users through accounting

CHAPTER 1 - INTRODUCTION TO reports, the most common

ACCOUNTING form of which is the financial
statements
Definition of accounting
Accounting is a process of identifying Nature of Accounting
recording and communicating economic Accounting is a process with the basic
information that is useful in making purpose of providing information about
economic decisions economic activities that is intended to be
useful in making economic decisions
Essentials elements of the definition of
accounting Types of information provided by accounting
1. Identifying 1. Quantitative information
- The account analyzes each - Expressed in numbers,
business transaction and quantities or units
identifies whether the 2. Qualitative information
transaction is an - Expressed in words or
“accountable event” or “non descriptive form
accountable event” 3. Financial information
Only accountable events are - Information expressed in
recorded in the books of accounts (non money. (It is also quantitative
accountable event not recorded) information)

Accountable events (or economic events) Accounting as science and art

are those that affect the assets, liabilities, 1. As a social science, accounting is a
equity, income or expenses of a business. body of knowledge which has been
systematically gathered, classified
2. Recording and organized
the identified “accountable events” 2. As a practical art, accounting
this process is called “journalizing” required the use of creative skills
After journalizing, the accountant then and judgement
classifies the effects of the event on the
“accounts”. Accounting as an information system
Process called “posting” ● consist of an input, process and
output
3. Communicating
- At the end of each Bookkeeping and Accounting
accounting period, the ● they are not the same
accountant summarizes the
information processed in the Bookkeeping - refers to the
accounting system in order to process of recording the accounts or
produce meaningful reports. transactions of an entity. (normally
- Accounting information is ends with the preparation of the trial
communicated to interested balance)

1
 Examples :
Accounting - on the other hand, a. Existing and potential investors (e.g.,
covers the whole process of stockholders who are not directly
identifying, recording, and involved in managing the business)
communicating information to b. Lenders (e.g., banks) and Creditors
interested users. (e.g., suppliers)
c. Government agencies (e.g, Bureau
Functions of Accounting in Business of Internal Revenue 'BIR', Securities
and Exchange Commission (SEC)
Accounting is often referred to as the d. Non-managerial employees
"language of business" because it is e. Customers
fundamental to the communication of f. Public
financial information.
Types of accounting information
Accounting has the following two broad classified as to users' needs
functions in business:
1. General purpose accounting
1. To provide external users with information - is information designed to
information that is useful in making, among meet the common needs of most staterment
others, investment and credit decisions; and users.

2. To provide internal users with 2. Special purpose accounting

information that is useful in managing the information - is information designed to
business. meet the specific needs of particular
statement users.
Users of Accounting Information
Users of accounting information are broadly Common branches of accounting
classified into two, namely: 1. Financial accounting - is the branch of
accounting that focuses on general purpose
1. Internal users - those who are directly financial statements.
involved in managing the business. ● General purpose financial
statements are those statements
Examples : that cater to the common needs of
a. Business owners who are directly external users, primarily the potential
involved in managing the business and existing investors, and lenders
b. Board of directors and other creditors.
C. Managerial personnel ● Financial accounting is governed
by the Philippine Financial Reporting
2. External users - those who are not Standards (PFRSS).
directly involved in managing the business.
2. Management accounting - involves the
accumulation and communication of
information for use by internal users.
3. Government accounting - refers to the 1. Sole or single proprietorship - is a
accounting for the government and its business that is owned by only one
instrumentalities, focusing attention on the individual. It is the most common and
custody of public funds, the purpose or simplest form of a business organization.
purposes to which
those funds are committed, and the 2. Partnership - is a business that is owned
responsibility and accountability of the by two or more individuals who entered into
individuals entrusted with those funds. a contract to carry on the business and
divide among themselves the earnings
4. Auditing – involves the inspection of an therefrom.
entity's financial statements business
processes correspondence with established 3. Corporation - a corporation is also
criteria. owned by more than one individual.

5. Tax accounting- is the preparation of tax 4. Cooperative - a cooperative is also

returns and rendering of tax advice, such as owned by more than one individual
the determination of tax consequences of
certain proposed business endeavors. Types of Business According to
Activities
6. Cost accounting - is the systematic The following are the major types of
recording and analysis of the costs of business according to the activities they
materials, labor, and overhead incident to undertake:
the production of goods or rendering of 1. Service business
services. 2. Merchandising (Trading)
3. Manufacturing
7. Accounting education - refers to
teaching accounting and accounting-related Service business
subjects in an organized learning A service business is one that offers
environment. services as its main product rather than
physical goods.
8. Accounting research - pertains to the
careful analysis of economic events and Merchandising business
other variables to understand their impact A merchandising business (or trading
on decisions. business) is one that buys and sells goods
without changing their physical form.
Forms of Business Organizations
A business is an activity where goods or Manufacturing business
services are exchanged for money. A A manufacturing business is one that buys
person who is engaged in business is raw materials and processes them into final
called an “entrepreneur or businessman” products.

Businesses in the Philippines are organized Unlike a merchandising business, a

in one of the following: manufacturing business changes the
physical form of the goods it has purchased as expenses only when the related revenue
in a production process. is recognized.

5. Accrual Basis of accounting - Under

CHAPTER 2 : ACCOUNTING CONCEPTS the accrual basis of accounting, economic
AND PRINCIPLES events are recorded in the period in which
they occur rather than at the point in time
Accounting concepts and principles when they affect cash.
(assumptions or postulates) are a set of
logical ideas and procedures that guide the 6. Prudence (or Conservatism)- Under this
accountant in concept, the accountant observes some
recording and communicating economic degree of caution when exercising
information. judgments needed in making accounting
estimates under conditions of uncertainty
Basic Accounting Concepts
There are numerous concepts and 7. Time Period (Periodicity, AcCounting
principles used in accounting. period, or Reporting perioad concept) -
Under this concept, the life of the business
These are sourced from the Standards is divided into series of reporting periods.
(PFRSS), the Conceptual Framework for
Financial Reporting, or general acceptance 8. Stable monetary unit - Under this
in the profession due to long-time use. concept, assets, liabilities, equity, income
and expenses are stated in terms of a
1. Separate entity concept- Under this common unit of measure, which is the peso
concept, the business is viewed as a in the Philippines.
separate person, distinct from its owner(s).
Only the transactions of the business are 9. Materiality concept - This concept
recorded in the books of accounts. The guides the accountant when applying
personal transactions of the business accounting principles. This is because
owner(s) are not recorded. accounting principles are applicable only to
material items.
2. Historical cost concept (Cost principle)
- Under this concept, assets are initially 10. Cost benefit (Cost constraint) - Under
recorded at their acquisition cost. this concept, the costs of processing and
communicating intormation should not
3. Going concern assumption - Under this exceed the beneits to be derived tom the
concept, the business is assumed to information's use,
continue to exist for an indefinite period of
time. 11. Full disclosure principle- This concept
is related to both the concepts of materiality
4. Matching (or Association of cause and and cost-benefit.
effect) Under this Concept, some costs are
initially recognized as assets and charged 12. Consistency concept - This concept
requires a business to apply accounting
policies consistently, policies consistently, Relevant regulatory bodies
and present information consistentły, from Other than the Financial Reporting
one period to another. Standards Council (FRSC), the following
also affect the accounting policies used by
businesses
Accounting standards and their financial reporting:
Accounting concepts and principles are
either explicit or implicit. Explicit concepts 1. Securities and Exchange Commission
and principles are those that are specifically (SEC) – The SEC is tasked with regulating
mentioned in the Conceptual Framework corporations, including partnerships. The
for Financial Reporting and in the SEC
Philippine Financial Reporting Standards requires corporations and partnerships to
(PERSS). Implicit concepts and principles file audited financial statements.
are those that are not specifically mentioned
in the foregoing but are customarily used 2. Bureau of Internal Revenue (BIR) - The
because of their general and longtime BIR is tasked in collecting national taxes
acceptance within the accountant and administering the provisions of the Tax
profession. Code.

The terms "concepts," "principles," 3. Bangko Sentral g Pilipinas (BSP) - The

"assumptions" and "postulates" are used BSP is tasked in regulating banks and other
interchangeably standards practice. entities performing banking functions. The
However, the term "standards" is used to BSP influences the selection and
specifically refer to the Philippine Financial application of accounting policies by these
Reporting Standards (PERSS. businesses.
Traditionally, accounting standards were
referred to as generally accepted 4. Cooperative Development Authority
accounting principles (GAAP). (CDA) - the CDA is tasked in regulating
cooperatives. The CDA influences the
selection and application of accounting
Philippine Financial Reporting Standards policies by cooperatives.
(PFRSS)
The Philippine Financial Reporting The Conceptual Framework for Financial
Standards (PERSS) are Standards and Reporting
Interpretations adopted by the Financial Just like the Standards, the Conceptual
Reporting Standards Council (FRSC). Framework for Financial Reporting also
They consist of the following: prescribes accounting concepts that are
a. Philippine Financial Reporting Starndards relevant to the preparation of financial
(PFRSS); statements. However, the Conceptual
b. Philippine Accounting Standards (PASs); Framevork is not a standard. Rather, the
and Conceptual Fram ework serves as a general
C. Interpretations frame of reference in developing or applying
the standards.
Qualitative Characteristics of useful B. Confirmatory value (or Feedback
financial information value) - This concept is related to
Among the concepts stated in the the predictive value. Information has
Conceptual Framework are the qualitative a confirmatory value if it can help
characteristics of useful financial users confirm their past predictions.
information. C. Materiality - is an 'entity-specific
aspect of relevance, meaning it
Qualitative characteristics are the traits depends on the facts and
that determine whether an item of circumstances surrounding a
intormation is useful to users. Without these specific entity.
Characteristics, information may be deemed
useless. Faithful representation
Information is faithfully represented if it is
The qualitative characteristics are factual, meaning it represents the actual
broadly classified into two, namely effects of events that have taken place.
1. Fundamental qualitative
characteristics a. Completeness - All information
These are the characteristics that make necessary for users to have a complete
information useful to users. understanding of the financial statements is
A. Relevance provided.
B. Faithful representation b. Neutrality – information is selected or
presented without bias. Information is not
2. Enhancing qualitative chạracteristics manipulated to increase its favorability or
these characteristic support the decrease its unfavorability.
fundamental characteristics. They enhance C. Free from error - Free from error means
the the information is not materially misstated.
usefulness of information. As such, they
must be maximized.
A. Comparability Enhancing qualitative characteristics
B. Verifiability Comparability
C. Timeliness Information is comparable if it can help
D. Understandability users identify similarities and differences
between different sets of information. Unlike
Fundamental qualitative characteristics the
Relevance other qualitative characteristics,
Information is relevant if it can affect the comparability does not relate to only one
decisions of users. Without this trait, item because a comparison requires at least
information is deemed irrelevant. Relevant two items.
information has the following aspects:
Verifiability
A. Predictive value - Information has a Information is verifiable if different users
predictive value if it can help users could reach a general agreement as to what
to make predictions about future the information intends to represent.
outcomes.
Timeliness
Information is timely if it is available to users LIABILITIES - are your present obligations
in time to be able to influence their that have resulted from past events and
decisions. This is like the saying "Aanhin pa carn require you to give up economic
ang damo kung patay na ang kabayo" or resources when settling them.
"Too late the hero."
Obligation
Understandability Obligation means a duty or responsibility.
Information is understandable if it is
presented in a clear and concise manner. An obligation is either:
On the other hand, users are expected to a. Legal obligation - an obligation that
have a reasonable knowledge of business results from a contract, a legislation, or
activities and willingness to analyze the other operation of law; or
information diligently. b. Constructive obligation - an
obligation that results from your past actions
(e.g., past practice or published policies)
that have created a valid expectation on
CHAPTER 3 : THE ACCOUNTING others that you will accept and
EQUATION discharge certain responsibilities.

The Basic Accounting Equation Giving up of economic resources- settling

All the processes in an accounting system the obligation necessarily woud require you
must observe the equality of the accounting to pay cash, to transfer other non-cash
equation, which is basically an algebraic assets, or to ender a service.
equation. The basic accounting equation is
shown below: The Expanded Accounting Equation
We can expand the basic accounting
Assets = Liabilities + Equity equation by including two more elements-
inconte and expenses. The expanded
ASSETS - are the economic resources you accounting equation shows all the financial
control that have resulted from past events statement elements. The expanded
and can provide you with economic accounting equation is as follows:
benefits.
Assets = Liabilities + Equity + Income -
Control- refers to having the exclusive right Expenses
to enjoy those benefits and the ability to
prevent others from enjoying those benefits. Notice that income is added while expenses
are deducted in the equation. These are
Past events- The control over an economic because income increases equity while
resource have resulted from a past event expenses decrease equity.
ortransaction. Therefore, resources for
which control is yet to be obtained in the INCOME - is increases in economic benefits
future do not qualify as assets in the during the period in the form of increases in
present. assets, or decreases in liabilities, that result
in increases in equity, excluding those
relating to investments by the business
owner.

EXPENSES - are decreases in economic

benefits during the period in the form of
decreases in assets, or increases in
liabilities, that result in decreases in equity,
excluding those relating to distributions to
the business owners
Financial Accounting and Reporting Midterm Reviewer
CHAPTER 4 Income includes both revenue and gains
a. Revenue- arises in the course of the ordinary
TYPES OF MAJOR ACCOUNTS
activities of a business. EX: Sales and service
Account fees.
b. Gains- items that meet the definition of
Basic storage of information in accounting. It
income and may or may not arise in the
is a record of the increases and decreases in a
course of the ordinary activities of an entity.
specific item of asset, liability, equity, income, and
5. Expenses- decreases in economic benefits
expenses.
during the period in the form of decreases in
T-Account assets, or increases in liabilities, that result in
decreases in equity, excluding those relating to
An account may be depicted through. It
distributions to the business owner.
resembles the letter “T.”
Expenses include both expenses and losses
Three (3) Parts of T-Account: a. Expenses- arise in the course of the ordinary
1. Account title- describes the specific item of activities of a business.
asset, liability, equity, income, or expenses. b. Losses- items that meet the definition of
2. Debit Side- left side income and may or may not arise in the
3. Credit Side- right side course of the ordinary activities of an entity.

Illustration: Classification of the Five Major Accounts

Balance Sheet Income Statement

Accounts Accounts
1. Assets 1. Income
2. Liabilities 2. Expenses
3. Equity
➢ Balance Sheet (statement of financial position)-
Component of a complete set of financial
statements. It shows the financial position of a
Five Major Accounts business.
- Elements of the financial statements ➢ Income Statement (statement of profit or loss)-
1. Assets- economic resources you control that sub-component of the statement of
have resulted from past events and can provide comprehensive income. It is also a component
you with future economic benefits. of a complete set of financial statements. It
2. Liabilities- present obligations that have shows the profit or loss of a business
resulted from past events and can require you to
give up resources when settling them.
3. Equity- assets minus liabilities
4. Income- increases in economic benefits during
the period in the form of increases in assets, or
decreases in liabilities, that result in increases in
equity, excluding those relating to investments
by the business owner.

1
Financial Accounting and Reporting Midterm Reviewer
Chart of Accounts Common Account Titles

1. The first digit in the 3-digit numbering refers Balance Sheet Accounts:
to the major types of accounts
1. Assets:
Major types of Assigned Number
• Cash- money or its equivalent that is readily
Accounts
Assets 1 available for unrestricted
Liabilities 2 • Accounts receivable- receivables supported
Equity 3 by oral or informal promises to pay.
Income 4 • Allowance for bad debts- aggregate amount
Expenses 5 of estimate losses from uncollectible
accounts receivable.
2. The second digit in the 3-digit numbering • Notes receivable- receivables supported by
refers to the account titles and the sequence written or formal promises to pay in the form
how they are listed in the chart of accounts of promissory notes.
110 Cash • Inventory- the goods that are held for sale by
120 Accounts receivables a business or raw materials in manufacturing
business.
• Prepaid supplies- cost of unused office and
3. The third digit in the 3-digit numbering, if
other supplies.
not zero, signifies contra account or an
• Prepaid rent- rent paid in advance
adjunct account to a related account.
• Prepaid insurance- insurance paid in advance
180 Building
• Land- lot on which the building of the
185 Accumulated depreciation- Bldg.
business has been constructed
• Building- structured owned by a business for
Business shall use account titles that use in its operations
conform to the PFRSs (Philippine Financial Reporting • Accumulated depreciation- building- total
Standards). amount of depreciation expense of the
building.
Sources of Chart of Accounts
• Equipment- assets such as:
a. Bank- Bangko Sentral ng Pilipinas (BSP) a. Machineries
b. Cooperative- Cooperative Development b. Transportation Equipment
Authority (CDA) c. Office Equipment
c. National Government Agency- Revised chart d. Computer Equipment
of Accounts (RCA) issued by the Commission e. Furniture and Fixtures
on Audit (COA). • Accumulated Depreciation- equipment-
total amount of depreciation expenses
2. Liabilities:
• Accounts payable- obligations supported by
oral or informal promises to pay by the
debtor

2
Financial Accounting and Reporting Midterm Reviewer
• Notes payable- obligations supported • Salaries expense- salaries earned by
written or formal promises to pay by the employees for the services they have
debtor in the form of promissory notes. rendered.
• Interest payable- interest incurred but not • Rent expense- rentals that have been used
yet paid up.
• Salaries payable- salaries earned by • Utilities Expense- cost of utilities that have
employees but not yet paid by the business. been used.
• Utilities payable- utilities used but not yet • Supplies Expense- cost of supplies that have
paid. been used during the period.
• Unearned Income- income that were • Bad debt expense- estimated losses from
collected in advance before they earned. uncollectible accounts receivable.
3. Equity: • Depreciation expense- cost of a depreciable
• Owner’s Capital (Owner’s Equity)- residual asset that has been collected.
amount after deducting liabilities from • Advertising expense- cost of promotional or
assets. marketing activities.
• Insurance expense- cost of insurance
Increased Decreased
➢ Investments or ➢ Withdrawals or pertaining to the current accounting period.
contributions distributions • Taxes and Licenses- cost of business and
➢ Income or Profit ➢ Expenses or Loss local taxes required by the government for
the conduct of business.
• Transportation expense- necessary and
• Owner’s drawings- temporary withdrawals
ordinary cost of employees getting from one
of the owner during the period.
workplace to another which are
Income Statement Accounts reimbursable by the business
• Travel expense- costs uncured when
1. Income
travelling on business trips.
• Service fees- revenues earned from
rendering services • Interest income- cost of borrowing money
• Miscellaneous expense- small expenditures
• Sales- revenues earned from the sale of
goods which do not want warrant separate
presentation.
• Interest Income- earned from the issuance
• Losses- may arise from:
of interest- bearing receivables
a. Sale of assets, other than inventory, at a
• Gains- income earned from the sale of assets
sale price that is less than the carrying
or from enhancements of assets or
amount.
decreases in liabilities that are not classified
b. Decreases in the value of assets due to
as revenue.
destruction, damage, obsolescence and
2. Expenses:
other changes in values caused by
• Cost of Sales (Cost of goods sold)- value of
market factors.
the inventories that have been sold.
• Freight-out- sellers’ cost of delivering goods
to customers.

3
 CHAPTER 6 events often not signaled by new source
BUSINESS TRANSACTION AND THEIR documents.
ANALYSIS 6. Preparing the adjusted trial balance (or
worksheet preparation) the equality of debits
The Accounting Cycle and credits are rechecked after adjustments
The accounting cycle represents the steps or are made. The adjusted trial balance serves as
procedures used to record transactions and basis for the preparation of the financial
prepare financial statements. The accounting statements.
cycle implements the accounting processes of 7. Preparing the financial statements these are
dentifying, recording, and communicating the means by which the information processed
economic information. is communicated to users.
8. Closing the books this involves journalizing
Steps in the Accounting cycle and posting closing entries and ruling the
The following are the steps in the accounting ledger. Temporary accounts (or nominal
cycle: accounts) are closed and the resulting profit or
1. Identifying and analyzing business loss is transferred to an equity account.
documents or transactions. - The accountant 9. Preparing the post-closing trial balance the
gathers information from source documents equality of debits and credits are again
and determines the effect of the transactions rechecked after the closing process.
on the accounts. 10. Recording of reversing entries reversing
2. Journalizing the identified accountable entries are usually made at the beginning of
events are recorded in the journals. the next accounting period to simplify the
3. Posting information from the journal are recording of certain transactions in that period.
transferred to the ledger.
4. Preparing the unadjusted trial balance - the Summary of the steps in the accounting
balances of the general ledger accounts are cycle:
proved as to the equality of debits and credits. 1. Identifying and analyzing
The unadjusted trial balance serves as basis 2. Journalizing
for adjusting entries. 3. Posting
5. Preparing the adjusting entries - the 4. Unadjusted trial balance
accounts are updated as of the reporting date 5. Adjusting entries
on an accrual basis by recording accruals, 6. Adjusted trial balance (and/or Worksheet)
expiration of deferrals, estimations, and other 7. Financial statements
8. Closing entries
9. Post-closing trial balance each transaction is recorded in the journal in
10. Reversing entries two parts-debit and credit.

Types of events 3. Short description of the transaction - a

1. External events are transactions that short description of the transaction is provided
involve the busines and another external party. for future reference.
Examples include sale, purchase borrowing of
money, payment of liabilities, and the like. Simple and Compound journal entries
2. Internal events are events that do not A journal entry may have one of the following
involve an extermal party. Examples include formats:
production (cooking of barbecue) and Casualty a. Simple journal entry one that contains a
losses (e.g., destruction of properties due to single debit and a single credit element. The
storm, earthquake, and the like). illustrated journal entry above is an example of
a simple journal entry.
Journalizing b. Compound journal entry one that contains
After an accountable event is identified and two or more debits or credits.
analyzed, the second step is to record it in the
journal by means of a journal entry. This The Compound journal entry to record the
recording process is called journalizing. transaction is as follows:

Date Building P1,000,000

Journal entry Transportation Equip. 500,000
Owner's Equity P1.5M
A journal entry has the following format: to record _____
Account title to be debited

Date Account to be debited P ××× Alternatively, the transaction above can be

Account to be credited P ××× recorded through Simple journal entries as
short description
follows:

The following are the parts of a journal

entry: Date Building P1,000,000
Owner's Equity
1. Date journal entries are recorded in the to record _____ 500,000
journal chronologically, i.e., arranged according
Date Transportation Equip. 500,000
to the dates they are recorded. Owner's Equity 500,000
2. Account titles and Amounts to be debited to record _____

and credited - under the double-entry system,

 CHAPTER 7
POSTING TO LEDGER

Posting, the third step in the accounting cycle,

is the process of transferring data from the
journal to the appropriate accounts in the
ledger. More specifically, posting is done by
transferring the amounts of debits and credits
in a recorded journal entry to the ledger
accounts.

The purpose of posting is to classify the effects

of transactions on specific asset, liability,
equity, income and expense accounts in order
to provide more meaningful information. We
may think of it this way - data processed in the
joumul is "raw" information. We need to classify
(i.e., post) the information in the ledger so as to
provide information.
 Errors revealed by a trial balance
The trial balance can reveal errors that caused
the total debits and total credits to be unequal.
Examples:

1. Journalizing or posting one-half of an entry,

i.e., a debit without a credit, or vice versa.
2. Recording one part of an entry for a different
amount than the other part.
3. Transplacement error on one side of an
Preparing the Unadjusted Trial Balance entry.
A trial balance is a list of general ledger 4. Transposition error on one side of an entry.
accounts and their balances, It is prepared to ● Transplacement error (Slide error) is
check the equality of total debits and total committed when the number of digits in
credits in the ledger. The preparation of the trial an amount is incorrectly increased or
balance creates a starting point for the decreased, for example, a 1,000 amount
preparation of the financial statements. is recorded as P100 or 10,000.
● Transposition error is committed when
Types of Trial balance digits in an amount are interchanged, for
a. Unadjusted trial balance this is prepared example, a 15,652 amount is recorded s
before adjusting entries are made. Adjusting 15,625 or P15,265.
entries, and consequen entriccial statements, Errors not revealed by a trial balance
cannot be prepared unless the total debits and The trial balance cannot reveal errors that do
credits in the unadjusted trial balance are not cause the total debits and total credits to be
equal. unequal.
b. Adjusted trial balance - this is prepared Examples:
after adjusting entries but before the financial 1. Omitting entirely the entry for a transaction
statements are prepared. 2. Journalizing or posting an entry twice.
c. Post-closing trial balance - this is prepared 3. Using a wrong account with the same
after the closing process. normal balance as the correct account.
[Link] computation with same erroneous
Although optional, a trial balance shall amount posted to both the debit and credit
nevertheless be prepared because it helps in sides.
revealing some errors.
The purpose of preparing a trial balance is to The journal entries for the above transactions
determine whether the total debits and total are as follows:
credits in the ledger are equal. Date Transaction Debit Credit
● If total debits and total credits are not
Jan 1 Cash 500,000
equal, an error surely exists. Astig, Capital 500,000
● However, if total debits and total credits to record investment

are equal, it does not necessarily mean 2 Equip - Washing 200,000

that there are no errors. Cash 200,000
to record acquired WM

3 Equip - Dryer 100,000

Illustration 1: Unadjusted Trial Balance Cash 100,000
Preparation On January 1, 20x1, Mr. Tiger to record acquired dryer

Astig started a laundry business called "Tiga 4 Supplies 20,000

Laba Laundry Shop." The following were the Cash 20,000
to record purchased
transactions during the first week of operations: supplies

5 Service Revenue 15,000

Jan. Transactions Cash 15,000
to record service on
cash
1 Provided P500,000 cash as initial investment
to the business. 6 Service Revenue 10,000
A/R 10,000
2 Acquired a washing machine for P200,000 to record service on
account
cash.
3 Acquired a dryer machine for P100,000 cash. 7 Salaries Expense 2,500
Cash 2,500
4 Purchased supplies for 20,000 cash. to record paid
expense
5 Rendered laundry services worth 15,000 on
cash basis.
"Another way of setting up the "Owner's
6 Rendered laundry services worth P10,000 on
capital" and "Owner's drawings" accounts is
account.
by using the name of the business owner in
7 Paid P2,500 to an employee representing her
lieu of the word "Owner's," e.g., "Astig,
week's salary.
Capital" and "Astig Drawings.”
 Notes:
● The unadjusted trial balance is simply a
list of the ending balances of accounts
in the general.
● The heading of the trial balance consists
of the following:
1. Name of the business (i.e., "Tiga
Laba Laundry Shop answers the
question "Who?"
2. Title of the report (i.e.,Unadjusted
Trial Balance)-answers the
question "What?"
3. Date of the report (ie, January 7,
20x1') answers the question
"When?"
● Account titles are listed in the
unadjusted trial balance in the following
order.
Mr. Tiger Astig 1. Assets;
Unadjusted Trial Balance 2. Liabilities;
For the year ended December 31, 20x1 3. Equity:

Accounts Debit Credit 4. Income; and

5. Expenses
Cash P192,500

Accounts Receivable 10,000 Recall again the normal balances of accounts:

Supplies 20,000 ✔ Assets and Expenses —--------- DEBIT
Equipment - WM 200,000 ✔Liabilities, Equity and Income — CREDIT

Equipment - Dryer 100,000

Astig, Capital P500,000

Service Revenue 25,000

Salaries Expense 2,500

Total P525,000 P525,000

 CHAPTER 8 Accruals give rise to both income and
ADJUSTING ENTRIES receivable (or both expense and payable).

Adjusting entries Observe the application of the following

Adjusting entries are entries made prior to the concepts in the succeeding illustrations:
preparation of financial statements to update 1. All adjusting entries involve at least one
certain accounts so that they reflect correct balance sheet account and one income
balances as of the designated time. statement account (or statement of
comprehensive income account).
Purpose of adjusting entries 2. All adjusting entries affect the profit or loss
1. To take up unrecorded income and for the period for comprehensive income (or
expenses of the period. the period).
2. To split mixed accounts into their real and
nominal elements. Case #1:Accrual of income- Interest income
ABC Co. received a 12%, P100,000, one-year,
Mixed, real and nominal accounts will be note receivable on April 1, 20x1. ABC uses a
discussed momentarily. calendar year period. The principal and interest
on the note are due on April 1, 20x2.
Our subsequent discussions on adjusting
entries are subdivided into the following: i = Prt
1. Accruals of income and expenses Where:
2. Recognition of depreciation expense and i = Interest
bad debts expense. P= Principal
3. Deferrals of income and expenses (splitting r = Rate
of 'mivel accounts'). t = Time
(i=Prt: Interest equals principal times rate times
Accruals of Income and Expenses time)
In accounting, the term "accrual" (or to accrue) ● Principal (P) is the P100,000 face
means to recognize an: amount of the note.
a. income that is already earned but not ● Rate (r) is the 12% interest rate.
yet collected; or ● Time (f) is the expired time of 9 months
b. expense that is already incurred but not (i.e., April 1 to December 31, 20x1) over
yet paid. the total of 12 months in a year.
Interest = (100,000 x 12% x 9/12) = 9,000 ● The credit to interest receivable pertains
Adjusting Entries to the accrued interest on December 31,
The adjusting entry for the accrued interest 20x2.
income is as follows: ● The credit to interest income pertains to

Interest receivable P 9,000 the 3-month interest income earned in

Interest income P 9,000 the months of Jan. 1 to Mar. 31. 20x2
to accrue interest income
earned but not yet collected This is computed as follows: i Prt
Notes: (100,000) x 12% x 3/12) = 3,000.
● The adjusting entry is dated as at the
end of the reporting period (i.e., 1-yr. interest: Apr. 1, 20x1 to Mar. 31, 20x2:
December 31, 20x1). (100,000 x 12% x 12/12) 12,000
● "Interest receivable" is debited because
the interest is yet to be collected in the ● 3-mo. Interest: Jan. 1 to Mar. 31, 20x2
future (i.e., on April 1, 20x2). (100,000 x 12% x 3/12)- 3,000
● In 20x1, interest income is recognized recognized in 20x2.
only for the expired period (time passed) ● 9-mo. interest: Apr. 1 to Dec. 31, 20x1:
of April 1 to December 31, 20x1. Interest (100,000 x 12% x 9/12)-9,000
covering the remaining 3 months of recognized in 20x1.
January 1 to March 31, 20x2 will be
recognized in the next accounting
period. This is an application of the time The preparation of adjusting entries is an
period concept. application of the concepts of time period and
accrual basis of accounting (see Chapter 2).
In the next accounting period, the collection
of the interest is recorded as follows: The application of the accrual basis causes
timing differences between the date income is
April 1 Cash* P 12k
20x2 Interest receivable* P 9k recognized and the date it is collected.
Interest Income* 3k Adjusting entries are needed to ensure that
income is recognized in the proper period
● The cash collection pertains to the
when it was earned (time period).
1-year total interest covering the months
of April 1, 20x1 to March 31, 20x2. This
is computed as follows: i Prt (100,000 x
12% x 12/12) - 12,000.
Accrual of income-Rent income Adjusting journal entry (AJE)
ABC Co. rents out its building to a tenant for a The adjusting entry for the accrued interest
monthly rent of P50,000. As of December 31, expense is as follows:
20x1, the tenant has not yet paid the rent for Dec 31, Interest expense 3,000
the month of December. 20x1 Interest payable 3,000
to accrue interest
expense incurred but not
yet paid
Adjusting entries:

Dec Rent Receivable P 50k ● Notes "Interest payable" is credited

31, Rent Income P 50k because the interest is yet to be paid in
20x1 to accrue rent income
the future (i.e., Oct. 1, 20x2).
● In 20x1, interest expense is recognized
In the next accounting period, the collection
only for the expired period (time passed)
is recorded as follows:
from October 1 to December 31, 20x1.
Interest covering the remaining 9
Jan Cash* 50k
20x2 Rent Receivable 50k months of January 1 to October 31,
to record collection of 20x2 will be recognized in the next
Dec 31, 20x1
accounting period.

Observe that rent income is recognized in

In the next accounting period, the payment
20x1 when it was earned rather than in 20x2
of the interests recorded as follows:
when it was collected.
Oct 1, Interest payable 3,000
20x2 Interest expense 9,000
Accrual of expense - Interest expense Cash 12,000
to record the
ABC Co. issued a 12% P100.000, one-year, payment of interest

note payable October 1, 20x1. The principal

and interest are due on October 1 20x2. The debit to interest payable pertains to the
Formula: accrued interest on December 31, 20x1 (see
i=Prt adjusting entry above).
Principal (P)-P100,000 face amount.
Rate (r) = 12% The debit to interest expense pertains to the 9
Time (t) = expired time of 3 months (i.e., months interest omputed as follows: i Prt
October 10. December 31, 20x1) over 12 (100,000 x 12% x 9/12) -9,000. aperse incurred
months in a year. in the months of Jan. 1 to Oct. 1, 20x2.
Interest = (100,000 x 12% x 3/12) = 3,000
The cash payment pertains to the total 1-year Accrual of expense - Salaries expense
interest covering the months of Oct. 1, 20x1 to Employees earned total salaries of P100,000 in
Sept. 30, 20x2. This is computed follows: i-Prt December 20x1. However, the salaries were
(100,000 x 12% x 12/12)=12,000. paid only in January 20x2.

1-yr. interest: Oct. 1, 20x1 to Sept. 30, -20x2 Adjusting journal entry
(100.000 x 12% x 12/12) P12,000 The adjusting entry to record the accrued
salaries is as follows:
3-mo. interest: Oct. 1 to Dec 31, 201 (100,000
Dec 31 Salaries expense 100k
x 12% × 3/12) -P3,000 recognized in 20x1. 20x1 Salaries payable 100k
to accrue salaries
expense

9-mo. Interest: Jan. 1 to Sept. 30, 20x2

(100,000 x 12% x 9/12) P9,000 recognized in Depreciation expense
20x2. On January 1, 20x1, a business acquired
equipment for P20,000. The business expects
Accrual of expense - Utilities expense to use the equipment over the next 4 years.
The cost of electricity used for the month of
December 20x1 is P4,000. The electricity bill The cost of the equipment is initially recorded
was received and paid in January 20x2. as an asset (rather thari an expense) because
it provides future economic benefits, i.e., the
Adjusting journal entry equipment will be used over the next 4 years
The adjusting entry is as follows: As the equipment is used, a portion of the cost

Dec 31 Utilities expense 4,000 recognized as expense on a piecemeal basis

20x1 Utilities pay 4,000 (or 'little by little). This portion is called
to accrue unpaid
utilities
depreciation. In accounting, depreciation
means the allocation of the cost of a
In the next accounting period, the payment
depreciable asset over the periods the
of the tricity bill is recorded as follows:
asset is used.
Jan 1 Utilities payable 4,000
20x2 Cash 4,000
On December 31, 20x1, the equipment has
to record the
payment of the Dec.
20x1 electricity bill
already been used for 1 year out of its total
useful life of 4 years. Thus, one-fourth of the
cost should be recognized as expense.
The annual depreciation expense is computed The Concept of Immediate recognition
as follows: Under the concept of immediate recognition, a
20,000 ÷ 4 = 5,000 cost that produces no future economic benefits
A P5,000 depreciation expense will be or an asset that ceases to provide future
recorded at the end of each of the next four economic benefits is recognized immediately
years (i.e., every December 31) as adjusting as an expense. One application of this concept
entry. is the recognition of bad.. debts expense, In

Dec 31 Depreciation Exp. 5,000 the case above, the P500 account receivable is
20x1 Accumulated Dep 5,000 immediately charged as bad debt expense
to record Depreciation
Expense because it ceased to provide future economic
benefits, i.e., it became uncollectible.
Recognition of Bad debts expense
Illustration: Adjusting entries - Bad debts As of this point, we have already completed
expense discussing the three expense recognition
A business has total accounts receivable of principles. A summary is shown below:
2,000 on December 31, 20x1 before any
adjustments. Of the total amount, it was
Expense Recognition Description
Principles
estimated that 500 is doubtful of collection
('doubtful of colection Filipino means 'alanganin 1. Matching - Costs that are
directly
na makolekta). associated
with the
Dec 31 Bad Debt exp 500
earning of
20x1 Allowance for 500
revenue are
doubtful account
recognized as
to record bad Debt
expene expenses in
the same
period in
After recording the adjusting entry, the carrying which the
related revenu
amount of the receivable is brought equal to is recognized
the estimated collectible amount of 1,500. (See Chapter
2).
- Application:
Accounts receivable 2,000 The cod is
inventory
Allowance for bad debts ( 500) initially
Accounts receivable - net. P1,500 recognized as
asset and
charged as
expense (ie,
Cog of goods
 sold) when the collection is
inventory is immediately
sold. recognized as
expense (i.e.,
2. Systematic & - Costs that are Bad debts.
rational not directly
allocation associated
with the Methods of Initial Recording of income and
eaming of
revenue are expenses
recognized as To understand how adjusting entries for
expenses over
the periods the "mixed accounts" are made, let us first take up
economic the methods of initial recording of income and
benefits
consumed. ate expenses.

- Application:
The cost of Income
equipment is Advanced collections of income are initially
initially
recognized as recorded using either the (1) liability method or
asset and (2) income method.
charged as
expense (le
Depreciation) 1. Liability method-under this method,
over the
periods the advanced collections of income are initially
equipment is credited to a liability account. At the end of the
used.
period, the earned portion is recognized as
3. Immediate - Costs that do income. while the unearned portion remains as
recognition not provide
future liability.
economic 2. Income method - under this method,
benefits or
assets that advanced collections of income are initially
cease to credited to an income account.
provide future
economic
benefits are Liability method vs. Income method
recognized
immediately A business rents out its building to various
as expenses. tenants. On April 1. the business receives
- Application: one-year rent in advance of April thom one of
An account its tenants. Rent per month is 10,000.
receivable that
becomes
doubtful of
The receipt of the advance rent is recorded as The earned portion is recognized as income for
follows: the period (i.e., 20x1).

b. Unearned portion ('unused') pertains to the

remaining 3 months covering January 1 to
March 31, 20x2. This portion is computed as
follows:
Observe that under the liability method, the (10,000 rent per month x 3 months) = 30,000;
rent received in advance is credited to a liability от (120,000 x 3 mos./12 mos.) - 30,000.
account, while under the income method, the
rent received in advance is credited to an The unearned portion is recognized as liability
income account. on December 31, 20x1. It will only be
Before any necessary year-end adjustments recognized as income in the next accounting
on December 31, 20x1, both the "unearned period (i.e., 20x2).
rent" (liability method) and the "rent income"
(income method) accounts are considered Adjusting entries are needed to separate the
"mixed accounts." This is because both real account and nominal account
accounts contain earned and unearned components of a mixed account.
portions. The "earned" portion relates to the The adjusting entries (AJE) on December
income statement (nominal account), while the 31, 20x1 are as follows:
"unearned" portion relates to the balance sheet
(real account). These portions are analyzed as
follows:

a. Earned portion ('used up') - pertains to the

first 9 months of the 1-year rent in advance
covering the months of April 1 to December 31,
20x1. This portion is computed as follows:

(10,000 rent per month x 9 months) = 90,000;

or (120,000 x 9 mos./12 mos.) = 90,000
Expenses considered "mixed accounts." This is because
Prepayments of expenses are initially recorded both accounts contain incurrel and not yet
using either the (1) asset method or (2) incurred portions. The "incurred" portion relates
expense method. to the income statement (nominal account),
while the "not yet incurred portion relates to the
1. Asset method - under this method, balance sheet (real account). These portions
prepayments of expenses are initially debited are analyzed as follows:
to an asset account. At the end of the period,
the incurred portion ('used up' or 'expired') is a. Incurred portion ('used up' or 'expired') -
recognized as expense, while the unused pertains to the first 3 months of the 1-year
portion remains as asset prepaid insurance covering the months of Oct.
2. Expense method under this method, 1 to December 31, 20x1. This portion is
prepayments of expenses are initially debited computed as follows:
to an expense account. At the end of the
period, the unused portion ('not yet incurred' or (120,000 x 3 mos./12 mos.) = 30,000.
unexpired') is recognized as asset, while the
incurred portion remains as expense. The incurred portion is recognized as expense
for the period (i.e., 20x1).

b. Not yet incurred portion ( unused" or

"unexpired") - pertains to the remaining 9
months of January 1 to Sept. 30, 20x2 This
portion is computed as follows:

(120,000 x 9 mos./12 mos.) = 90,000

Observe that under the asset method, the
prepayment of insurance is debited to an asset The not yet incurred portion is recognized as
account, while under the expense method, the asset as of December 31, 20x1. It will only be
prepayment is debited to an expense account. recognized as expense in the next accounting
period (i.e., 20x2).
Before any necessary year-end adjustments on
December 31, 20x1, both the "prepaid
insurance" (asset method) and the "insurance
expense" (expense method) accounts are
Notes:
● Under the asset method, adjusting entry
is needed to recognize the expired
portion (expense) of a mixed account.
● Under the expense method, adjusting
entry is needed to recognize the
unexpired portion (asset) of a mixed
account.

Both the asset and expense methods are

acceptable Regardless of the method used, the
adjusted amounts of insurance expense and
prepaid insurance to be presented in the
financial statements are the same.