Accounting Fundamental: BY: Bayani D. Edlagan Ma. Cecilia S. Mercado

ACCOUNTING
FUNDAMENTAL
BY:
Bayani D. Edlagan
Ma. Cecilia S. Mercado

INTRODUCTION

This presentation covers the concepts and practice of
accounting fundamental. From the concepts and information
about accounting up to the accounting cycle, which includes
journalizing, reversing and closing entries. Accounting is a
profession similar to medicine and law. Such profession
continually evolve and change as society and the needs of
society change.
The objective of this presentation is to make people
aware of how accounting works in relation to business and
also how can it be helpful even in a simple way of living.
This also emphasized the importance of accounting in any
types of business. Little by little, you will be able to
understand how accounting works and you will realize its
significance to our daily living.
This presentation is based on the book of Bayani D.
Edlagan and Ma. Cecilia S. Mercado, Accounting
Fundamental.

CHAPTER 1
Introduction to Accounting
Concepts and Practice
CHARACTERISTICS OF ACCOUNTING
INFORMATION
Accounting information is composed principally
of financial data about business transactions,
expressed in terms of money. The mere records
of transactions are of little use in making
informed judgments and decisions. The
recorded data must be sorted and summarized
before significant reports and analyses can be
prepared.
The basic raw materials of accounting are
composed of business transaction data. Its
primary end products are composed of various
summaries, analyses, and reports.
USERS OF ACCOUNTING INFORMATION
Accounting provides the techniques for accumulating
and the language for communicating economic data
to various categories of individuals and institutions.
Investors in a business enterprise need information
about its financial status and its future prospects. The
government agencies are concerned with the financial
activities of business organizations for purposes of
taxation and regulation.
The individuals most dependent upon and most
involved with the end products of accounting are
those charged with the responsibility for directing the
operations of enterprises.
USERS OF ACCOUNTING INFORMATION
For example, in the conduct of day-to-day operations,
management relies upon accounting to provide the
amount owed to each creditor and by each customer
and the date each payment is due.
The relevant information for one category of users
may differ markedly from that needed by other users.
Once the user groups are identified, however, and the
nature of the relevant data determined, the accountant
is able to establish an information network to assist
each group in forming judgments and making
decisions regarding future actions.

RELATIONSHIP OF ACCOUNTING TO
OTHER FIELDS
Everyone engaged in business activities, from the
youngest employee to the manager and owner, comes
into contact with accounting. The higher the level of
authority and responsibility, the greater is the need
for an understanding of accounting concepts and
terminology.
The importance of understanding accounting is not
limited to the business world. Many employees with
specialized training in non-business areas also make
use of accounting data and should understand
accounting principles and terminology.
PROFESSION OF ACCOUNTANCY
Accountancy is a profession with stature comparable to that of
engineering or law. The rapid development of accounting
theory and technique during the current century has been
accompanied by an expansion of the career opportunities in
accounting and an increasing number of professionally trained
accountants.
Accountants who render accounting services on a fee basis,
and staff accountants employed by them, are said to be
engaged in public accounting. Accountants employed by a
particular business enterprise or not-for-profit organization, as
chief accountant, controller, or financial vice-president, are
said to be engaged in private accounting.
PUBLIC ACCOUNTING
The practice of public accounting is generally restricted to
licensed CPAs. Recognizing the need for reliable professional
accounting service, the Philippine Legislature passed the
Accountancy Act in March 1923. This act created the Board of
Accountancy which was given the power among other, to issue
the certificate of Certified Public Accountant, abbreviated as
CPA. In May 1975, The revised Accountancy Law was
released which define the practice of accountancy to include
not only CPAs in public practice, but also those in private
accounting, in government services and in education, and
increased the contents and coverage of subjects in the CPA
examinations.
PUBLIC ACCOUNTING
In Section 10 of the Law, it is provided that: an applicant for
the CPA certificate must be a Filipino citizen (or a citizen of
foreign country granting reciprocal privileges, by law, to
Filipino with respect to the practice of accountancy), of good
moral character and at least twenty one year of age. He/she
must be a holder of a degree of Bachelor of Science in
Commerce or its equivalent from any college or university
recognized by the government.
The CPA candidate is required to successfully pass a written
examination, given by the Board of Accountancy, covering
theory of accounts, business law, taxation, management
advisory services, auditing theory, auditing theory, auditing
problems, practical accounting problem1, problem 2. To
practice public accountancy, CPAs and firms or partnerships,
including partners and staff members must register with the
Professional Regulation Commission, such registration to be
made annually.

PRIVATE ACCOUNTING
The scope of activities and duties of private
accountants varies widely. Private accountants are
frequently called management accountants. If they are
employed by a manufacturing concern, they may be
call industrial or cost accountants. The chief
accountant in a business may be call controller.
Various governmental units and other not-for-profit
organizations also employ accountants.
Internal auditors are accountants who review the
accounting and operating procedures prescribed by
their companies. Accountants who specialize in
internal auditing may be granted the Certified
Internal Auditor (CIA) certificate.
For example, an engineer responsible for selecting
the most desirable solution to a technical
manufacturing problem may consider cost accounting
data to be the decisive factor. Lawyers use accounting
data in tax cases and in lawsuits involving property
ownership and damages from breach of contract.
Governmental agencies rely on accounting data in
evaluating the efficiency of government operations
and for appraising the feasibility of proposed taxation
and spending programs. Accounting plays an
important role in modern society and, broadly
speaking, all citizens are affected by accounting in
some way.

RELATIONSHIP OF ACCOUNTING TO
OTHER FIELDS
SPECIALIZED ACCOUNTING FIELD

FINANCIAL ACCOUNTING
It is concerned with the recording of
transactions for a business enterprise or other
economic unit and the periodic preparation of
various reports from such records. Corporate
enterprise must employ such principles in
preparing their annual reports on profitability
and financial status for their stockholders and
the investing public.

AUDITING
It is a field of activity involving an independent review of
the accounting records. In conducting an audit, public
accountants examine the records supporting financial reports
of an enterprise and express an opinion regarding their fairness
and reliability.
COST ACCOUNTING
It emphasizes the determination and control of costs. It is
concerned primarily with the costs of manufacturing processes
and of manufactured products, but increasing attention is being
given to distribution costs. In addition, one of the principal
functions of cost accountants is to assemble and interpret cost
data, both actual and prospective for the use of management in
controlling current operations and in planning for the future.

MANAGEMENT ACCOUNTING
It employs both historical and estimated data in assisting
management in daily operations and in planning future
operations. It deals with the specific problems that confront
enterprise managers at various organizational levels. The
management accountant is frequently concerned with
identifying alternative courses of action and in helping to
select the best one.
TAX ACCOUNTING
It encompasses the preparation of tax returns and the
consideration of the tax consequences of proposed business
transactions or administrative courses of action. Accountants
specializing in this field, particularly in the area of tax
planning, must be familiar with tax statutes affecting their
employer or clients and also must keep up to date on
administrative regulations and court decisions on tax cases.

ACCOUNTING SYSTEM
It is the special field concerned with the design and
implementation of procedures for the accumulation and
reporting of financial data. The systems accountant must
devise appropriate checks and balances to safeguard
business assets and provide for information flow that will be
efficient and helpful to management.
BUDGETARY ACCOUNTING
It presents the plan of financial operations for a period
and, through records and summaries provides comparisons of
actual operations with the predetermined plans. A combination
of planning and controlling future operations, it is sometimes
concerned to be a part of management accounting.

INTERNATIONAL ACCOUNTING
It is concerned with the special problems associated with
the international trade of multinational business organizations.
Accountants specialized in this area must be familiar with the
influences of customs law, and taxation of various countries
bear on international operations and accounting principles.
NOT-FOR-PROFIT ACCOUNTING
It specializes in recording and reporting the transactions
of various governmental units and other not-for-profit
organizations such as church, charities, and educational
institutions. An essential element in an accounting system that
will insure strict adherence on the part of management to
restrictions and other requirements imposed by law, by other
institutions, or by individual donors.

SOCIAL ACCOUNTING
It is the newest field of accounting and is the
most difficult to describe concisely. One of the
engagement in this field involved measurement of
traffic patterns in a densely populated section of the
nation (like Metro Manila) as part of a government
study to determine the most efficient use of
transportation funds, not only in terms of facilitating
trade but also of assuring a good environment for the
areas residents.
BOOKKEEPING AND ACCOUNTING
BOOKKEEPING is the recording of business data in a
prescribed manner. A bookkeeper may be responsible for
keeping all the records of a business or only a minor segment,
such portion of customer accounts in department store. Much
of the work of the bookkeeper is critical in nature and
increasingly being accomplished through the use of
mechanical and electronic equipment.

ACCOUNTING is primarily concerned with the design of the
system of records, the preparation of reports based on the
recorded data, and the interpretation of the reports.
Accountants often direct and review the work of bookkeeper.
In event, the accountant must possess a much higher level of
knowledge, conceptual understanding, and analytical skill than
is required of the bookkeeper.
BUSINESS ENTITY CONCEPT
The business entity concept is based on identifying the
individual economic units for which economic data are
needed. Once the entity is identified, the accountant can
determine which economic data and activities should be
analyzed, recorded, and summarized in reports. The
business entity concept is based on the applicability of
accounting to individual economic units in society. These
individual economic units include all business enterprises
organized for profit, numerous governmental units, such as
provinces, cities, and towns, other bit-for-profit units like
church and clubs, and individual persons and family units.
The basic economic data for a unit must first be recorded,
followed by analysis and summarization, and finally by
periodic reporting. Thus, accounting applies to each
separate economic unit.
BUSINESS ENTITY CONCEPT
This subject is concerned primarily with the
accounting principles and techniques applicable to
profit making businesses. Such businesses are
customarily organized as a sole proprietorship,
partnerships, or corporations. A sole proprietorship
is owned by one individual. And is owned by two or
more individual in accordance with a contractual
agreement. A corporation, organized in accordance
with the Corporation Law, is a separate legal entity in
which ownership is divided into shares of stock.
ACTIVITIES PERFORMED BY BUSINESS
ORGANIZATION
SERVICE
Companies perform services for a fee.
Example: Accounting firms, law firms, and other service
establishments

MERCHANDISING
Companies purchase goods that are ready for sale and
then sell these goods to customers.

MANUFACTURING
Companies buy raw materials, convert them into another
form of products and the sell the products to other companies
or to final consumers.
BUSINESS TRANSACTIONS
A business transaction is the occurrence of an
event or of a condition that must be recorded.
A particular business transaction may lead to
an event or condition that constitutes another
transaction.
ASSETS, LIABILITIES, AND CAPITAL
The properties owned by a business enterprise are
referred to as assets and the rights or claims to the
properties are referred to as equities. If the assets
owned by the business amount to P1,000,000, the
equities on the assets must also amount to
P1,000,000. The relation between the two may be
stated in the form of an equation, as follows:

Assets = Equities
Equities may be subdivided into two types: the
right of creditors and the rights of owner. The equities
of creditors represents debts of the business and are
called liabilities. The equity of the owners is called
capital or owners equity. Expansion of the equation
to give recognition to the two basic types of equities
yields the following, which is known as the
accounting equation:

Assets = Liabilities + Capital (or Owners Equity)
It is customary to place Liabilities before Capital in
the accounting equation because creditors have preferential
rights to the assets. The residual claim of the owner or owners
is sometimes given greater emphasis by transposing liabilities
to the other side of the equation, yielding:

Asset - Liabilities = Capital

Every business transaction affects the assets, liabilities
and/or capital of the business. However, the changes in these
items are such that the equality of two sides of the accounting
equation is always maintained.
RULES OF DEBIT AND CREDIT
Based on the positions of increases and
decreases in an account for an asset, liability,
or capital item, the rules of debit and credit
may be stated as follows:

TABLE 1.1

DEBIT CREDIT
1. Increase in Assets 1. Decrease in Assets
2. Decrease in Liabilities 2. Increase in Liabilities
3. Decrease in Capital 3. Increase in Capital
a. Withdrawal by the
Owner a. Investment by the Owner
b. Increase in Expenses b. Decrease in Expenses
c. Decrease in Revenue c. Increase in Revenue
TRANSACTIONS AND THE ACCOUNTING
EQUATION
All business transactions, from the simplest to the most
complex, can be stated in terms of the resulting change in the
three basic elements of the accounting equation. Before a
transaction can be recorded in the book of accounts, it must be
analyzed into its debit and credit elements. The following
questions will be helpful in analyzing a business transaction;

Which item (items) is/are affected Assets, Liabilities,
Capital?
How is each item affected it is increased or decreased?
According to the rules of debit and credit, is the increase or the
decrease in the item to be debited or credited?
What account titles should be used to record the debit or
credit item?
DOUBLE ENTRY BOOKKEEPING
Every business transaction has two-fold effect on
the assets, liabilities, and/or capital of the business.
For every debit element, there is a corresponding
credit element. The money values of these two
elements are equal. The manner of recording both the
debit and credit elements of each transaction is
referred to as double-entry bookkeeping. The double-
entry bookkeeping is preferred because it generally
result in more accurate accounting records and
statements. Moreover, it affords numerous checks and
safeguard which reduce to a minimum the chances of
loss through intentional r unintentional errors
committed by personnel.

The effect of these changes on the
accounting equation can be demonstrated by
studying some typical transactions using the
analysis sheet as follows:

Table 1.2

ASSETS LIABILITIES CAPITAL

As the basis of this illustration, assume that
on September 1, 19xx Nick Requijo
establishes a sole proprietorship to be known
as Requijo Taxi. Each transaction or group of
similar transactions during the first month of
operations is described followed by an
illustration of its effect(s) on the accounting
equation and the corresponding two-column
journal entry and explanation of entry for each
give transaction.
TRANSACTION ONE
Nick Requijo deposited P500,000 in a bank
account in the name of Requijo Taxi. The
effect of this transaction is to increase the asset
cash by P500,000 and to increase capital, on
the other side of the equation, by the same
amount. After the transaction, the equation for
Requijo Taxi will appear as follows:

Table 1.3

1
+ Cash
P500,000
+Requijo,
Capital
P500,000
It should be noted that the equation relates
only to the business enterprise. Nick Requijos
personal assets, such as his home, car, his
personal bank account, and his personal
liabilities are excluded from consideration. The
business is treated as a distinct entity, with
cash of P500,000 and the owners equity of
P500,000.

Table 1.4

Date DESCRIPTION
Post
Ref.
Debi
t
Credi
t
Sept. 1 Cash
500,
000
Nick Requijo, Capital
500,0
00

To record investment
of the owner
The explanation of each debit or credit
entry on the journal is based on the rules of
debit and credit. Cash was debited because of
increase in asset while Capital was credited
because of increase in capital due to
investment of the owner.
TRANSACTION TWO
Requijos next transaction on September 5 is to
purchase land as a future building site, for which
P100,000 cash is paid. This transaction changes the
composition of the assets but does not change the
total amount. The items in the equation prior to this
transaction, the effects of this transaction, and the
new balance after the transaction are as follow:

Table 1.5

1.
+ Cash
P500,000
+ Requijo, Capital
P500,000
2.
- Cash
P100,000

+ Land
P100,000

After the transaction, there is a land costing
P100, 000 but the balance is reduced to P400,
000. The total assets composed of cash and
land total to P500, 000. Notice that there is no
change in the liability and capital items.

Table 1.6
Date DESCRIPTION
Post
Ref. Debit Credit
Sept. 5 Land
100,00
0
Cash 100,000

To record purchase
of land for cash
In the transaction recorded, there was a
change in the asset element. Land was debited
because of increase in assets while Cash was
credited because of decrease in assets. The
reason for the debit and credit comes from the
rules of debit and credit.
TRANSACTION THREE
Requijos current plans are to lease cars and other
equipment from California Bus Company for several months
until he can arrange financing for the purchase of cars and
other equipment and for the construction of garage and storage
facilities.
On September 7 Requijo purchases P60, 000 of parts and
other supplies from various suppliers, agreeing to pay in the
near future. This type of transaction is called purchase of
supplies on account and the liability created is termed
accounts payable. Consumable commodities acquired, such
as supplies, are considered to be prepaid expenses. Prepaid
expenses are expenses paid in advance and are classified as
asset.
In actual practice, each purchase would be
considered and recorded as it occurred and a
separated record would be maintained for each
creditor. In this illustration, however, the
purchases are recorded as a group. The effect
is to increase the assets and liabilities by P600,
000, as indicated below:

Table 1.7

1.
+ Cash
P500,000
+ Requijo, Capital
P500,000
2.
- Cash
P100,000

+ Land
P100,000

3.
+ Supplies P
60,000
+ Account Payable
P60,000
After this transaction, the total assets amount to
P560, 000 composed of Cash P400, 000, Land P100,
000, and Supplies P60, 000. The total equity is also
P560, 000 composed of Accounts Payable P60, 000
and Capital of P500, 000. The total of the two
column, debit and credit, still balance.

Table 1.8
Date DESCRIPTION
Post
Ref. Debit Credit
Sept. 7 Supplies
60,00
0
Accounts Payable 60,000

To record purchase of
supplies on account
In the transaction recorded, Supplies (unused) was
debited because of increase in assets while
Accounts Payable is credited because of increase
in liability.
TRANSACTION FOUR
On September 9, P10,000 is paid to
creditors on account, thereby reducing both
assets and liabilities. The effect on the
equation is as follows:

Table 1.9

1.
+ Cash
P500,000
+ Requijo, Capital
P500,000
2.
- Cash
P100,000

+ Land
P100,000

3.
+ Supplies P
60,000
+Account Payable
P60,000
4.
- Cash P
10,000
- Account Payable
P10,000
After this transaction, the total assets amount to
P550, 000 composed of Cash P390, 000, Land P100,
000, and Supplies P60, 000. The total equity is also
P550, 000 composed of Accounts Payable P50, 000
and Capital P500, 000. The equation is still balance.

Table 1.10
Date DESCRIPTION
Post
Ref. Debit Credit
Sept. 9 Accounts Payable
10,
000
Cash 10,000

To record payment of
account
In the transaction recorded, Accounts Payable
was debited because of decrease in liability
while cash was credited because of decrease
in assets.
TRANSACTION FIVE
The principal objective of the owner of a business
enterprise is to increase capital through earnings. For Nick
Requijo, this means that the cash and other assets acquired
through the sale of taxi services must be greater than the cost
of the gasoline and other supplies used, the wages of drivers,
the rent, and all of the other expenses of operating the
business.
In general, the amount charged to customers for goods or
services sold to them is called revenue. Alternative terms may
be used for particular types of revenue, such as sales for the
sale of merchandise or business services, fees earned for
charges by a physician to patients, rent revenue for the use of
real estate or other property, and fares earned for Requijo
Taxi.
In a broad sense, the amount of assets consumed or
services used in the process of earning revenue is called
expense. Expenses would include supplies used, salaries and
wages of employees, and other assets and services used in
operating the business.

The excess of the revenue over the expenses incurred in
earning the revenue is called net income or net profit. If the
expenses of the enterprise exceed the revenue, the excess is a
net loss. Since it is ordinarily impossible to determine the
exact amount of expense incurred in connection with each
revenue transactions, it is considered satisfactory to determine
the net income or the net loss for a specified period of time,
such as a month, or a quarter, a semester, or a year, rather than
each of small group of sales.
During the first month of operations Requijo Taxi
earned fares of P150, 000, receiving the amount in
cash. The total effect of these transactions is to
increase cash by P150, 000 and to yield revenue in
the same amount. The revenue can be viewed as
though it affected a P150, 000 increases in capital.
At the time expenses of the business are incurred,
they are treated as offsets against revenue and hence
as reduction in capital. In terms of the accounting
equation, the effect of the receipt of cash for services
performed follows:

Table 1.11
1.
+ Cash
P500,000
+ Requijo, Capital
P500,000
2.
- Cash
P100,000

+ Land
P100,000

3.
+ Supplies P
60,000
+Account Payable
P60,000
4.
- Cash P
10,000
- Account Payable
P10,000
5.
+ Cash
P150,000
+ Fares Earned
P150,000
After this transaction, the total assets amount to P700, 000 composed
of Cash P540, 000, Land P100, 000, and Supplies P60, 000. The total
equities are also P700, 000 composed of Accounts Payable P50, 000 and
Capital of P650, 000 (including the fare earned).
Instead of requiring payment of cash at the time goods or services are
sold or rendered, a business may make sales of goods or services on
account, allowing customer to pay later. In such cases, the business
acquires a claim against the customer, called an account receivable. An
account receivable is as much an asset as cash, and the revenue is realized
in exactly the same manner as if cash had been immediately received. At a
later date, when the money is collected, there is only an exchange of one
asset for another, with cash increasing and accounts receivable decreasing.

In the transaction recorded, Cash was debited because of increase in assets
while Fares Earned was credited because of increase in capital due to
increase in revenue.
Table 1.12

Date DESCRIPTION
Post
Ref. Debit Credit
Sept. 30 Cash
150,0
00
Fares Earned
150,00
0

To record receipt of revenue
from various customer.
TRANSACTION SIX
Various business expenses incurred and paid
during the month were as follow: wages, P40, 000;
rent, P20, 000; gas and oil, P50, 000; miscellaneous
expenses, P10, 000. The effect of this group of
transaction is to reduce cash and to reduce capital, as
indicated in the following manner in the equation:

Table 1.13

1. + Cash P500,000
+ Requijo, Capital
P500,000
2.
- Cash P100,000

+ Land P100,000
3. + Supplies P 60,000
+Account Payable
P60,000
4. - Cash P 10,000
- Account Payable
P10,000
5. + Cash P150,000
+ Fares Earned
P150,000
6. - Cash P120,000
- Wages Expense P
40,000

- Rent Expense P
20,000

- Gas & Oil P
50,000

- Misc. Expense P
10,000
After this transaction, the total asset
amount to P580, 000 composed of Cash P420,
000, Land P100, 000, and Supplies of P60,
000. The total equities are also P580, 000
composed of Accounts Payable P50, 000 and
Capital of P530, 000. It should be remembered
that revenue and expense accounts are
temporary capital accounts; these items are
closed to capital at the end of the accounting
period.
Table 1.14

Date DESCRIPTION
Post
Ref. Debit Credit
Sept. 30 Wages Expense
40,00
0
Rent Expense
20,00
0
Gas and Oil Expense
50,00
0
Miscellaneous Expense
10,00
0
Cash
120,00
0

expenses.

In the transaction recorded, Wages
Expense, Rent Expense, Gas and Oil
Expense, Miscellaneous Expense were
debited because of decrease in capital due to
increase in expenses while cash was credited
because of decrease in assets.
TRANSACTION SEVEN
At the end of the month it is determined that the cost of
supplies on hand is P40, 000, the remainder of P20, 000 (P60,
000- P40, 000) have been used in the operations of the
business. This deduction of P20, 000 in supplies and capital
may be shown as follows:

After this transaction, the total assets amount to P560, 000
composed of Cash P420, 000, Land P100, 000, and Supplies of
only P40, 000. The total equities are also P560, 000 composed
of Accounts Payable of P50, 000 and Capital of P510, 000.
Table 1.15

1. + Cash P500,000 + Requijo, Capital P500,000
2.
- Cash P100,000

+ Land P100,000
3. + Supplies P 60,000 +Account Payable P60,000
4. - Cash P 10,000 - Account Payable P10,000
5. + Cash P150,000 + Fares Earned P150,000
6. - Cash P120,000 -Wages Expense P 40,000
-Rent Expense P 20,000
-Gas & Oil P 50,000
-Misc. Expense P 10,000
7. - Supplies P20,000 -Supplies Expense P20,000
Table 1.16

Date Particulars Debit Credit
Supplies Expense P20,000
Supplies P20,000

To record part of the
supplies used in the
operation of the business
Date DESCRIPTION
Post
Ref. Debit Credit
Sept. 30 Supplies Expense 20,000
Supplies 20,000

To record part of
supplies in the operation of
the business
In the transaction recorded, Supplies Expense was
debited because of decrease in capital due to increase
in expenses while Supplies (Unused) was credited
because of decrease in assets. Note to Students The
terms unused, unexpired, inventory, and
prepaid denote asset.
TRANSACTION EIGHT
At the end of the month, Nick Requijo withdraws from the business
P20, 000 in cash for his personnel use. This transaction, which affects a
decrease in cash and a decrease in capital, is the exact opposite of an
investment in the business by the owner. The withdrawal is not a
business expense, and it should be excluded from consideration in
determining the net income from operations of the enterprise. The
effect of the P20, 000 withdrawals on the equation is as follows:

After this transaction, the total assets amount to P540, 000 composed
of Cash P400, 000, Land P100, 000, and Supplies of P40, 000. The total
equities are also P540, 000 composed of Accounts Payable P50, 000 and
Capital P490, 000.
Table 1.17
1. + Cash P500,000 + Requijo, Capital P500,000
2.
- Cash P100,000

+ Land P100,000
3. + Supplies P 60,000 +Account Payable P60,000
4. - Cash P 10,000 - Account Payable P10,000
5. + Cash P150,000 + Fares Earned P150,000
6. - Cash P120,000 -Wages Expense P 40,000
-Rent Expense P 20,000
-Gas & Oil P 50,000
-Misc. Expense P 10,000
7. - Supplies P20,000 -Supplies Expense P20,000
8. - Cash P20,000 -Requijo, Drawing P20,000
Table 1.18

.
Date DESCRIPTION
Post
Ref. Debit Credit
Sept. 30 Requijo, Drawing 20,000
Cash 20,000

To record withdrawal of
owner.
In the transaction recorded, Requijo, Drawing was
debited because of decrease of capital due to
withdrawal and cash was credited because of
decreases in assets
SUMMARY
The business transactions of Requijo Taxi are summarized in
tabular form below. The transactions are identified by
transaction numbers and the balance of each item is shown
after each transaction. The following observations, which
apply to all types of businesses, should be noted:
The effect of every transaction can be stated in terms of
increases and/or decreases in one or more of the accounting
elements.
The equality of the two sides o the accounting equation is
always maintained.

Table 1.19
ACCOUNTING STATEMENTS
BALANCE SHEET
A kind of financial statement that list the assets, liabilities, and capital
of a business entity as of a specific dated, usually at the close of the last day
of a month or of a year. It is a kind of financial statement that shows the
financial position of the business entity as of a given date, usually the end
of the year.

The amount of Requio Taxis assets, liabilities, and capital at the end
of the first month of operation appears on the last line of the summary in
the preceding page. Minor arrangements of these data and the addition of a
heading yield the balance sheet illustrated below. This form of balance
sheet, with the liability and capital section presented below the asset
section, is called the report form. Another arrangement in common use
lists the assets on the left and the liabilities and capital on the right.
Because of its similarity to the account, a basic accounting device described
earlier in the chapter, it is referred to as the account form of the balance
sheet.
Requijo Taxi
Balance Sheet
September 30, 19xx

Assets
Cash P400, 000
Supplies 40, 000
Land 100, 000
Total Assets P540, 000
Liabilities
Accounts Payable P 50, 000
Capital
Capital 490, 000
Total Liabilities and Capital P540, 000
It is customary to begin the asset section with cash, which
is followed by receivables, inventory (for trading business),
supplies, prepaid expense items, and other assets that will be
converted into cash or consumed in the near future. The assets
of a relatively permanent nature, such as land, buildings, and
equipment, follow in that order. Note that in the balance sheet
presented the total assets and the total of liability and capital
are equal.
The balance sheet shows the liquidity (solvency) and
stability of as enterprise. Solvency refers to the ability of the
business to pay currently maturing liabilities while stability
refers to the ability of the enterprise to pay maturing
obligations and give return on the investment of the owner(s).
In the liabilities and capital section of the
balance sheet, it is customary to present the
liabilities first followed by capital. In the
illustration for Requijo Taxi the liabilities are
composed entirely of accounts payable. When
there are two or more categories of liabilities,
each should be listed and the total amount of
liabilities presented in the following manner:
Liabilities
Accounts Payable P150, 000
Notes Payable 50, 000
Salaries Payable 6, 000
Total Liabilities P206, 000
INCOME STATEMENT
A kind of financial statement that shows the summary of
the revenue and the expenses of a business entity for a specific
period of time, such as a month or a year. It is a kind of
financial statement that shows result of business operations for
a period of time, usually a year.

Revenue earned and expenses incurred during the month
were recorded in the equation as increases and decreases in
capital, respectively. The details together with net income in
the amount of P10, 000, are reported in the income statement
presented below.
Requio Taxi
Income Statement
For the Month Ended September 30, 19xx
Fares Earned P150, 000
Operating Expenses
Gas & Oil Expense P 50, 000
Wages Expense 40, 000
Rent Expense 20, 000
Supplies Expense 20, 000
Miscellaneous Expense 10, 000
Total Operating Expenses 140,000

Net Income P 10, 000

The order in which the operating expenses are presented
in the income statement varies among businesses. One of the
arrangements commonly followed is to list them in the order
of size, beginning with the larger items. Miscellaneous
expenses is usually shown as the last item regardless of the
amount.
In the income statement, users will know if the operation
of the business is profitable. Profitability refers to the ability
of the business to increase owners capital. If the total net asset
inflow is more than the net asset outflow, the resulting effect is
net income. If the net asset outflow is more than the net asset
inflow, it is a net loss.
CAPITAL STATEMENT (Statement of Owners Equity)
It is a statement that shows the summary of the changes in
capital of a business entity that have occurred during a
specific period of time, such a month or a year.
Comparison of the original investment of P500, 000 at the
beginning of the month with the P490, 000 of capital reported
in the balance sheet at the end of the month reveals a decrease
of P10, 000. This net decrease is composed of two significant
changes in capital that occurred during the period: (1) the net
income of P10, 000, and (2) a withdrawal of P20, 000 by the
owner. This information is presented in the capital statement,
which serves as a connecting link between the balance sheet
and the income statement.
Requijo Taxi
Capital Statement

Capital, September 1, 19xx P500, 000
Net Income P10, 000
Withdrawal 20, 000
Decrease in Capital 10, 000
Capital, September 30, 19xx P490, 000

Basically, there are two accounting period,
the calendar year and the fiscal year. A
calendar year is a twelve-month period that
ends on December 31 while the fiscal year is a
twelve-month period that ends at the end of
any month other than December. In the
Philippines, only partnership and corporation
are allowed to use fiscal year, single
proprietorship is allowed only to use
calendar year.
STATEMENT OF CASH FLOWS
The statement of cash flows consists of three sections: (1)
operating activities, (2) financing activities, and (3) investing
activities. Each of these sections is described below:

Cash Flows form Operating Activities
This section reports a summary of cash receipts and cash
payments from operations. The net cash flow from operating
activities will normally differ from the amount of net income
for the period. This difference occurs because revenues and
expenses may not be recorded at the same time that cash is
received from customers and cash is paid to creditors.
Cash Flows from Financing Activities
This section reports the cash transactions related to cash
investments by the owner, borrowing, and cash withdrawals by
the owner.

Cash Flow from Investing Activities

This section reports the cash transactions for the acquisition
and sale of relatively long-term or permanent-type assets.

The preparation of the statement of cash flow is required by
pronouncement, every year that the income statement is
presented. Preparing the statement of cash flows requires an
understanding of concepts that we will not discuss in the chapter.
But a simple illustration will be given to be able to illustrate how
statement of cash flow is prepared.
Requijo Taxi
Statement of Cash Flows
Cash Flows from Operating Activities:
Net Income P10, 000
Add: Increase in Supplies 40, 000
Total P50, 000
Less: Increase in Accounts Payable 50, 000

Cash from Operating Activities P 0

Cash Flows from financing Activities
Investment of Owner 500, 000

Cash Flows from Investing Activities
Acquisition of Land (100, 000)
Increase in Cash P400, 000
CHAPTER 2
The Accounting Cycle
THE ACCOUNTING CYCLE
The double entry accounting system provides
a basic framework for the analysis of business
activities. Now we wish to go into greater detail
about the accounting procedures used to account
for the operations of a business during a specific
period. The accounting procedures of most
businesses involve certain basic steps that are
accomplished in a given order. This sequence of
operations is known as the accounting cycle.
THE ACCOUNTING CYCLE
The steps of the accounting cycle are listed below:

1. Gather documents and analyze transactions from source
documents.
2. Record transactions in journals.
3. Post journal entries to general ledger accounts.
4. Prepare a trial balance.
5. Prepare adjusting entries and adjust the general ledger
accounts.
6. Prepare financial statements.
7. Journalize closing entries.
8. Prepare post-closing trial balance.
9. Journalize reversing entries.
The annual period adopted by a business
enterprise is known as fiscal year. Business
enterprises whose fiscal year ends in
December are said to be on a calendar-year
basis. Many enterprises prefer to have their
accounting year coincide with their natural
business year; that is, the fiscal year ends
when business is slow and inventory quantities
are small and easy to count.
STEP 1
ANALYZING TRANSACTIONS FROM SOURCE
DOCUMENTS
Source documents are printed or written forms
that generate when the enterprise engages in business
transactions. Even a brief source document usually
specifies the peso amount involved, the date of
transaction, and possibly the party dealing with the
enterprise. Some examples of source documents are
(1) a purchase or sellers invoice showing evidence of
a purchase of merchandise (or supplies) on account,
(2) a bank check indicating the payment of obligation,
(3) a deposit slip showing the amount of funds turned
over to the bank, (4) a cash receipt indicating funds
received from a customer, and (5) a cash register tape
listing a days over-the-counter sales to customers.
BUSINESS PAPERS
All business transactions are evidenced
supported by printed forms or documents,
called business papers. These business papers
furnish the information needed in recording
business transactions. Without business
papers, it would be difficult to keep accurate
record of business transactions. The following
are good example of business papers
commonly used in a business:
BUSINESS PAPERS
1. Sales or Service I nvoice after the sale of goods of service
has taken place, a business form called invoice is prepared.
The invoice shows the date of sale/service rendered, list of the
articles sold or list of services rendered, and other information.
Invoices are prenumbered and usually made out in triplicate or
quadruplicate depending upon the need of the business. The
original of the invoice is given to the buyer of goods or
services.
In a merchandising business, from the point of vies of the
seller, the invoice is called sales invoice; from the point of
view of the buyer, it is a purchase invoice. The sample of an
invoice is given below.

Table 2.1
BUSINESS PAPERS
2. Official Receipt official receipt are issued every
time the business receives cash. The receipt shows the
date on which the cash is received, the party from
whom the cash is received, the amount of cash
received, the explanation of the transaction, and the
signature of the personnel who issued the receipt.

Table 2.2
BUSINESS PAPERS
3. Statement of Accounts many business like
Meralco, P.L.D.T., M.W.S.S., SMART
Communication, Inc., and others send bills to their
customers to inform them of the amount they have to
pay. Thus, there are electric bills, light bills, water
bills, telephone bills, and many others. These bills
sent by these companies are called Statement of
Account. A sample of statement of account is given
below.

Table 2.3

BUSINESS PAPERS
4. Deposit Slip at present, many businesses have
current account or checking accounts with the banks.
They deposit their money in the bank and the
payment from their deposit are made by means of
issuing checks.
Deposit slip is filled up every time money is
deposited in the bank. The deposit slip shows the date
of the deposit , the name if the depositor, the account
number of the depositor, the amount of cash
deposited, and the signature of the depositor.

BUSINESS PAPERS
5. Check a check is an order to the bank signed
by the person issuing it (the depositor), to pay
the bearer or order a certain sum of money.
After the bank have paid the payee, the amount
is deducted from the deposit of the person who
issued the check.
BUSINESS PAPERS
6. Cash Voucher the cash voucher is the document
prepared every time payment of an obligation is
made. The voucher is a business preprinted form that
is prenumbered, and should include the following
information; date of payment, name of the payee,
address of the payee, description of the obligation to
be paid, amount paid, approval of payment\, and
signature of the payee. A sample of cash voucher is
presented below.

Table 2.4
BUSINESS PAPERS
7. Cash Register Slip in many businesses, like in restaurants, cash registers
are used. Strip of paper comes out as evidence of the money received by
the cashier. The slip shows the date, items ordered, amount paid, and other
information.
8. Other Business papers there are many other documents that are used by
accountant to obtain information regarding business transactions. When
buyer/customer is given allowance, returned the goods purchased, or
discovered error in the invoice, the seller of the goods or services should be
notified. If the claim is valid, the seller of goods or services sends a credit
memorandum which shows the amount by which account is reduced.
When the depositor obtains a checkbook from the bank and the depositor
did not pay it, the bank charges the depositor a debit memorandum.
Promissory Notes may be received by the business from its debtors, or the
business may give it to its creditors. A promissory note is a written promise
to pay signed by one party, called the maker, to pay a certain specified sum
to another. The note may or may not be interest bearing. The amount to be
paid not including the interest, is called the face of the note. The amount to
be paid including the interest is called the maturity value.
STEP 2
JOURNALIZING
Journalizing is the process of recording
business transactions to the book of original
entry called journals. Journals, or records of
original entry, are tabular records in which
business activities are analyzed in terms of
debits and credits and recorded in
chronological order before they are entered in
the general ledger. An accounting journal may
be one of a group of special journals, or it may
be a general journal.
STEP 2
JOURNALIZING
A special journal is designed to record a specific
type of frequently occurring business transactions.
For example, a business with 100 employees who are
paid every two weeks would probably use a special
journal for payrolls. Because two paydays would
normally occur in a month, at least 200 payroll
transaction would be recorded. Special journals are
used to facilitate the recording of business
transactions in the book of accounts. Other types of
transactions that are often recorded in special journals
are cash receipts, cash disbursements, sales of goods
or services, and purchases of goods or services.
STEP 2
JOURNALIZING
In contrast to the special journals, the
general journals (two-column journal) is a
relatively simple record in which any type of
business transaction may be recorded. All
businesses, even those using many special
journals, have a general journal. Transactions
that do not occur often enough to warrant
entry in a special journal are recorded in the
general journal.
STEP 2
JOURNALIZING
The procedure for recording entries in the general journal is as
follows:
Indicate the year, month, and date of the entry. Usually the
year and month are rewritten only at the top of each journal
or at the point where they change.
Enter titles of the accounts affected in the description
column. Accounts debited are entered close to the left-hand
margin and are traditionally recorded first. Accounts
credited are then recorded, indented one-half inch to the
right.
Place the appropriate money amounts in the left-hand
(debit) and right (credit) money columns.
Write an explanation of the transaction below the account
titles, indented one-half inch from margin. The explanation
should be as brief as possible, disclosing the information
necessary to understand the event being recorded.

STEP 2
JOURNALIZING
Each transaction entered in the journal should
stated in terms of equal debits and credits. The
account titles cited in the description column should
correspond to those used for the related general
ledger accounts. To separate clearly the various
entries, we should leave a line blank between entries.
We will explain the use of the column headed Post
Ref. (posting reference) later in step 3 of the
accounting cycle.

Table 2.5
STEP 2
JOURNALIZING
Compound Journal Entries
A journal entry that involves more than just two
accounts is called a compound entry. The last
journal entry in Exhibit 1-2 is an example of
compound journal entry involving three accounts.
The debit of P9,600 to Test Equipment is offset by
credits of P5,000 to Cash and P4,600 to Accounts
Payable. Any number of accounts may appear in a
compound entry; but regardless of how many
accounts are used, the total of the debit amounts must
always equal the total of the credit amounts.
STEP 2
JOURNALIZING
Correction of Journal Errors
Certain procedures should be followed when errors are
found in journal entries. Errors should not be erased, because
erasures completely remove the original recording. As you
might imagine, the acceptance of erasures might allow
someone to falsify accounting records; consequently, other
procedures are used.
If an error journal entry has not been transferred to the
general ledger, a single line is drawn through the erroneous
amount or accounts title, and the correction is entered on the
same line just above the error. Often the person correcting the
entry must place his or her initials near the correction. This
facilitated any further inquiry about the nature of or reason for
the correction. Once an erroneous journal entry has been
transferred to the ledger accounts, both records contain error.
The recommended procedures for correcting this situation are
discussed in step 3 below.
STEP 3
POSTING TO THE LEDGER
After transactions have been journalized, the next
step in the accounting cycle is to transfer the debits
and credits in each journal entry to the appropriate
general ledger accounts. Thus, data from the journal
that stresses the total of particular transaction (such as
collection of accounts receivable) are transcribed to a
ledger that stresses the total effect of many business
transactions on a particular business variable (such as
cash, accounts receivable, and so on). This type of
data is specifically needed for the preparation of
financial statements.
STEP 3
Posting References
It is important to be able to trace any entry in a ledger
account to the journal from which it was posted.
Consequently, accounting records use a system of references.
Both journals and accounts have posting reference columns.
Entries in the posting reference columns of journals
indicate the account to which the related debit and credit
has been posted. Posting references appearing in ledger
accounts identify the journal from which the related entry
was recorded. The posting references in the journals and
ledger accounts are entered when the journal entries are posted
to the ledger accounts.
STEP 3
Chart of Accounts
A chart of accounts is usually prepared in order to
facilitate the analysis of activities and the formulation of
journal entries. The chart of accounts is a list of the titles and
numbers of all accounts found in the general ledger. The
account titles should be grouped by, and in order of, the five
major sections of the general ledger (assets, liabilities, owners
equity, revenue, and expenses). Exhibit 1-3 shows a chart of
accounts for Dalay TV Service, indicating the account
numbers that will now be used.

Table 2.6
STEP 3
Illustration Of Posting. Exhibit 1-4 of Dalay TV Services December
transactions from the general journal to the ledger accounts. Each debit
entry is posted as follows:

The date (year, month, and day) is entered in the appropriate account.
Note that this is the date of the journal entry, not necessarily the date of
the actual posting. As with journals, the year and month are restated
only at the top of a new accounts page or at the point where they
change.
The amount is entered in the account as a debit or a credit, as indicated
in the journals money columns, and the new balance is calculated.
The posting reference from the journal (both symbol and page number)
is placed in the posting reference column of the ledger account.
The account number is placed in the posting reference column of the
journal.

STEP 3
Regardless of the type of journals or the number of entries
involved, the total debit posted should equal the total credit
posted. Exhibit 1-4 (see following pages) is a comprehensive
illustration of the journalizing and posting of the December
transactions of Dalay TV Service. You should review each
transaction in the illustration form.

the nature of the transaction
the related journal entry, and
the subsequent postings.
Bear in mind that the account numbers in the posting
reference of the journal are not entered when the journal
entry in recorded; they are inserted when the entry is
posted.

Table 2.7
STEP 3
The foregoing should have been noted in the
illustration; in every entry in the journal the debit
amount equal the credit amount. Debit amount in the
journal are posted to the debit side of the
corresponding accounts in the general ledger. In like
manner, credit amounts in the journal are posted to
the credit side of the corresponding accounts in the
general ledger. Therefore, it follows that the sum of
the debit amounts and that of the credit amounts
would also be equal in the ledger.
STEP 3
Correction Erroneous Postings
Even the most carefully kept accounts will occasionally
contain posting errors. An error involving only the wrong
amount being posted may be corrected by drawing a line
through the incorrect amount, entering the correct amount
above, and initialing the correction. When an amount has been
posted to the wrong account, however, the correction should
be made with a journal entry. Some common errors are as
follows: transposition (transfer of position) which means that
there was a change in the position of numbers, e.g. 936 was
written as 396; slide (transplacement) which means that the
decimal point was placed in wrong position, e.g. 10,000 was
written as 1,000 or 100,000. more detailed discussion on this
matter is provided in the section of adjusting entry.
STEP 4
PREPARATION OF A TRIAL BALANCE
After the journal entries have been posted to the general
ledger accounts, a trial balance is prepared from the general
ledger. Periodically, a test of the equality of the debit amounts
and credit amounts in the general ledger is made. The test is
known as the trial balance. It is usually prepared at the end of
a month, a quarter, a semester, or a year.
Preparatory to the setting of the trial balance, each general ledger
account with more than one entry on either side is footed.
Pencil footing means that the temporary total of the amounts
of each side of the account is taken. Each of the debit totals
and credit totals of the accounts are written (in pencil) just
below the last entry on the particular side. This facilitate the
determination of the account balance after transactions have
been posted. Accounts with only one entry on either side need
not be footed.
STEP 4
Open and Closed Accounts
The difference between a debit total and a
credit total of an account is called account
balance. When the debit total and credit total
of an account are not equal, the account is said
to be an open account (with balance). When
the debit total and credit total of an account are
equal, the account is said to be, closed account
( without balance).
STEP 4
Types of Trial Balance
Trial balance could either be trial balance of totals or trial
balance of balances. The trial balance of totals is a list of all
accounts (that have entry, whether open or closed) in the general
ledger with their total debit amounts and total credit amounts. For
this reason, it is called trial balance of totals. The trial balance of
balances is a list of the open accounts in the general ledger and their
balances. Only open accounts are included when preparing trial
balance of balances, closed accounts are excluded. The
conventional way is the preparation of trial balance of balances
rather than the trail balance of totals. This type of trial balance is
commonly used because it gives the detailed information needed in
the other steps of the accounting cycle.
The preparation of the trial balance is more of a check on the
arithmetical accuracy of the accounting records rather than an
absolute guarantee that all generally accepted accounting principles,
practices, and procedures have been complied accurately.
STEP 4
Steps in Preparing Trial Balance
Prepare the trial balance in a two-column journal. Heading
should be written on top of the page. The heading shows the
name of the business on the first line. Trial balance on the
second line, and the date on the third line. Each line of the
heading must be centered on the page.
Write the title of each open account on the Account Titles
column. If the account has a debit balance, write the
balance in the debit column of the trial balance. If it has a
credit balance, write the balance on the credit amount
column. All the account titles in the trial balance are written
with the same margin from the left side of the page, that is,
credit account titles should not be indented.
Add each amount column to prove that the two totals are
equal.
If the two totals are equal, draw lines under the totals.

STEP 4
The trial balance of the Dalay TV Service at
December 31 is shown in Exhibit 1-5. showing all the
general ledger account balances in one report, as is
done in this trial balance, makes it easier to review
the accounts and determine which account balances
need to be adjusted before preparing the financial
statements.

Table 2.8

CHAPTER 3
Adjusting Entries and the Preparation of the
Financial Statements
Adjusting Entries and the Preparation of the
Financial Statements
Before the books of accounts are adjusted at the
end of the accounting period, the accounts may be
classified into real, nominal, and mixed. Real
accounts are the asset, liability, and the capital
accounts. Nominal accounts are the expense and
income accounts. Mixed accounts are those which
contain both real and nominal elements and which are
adjusted at the end of the period so that their balances
become either purely real or purely nominal. Thus,
after the accounts have been adjusted, only real and
nominal accounts exist; the real and nominal elements
contained in the mixed accounts have been recorded
in separate accounts.
STEP 5: GATHERING DATA TO ADJUST THE
ACCOUNTS AND PREPARATION OF A
WORKSHEET
ADJUSTING ENTRIES UNDER THE ACCRUAL BASIS OF
ACCOUNTING
The extent and nature of adjusting entries depend on the
basis on which the books are kept by the enterprise. There are
generally two methods of keeping accounting records; the cash
basis and the accrual basis. Under the cash basis of
accounting revenues are recognized as expense on the period
of payment. In the accrual basis of account, revenues are
recognized are recognized as income on the period that
revenue is earned not in the period of collection, while
expenses are recognized as expense on the period that it was
incurred not on the period of payment.
STEP 5: GATHERING DATA TO ADJUST THE
ACCOUNTS AND PREPARATION OF A
WORKSHEET
The application of the accrual basis of accounting
necessitates adjusting entries for the following
seven items:
Doubtful Accounts
Depreciation
Accrued Expenses
Accrued Revenue
Prepaid Expenses
Unearned Revenue (Deferred Revenue)
Ending Merchandise Inventory
DOUBTFUL ACCOUNT
DOUBTFUL ACCOUNTS
When a business allows customers to avail services on
credit, it maybe inevitable that some of the receivables will
not be collected. The loss which is a result of worthless or
bad accounts is referred to as doubtful accounts expense. For
proper income measurement, it is important that a provision
for the uncollectible accounts be provided during the same
period that the income from services is recognized. This
produces a better matching of revenues and expenses and,
therefore, a better income measurement procedure. Using
this procedure, operations are charged with estimated
expenses, and receivables are reduced by means of a contra
asset account Allowance for Doubtful Accounts.
DOUBTFUL ACCOUNT
The provision for doubtful accounts is
based on estimate and is computed usually as a
percentage of credit revenues or as a
percentage of outstanding accounts
receivable. The purposes of the adjustment
are: (1) to record the doubtful account expense
during the same period that the related revenue
is recognized, and (2) to report the accounts
receivable at the approximate collectible
amount.
DOUBTFUL ACCOUNT
ADJUSTING ENTRY FOR DOUBTFUL ACCOUNTS
The pro-forma adjusting journal entry for the
estimated loss on uncollectible account is:

Table 3.1

To illustrate, let us assume the following data as part of the
trial balance of an enterprise rendering repair services for
home appliances:

Table 3.2
DOUBTFUL ACCOUNT
Percentage Revenue
Assume it was provided that the expected
uncollectible account during the year would be
equal to 1% of the Service Income earned
during the period, the adjusting entry for
doubtful accounts would be:

Table 3.3
DOUBTFUL ACCOUNT
Percentage Receivable
When the provision for doubtful accounts is
based on percentage of receivable, it may based on
the following estimates of computation: (1) allowance
for doubtful accounts increased (decreased) by
percentage of outstanding receivable, or (2)
allowance for doubtful accounts increased
(decreased) to percentage of outstanding receivable.
It should be noted that the difference of the two
methods is only the words by and to, but it should be
remembered because it makes a lot of difference.
DOUBTFUL ACCOUNT
Allowance for Doubtful Accounts Increased BY percentage of
receivable
Assume that it was agreed that the allowance for doubtful
accounts will be increased by 1% of the outstanding receivable.
The adjusting journal entry will be:

Table 3.4

Note that if the allowance for doubtful accounts will be
increased by percentage of receivable, the doubtful
accounts expense is computed by multiplying the
receivable by the given percentage.
DOUBTFUL ACCOUNT
Allowance for Doubtful Accounts Increase
TO percentage of receivable
Assume that it was agreed that the
allowance for doubtful accounts will be
increased to 1% of the outstanding receivable.
The adjusting journal entry will be:

Table 3.5
DOUBTFUL ACCOUNT
Computation:
Balance after adjustment (P50,000 x 1%) P500
Less: Balance before adjustment 200
Amount of adjustment for Doubtful Accounts 300

Note that if the allowance for doubtful account will be
increased to percentage of receivable, the doubtful account
expense is computed by multiplying the receivable by the
given percentage to compute for the desired balance of the
allowance after adjustment, then the balance before the
adjustment is deducted from it to arrive at the amount of
doubtful accounts to be provided.
DEPRECIATION
DEPRECIATION
When the business entity acquired tangible fixed assets such as
delivery equipment, furniture, computer, machines, building, and other
long-life assets, it is basically paying in advance for the usefulness of
such asset. These assets help generate revenue for the entity. Each
accounting period in which such assets are used should share a portion
of their cost as expense. Proper accounting requires the systematic
allocation (assignment) of the cost of the assets over its estimated useful
life. Depreciation is the assignment of part of the cost of the asset over
the period it was used to properly match the revenue and cost of that
period.

The following three factors are considered in the computation of depreciation:
Cost of the fixed asset
The estimated useful life
The estimated scrap value of the asset

Table 3.6
Date DESCRIPTION
Post
Ref. Debit
Credi
t
19xx
Dec. 31
Depreciation Expense-Name
of Asset xxx

Accumulated
Depreciation-Name of Asset xxx

To record depreciation
for the period
Adjusting Entry for Depreciation
DEPRECIATION
The account Depreciation is an expense account while the
account Accumulated Depreciation is a contra asset account which
is deducted from the appropriate fixed asset account when preparing
a balance sheet.

To illustrate, assume that an equipment was purchased on
January 1 of the year for P1,000,000. It has an estimated life of 10
years and a scrap value of P100, 000 after its useful life. At the end
of the year, before the financial statements are prepared, annual
depreciation should be adjusted. The annual depreciation is
computed as follows:

Formula to Compute Annual Depreciation:
Cost of Asset - Scrap Value
Estimated Useful Life
DEPRECIATION
At the end of the accounting period, the
depreciation to be provided would amount to P90, 000
(P1,000,000 P100, 000 10 years ). Accordingly,
the adjustment would be:

Table 3.7

Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Dec. 31
Depreciation Expense-
Equipment 90,000

Accumulated
Depreciation-Equipment 90,000

for the period
The method used in computing depreciation for the
equipment is the straight-line method. This is the
simplest and the most commonly used method in
computing depreciation.
DEPRECIATION
Depreciation expense is the assigned portion of the cost of the fixed
asset to the periods during which it is used. Accumulated depreciation is
the total accumulated amount of depreciation that has been recorded for the
fixed asset. The difference between the cost of the fixed asset and the
accumulated depreciation is the book value of the asset. The book value
represent the portion of the cost of the fixed asset that has not yet been
recorded as depreciation expense. In the illustration provided above, the
equipment would be presented in the balance sheet as follows:

Equipment P1,000,000
Less: Accumulated Depreciation 90,000
Book Value P 910,000

The accumulated depreciation account is known as the contra-asset
account, since it is presented as a deduction from the asset account.
DEPRECIATION
Fractional Depreciation
In the illustration given, it was assumed that the
asset is used for one year. Let us assume now that the
equipment was acquired only July 1 (not January 1)
and was used only for six months. How much
depreciation should be provided as of December 31
of the year?
Formula to Compute Fractional Depreciation
Cost of Asset Scrap Value x = Fractional Depreciation
Estimated Useful Life
DEPRECIATION
Following the given formula, the
depreciation to be provided at the end of the
year would be P45, 000 (P1,000,000 P100,
000 10 years x ). The adjusting entry to
record the depreciation of the above equipment
would be:

Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Dec.
3
1
Depreciation Expense-
Equipment
45,00
0

Accumulated
Depreciation-Equipment 45,000

for six months.
Table 3.8
ACCRUED EXPENSES
3. ACCRUED EXPENSES
Accrued Expenses are expenses already incurred but not yet paid.
The business usually incurs expenses but may take time before it could pay
them. Usually expenses is recorded when payment is made. If at the end of
the period the expense is not yet paid, it may therefore still be unrecorded.
This situation creates understatement of expenses on the income
statement which will overstate the net income and understate liabilities
in the balance sheet. Consequently, an adjustment is needed to up-date the
accounts for proper financial statement presentation.
The accrued expenses are usually incurred on various continuing
services provided to the business such as electricity, water, telephone,
taxes, rental, interest, salaries and many others.

Adjusting Entry for Accrued Expenses
The pro-forma adjusting journal entry for accrued expense is:

Table 3.9

Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Dec. 31 An Expense Account 20, 000

(Name of expense)
Payable
20,
000

To record accrued
expense for the period
ACCRUED EXPENSES
Illustration. Assume Nikko Jay Service Co. is renting a
shop location at the rate of P20, 000 per month. Its lease
agreement provides that payment of rental should be made on
or before the 5th day of every month for the month after the
facility was used. Meaning, October rental should be paid by
November 5, November rental should be paid December 5,
and so on. At December 31, when the business will prepare the
financial statements, the December rental is still unpaid
although they have use the facility. Correspondingly, because
rent expense is understated and liability is understated too,
an adjusting entry as follows is necessary:

Table 3.10
Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Dec. 31 Rent Expense
20,
000
Rent Payable
20,
000

To record accrued
expense for the period
ACCRUED REVENUE
ACCRUED REVENUE
Accrued revenues are revenue already earned but collection has not
yet been received. Many kinds of revenues like revenue from interest,
revenue from commission, from rental on property, are recorded only
when received. It goes to say, therefore, that when no collection is
received these revenues are not yet recorded. This results in the
understatement of revenue account on the income statement and
subsequently understatement of receivable account in the balance
sheet. Consequently, an adjusting entry is necessary to up-date and
correct the accounts to be able to present reliable financial statements.

Adjusting Entry for Accrued Revenue
The pro-forma adjusting entry for accrued revenue is:

Table 3.11

Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Dec. 31
(Name of Income)
Receivable xxx
Revenue Account xxx

To record accrued
revenue for the period
ACCRUED REVENUE
Illustration: In the preceding illustration for
Nikko Jay Co. above, was analyzed on the point of
view of the lessee. Let us now analyze it from the
point of view of the owner of the owner of the
property. If you were the owner of the property, at the
end of December, you have already earned your rent
revenue because they have already used the property
but you have not received their payment. This is a
good example of accrued revenue. For this
illustration, the necessary adjusting entry is:

Table 3.12
Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Dec.
3
1 Rent Receivable 20,000
Rent Revenue 20,000

To record accrued rent
for December.
PREPAID EXPENSES
PREPAID EXPENSES
Prepaid expenses are expenses already paid but not yet
incurred. Expenses could be paid in advance. Some example of
prepaid expenses are rent paid in advance, advertising paid in
advance, interest on discounted notes, purchase of supplies, and
insurance premium paid on the beginning of the policy period.
Prepaid expenses are assets, not expenses. The terms prepaid,
unexpired, unused, on hand, and inventory denotes assets. At the
end of the accounting period, when the portion of these assets
have been used or expired, they become expense that requires
adjustment.

Advance payment of expenses (Prepaid expense) could be
recorded in the accounting records under any one of the two
methods: (1) the asset method, and (2) the expense method.
PREPAID EXPENSES
The Asset Method
The asset method is the procedure of recording the advance payment
of expenses by debiting an asset account. At the end of the accounting
period, the asset recorded could have been partly used up, rendering the
asset account debited to be overstated while the expense account is
understated. This situation requires the preparation of an adjusting entry to
correct and up-date the accounts for proper financial statement
presentation.

Entry for Prepaid Expenses using Asset Method
The journal entry to record the payment of expenses using the asset
method is:

Table 3.13

Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Sept. 1
Asset Account (Prepaid,
Unused, etc.) xxx
Cash xxx

To record advance
payment of expenses.
Note that asset account is debited to record the
advance payment of expenses. For this reason, it is
called asset method.
PREPAID EXPENSES
Adjusting Entry for Prepaid Expenses using
Asset Method
The pro-forma adjusting journal entry for
prepaid using the asset method is:

Table 3.14
Date DESCRIPTION
Post
Ref. Debit
Credi
t
19xx
Dec.
3
1 Expense Account xxx

Asset Account
(Prepaid, Unused, etc.) xxx

To record unexpired
portion of an asset for the
period.
PREPAID EXPENSES
Illustration. Assume that on September 1 if the current
year, Ma. Gina Trucking Service paid six-month advertising
amounting to P120, 000 to Ace Advertising Company. If the asset
method of recording is used, then the entry on September 1 will be:

Table 3.15

Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Sept. 1 Prepaid Advertising
120,0
00
Cash
120,00
0

To record advance
payment of advertising.
Analysis. The rate of advertising per month is P20, 000 (P120,
000 6). At December 31, the end of the accounting period,
P80, 000 (P20, 000 x 4 months) of the advertising applicable
to the months of September to December have expired while
P40, 000 (P20, 000 x 2 months) the portion applicable to the
months of January and February (next year) remains unused.
At December 31, the recorded prepaid advertising is P120,
000, when it should only be P40, 000.
PREPAID EXPENSES
The asset is overstated by P80, 000, the same amount of
understatement of the advertising expense account. At December
31, the adjusting entry should be:

Table 3.16

Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Dec. 31 Advertising Expense
80,
000
Prepaid Advertising
80,
000

To record advertising
expense incurred for the
period
It should be noticed in the analysis, that the account
debited in the original entry (upon payment) is the
account credited on the adjustment. It is so because
the account debited in the recording of the payment is
overstated at the end of the period.

PREPAID EXPENSES
The Expense Method
The expense method is the procedure of recording the advance
payment of expenses by debiting an expense account. At the end of the
accounting period, the expense recorded could not have been used up,
rendering the expense account debited to be overstated while the asset is
account understated. This situation requires the preparation of adjusting
entry to correct and up-date the accounts for proper financial statement
presentation.

Original Entry for Prepaid Expenses using Expense Method
The journal entry to record the payment of expenses using the
expense method is:

Table 3.17

Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Sept. 1 Expense Account xxx
Cash xxx

To record advance
payment of expenses
Note that expense account is debited to record the advance
payment of expenses. For this reason, it is call expense
method.
PREPAID EXPENSES
Adjusting Entry for Prepaid Expenses using
Expense Method
prepaid expenses using the expense method is:

Table 3.18
Date DESCRIPTION
Post
Ref. Debit
Credi
t
19xx
Dec.
3
1
Asset Account (Prepaid,
Unused, etc.) xxx
Expense Account xxx

To record Unexpired
expense during the period
PREPAID EXPENSES
Illustration. We will be using the same data for asset
method, on the P120, 000 advertising paid by Ma. Gina
Trucking Service to Ace Advertiser Company for the period
September 1 (current year) to February (next year). If the
expense method of recording is used, then the entry for
September 1 would be:

Table 3.19

Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Sept. 1 Advertising Expense
120,00
0
Cash
120,00
0

To record advance
payment of Advertising
Analysis. The analysis made using the asset
method is still valid. But, because the expense
account was debited and the P120, 000 is not all
used up, the expense account is overstated by
P40, 000, the portion applicable to the months of
January and February (next year). It is the same
amount of understatement of the asset (prepaid)
account.

Table 3.20

Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Dec. 31 Prepaid Advertising
40,00
0
Advertising Expense 40,000

To record the
amount of unexpired
advertising at the end of
the period.
PREPAID EXPENSES
It should be noticed in the analysis, that the
account debited in the original entry (upon
payment) is the account credited on the
adjustment. It is so because the account debited in
the recording of the payment is overstated at the end
of the period.
In the two analysis provided, both for the asset
method and the expense method, it should be noted
that after the adjustment have been recorded in the
accounts the resulting balance for both accounts will
be the same, P80, 000 for Advertising Expense and
P40, 000 for Prepaid Advertising. The amounts
represent the correct balances in our analysis.
UNEARNED REVENUE (Deferred Revenue)
Unearned revenues are revenues already received
(collected) but not yet earned. Sometimes the business
receives payment for the services (or goods) before service
is actually rendered. When such revenues are received in
advance, the enterprise has an obligation to perform services
(or delivery of goods). The liability is referred to as
unearned revenue.
Like in prepaid expenses, advance receipt of revenue
(Unearned revenue) may be recorded in the accounting
records under any one of the two methods:
Liability Methods
Revenue Methods
The Liability Method
The liability method is the procedure of recording the
advance receipt of revenue by crediting a liability account. At
the end of the accounting period, the liability recorded
could have been partially earned rendering the liability
account credited to be overstated and the revenue account
understated. This situation requires the preparation of
adjusting entry to correct and up-date the accounts for proper
financial statement presentation.

Original Entry for Unearned Revenue using Liability Method
The journal entry to record the receipt of revenue in
advance using the liability method is:

Table 3.21

Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Aug.
1
Cash xxx

Unearned (Name of
Revenue) Account xxx

To record advance
receipt of revenue
Adjusting Entry for Unearned Revenue
using Liability Method
unearned revenue using the liability method is:

Table 3.22
Table 3.22
Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Dec. 31
Liability (Unearned)
Account xxx
Revenue Account xxx

To record revenue
earned for the period.
Illustration. Assume that on August 1, the
business received P72, 000 from a tenant,
representing 6-month advance rental, covering
the period from August (current year) to
January (next year). If the liability method is
used, the entry on August 1 would be:

Table 3.23
Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Aug. 1 Cash 72,000
Unearned Rent 72,000

To record advance
receipt of revenue.
Analysis. The rate of the monthly rental is P12, 000 (P72, 000 6). At
December 31, the end of the accounting period, P60, 000 (P12, 000 x 5
months) of the rent applicable to the months of August to December have
been earned while P12, 000 the rent applicable to the month of January
(next year) remains unearned. At December 31, the recorded unearned rent
per record before any adjustment is P72, 000, when it should only be P12,
000. The liability account is overstated by P60, 000, the same amount of
understatement of the rent revenue account. At December 31, the adjusting
entry should be:

It should be noted in the analysis, that the account credited in the original
entry (upon receipt of revenue) is the account debited on the adjustment.
It is so because the account credited in the recording of the receipt of revenue
is overstated at the end of the period.
Table 3.24
Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Dec. 31 Unearned Rent 60,000
Rent Revenue 60,000

To record revenue
earned during the period
The Revenue Method
The revenue method is the procedure of recording the
advance receipt of revenue by crediting a revenue account. At
the end of the accounting period, the revenue recorded
could not have been all earned, rendering the revenue
account credited to be overstated and the liability account
understated. This situation requires the preparation of an
adjusting entry to correct and up-date the accounts for proper
financial statement presentation.

Original Entry for Unearned Revenue using Revenue Method
The journal entry to record the receipt of revenue in
advance using the revenue method is:

Table 3.25

Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Aug. 1 Cash xxx
Revenue Account xxx

To record advance
receipt of revenue.
Adjusting Entry for Unearned Revenue using Revenue
Method

The pro-forma adjusting journal entry for unearned revenue
using the revenue method is:

Table 3.26
Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Dec.
3
1 Revenue Account xxx

Unearned (Name of

To record revenue
unearned at the end of the
period
Illustration. Applying the same example in the liability
method, that on August 1, the business received P72, 000
from a tenant, representing a 6-month advance rental
covering the period from August (current year) to
January (next year), if the revenue method is used, the
entry would be:

Table 3.27
Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Dec. 31 Revenue Account xxx

Unearned (Name of

To record revenue
period
Analysis. The rate of the monthly rental is P12, 000 (P72, 000
6). At December 31, the end of the accounting period, only
P60, 000 (P12, 000 x 5 months) of the rent applicable for the
months of August to December have been earned while P12,
000 the rent applicable to the months of January (next year)
remains unearned. At December 31, the recorded rent revenue
before any adjustment is P72, 000, when it should only be P60,
000. The revenue account is overstated by P12, 000, the same
amount of understatement of the unearned rent account. At
December 31, the adjusting entry should be:

Table 3.28
Date DESCRIPTION
Post
Ref. Debit Credit
19xx
Dec.
3
1 Rent Revenue
12,00
0
Unearned Rent 12,000

To record revenue
period
It should be noticed in the analysis, that
the account credited in the original entry
(upon receipt of revenue) is the account
debited on the adjustment. It is so because
the account credited in the recording of the
receipt of revenue is overstated at the end of
the period.
PREPARATION OF THE WORK SHEET
The work sheet is also a tool used by the accountant to
facilitate the preparation of adjusting entries, closing entries,
and financial statements. It is a columnar paper which can be
used for the following purposes:

Compute adjustments and the adjusted balances of the
accounts.
Classify the accounts into income statement accounts
(nominal accounts) and balance sheet accounts (real
accounts) for financial statements preparation.
Determine net income (or loss).
Accountants often use work sheet to facilitate preparation
of financial statements. The financial statements maybe
prepared directly from the trial balance if the business has
relatively few accounts and if it shows the correct balances of
the accounts. If not, adjustments must therefore be posted to
the general ledger to bring the balances to correct amounts. To
facilitate such work, the trial balance may be prepared on a
work sheet (may be called analysis sheet), a multi-column
document which provides efficient way of summarizing
necessary data for the financial statements preparation. Using
the work sheet, the accountant is assured of the mathematical
accuracy of his work.
The following steps are followed when preparing the work sheet:
Place the heading at the center of the columnar form: Name of the
Company, Work Sheet, and, the period covered.
Place the trial balance on the first section (first two column). List
the accounts as they appear in the general ledger. See to it that the
debit and credit totals are balanced.
Enter all the adjustments in the next section (third and fourth
columns). Use numbers or letters to identify each entry. Prove
equality of the debit and credit amounts, double-rule if equal.
New account titles are placed below, in the appropriate account
title column.
Complete the next section (fifth and sixth columns), extend the
adjusted balances of all accounts to the adjusted trial balance
columns.
Complete the statement sections, extend the fourth
section (seventh and eight columns) all income
statement accounts (nominal accounts), and to the
fifth section (ninth and tenth columns) all balance
sheet accounts (real accounts).
Determines the net income (or net loss) by
analyzing the column totals of the income statement
columns. If the credit column total exceed the debit
column total, it represent net income. If the debit
column total exceed the credit column total, it
represent a net loss.
Illustrative Problem Preparation of Work
Sheet. Sagum Laboratory began operation on
January 1, 19xx, and provides various
diagnostic services for physicians and clinics.
Its accounting period ends December 31 and
the accounts are adjusted annually on this date.
Its unadjusted trial balance at December 31,
19xx, is as follows:
Sagum Laboratory
Trial Balance
December 31, 19xx

Account Titles Debit
Credit
Cash 1, 000
Accounts Receivable 9, 200
Medical Supplies 31, 300
Prepaid Insurance 6, 000
Laboratory Equipment 270, 000
Accumulated Depreciation Laboratory
Equipment 60, 000
Accounts Payable 3, 000
Unearned Diagnostic Fees 4, 000
Cecil Sagum, Capital 110, 000
Diagnostic Fees 220, 000
Salaries and Wages Expense 58, 000
Rent Expense __________________
Total 397, 500 397, 500

Table 3.29

STEP 6
PREPARATION OF FINANCIAL STATEMENTS
After the worksheet has been completed, the formal
financial statements are prepared. The kind of financial
statements have been illustrated, the nature and form of the
income statement and the balance sheet have been taken up in
Chapter 1. The financial statement of Sagum Laboratory will
be prepared with the aid of a worksheet in this chapter.

Basically, there are two principal accounting statements
for a sole proprietorship: the balance sheet and the income
statement. The balance sheet is that kind of financial
statement that shows the financial position of the business as
of a given date, usually the end of the accounting period. The
income statement is the kind of financial statement that
shows results of operations for a period of time, usually a year,
STEP 6
Kinds of Income Statement
Single-step form in this type of income statement,
all revenues are grouped together in one section, and
all expenses in another section. The net income or net
loss are determined by deducting the total expenses
from the total revenue.
Multi-step form

Forms of Balance Sheet
Report Form - a balance sheet that presents the
assets on the top section and the liabilities and
owners equity at the bottom section of the report.
Sagum Laboratory
Balance Sheet
As of December 31, 19xx
ASSETS
Current Assets
Cash P 1,000
Accounts Receivable P 9,200
Less: Allowances for Doubtful Depreciation P 300 P 8,900
Medical Supplies P 6,300
Prepaid Insurance P 4,500
Total Current Assets P 20,700
Property, Plant, and Equipment
Laboratory Equipment P 270,000
Less: Accumulated Depreciation P 90,000
Total Property, Plant, and Equipment 180,000
Total Assets P 200,700

LIABILITIES
Current Liabilities
Accounts Payable P 3,100
Unearned Diagnostic Fees 1,000
Salaries Payable 600
Rent Payable 2,000
Total Current Liabilities P 6,700

OWNERS EQUITY
Cecil Sagum, Capital (per Capital Statement) 194,000
Total Liabilities and Owners Equity P 200,700
Account Form the balance sheet that is presented in account form
presents the assets o the left side and the liabilities and owners
equity on the right side of the statement.

Name of Company
Balance Sheet
As of December 31, 19xx

ASSETS LIABILITIES AND OWNERS EQUITY
Total Current Assets xxx Total Liabilities xxx
Total Property, Plant, and Equipment xxx Owners Equity xxx
Total Assets xxx Total Liabilities and owners Equity xxx

STEP 6
Other method of Presentation
There is a Form of balance sheet presentation that
gives emphasis on the current working capital
position of the business, the financial position form.
In the first section, the total current liabilities are
deducted from the total current assets to arrive at the
working capital. In the second section, the total of the
property and equipment is added to working capital
and the long-term liabilities are deducted to arrive at
the net assets and owners equity.
STEP 6
Classification of Assets
For a service business, assets are normally classified in the balance sheet into the (1)
current, and (2) property and equipment.

Current Assets includes cash and other assets that will be converted into cash or used
up by the business , whichever is longer.
Cash is any medium of exchange that the bank accepts at face value. It includes
deposits in banks available for current operations at the balance sheet date, plus cash
on hand consisting of currency, undeposited checks, drafts, and money orders. These
are items without restriction and available for current operations of the business.
Accounts Receivable is the amount owed to a business by customers (clients). It is
evidenced by an oral promise to pay.
Notes Receivable is same as account receivable except that the customer or client
gives a promissory note to evidence its obligation.
Prepaid Expense is also known as Deferred Expenses which is the expenses paid in
advance. It is an asset awaiting assignment to expense. An example is prepaid
insurance.
STEP 6
Property, plant and equipment is an asset acquired for use in a
business rather than for resale; also called plant assets or
fixed assets.
Land is the ground on which the business buildings of the enterprise
are located. Land can also be used for outside storage space or a
parking lot.
Building is an edifice or structures constructed on the land, such as
office building.
Equipments are those items refer to the filing cabinet, calculator,
adding machine, cash register, and computer used either in the office,
store, or for delivery. Delivery Equipment refers to trucks, cars,
motorcycles, and other transportation vehicles used for delivery
purposes.
Furnitures and Fixtures refers to the tables and chairs, cabinet,
counter, and other fixtures used in the business.
STEP 6
Classifications of Liabilities
Current Liabilities are debts usually due within one year, the payment of
which normally will require the use of current assets.
Accounts Payable is the amount owed by the business to creditors for the
items or services purchased from them.
Notes Payable are unconditional written promises by an enterprise to pay
certain sum of money at a determinate future date.
Salaries and Wages Payable are amounts owed to employees for services
rendered but for which payment has not been made at the balance sheet date.
Interest Payable arises when interest has been incurred but not yet paid at
the balance sheet date because the amount is not due on Notes Payable until
later.
Unearned Revenue or Deferred Revenue is payments for services or sale
of goods that are received in advance from customer or client.

Long-term Liabilities are liabilities not due for a relatively long period of time,
usually more than one year.

STEP 6
Classification of Owners Equity
Owners Equity is the claim of the owner over the asset of the
business. It is residual claim because it will only be satisfied
after the payment of the obligation of the business to its
creditors.
Owners Capital is the investment of the owner of the business.
Owners Drawing is the withdrawals of the owner on the capital
and earnings of the business.
Income Summary is an account used in the closing process for
transferring the revenue and expense account balances to the
owners capital account at the end of the period.
STEP 6
Classifications of Revenue
Professional Fees is the income or remuneration
received by professionals from rendering services to
clients. The fee could be described depending upon
the line of professional like legal fee for lawyers,
dental fee for dentist, medical fee for doctors, and
retainers fee or audit fee for CPAs.
Other Revenues are revenues derived from sources
other than the principal line of service rendered like
interest, rent, and commission.
STEP 6
Classification of Operating Expenses
Operating Expense is the cost of the services that are used or consumed in the
operation of the business or practice of profession like salaries and wages,
rent, supplies, utilities, taxes, insurance and others.
Salaries and Wages Expenses are payments made to employees for the
services they rendered to the business.
Rent Expenses are expenses incurred for the use of rented facility like
building.
Supplies Expense is the cost office stationery, envelopes, pencils, pens and
other necessary supplies used in the business.
Utilities Expense refers to the various expenses incurred by the business on
water, electricity, telephone, and other means of communication to
customers or clients.
Insurance Expense is payment made for the premium of an insurance policy.
Advertising Expense is payment made to the advertisement of the business or
practice of the profession.
CHAPTER 4

Completing the Accounting Cycle
The Closing Process
COMPLETING THE ACCOUNTING CYCLE
THE CLOSING PROCESS
Nature of closing process
At the end of the accounting period, the revenue and
expense account balances are reported in the income
statement. The expenses are deducted from revenues to
determine the net income or net loss during the period. Since
revenues and expenses are reported for each period, the
balances of these accounts should be zero at the beginning of
the next period. The zero balances allow the next periods
revenues and expenses to be recorded separately from the
preceding period. Because the balances of revenue and
expense accounts are not carried forward, they are generally
called temporary accounts or nominal accounts. The
balances of the accounts reported in the balance sheet are
carried forward from year to year. Because of their permanent
nature, balance sheet accounts are called real accounts.
COMPLETING THE ACCOUNTING CYCLE
THE CLOSING PROCESS
How are the end-of-period of balances of temporary accounts
converted to zero? To begin, the revenue and expense account balances are
transferred to an account called Income Summary. The balance of Income
Summary is then transferred owner capital account and the balance of the
owners drawing account is transferred to owners capital accounts.

At the end of an accounting period, the balance of the owners
drawing account is reported on the statement of owners capital (statement
of owners equity). The owners withdrawal are deducted from the net
income or added to the net loss for the period to determine the net increase
or decrease in owner equity. Since withdrawals are reported for each
period, the balance of the owners drawing accounts should be zero at the
beginning of the next period. Thus the owners drawing account is also a
temporary account. Its balance is transferred to the owners capita; account
at the end of the period.
STEP 7
JOURNALIZING AND POSTING CLOSING
ENTRIES
Revenue, expense, and drawing account balances are transferred to
the owners equity account by a series of entries called closing entries.
The transfer process is called closing process. Four entries are required
at the end of the period. For sole proprietorship, these entries are as
follows:

Debiting all nominal accounts with credit balances (revenues) and
crediting the total to Income Summary account.
Crediting all nominal accounts with debit balances (expenses), and
debiting the total to Income Summary.
the Net Income is transferred to the Capital account by debiting the
Income Summary for the amount of its balance and the Capital account
is credited for the same amount. (The accounts debited and credited are
reversed if there is a net loss).
the drawing account is transferred to capital account by debiting the
capital account and crediting the drawing account for the same amount.

STEP 7
ENTRIES
The account titles and balances in preparing the closing
entries may be obtained from either the work sheet, the income
statement, the statement of owners equity, and or ledger. If a
work sheet is used, the date for the first two entries appeared
in the Income Statement columns. The amount for the third
entry is the net income or net loss appearing at the bottom of
the work sheet. The drawing account balance appears in the
Balance Sheet debit column of the work sheet.

The closing entries for Sagum Laboratory (See illustration
on Chapter 3) is shown below:

Table 4.1
Table 4.1
STEP 7
ENTRIES
After the closing entries have been posted to the ledger, the balance in the
capital account will agree with the amount reported on the statement of owners
equity and the balance sheet. In addition, the revenue, expense, and drawing
accounts will have zero balances.

It should be noted that Income Summary is used only at the end of the period.
At the beginning of the closing process, Income Summary has no balance. During
the closing process, Income Summary will be debited and credited for various
amounts. At the end of the closing process, Income Summary will again have no
balance. Because income summary has the effect of clearing the revenue and
expense accounts of their balances, it is sometimes called a clearing account.
Other titles used for this account include Revenue and Expense Summary, Profit
and Loss Summary, and Income and Expense Summary.

Balancing and ruling
After the closing process, a line should be inserted in both balance columns
opposite the final entry. If the books will still be used in the next accounting period,
the next periods transaction for the revenue, expense, and drawing will be posted
directly below the closing entry.
STEP 8
POST-CLOSING TRIAL BALANCE
The last accounting procedure for a period is to
prepare a trial balance after the closing entries have
been posted. The purpose of post-closing (after
closing) trial balance is to make sure that the ledger is
in balance at the beginning of the next period. The
accounts and amounts should agree exactly with the
accounts and amounts listed on the balance sheet at
the end of the period.
The post-closing trial balance of Sagum
Laboratory is shown in Exhibit 4-1 below.

Table 4.2
Table 4.2

STEP 8
POST-CLOSING TRIAL BALANCE
Instead of preparing a formal post-closing
balance, it is possible to list the accounts
directly from the ledger, using a printing
calculator or a computer. The calculator tape
or computer printout, becomes the post-closing
trial balance. Without such tape or printout,
there are no efficient means of determining the
cause of inequality.
STEP 9
REVERSING ENTRIES
Some of the adjusting entries recorded at the end of the accounting
period have an important effect on otherwise routine transactions that occur
in the following period. A typical example is accrued wages owed to
employees at the end of the period. If there has been an adjusting entry for
accrued wages expense, the first payment of wages in the following period
will include the accrual. In the absence of some special provision, Wages
Payable must be debited for the amount owed for the earlier period, and the
Wages Expense must be debited for the portion of the payroll that
represents expense for the later period. However, an optional entry --- the
reversing entry ---- may be used to simplify the analysis and recording of
this first payroll entry in a period. As the tem implies, a reversing entry is
the exact reverse of the adjusting entry to which it relates. The amounts and
accounts are the same as the adjusting entry; the debits and credits are
reversed. Reversing entries are generally made on the first day of the next
accounting period.
Adjustments that can be reversed are enumerated as follows.
Accrued expenses
Accrued revenues
Prepaid expenses, if expenses method is used
Unearned revenues, if the revenue method is used
STEP 9
REVERSING ENTRIES
Reversing Entry For Accrued Expenses
Accrued expenses of the present period are usually pain in the next
period. If the adjusting entries for accrued expenses are not reversed, the
accrued expenses paid in the next period necessarily be debited to the
accrued liability account. However, if there are reversing entries for these
items, all expenses pain in the future, whether accrued or not, can be
consistently debited to the expense accounts.

Illustration: analysis of the adjusting entry, closing entry and reversing
entry for accrued Expense. On December 31, the end of the accounting
period, the business have issued a nine-percent, six-month note for P20,000
dated accrued interest on this note is P300 (P20,000 x 9% x 2/12). The
adjusting entry for this is:

Table 4.3
Table 4.3
Date Description
Post
Ref. Debit Credit
19xx
Dec.
3
1 Interest Expense 515 300
Interest Payable 202 300

To record accrued
interest for the period.
STEP 9
REVERSING ENTRIES
The closing entry for the Interest Expense
account at December 31 is:
Table 4.4

Date Description
Post
Ref. Debit Credit
19xx
Dec. 31 Income Summary 303 300
Interest Expense 515 300

To close interest
expense
On January 1, the Reversing Entry for the accrued
interest (expense) is:

Table 4.5
Date Description
Post
Ref. Debit Credit
19xx
Dec. 31 Interest Payable 202 300
Interest Expense 515 300

To reverse the
adjusting entry for
accrued interest on
Notes Payable
STEP 9
REVERSING ENTRIES
After this entry, all interest paid, whether accrued or not
could be debited to Interest Expense. The credit to Interest
Expense in the reversing entry will serve to adjust the account
balance to the amount of interest incurred in the current period.
The debit to Interest Payable in the reversing entry closes the
credit to the same account in the adjusting entry. Thus, the
accounts Interest Expense and Interest payable after the
adjusting entry and reversing entries have been posted are as
follows:

Table 4.6

INTEREST
PAYABLE
account no.
202
Date Items Ref. Debit Date Items Ref. Credit
19xx 19xx
Jan. 1 Revers
ing
GJ
300
Dec.
31
Adjusti
ng
GJ
300

Table 4.7

INTEREST EXPENSE
19xx 19xx
Jan. 1
Adjust
ing GJ 300
Dec.
31
Closin
g GJ 300
Jan. 1
Revers
ing GJ 300

STEP 9
REVERSING ENTRIES
At April 30, the date of maturity of the note, the
total interest to be paid in the note is P900 (P20,000 x
9% x 6/12). Upon payment, an entry debiting Interest
Expense will be made and if the entry is posted to the
Interest Expense account, the account will appear as
follows.
Table 4.8

This shows that while the interest pain in April
amounted to P900, only the balance of the account of
P600 (P900 P300) is the expense incurred and paid
in April, and the P300 is payment of accrued interest.
Table 4.8
INTEREST EXPENSE
19xx 19xx
Dec.
31
Adjustin
g 300
Dec.
31
Closin
g 300
Jan. 1
19xy 19xy
Apr.30
Payment
of
Interest 900 Jan. 1
Revers
ing 300
STEP 9
REVERSING ENTRIES
Reversing Entry for Accrued Revenue
Accrued revenue for the present period is usually
collected in the next accounting period. If no
reversing entry is made, this accrued revenue when
received in the future must necessarily be credited to
the accrued revenue account. However, if there is a
reversing entry, all revenue in the future, whether
accrued or not, can be uniformly credited to the
revenue account.
STEP 9
REVERSING ENTRIES
Illustration: analysis of the adjusting entry, closing entry and
reversing entry for accrued interest revenue. Using the same
illustrative example as above, let us now analyze it on the
point of view of the recipient of the note. On December 31, the
end of the accounting period, the business received a none-
percent, six-month note for P20,000 dated November 1
(current year0 collectible April 30 (next year). At December
31, the accrued interest on this note is P300 (P20,000 x 9% x
2/12).

The adjusting entry for this is:

Table 4.9
Table 4.9
Date Description
Post
Ref. Debit Credit
19xx
Dec. 31 Interest Receivable 107 300
Interest Revenue 405 300

To record accrued
interes revenue for the
period
STEP 9
REVERSING ENTRIES
The closing entry for the Interest Income
at December 31 is:
Table 4.10

On January 1, the reversing entry for the
accrued interest revenue is:
Table 4.11

Table 4.10
Date Description
Post
Ref. Debit Credit
19xx
Dec. 31 Interest Revenue 405 300
Income Summary 303 300

To close interest
revenue
Table 4.11
Date Description
Post
Ref. Debit Credit
19xx
Jan. 1 Interest Income 405 300
Interest Recevable 107 300

To reverse the
adjusting entry for
accrued interest on
Notes Receivable
STEP 9
REVERSING ENTRIES
After this entry, all interest collected, whether accrued or
not could be credited to Interest Revenue. The debit to Interest
Revenue in the reversing entry will serve to adjust the account
balance to the amount of interest earned in the current period.
The credit to Interest Receivable in the reversing entry closes
the debit to the same account in the adjusting entry. Thus, the
accounts Interest Revenue and Interest Receivable after the
adjusting entry and reversing entries have been posted are as
follows:

Table 4.12
Table 4.13
Table 4.12
INTEREST RECEIVABLE
Date Items
Ref
. Debit Date Items Ref.
Credi
t
19xx 19xx
Dec 31 Adjusting GJ 300 Jan 1 Reversing GJ 300

Table 4.13
INTEREST REVENUE
Date Items Ref. Debit Date Items Ref.
Cre
dit
19xx 19xx
Dec 31 Closing GJ 300
Dec
1
Adjust
ing GJ 300
Jan 1 Reversing GJ 300
STEP 9
REVERSING ENTRIES
At April 30, the date of maturity of the note, the total
interest to be collected on the note in P900 (20,000 x 9%
6/12). Upon collection, a P900 entry to credit Interest Revenue
account, the account will appear as follows:

Table 4. 14

This shows that while the interest collected in April
amounted to P900, only the balance of the account of P600
(P900 P300) is the revenue earned and collected in April,
and the P300 is collection of accrued interest.
Table 4. 14
INTEREST REVENUE
Cre
dit
19xx 19xx
Dec 31 Closing GJ 300
Dec-
03
Adjusti
ng GJ 300
19xx1
19xx
1
Jan 1
Reversin
g GJ 300
Apr
30
Collecti
on of
Interest GJ 900
STEP 9
REVERSING ENTRIES
Reversing Entry for Prepaid Expenses
Asset Method is when an expense paid in advance is debited
to and Asset Account, the adjusting entry to record the
expense incurred during the current period need not be
reversed because there will be no inconsistency of recording
that will occur in the next period.

Expense Method is when an expense is paid in advance is
debited to an Expense Account, the adjusting entry to record
the asset (prepaid) portion of the expense should be reversed
on the beginning of the next period, to ensure consistency of
the method of recording being used and for proper recognition
of the expense on the proper accounting period.
STEP 9
REVERSING ENTRIES
Illustration. Analysis of the original entry, adjusting entry,
closing entry and reversing entry on Prepaid Expenses,
when Expense Method is used. On October 1, current year,
the business paid P50,000 to Ace Realty, representing 5-month
rent covering the period October (current year) to February
(next year). At December 31, only P30,000 for three months
(October to December) rental have been used up. The
remainder is applicable to the months of January and February
next year.
The original entry to record transaction, upon payment
is:

Table 4.15
Date Description
Post
Ref. Debit Credit
19xx
Dec 1 Expense 508 50,000
Cash 101 50,000

rent in advance
STEP 9
REVERSING ENTRIES
The adjusting entry for the Prepaid Rent at
December 31 is:
Table 4.16

The closing entry for the Rent Expense at
December 31 is as follows:
Table 4.17
Table 4.16
Date Description
Post
Ref. Debit Credit
19xx
Dec 31 Prepaid Rent 110 20,000
Rent Expense 508 20,000
To record Prepaid REnt
Table 4.17

Date Description
Post
Ref. Debit Credit
19xx
Jan. 1 Rent Expense 508 20,000
Prepaid Rent 110 20,000

To reverse the
adjusting entry for
Prepaid Rent.
STEP 9
REVERSING ENTRIES
After these entries are posted, the Prepaid Rent
account and the Rent Expense account will be
as follows:
Table 4.18
Table 4.19
It should be noted that the Prepaid Rent has
become a closed account and the Rent Expense
account has a debit balance of P20,000. Thus, in
the next period, the adjustment under the expense
method can be used again.
Table 4.18

PREPAID RENT
Credi
t
19xx
Dec.3
1
Adjusti
ng GJ
20,00
0
19xx
Jan. 1
Reversi
ng GJ
20,00
0

Table 4.19

19xx
Oct.31
Payment
of Rent GJ 50,000
19xx
Dec. 1
Adjust
ing GJ 20,000
19xx1 19xx1
Jan 1
Reversi
ng GJ 20,000 31
Closin
g GJ 30,000
STEP 9
REVERSING ENTRIES
Reversing Entry for Unearned Revenues
Liability Method is when a revenues received in advance is
credited to a Liability Account, the adjusting entry to record
the revenue earned during the current period need not be
reversed because there will be no inconsistency of recording
that will occur in the next period.
Revenue Method is when a revenue received in advance is
credited to a Revenue Account, the adjusting entry to record
the liability (Unearned) portion of the revenue should be
reversed on the beginning of the next period, to ensure
consistency of the method of recording being used and for
proper recognition of the revenue on the proper accounting
period.
STEP 9
REVERSING ENTRIES
Illustration. Analysis of the original entry, adjusting entry,
closing entry and reversing entry on Unearned Revenue,
when Income Method is used. On September 1, current year,
the business received P48,000 from a tenant, representing 6-
mont rent covering the period September (current year) to
February (next year). At December 31, only P32,000 for four
months (September to December) rental have been earned, the
remainder of P16,000 applicable to the months of January and
February next year is still unearned.
The original entry to record the transaction, upon
collection is:

Table 4.20
Table 4.20
Date Description
Post
Ref. Debit Credit
19xx
Sept. 1 Cash 101 48,000
Rent Revenue 404 48,000

To record collection
of rent in advance
STEP 9
REVERSING ENTRIES
The adjusting entry for the Unearned Rent at
December 31 is:
Table 4.21

The closing entry for the Rent Revenue at
December 31is:
Table 4.22
Table 4.21
Date Description
Post
Ref. Debit Credit
19xx
Dec. 31 Rent Revenue 404 16,000
Unearned Rent 207 16,000

To record Unearned
Rent
Table 4.22
Date Description
Post
Ref. Debit Credit
19xx
Dec. 31 Rent Income 404 32,000
Income Summary 303 32,000

To close Rent
Revenue
STEP 9
REVERSING ENTRIES
On January 1, the reversing entry for the
Unearned Rent is:
Table 4.23

After these entries are posted, the Unearned
Rent account and the Rent Revenue account
will be as follows:
Table 4.24
Table 4.23
Date Description
Post
Ref. Debit Credit
19xx
Jan. 1 Unearned Rent 207 16,000
Rent Revenue 404 16,000

To reverse the
adjusting entry for
Unearned Rent.
Table 4.24
UNEARNED RENT
Credi
t
19xx
Jan 1
Reversi
ng GJ
16,00
0
19xx
Dec.
31
Adjus
ting GJ
16,00
0

STEP 9
REVERSING ENTRIES
It should be noted that the Unearned Rent has
become a closed account and the Rent Revenue
account has a credit balance of P16,000. Thus, in the
next period, the adjustment under the revenue method
can be used again.
The following are the main purposes of reversing
entries that should be remembered: (1) consistency in
the use of method, and (2) recording of revenues and
expenses in the proper accounting period.
Thank you!
PRESENTED BY:

Julie Anne P. Jamora
Nancy Bunag
Acknowledgment
Special thanks to the writers of the book
Accounting Fundamental, Bayani D.
Edlagan and Ma. Cecilia S. Mercado, for
without them this presentation would not be
possible.

Polytechnic University of the Philippines
Taguig Campus
As partial requirement in the subject OS
341Web Page Development , this project
is submitted by Julie Anne Jamora and
Nancy Buag to Prof. Angela David.

Accounting Fundamental: BY: Bayani D. Edlagan Ma. Cecilia S. Mercado

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