “book of original entry”. A formal record
where transactions are initially recorded
chronologically through journal entries.
▪ Types of Journals:
o General Journal – used to record
transactions other than those that are
recorded in the special journals.
o Special Journal – used to record
transactions of a similar nature. Examples
of Special Journal:
 Sales journal – used to record sales
on account.
 Purchase journal – used to
purchases of inventory on account.
 Cash receipts journal – used to
record all transactions involving
receipts of cash.
 Cash disbursement journal – used
to record all transactions involving
payments of cash.
 Transactions that cannot be recorded in the special
journals are recorded in the general journal.
Examples of such transactions include purchases of
inventory for note payable, adjusting entries,
reversing entries and the like.
▪ Types of Journal entries:
o Simple journal entry – one which
contains a single debit and a single credit
element.
o Compound journal entry – one which
contains two or more debits or credits.
o Adjusting entries – entries made prior to
the preparation of financial statements to
update certain accounts so that they reflect
correct balances as at the designated time.
o Closing entries – entries made at the end
of the accounting period after all
adjustments have been made to zero-out
the balances of all nominal accounts and
to update the retained earning account.
o Reversing entries – entries usually made
on the first day of the accounting period
to reverse certain adjusting entries in the
immediately preceding period.
o Correcting entries – entries made to
correct accounting errors.
o Reclassification entries – entries made
to transfer an amount from one account
to another account that better describe the
nature of the transaction being recorded.
• Ledger – “book of secondary entries or final
entries”. A systematic compilation of group of
accounts. Posting is the process of transferring
data from the journal to the appropriate accounts in
the ledger.
▪ Kinds of Ledger:
o General ledger – contains all accounts
appearing in the financial statements.
o Subsidiary ledger – supporting ledger for
controlling accounts in the general ledger.
Provides a breakdown of the balances of
controlling accounts.
 A controlling account (or control account) is one
which consists of a group of accounts with similar
nature. The balance of the controlling account is
shown in the general ledger while the balances of
the accounts that comprise the controlling accounts
are shown in the subsidiary ledger. Not all
accounts in the general ledger though are
controlling accounts. Only those whose balances a
necessarily need a breakdown are considered
controlling accounts.
 For example, the “accounts receivable” account is a
controlling account appearing in the general ledger.
This account is supported by various subsidiary
accounts in the subsidiary ledger, such as “Accounts
receivable from Customer A,” Accounts receivable
from Customer B,” etc. The sum of the subsidiary
account should be equal to the balance of the
related controlling account in the general ledger.
Account
• Is the basic storage of information in accounting,
• e.g., “cash,” “land,” “accounts payable,” etc.
Accounts in the ledger follow the format of T-
account.
• Chart of accounts – list of all the accounts used by
the entity.
• Types of Accounts:
▪ Real accounts – accounts that are not closed
at the end of the accounting period. These
accounts are shown in the statement of
financial position.
▪ Nominal accounts – accounts that are closed
at the end of the accounting period. These
accounts include all income and expenses
accounts, drawings and dividends accounts,
clearing accounts (e.g., ‘Income summary’
account) and suspense accounts (e.g., ‘Cash
shortage or overage’ account).
▪ Mixed accounts – accounts that have both
real and nominal account components. These
accounts are subject to adjustment. Mixed
accounts include unadjusted prepayments and
deferrals having both expired and unexpired
components. The expired portion is the
nominal account component while the
unexpired portion is the real account
component.
▪ Contra accounts – accounts that are deducted
from a related account e.g., accumulated
depreciation.
 ▪ Adjunct accounts - accounts that are added
from a related account e.g., premium on bonds
payable.
 Conceptually, valuation accounts such as contra
accounts and adjunct accounts are neither assets nor
liabilities.
Trial Balance
• is a list of general ledger accounts and their balances.
It is prepared to check the equality of total debits
and total credits in the ledger.
• The preparation of the trial balance creates a
starting point for the preparation of the financial
statements.
• The concepts in the preparation of the unadjusted
trial balance as it relates to internal control is that
adjusting entries, and consequently financial
statements, cannot be prepared unless the total
debits and credits in the unadjusted trial balance are
equal.
• Types of Trial balance:
o Unadjusted trial balance – this is prepared
before adjusting entries. It contains real,
nominal and mixed accounts.
o Adjusted trial balance – this is prepared after
adjusting entries. It contains real and nominal
accounts.
o Post-closing trial balance – this is prepared
after the closing process. It contains real
accounts only.
• Errors revealed by a trial balance - the trial
balance can reveal errors that caused the total debits
and total credits to be unequal. Examples:
1. Journalizing of posting one-half of an entry,
i.e., a debit without a credit, or vice versa.
2. Recording one part of an entry at a different
amount than the other part.
3. Transplacement error (Slide error) on one side
of an entry. It is commited when the number
of digits in an amount is incorrectly increased
or decreased. (P1,000 but recorded as P100)
4. Transposition error on one side of an entry. It
is commited when the number of digits in an
amount is interchanged. (P15,652 but recorded
as P15,625)
• Errors not revealed by a trial balance - the trial
balance cannot reveal errors that do not cause the
total debits and total credits to be unequal.
Examples:
1. Omitting entirely the entry for a transaction.
2. Journalizing or posting an entry twice.
3. Using a wrong account with the same normal
balance as the correct account, e.g., a debit to
transportation expense is erroneously debited
to supplies.
4. Wrong computation with the same erroneous
amount posted to both the debit and credit
sides.
Adjusting entries
• are entries made prior to the preparation of financial
statements to update certain accounts so that they
reflect correct balances as of the designated time.
• All adjusting entries involve at least one statement
of financial position account and one statement of
profit or loss and other comprehensive income
account. Moreover, all adjusting entries affect the
comprehensive income for the period.
• Purpose of Adjusting entries:
a. To keep up unrecorded income and
expense of the period (e.g., accruals for
income and expenses).
b. To split mixed accounts into their real and
nominal elements (e.g., adjustments to
prepayments and unearned income).
Methods of initial recording of income and
expenses
• Income
a. Liability method – advanced collections of
income are initially credited to a liability
account. At the end of the period, the earned
portion is recognized as income while the
unearned portion remains as liability.
b. Income method – advanced collections of
income are initially credited to an income
account. At the end of the period, the unearned
portion is recognized as liability while the
earned portion remains as income.
• Expenses
a. Asset method – prepayments of expenses are
initially debited to an asset account. At the end
of the period, the incurred portion (‘used up’
or ‘expired’) is recognized as expense while the
unused portion remains as asset.
b. Expense method – prepayments of expenses
are initially debited to an expense account. At
the end of the period, the unused portion (‘not
yet incurred’ or ‘unexpired’) is recognized as
asset while the incurred portion remains as
expense.
Financial statements
• are the means by which the information
accumulated and processed in financial accounting
is periodically communicated to the users.
• A complete set of financial statements consists of:
1. Statement of financial position;
2. Statement of profit or loss and other
comprehensive income;
3. Statement of changes in equity;
4. Statement of cash flows;
5. Notes; (5a) Comparative information; and
6. Additional statement of financial position
(required only when certain instances
occur).
Heading of the financial statements
1. Name of the reporting entity
2. Title of the financial statement
3. Reporting period
Closing entries
• Closing the books is the process of preparing
closing entries for nominal accounts and ruling and
balancing real accounts.
• Closing entries are entries prepared at the end of
the accounting period to “zero out” all temporary
or nominal accounts in the ledger. This is done so
that the transactions in a period will not commingle
 with the next period’s transactions. Closing the
books is an application of the periodicity concepts.

Post-closing trial balance - is prepared in order to

prove the equality of debits and credits in the ledger after
the closing process. It contains statement of financial
position accounts only because all income statement
accounts are closed. The post-closing trial balance
contains the balances that are extended to the next
accounting period.

Reversing entries
• Are entries usually made on the first day of the
accounting period to reverse certain adjusting
entries in the immediately preceding period.
• The following are the purposes of reversing entries:
1. To facilitate recording of cash receipts and
disbursements in the next accounting period;
2. To promote convenience in recording the next
period’s year-end adjustments for accruals; and
3. To promote consistency of accounting
procedure.

Adjusting entries that may be reversed

• Not all adjusting entries may be reversed. Only the
adjusting entries made for the following may be
reversed:
a. Accrual for income or expense
b. Prepayments initially recorded using the
expense method
c. Advanced collections initially recorded using
the income method
• Entities normally use the income method and
expense method in recording cash receipts and cash
disbursements, respectively. When these methods
are used, special consideration should be given
when determining adjusting entries because
adjusting entries may vary depending on whether an
entity prepares reversing entries or not.