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Basic Accounting Module

Accountancy (College of Our Lady of Mercy of Pulilan Foundation Inc.)

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CHAPTER 1
ACCOUNTING CONCEPTS AND ITS CONSIDERATIONS

Desired Learning Outcomes

1. Understand and explain the definition, purpose, nature, functions and objectives of accounting.
2. Distinguish the branches of accounting, users of accounting information.
3. Understand the double entry bookkeeping concept and how it differs from single entry
bookkeeping.
4. Appreciate the history of accounting, accounting variations among countries
5. Adopt the basic professional values and ethics.

Why Do We Need Accounting?

So why do we need accounting? Asking that question of an accountant is like asking a farmer
why we need rain. We need accounting because it’s the only way for business to grow and flourish.
Accounting is the backbone of the business financial world. After all, accounting was created in
response to the development of trade and commerce during the medieval times.

Accounting is the conscious of the business world.

When handled with care and with respect, it performs as expected. When abuse occurs, and the
system is circumvented or overridden because of dishonesty and greed, it doesn’t work correctly.
Accounting is much like all other systems in place, they are only as good as the people using them.

ACCOUNTING is a service activity. Its function is to provide quantitative information, primarily

financial in nature, about economic entities that is intended to be useful in making economic decisions.

“Language of business”

Accounting as science and art

 Accounting is a social science with a body of knowledge Fixed, inflexible,
which has been systematically gathered, classified, and organized and systematic
organized. It is influenced by, and interacts with, economic, social and political environments.
 Accounting is a practical art which requires the use of creative skill
and judgment.

Accounting as an information system

 Accounting identifies and measures economic activities, processes information into financial
reports and communicates these reports to decision makers.

Economic Activities and their classification

•Production – the process of converting economic resources into outputs of
goods and services that are intended to have greater utility than the required
inputs.
•Exchange – the process of trading resources or obligations for other resources
or obligation.

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•Income distribution- the process of allocating rights to the use of output among
individuals and groups in society.

•Consumption – the process of using the final output of the production process.

•Investment – the process of using current inputs to increase the stock of

resources available for output as opposed to immediately consumable output.

•Savings – the process by which individuals and groups set aside rights to
present consumption in exchange for rights to future consumption.

BASIC PURPOSE OF ACCOUNTING: To provide quantitative information about economic

entities intended to be useful in making economic decisions.

TYPES OF INFORMATION PROVIDED BY ACCOUNTING

1. Quantitative information – expressed in numbers, quantities or units.
2. Qualitative information – expressed in words or descriptive form
3. Financial information – expressed in terms of money

ECONOMIC ENTITY VS BUSINESS ENTITY

 Economic entity – is a separately identifiable combination of persons and property that uses or
controls economic or scarce resources to achieve certain goals or objectives. Scarce resources
have no significant characteristics.
o Not-for-profit or non-profit entity is one that carries out some socially desirable
needs of the community or its members whose activities are not directed towards
making profit.
o Business entity is an entity that produces and distributes goods or services
primarily for profit.

FUNCTIONS OF ACCOUNTING
 Identification. The accounting process of recognition or nonrecognition of business
activities as accountable events or whether has accounting relevance.
One that is quantifiable and has an effect on assets, liabilities and equity. This also known as
economic activity, which is the subject matter of accounting.

Criteria for accountable event

1. It must affect a financial element of accounting (increasing or
decreasing asset, liability or equity)
2. It is a result of a past activity
3. Its cost can be measured reliably.

 Measurement. The accounting process of assigning of peso amounts or numbers to the

economic transactions and events. The unit of measure of accounting is money, expressed
in prices.

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 Communication. The accounting process of preparing and distributing accounting

reports to potential users of accounting information and interpreting the significance of this
processed information.

 Recording. the process of systematically committing to writing business transactions and

events after they have been identified and measured, in books of account in a systematic and
chronological manner according to accounting rules.
 Classifying. The grouping of similar and interrelated items into their respective classes.
 Summarizing. Putting together or expressing in condensed or brief form the recorded and
classified statements in financial statements.

BRANCHES OF ACCOUNTING/AREA OF SPECIALIZATION

1. Financial Accounting. The recording of transactions, preparation of financial
statements and communication of financial information to external user groups. Focuses on
general purpose reports.
2. Auditing. The examination of financial statements by independent certified public
accountant for the purpose of expressing an opinion on the fairness of presentation of financial
statements.
3. Management Accounting. Incorporates cost accounting data and adapts them for
specific decisions which management may be called upon to make. A management accounting
system incorporates all types of financial and non-financial information from a wide range of
sources.

4. Financial Management. Relatively new branch of accounting that has been grown
rapidly over the last 35 years. Financial managers are responsible for setting financial
objectives, making plans based on those objectives, obtaining the finance needed to achieve the
plans, and generally safeguarding all the financial resources of the entity.

5. Taxation / Tax accounting. Involves the preparation of tax returns and rendering of
tax advice, such as determination of tax consequences of certain proposed business endeavors.

6. Government Accounting. Accounting for the national government and its

instrumentalities, focusing attention on the custody of public funds and the purpose or purposes
to which such funds are committed.
7. Fiduciary Accounting. Handling of accounts managed by a person entrusted with the
custody and management of property for the benefit of another.

8. Social Responsibility. Reporting of programs and projects that have to do with the
upliftment of the welfare of the people of a community or of the nation.

9. Environmental Accounting. The area of accounting that focuses on programs,

activities and projects that are focused care for Mother Earth.

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One example of this is carbon accounting such as “Cap and Scheme”, which is a process of
encouraging reductions in greenhouse gas emissions.

10. Price-level Accounting. Otherwise known as Accounting for Hyperinflationary

Economies – simply defined, is accounting that recognizes in the financial statements changes
in the purchasing power of money.

USERS OF ACCOUNTING INFORMATION

• Internal Users are those who make decisions directly affecting the internal operations
of the business.
a. Managers are directly involved in operation of the business. They need accounting data to
improve the efficiency and effective of the organization.
b. Employees use financial data to assess whether they are receiving the right compensation and
to check if they bargain for higher remuneration, retirement benefits and employment
opportunities.
c. Officers, also called as the company executives who are interested to know if the company is
doing well in its operation so they can plan for possible expansion or branching out to widen its
geographical and demographic market.
d. Internal Auditors, there role is to protect and safeguard the resources of the company against
fraud or irregularities.

• External users are individuals or enterprises that have financial interest in the business
but they are not involved in the day activities of the organization. These are:
a. Investors (The providers of risk capital) are interested in information which enables them to
assess the ability of the enterprise to pay dividends. They need information on whether they
should buy, hold or sell their shares in.
b. Lenders are interested in information that enables them to determine whether their loans, and
their interest attaching to them will be paid when due.
c. Suppliers and other trade creditors are interested in information that enables them to
determine whether amount owing to them will be paid when due.
d. Customers are interested in the quality of goods and services that they are getting from the
entity.
e. Government and their agencies require information in order to regulate the activities of the
enterprise, determine taxation policies and as a basis for national income and similar activities,

o Public are assisted by information through financial statements about the trend and recent
developments in the prosperity of the enterprise and the range of its activities.

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FUNDAMENTAL CONCEPTS

Entity Concept
The most basic concept in accounting is the entity concept. An accounting entity is an organization or
a section of an organization that stands apart from other organizations and individuals as a separate
economic unit. Simply put, the transactions of different entities should not be accounted for together.
Each entity should be evaluated separately.

Periodicity Concept
An entity’s life can be meaningfully subdivided into equal time periods for reporting purposes.
For the purpose of reporting to outsiders, one year is the usual accounting period. Luca Pacioli, the
first author of an accounting text, wrote in 1494: “Books should be closed each year, especially in a
partnership, because frequent accounting makes for long friendship.”

Calendar Year – starts in January and ends in December.

Fiscal Year – starts in any month and ends after 12 months.

Stable Monetary Unit Concept

The Philippine Peso is a reasonable unit of measure and that its purchasing power is relatively
stable. This is the basis for ignoring the effects of inflation in the accounting records.

BASIC PRINCIPLES

Accounting practices follow certain guidelines. The set of guidelines and procedures that constitute
acceptable accounting practice at a given time is GAAP, which stands for generally accepted
accounting principles. In order to generate information that is useful to the users of financial
statements, accountants rely upon the following principles.

Objectivity Principle. Accounting records and statements are based on the most reliable data
available so that they will be as accurate and as useful as possible. Reliable data are verifiable when
they can be confirmed by independent observers.

Historical Cost. This principle states that acquired asset should be recorded at their actual cost and not
at what management thinks they are worth as at reporting date.

Revenue Recognition Principle. Revenue is to be recognized in the accounting period when goods
are delivered or services are rendered or performed.

Expense Recognition Principle. Expenses should be recognized in the accounting period in which
goods and services are used up to produce revenue and not when the entity pays for those goods and
services.

Adequate Disclosure. Requires that all relevant information that would affect the user’s
understanding and assessment of the accounting entity be disclosed in the financial statements.

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Materiality. Financial reporting is only concerned with information that is significant enough to affect
evaluations and decisions. Materiality depends on the size and nature of the item judged in the
particular circumstances of its omission.

Consistency Principle. The firms should use the same accounting method from period to period to
achieve comparability over time within a single enterprise. However, changes are permitted if
justifiable and disclosed in the financial statements.

UNDERLYING ASSUMPTIONS

Accrual Basis
Financial Statements are prepared on the accrual on the accrual basis of accounting and not as cash or
its equivalent is received or paid. Under this assumption, the effects of transactions and other events
are recognized when they occur and they are recorded in the accounting records and reported in the
financial statements of the periods to why they relate.
In short, transactions are recognized when “Revenue as they earned, even not yet received and;
Expenses as they incurred, even not yet paid.

In cash basis accounting, however, does not record a transaction until cash is received or paid.
Generally, cash receipts are treated as revenues and cash payments as expenses.

Going Concern
Financial statements are normally prepared on the assumption that an enterprise is a going concern
and will continue in operation for a foreseeable future. It is assumed therefore that the enterprise has
neither the intention nor the need to liquidate its operations.

BUSINESS ORGANIZATION

FORMS OF BUSINESS ORGANIZATIONS

 Sole Proprietorship. This business organization has a single owner called the proprietor who
generally is also manager. It tends to be small service-type (e.g. physicians, lawyers and accountants)
business and retail establishments. The owner receives all profits, absorbs all losses and is solely
responsible for all debts of the business. From the accounting viewpoint, the sole proprietorship is
distinct from its proprietor. Thus, the accounting records do not include proprietor’s personal financial
records.
 Partnership. A business owned and operated by two or more persons who bind themselves to
contribute money, property or industry to a common fund, with the intention of dividing the profits
among themselves. Each partner is personally liable for any debt incurred by the partnership, except
limited partner.
 Corporation. A business owned by its stockholders. It is an artificial being created by
operation of law, having the rights of succession and the powers, attributes and properties expressly
authorized by law or incident to its existence. The stockholders are not personally liable for the
corporation’s debt.

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PURPOSE OF BUSINESS ORGANIZATIONS

 Service companies perform services for a fee (e.g. law firms, accounting and law firms,
stock brokerage, beauty salons and recruitment agencies)

 Merchandising companies purchase goods that are ready for sale and then sell these to
customers (e.g. car dealers, clothing stores and supermarkets)

 Manufacturing companies buy raw materials, convert them into products and then sell
the products to other companies or to final consumers (e.g. paper mills, steel mills, car
manufacturers and drug manufacturers)

MICRO, SMALL AND MEDIUM ENTERPRISES (MSME)

 Micro Enterprises are those with assets, before financing of P 3 million or less and
employ not more than nine (9) workers.
 Small Enterprises are those with assets, before financing of above P 3
million to P 15 million and employ 10 to 99 workers.

 Medium Enterprises are those with assets, before financing of above P15 million to
P100 million and employ 100 to 199 workers.

ACTIVITIES IN BUSINESS ORGANIZATIONS

 Operating Activities are the principal activities of the enterprise. They are the
transactions and events that enter into the determination of profit and loss. E.g.: o Sale of
services o Purchase of supplies
o Payment of various expenses like salaries and other benefits to employees,
utilities, taxes and repairs and maintenance, insurance, transportation and gasoline
expense.
 Investing Activities are the acquisition and disposal of long-term assets and other
investments. E.g.:
o Purchase of equipment, furniture, automobile and land o Cost of developing
and constructing office or building o Sale of used fixed assets o Loans and advances to
other parties o Investments in equity or debt instruments
 Financing Activities are activities that result in charges in the size and composition of
the contributed equity and borrowings of the enterprise. E.g.:
o Cash proceeds from issuing shares of stocks by a corporation o Cash proceeds
and repayment of bank loans and other long-term barrowings.

References:
Ballada, Win and Susan Ballada. (2009). Basic Accounting Made Easy 14th Edition. Manila: Domdane
Publishers and Made Easy Books.
Ledesma, Ester L.(2014).Financial Accounting Theory Review Booklets. Manila: CRC-Ace The
Professional CPA Review School.
Rante, Gloria Aradaniel.(2013). Accounting for Service Entities. Mandaluyong City: Millenium
Books, Inc.

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NAME: YR.&SEC.
COURSE: DATE

ACTIVITY NO. 1

Multiple Choice
1. Accounting is a service activity. Its function is to provide
a. Quantitative information
b. Qualitative information
c. Quantitative and qualitative information
d. None of the above
2. The basic purpose of accounting is
a. To provide the information that the managers of an economic entity need to
control its operations.
b. To provide information that the creditors of an economic entity can use in
deciding whether to make additional loans to the entity.
c. To measure the periodic income of the economic entity.
d. To provide quantitative financial information about a business enterprise that is
useful in making rational economic decision.
3. Which of the following best describes the attributes of a partnership
a. Limited ability to raise capital; unlimited personal liability of owners.
b. Limited ability to raise capital; limited personal liability of owners.
c. Ability to raise large capital; unlimited personal liability of owners.
d. Ability to raise large amounts of capital; limited personal liability of owners.
4. Which of the following is true?
a. Stockholders are personally liable for the liabilities of the corporation if the
company us unable to pay.
b. Normally, stockholders can only sell their ownership interests when the
corporation terminates.
c. Partners are personally liable for the liabilities of the partnership if the
partnership is unable to pay.
d. Partners can normally transfer their partnership interests with ease.
5. Which accounting process is the recognition or non-recognition of business activities as
accountable events?
a. Identifying
b. Communicating
c. Recording
d. Measuring
6. The concept of the accounting entity is applicable
a. Only to the legal aspects of business organizations
b. Only to the economic aspects of business organizations
c. Only to business organizations
d. Whenever accounting is involved
7. The entity concept means that

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a. Because a firm is separate and distinct from its owners, those owners cannot
have access to its assets unless the firm ceases to trade.
b. Accounts must be prepared for every firm.
c. The financial affairs of a firm and its owner are always kept separate for the
purpose of preparing accounts.
d. None of the above
8. Accountants do not recognize that the value of the peso changes over the time. This
concept is called the
a. Stable money unit concept
b. Going concern concept
c. Cost principle
d. Entity concept
9. The principle of objectivity includes the concept of
a. Summarization
b. Verifiability
c. Classification
d. Conservatism
10. Which of the following is not a user of internal accounting information?
a. Store Manager
b. Chief executive officer
c. Creditor
d. Chief financial officer
11. An event that affects the financial position of an organization and requires recording is
called:
a. Transaction
b. Account
c. Business documents
d. Operating activities
12. All of the following are external users of accounting information except:
a. Creditors, lenders and suppliers
b. Present and potential investors
c. Government regulatory bodies
d. Managers and employees
13. It is the simplest of business organization
a. Service Entity
b. Merchandising Entity
c. Partnership
d. Sole Proprietorship
14. The following are examples of service business except:
a. SM Supermarket
b. Amana Hotel and Resorts
c. Cebu Pacific
d. Manila Water Inc.
15. The following are examples of manufacturing business, except:
a. Toyota Motors, Inc.

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b. Sony Philippines
c. Red Ribbon Bakeshop
d. Rolex Watch Repair Shop
16. All of the following are qualitative characteristics of financial statements except:
a. Understandability
b. Relevance
c. Materiality
d. Going Concern
17. Financial information must possess this characteristic in order for the users to easily
understand the contents of the financial statements.
a. Reliability
b. Completeness
c. Relevance
d. Understandability
18. The measurement phase of accounting is accomplished by
a. Storing data
b. Reporting to decision makers
c. Recording data
d. Processing data
19. The communication phase of accounting is accomplished by
a. Storing data
b. Reporting to decision makers
c. Recording data
d. Processing data
20. A professional accountant should be straightforward and honest in all professional and
business relationships. This is in consonance with the fundamental principle of
a. Integrity
b. Objectivity
c. Confidentiality
d. Professional competence and care

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CHAPTER 2
BASIC CONSIDERATION ON FINANCIAL STATEMENTS

Desired Learning Outcomes

1. Understand and explain the objective and qualitative characteristics of financial
statements.
2. Distinguish the elements of financial statements, its recognition and measurements.
3. Learn and apply the principle of Accounting Equation, the rule of debits and credits.
4. Understand Accounting events and transactions, types and effects of transactions

FINANCIAL STATEMENTS

OBJECTIVES
Provide information about the financial position, performance and changes in financial position
of an entity that is useful to a wide range of users in making economic decisions.
Financial statements prepared for this purpose:
 Meet the common needs of most users
 Also show the results of the stewardship* of management, or
accountability of management for the resources entrusted to it.
 Do not, however, provide all the information that users may need to make
decisions since they largely portray the financial effects of past events and do not
necessarily provide nonfinancial information.

*e.g. in prev. times, it is the one employed by a large household or estate to manage domestic
concerns such as supervision of servants, collection of rents and keeping of accounts.

QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS

A. Fundamental qualitative characteristics

a. Relevance
b. Faithful Representation

B. Enhancing Qualitative characteristics

a. Comparability
b. Verifiability
c. Timeliness
d. Understandability

RELEVANCE
Relevant financial information is capable of making a difference in the decision made by users,
influences the economic decisions of users by helping them to evaluate, past, present, or future
events or confirming, or correcting, their past evaluations.

a. Predictive value. Financial information has predictive value if it can be used as

input to processes employed by users to predict future outcomes. For e.g. information

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about financial position and past performance is frequently used in predicting wages
payments, and the ability of the entity to meet maturing obligations.

b. Confirmatory value (or feedback). Financial information has confirmatory

value if it provides feedback about (confirms or changes) previous evaluation.
Information with feedback value enables users to confirm or correct expectations.

FAITHFUL REPRESENTATION
To be useful, financial information must not only represent relevant phenomena, but it must also
faithfully represent the phenomena that it purports to represent.

a. Completeness. A complete depiction includes all information necessary for a user

to understand the event or information being presented, including all necessary
descriptions and explanations.

b. Neutrality. A neutral presentation is one without bias.

c. Freedom from error. Means there are no errors or omissions in the description
of the phenomenon, and the process used to produce the reported information has been
selected and applied with no errors in the process.

ENHANCING QUALITATIVE CHARACTERISTICS

a. Comparability. It enables the users to identify and understand similarities in, and
differences among, items. Consistency, although related to comparability, is not the same.
“Comparability is the goal; consistency helps to achieve that goal.”

b. Verifiability. Means that different knowledgeable and independent observers

could reach consensus, although not necessarily complete agreement, that a particular
depiction is a faithful representation.

c. Timeliness. Means having information available to decision-makers in time to be

capable of influencing their decisions.
d. Understandability. Means classifying, characterizing, and presenting
information clearly and concisely.

THE ELEMENTS OF FINANCIAL STATEMENTS

The financial statements portray the financial effects of transactions and other events by
grouping them into broad classes according to their economic characteristics. These termed the
elements of financial statements. Elements directly related to measurement of financial position
are:
Elements directly related to measurement of financial position are:
 Assets
 Liabilities
 Equity
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Elements directly related to measurement of performance are:

 Income
 Expense

RECOGNITION OF THE ELEMENTS OF FINANCIAL STATEMENTS

Recognition is the process of incorporating in the balance sheet or income statement an item that
meets the definition of an element and satisfies the criteria for recognition. An item that meets
the definition of an element should be recognized if:
 It is probable that any future economic benefit associated with the item will flow
to or from the enterprise; and
 The item has a cost or value that can be measured with reliability.

MEASUREMENT OF THE ELEMENTS OF FINANCIAL STATEMENTS

Measurement is the process of determining the monetary amounts at which the elements of
financial statements are to be recognized and carried in the balance sheet and income
statement. This involves the selection of a particular basis of measurement. A number of these
are used to different degrees and in varying combinations in financial statements. They include
the following:

HISTORICAL COST. Assets are recorded at the amount of cash or cash equivalents paid or the
fair value of the consideration given to acquire them at the time their acquisition.

CURRENT COST. Assets are carried at the amount of cash or cash equivalents that would have
to be paid if the same or an equivalent asset was acquired currently.

“Liabilities are carried at the discounted amount of cash and cash equivalents that would be
required to settle the obligation currently.”

REALIZABLE (SETTLEMENT) VALUE

Realizable value. Assets are carried at the amount of cash or cash equivalents that could
currently be obtained by selling an asset in an orderly disposal.

Settlement value. Liabilities are carried at the undiscounted amounts of cash or cash equivalents
expected to be paid to satisfy the liabilities in the normal course of business.

Present Value. Assets/liabilities are carried at present discounted value of the future net cash
inflows/outflows that the item is expected to generate/settle in the normal course of business.

GUIDELINES IN THE PRESENTATION OF FINANCIAL STATEMENTS

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Philippine Accounting Standard 1 (PAS) gives us the following guidelines in the presentation of
financial statements.
(1) Each component of the financial statements shall be clearly identified and
the following information shall be emphasized for a proper understanding of the
information presented:
i. The name of the reporting entity;
ii. Whether the financial statements cover the individual entity or a
group of entities.
(2) The period covered by the financial statement shall be specified.

Note: For Balance Sheet, use As of (date). For Income Statement, Statement of Changes in
Owner’s Equity and Statement of Cash flows, use For the month/year ended (date).

FINANCIAL POSITION

The financial position of an enterprise is affected by the economic resources it controls, its
financial structure, it liquidity and solvency, and its capacity to adapt to changes in the
environment in which it operates. This is primarily provided in the Statement of Financial
Position or Balance Sheet.
It answers the following questions:
 What assets does entity own?
 What does it owe?
 What are the residual equity interests in the entity’s net assets?

Other important information provided by the statement of financial position is as follows:

 Financial structure – is the source of financing for the assets of the enterprise. It
indicates what amount of assets has been financed by creditors, which is borrowed
capital, and what amount of assets has been financed by owners, which is invested
capital.
Significance:
(1) Useful in predicting future borrowing needs and how
future profits and cash flows will be distributed among those with
an interest in the enterprise.
(2) Useful in predicting how successful the enterprise is likely
to be raising further finance.
 Liquidity – refers to the availability of cash in the near future after taking
account of financial commitments over this period.
Significance:
(1) Useful in predicting the ability of the enterprise to meet its
short-term financial commitments as they fall due.

 Solvency – refers to the availability of cash over the longer term to meet
financial commitments as they fall due. Significance:
(1) Useful in predicting the ability of the enterprise to meet its
long-term financial commitments as they fall due.

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 Capacity for adaption – the ability of the enterprise to use its available cash for
unexpected requirements and investment opportunities. This is also known as
financial flexibility.
(1) Information about the economic resources controlled by
the enterprise and its capacity for adaptation is useful in
predicting the ability of the enterprise to generate cash and cash
equivalents in the future.

COMPOSITION OF A STATEMENT IN FINANCIAL POSITION

Assets

These are resources controlled by the enterprise* as a result of past events** and from which
future economic benefits*** are expected to flow to the enterprise.

For example, an asset may be:

• Used singly or in combination with other assets in the production of goods
or services to be sold by the enterprise;
• Exchanged for other assets;
• Used to settle a liability;
• Distributed to the owners of the enterprise.

Assets are should be classified only in two: current assets and noncurrent assets. Operating
Cycle is the time between the acquisition of assets for processing and their realization in cash or
cash equivalents. When the entity’s normal operating cycle is not clearly identifiable, it is
assumed to be twelve months.
*Controlled by the enterprise – control is the ability to obtain the economic benefits and to
restrict the access of others (e.g. an entity being the sole user of its plants and equipment or by
selling idle assets)
**Past events – The event must be past before an asset can rise. (E.g. equipment will only
become an asset when there is the right to demand delivery or access to the asset’s potential.
Dependent on the terms of the contract, this may be on acceptance of the order or on delivery.
***Future economic benefits – These are evidenced by the prospective receipt of cash. This
could be cash itself, an account receivable or any item which may be sold. Although, for
example, a factory may not be sold for it houses the manufacturing facility for the goods. When
these goods are sold, the economic benefit resulting from the use of the factory is realized as
cash.

Current Assets

An entity shall classify assets as current when:

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It expects to realize the asset, or intends to sell or consume it, in its normal
a.
operating cycle;
b. It holds the asset primarily for the purpose of trading;
c. It expects to realize the asset within twelve months after the reporting period;
d. The asset is cash or cash equivalent unless the asset is restricted from being
exchanged or used to settle a liability for at least months after the reporting period.
1. Cash any medium of exchange that a bank will accept for deposit at face value. It
includes coins, currency, checks, money orders, bank deposits and drafts.
*Money orders is a document which can be bought as a way of sending money through the post.

2. Cash Equivalents these are short-term, highly liquid investments that are readily
convertible to known amounts of cash and which are subject to an insignificant risk of
changes in value.
3. Accounts Receivable These are claims against customers arising from sale of
services or goods on credits. This type of receivable offers less security than a promissory
note.

4. Notes Receivable A note receivable is a written pledge that the customer will pay
the business a fixed amount of money on a certain date.
5. Inventory or Merchandise Inventory these are assets which are (a) held for sale
by the company, (b) in the process of production for such sale, (c) in the form of
materials (raw materials) or supplies to be consumed in the production.

6. Supplies this may be office supplies like bond papers, paper clips and the like or
can be also store supplies like boxes, bags, packaging tapes and other related materials.
7. Prepaid Expenses These are expenses paid for by the business in advance. It is
an asset because the business avoids, having to pay cash in the future for a specific
expense. This includes insurance and rent.

Non-current Assets

All other assets not classified or does not fall under the criteria of current assets are called non-
current assets.

1. Property, Plant and Equipment (PPE) these are tangible assets that are held by an enterprise
for use in the production or supply of goods or in rendering services, or for rental to other, or for
administrative purposes and which are expected to be used during more than one period.
These are:
a. Land e. Delivery Equipment
b. Building f. Store Equipment
c. Office Equipment g. Service Vehicle
d. Furniture and Fixtures

2. Accumulated Depreciation applies to property, plant and equipment except land as a contra
account that contains the sum of periodic depreciation charges. The reflected amount is deducted
from the cost of the related asset to obtain book value.

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To illustrate:
The Company has an office equipment worth P500,000 with a useful life of 10 years acquired
last June 1, 2013.
Office Equipment P 500,000
Accumulated Depreciation – O/E (100,000)
Net book value P 400,000

Formula:
Annual Depreciation = Cost of the PPE – salvage value* (if any)
Life (n)

Accumulated Depreciation = Annual depreciation x age of the PPE

*Salvage value is the value of an asset if sold for scrap and also called as Residual or scrap
value.

To compute:
= 500,000 = 50,000 annual depreciation
10
= 50,000 x 2 years = 100,000 Accu. Dep.
(from june 1 2013 to june 1 2015)

3. Intangible
These are identifiable, nonmonetary assets without physical substance held for use in the
production or supply of goods or services, for rentals to others or for administrative purposes.
These are:
a. Goodwill e. Franchises
b. Patents f. Trademarks
c. Copyrights g. Brand
d. Licenses names

LIABILITIES

A present obligation of the enterprise arising from past events, the settlement of which is
expected to result in an outflow from the enterprise of resources embodying can be measured
benefits.

*Obligation – These maybe legal or not. A duty to do something or a debt.

* Transfer economic benefits - This could be a transfer of cash, or another property, the
provision of a service or the refraining from activities which would otherwise be profitable.

The settlement of a present obligation involving outflow of resources may take the form of:
a. Payment of cash
b. Transfer of other assets

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c. Provision for services

d. Replacement of the present obligation with another obligation
e. Conversion of the obligation to equity

Current Liabilities

An entity shall classify a liability as current when:

a. It expects to settle the liability in its normal operating cycle
b. It holds the liability primarily for the purpose of trading
c. The liability is due to be settled within twelve months after the reporting
period; or
d. The entity does not have an unconditional right to defer settlement of the
liability for at least twelve months after the reporting period.
1. Accounts payable This account represents the reverse relationship of the
accounts receivable. Due to suppliers of goods and other assets purchased on credit.

2. Notes Payable A note payable is like a note receivable but in a reverse sense. The
business entity is the maker of the note; that is, the entity is the party who promises to
pay in a specified amount of money on specified future date.
3. Accrued Liabilities Amounts owed to others for unpaid expenses. This account
includes:
a. Salaries payable c. Interest payable b. Utilities payable d. Taxes payable

4. Unearned Revenues When the business entity receives payment before providing
its customers with goods or services, the amounts received are recorded in the unearned
revenue account (liability method). When the goods or services are provided to the
customer, the unearned revenue is reduced and income is recognized.

5. Current portion of Long-term debt These are portions of long-term liabilities

which are to be paid within one year from the balance sheet date.

Non-current liabilities

All other liabilities not classified or does not fall under the criteria of current liabilities are called
non-current liabilities.
1. Mortgage payable This account records long-term debt of the business entity for
which the entity has pledged certain assets as security to the creditor.

2. Bonds payable is an obligation in connection with the bond, a contract between

the issuer and the lender specifying the terms of repayment and the interest to be charged.

OWNER’S EQUITY

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Equity is defined as the residual interest in the asset of an entity that remains after deducting all
its liabilities.
1. Capital this account is used to record original and additional investment of the
owner of the business entity. In partnership, Partners’ Capital is use as its capital account
while in corporation is Shareholders’ Equity.

2. Withdrawals When the owner of a business entity withdraws cash or other

assets, such are recorded in the drawing or withdrawal account rather than directly
reducing the owner’s equity account.
3. Income Summary It is a temporary account used at the end of the accounting
period to close the income and expenses. This account shows the profit or loss for the
period before closing to the capital account.

FINANCIAL PERFORMANCE reflected by accrual accounting*

Performance of an enterprise – comprise its revenue, expenses, net income or loss for a period
of time. It is the level of income earned by the enterprise through efficient and effective use of its
resources. Information about performance is primarily provided in an Income Statement or
Statement of Financial Performance or Statement of Comprehensive Income or Statement of
Income and Expenses.

*Accrual Accounting recognizes transactions and other events of a reporting entity in the
periods in which those effects occur, even if the resulting cash receipts and payments occur in a
different period.

COMPOSITION OF STATEMENT OF FINANCIAL PERFORMANCE

REVENUE OR INCOME

These are increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decrease of liabilities from delivery or production of goods, rendering
of services, or other activities that constitute the enterprise’s major operations.
1. Service Income Revenues earned by performing services for a customer or client,
for e.g. accounting services by a CPA firm, laundry services by a laundry shop.

2. Sales Revenues earned as a result of sale of merchandise; for e.g. sale of

merchandise by General Merchandise Store.

EXPENSES

These are decrease in economic benefits during the period in the form of outflows or using up of
assets or incurrence of liabilities that result in decreases in equity, other than relating to
distributions to equity participants.
1. Cost of Sales The cost incurred to purchase or to produce the products sold to
customers during the period; also called as cost of goods sold.

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2. Salaries and Wages Expense includes all payments as a result of an employer-

employee relationship such as salaries and wages, 13th month pay, cost if living
allowances, other related benefits.
3. Utilities Expense expenses related to use of telecommunications facilities,
consumptions of electricity, fuel and water.
4. Rent Expense expense for space, equipment or other asset rentals.
5. Supplies Expense expense of using supplies in the conduct of daily business.

6. Insurance Expense portion of premiums paid on insurance coverage which has

expired.

7. Depreciation Expense portion of the cost of a tangible asset allocated or charged

as expense during an accounting period.
8. Uncollectible Accounts Expense the amount of receivables estimated to be
doubtful of collection and charged as expense during an accounting period.

9. Interest Expense An expense related to use of borrowed funds.

CHANGES IN FINANCIAL POSITION

It refers to the changes in the economic resources and obligation of an enterprise. In constructing
a statement of changes in Owner’s Equity, funds can be defined in various ways, such as all
financial revenues, working capital, liquid assets or cash.

THE ACCOUNT

The basic summary device of accounting is the account. A separate account is maintained for
each element that appears in the balance sheet (assets, liabilities, and equity) and in the income
statement (income and expense). Thus, an account may be defined as a detailed record of the
increases, decrease and balance of each element that appears in an entity’s financial statements.

The simplest form of the account is known as the “T” account because of its similarity to the
letter T. the account has three parts as shown on the next page.

Account Title

Left side or Debit Right side of Credit

side side

THE ACCOUNTING EQUATION and DEBITS AND CREDITS-THE DOUBLE ENTRY

SYSTEM
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Assets = Liabilities + Equity

Balance

The basic tool of accounting is the accounting equation. The left side of the equation shows
how much the business owns, and the right side of the equation shows how much resources do
the outside creditor and owner supplied to the business.

The logic of debiting and crediting is related to the accounting equation. Transactions may
require addition to both sides (left or sides), subtractions from both sides (left and right sides), or
an addition and subtraction on the same side (left or right sides). But in all cases the equality
must be maintained as shown above.

Accounting is based on a double-entry system which means that the dual effects of business are
recorded. A debit side entry must have a corresponding credit side entry. For every
transaction, there must be one or more accounts debited and one or more accounts credited and
must be equal both sides. Each transaction affects at least two accounts.

The rules of debit and credit in accounts.

ACCOUNT DEBIT CREDIT

Assets + -
Liabilities - +
Capital or Equity - +
Revenue or Income - +
Expenses + -
(+) increase; (-) decrease

ACCOUNTING EVENTS AND TRANSACTIONS

An accounting event is an economic occurrence that causes changes in an enterprise’s assets,

liabilities, and/or equity. A transaction is a particular kind of event that involves the transfer of
something of value between two entities.

Accountants observe many events that they identify and measure in financial terms. A business
transaction is the occurrence of an event or a condition that affects financial position and can be
reliably recorded.

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Financial transaction worksheet

Every financial transaction can be analyzed or expressed in terms of its effects on the accounting
equation. The financial transactions will be analyzed by means of a financial transaction
worksheet which is a form used to analyze increases and decreases in the assets, liabilities or
owner’s equity of a business entity.

When a specific asset, liability or owner’s equity item is created by a financial transaction, it is
listed in the financial transaction worksheet using the appropriate accounts.

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To illustrate:

Mr. Wagmalito Kayayan wants to open an accounting firm this year. The following transactions are made
during the month.

May 1. Mr. W. Kayayan invested P100,000 to start an accounting office.

W. Kayayan Accounting Firm
Financial Transaction Worksheet
Month of May 2015

ASSET = LIABILITIES + OWNER’S EQUITY

May 2015
Cash Accounts Office Office = Accounts Notes + W. Kayayan
Receivable Supplies Equipment Payable Payable Capital

1 100,000 100,000

The financial transaction is analyzed as follows:

• An entity separates and distinct from Kayayan’s personal financial affairs is created.
• An economic resource – cash of P 100,000 is invested in the business entity. The source of
this asset is the contribution made by the owner, which represents owner’s equity. The owner’s
equity account is W. Kayayan, Capital.
• The dual nature of the transaction is that cash is invested and owner’s equity created. The
effects of this transaction on the accounting equation are as follows: increase in asset – cash
from zero to P 250,000 and increase in owner’s equity from zero to P 250,000.

May 3. Purchased office supplies worth P20,000 on account.

The effect of transaction is increase in asset and increase in liabilities. Take note that the equality of the two
sides of the equation is maintained.

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May 5. Purchased additional office supplies for cash, P10,000.

ASSET = LIABILITIES + OWNER’S EQUITY
May 2015 Cash Accounts Office Office Accounts Notes + W. Kayayan
Receivable Supplies Equipment Payable Payable Capital

Bal.
100,000 10,000
5 90,000 0 30,000 0 = 20,000 0 + 100,000
120,000 = 120,000
(10,000)
Bal.

The effect of transaction is increase in asset and decrease in another asset form of asset. After posting the
transaction, total asset amounts to P120,000 and total liabilities and capital amount to P120,000.

May 6. Paid the accounts payable in full.

Transaction reduces both sides of the equation by P20,000 resulting to the equality of the equation after
posting.

May 8. Purchased 2 units of computer with printer for P50,000, 30 days.

ASSET = LIABILITIES + OWNER’S EQUITY
May
2015 Cash Accounts Office Office = Accounts Notes + W. Kayayan
Receivable Supplies Equipment Payable Payable Capital
Bal. 100,000 100,000
8 50,000 50,000
Bal. 70,000 0 30,000 50,000 = 50,000 0 + 100,000
150,000 = 150,000

May 10. Rendered accounting services for cash, P25,000.

ASSET = LIABILITIES + OWNER’S EQUITY

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May 15 Rendered accounting services on account, P 30,000.

ASSET = LIABILITIES + OWNER’S EQUITY
May 2015
Cash Accounts Office Office = Accounts Notes + W. Kayayan
Receivable Supplies Equipment Payable Payable Capital

Bal. 95,000 0 30,000 50,000 50,000 0 + 125,000

15 30,000 30,000 Prof.fee
Bal. 95,000 30,000 30,000 50,000 = 50,000 0 + 155,000
= 205,000 205,000

May 15 Paid Meralco bills, P 3,500.

ASSET = LIABILITIES + OWNER’S EQUITY
May 2015
Cash Accounts Office Office = Accounts Notes + W. Kayayan
Receivable Supplies Equipment Payable Payable Capital

Bal. 95,000 30,000 30,000 50,000 = 50,000 0 + 155,000

15 (3,500) (3,500)Utility
Exp.
Bal. 91,500 30,000 30,000 50,000 = 50,000 0 + 151,500
201,500 = 201,500

May 15 Paid salaries for the period, P15,000.

ASSET = LIABILITIES + OWNER’S EQUITY

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May 20 Collected P10,000 from customer.

ASSET
May OWNER’S
Cash Accounts Office Office = LIABILITIES + EQUITY
2015 Accounts Notes + W. Kayayan
Receivable Supplies Equipment = Payable Payable Capital
Bal. 76,500 30,000 30,000 50,000 = 50,000 0 + 136,500
20 10,000 (10,000)
Bal. = 136,500
86,500 20,000 30,000 50,000 50,000 0
May 2015
Cash Accounts Office Office = Accounts Notes + W. Kayayan
Receivable Supplies Equipment Payable Payable Capital

Bal. 91,500 30,000 30,000 50,000 = 50,000 0 + 151,500

15 (15,00) (15,000)Salaries
Exp.
Bal. 76,500 30,000 30,000 50,000 = 50,000 0 + 136,500
186,500 = 186,500

186,500 =

May 22 A Short term loan from a local bank was granted in the amount of P50,000, less P5,000 financing
charges. Mr. W. Kayayan issued 1 year promissory note.
ASSET = LIABILITIES + OWNER’S EQUITY
May 2015
Cash Accounts Office Office = Accounts Notes + W. Kayayan
Receivable Supplies Equipment Payable Payable Capital

Bal. 86,500 20,000 30,000 50,000 = 50,000 0 + 136,500

22 45,000
50,000
131,500 20,000 30,000 50,000
Bal. 231,500

Interest Expense
131,500
= 50,000 50,000 +
231,500

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May 25 Paid telephone bill amounting to P 6,000.

ASSET = LIABILITIES + OWNER’S EQUITY
May 2015
Cash Accounts Office Office = Accounts Notes + W. Kayayan
Receivable Supplies Equipment Payable Payable Capital
Bal. 131,500 20,000 30,000 50,000 = 50,000 50,000 + 131,500
25 ( 6,000) (6,000) Comm.
Bal. 125,500 20,000 30,000 50,000 = Expense
225,5 00 = 50,000 50,000 + 125,500
225,500

May 27 Mr. Kayayan withdrew P20,000 for personal use.

ASSET = LIABILITIES + OWNER’S EQUITY
May 2015
Cash Accounts Office Office = Accounts Notes + W. Kayayan
Receivable Supplies Equipment Payable Payable Capital

Bal. 125,500 20,000 30,000 50,000 = 50,000 50,000 + 125,500

27
105,500 20,000 30,000 50,000 = 50,000 50,000 + 105,500
205,500 205,500
(20,000)
(20,000)Kayayan,
Withdrawals Bal.
=

May 30 At the end of the month, physical count of the office supplies revealed that P 5,000 had been
consumed.
ASSET = LIABILITIES + OWNER’S EQUITY
May 2015
Cash Accounts Office Office = Accounts Notes + W. Kayayan
Receivable Supplies Equipment Payable Payable Capital

Bal. 105,500 20,000 30,000 50,000 = 50,000 50,000 + 105,500

30 ( 5,000) Expense
Bal. 105,500 20,000 25,000 50,000 = 50,000 50,000 + 100,500
= 200,500 200,500

Summary of W. Kayayan in tabular Form

W. Kayayan Accounting Firm

Financial Transaction Worksheet
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Month of May 2015

ASSET = LIABILITIES + OWNER’S EQUITY

May 2015
Cash Accounts Office Office = Accounts Notes + W. Kayayan
Receivable Supplies Equipment Payable Payable Capital

1 100,000 100,000
3 20,000 20,000
5 (10,000) 10,000
6 (20,000) (20,000)
8 50,000 50,000
10 25,000 25,000 Prof.fee
15 30,000 30,000 Prof.fee
15 (3,500) (3,500)Utility
Exp.
15 (15,00) (15,000)Salaries
Exp.
20 10,000 (10,000)
22 45,000 50,000 (5,000) Interest
Expense
25 ( 6,000) (6,000) Comm.
Expense
27 (20,000) (20,000)Kayayan,
Withdrawals
30 ( 5,000)
105,500 20,000 25,000 50,000 = 50,000 50,000 + 100,500
200,500 200,500
Expense Bal.
=

USE OF T-ACCOUNTS

Analyzing and recording transactions using the accounting equation is useful in conveying a basic
understanding of how transactions affect the business. However, it is not an efficient approach once the

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number of accounts involved increases. Double-entry system provides a formal system of classification and
recording business transactions.

May 1. Mr. W. Kayayan invested P100,000 to start an accounting office.

Cash W. Kayayan, Capital
5/1 100,000 100,000 5/1

May 3. Purchased office supplies worth P20,000 on account.

Office Supplies Accounts Payable
5/3 20,000 20,000 5/3

May 5. Purchased additional office supplies for cash, P 10,000.

Office Supplies Cash
5/3 20,000 5/1 100,000 10,000 5/5
5/5 10,000

May 6. Paid the accounts payable in full, P20,000

Accounts Payable Cash
5/6 20,000 20,000 5/3 5/1 100,000 10,000 5/5
20,000 5/6

May 8. Purchased 2 units of computer with printer for P50,000, 30 days.

Accounts Payable Office Equipment
5/6 20,000 20,000 5/3 5/8 50,000
50,000 5/8

May 10. Rendered accounting services for cash, P25,000.

Cash Professional Fees
5/6 20,000 20,000 5/3 25,000 5/10
5/10 25,000 50,000 5/8

May 15. Rendered accounting services on account, P30,000.

Accounts Receivable
May 15. Paid Meralco bills, P3,500.
Cash Utilities Expense
5/15 3,500
5/15 30,000

25,000 5/ 10
30,000 5/15

5/6 20,000 20,000 5/3

5/10 25,000 50,000 5/8 3,500 5/15

May 15. Paid salary of office staffs,P15,000

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Cash Salaries Expense

5/6 20,000 20,000 5/3 5/15 15,000
5/10 25,000 50,000 5/8 3,500 5/15
15,000 5/15

May 20. Collected P 10,000 from customer.

Cash Accounts Receivable
5/6 20,000 20,000 5/3 5/15 30,000 10,000 5/ 20
5/10 25,000 50,000 5/8
5/20 10,000 3,500 5/15 15,000 5/15

May 22. A short term loan from a local bank was granted in the amount of P50,000, less P5,000 finance
charges. W. Kayayan issued 1 year promissory note.
Cash Notes Payable
5/6 20,000 20,000 5/3 50,000 5/22
5/10 25,000 50,000 5/8
5/20 10,000 3,500 5/15
5/22 45,000 15,000 5/15

Interest Expense
5,000 5/22

May 25. Paid telephone bill amounting to P6,000.

Cash Telephone Expense
5/6 20,000 20,000 5/3 5/25 6,000
5/10 25,000 50,000 5/8
5/20 10,000 3,500 5/15
5/22 45,000 15,000 5/15 6,000 5/25

May 27. W. Kayayan withdrew cash P20,000 for her personal use.
Cash W. Kayayan drawing
5/6 20,000 20,000 5/3 5/27 20,000
5/10 25,000 50,000 5/8
5/20 10,000 3,500 5/15
5/22 45,000 15,000 5/15 6,000 5/25
20,000 5/27

May 30. At the end of the month, physical count of the office supplies revealed that P5,000 had been
consumed.
Office Supplies Supplies Expense
5/3 20,000 5,000 5/30 5/30 5,000
5/5 10,000

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References:
Ballada, Win and Susan Ballada. (2009). Basic Accounting Made Easy 14th Edition. Manila: Domdane
Publishers and Made Easy Books.
Ledesma, Ester L.(2014).Financial Accounting Theory Review Booklets. Manila: CRC-Ace The Professional
CPA Review School.
Rante, Gloria Aradaniel.(2013). Accounting for Service Entities. Mandaluyong City: Millenium Books, Inc.

ACTIVITY NO. 1

NAME: YR.&SEC.
COURSE: DATE

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MULTIPLE CHOICE

1. If a business is not being sold or closed, the amounts reported in the accounts for assets
used in the business operations are based on the cost of assets. This practice is justified by
a. Accrual
b. Time period
c. Going concern
d. Accounting entity
2. It is the capacity of information to make a difference in decision by helping users
evaluate past, present and future events, or confirming, or correcting their past evaluations.
a. Relevance
b. Reliability
c. Understandability
d. Comparability
3. The attributes of relevance include all except
a. Neutrality
b. Materiality
c. Predictive value
d. Feedback value
4. It is the quality of information that assures readers that the information is free from bias
or error and faithfully represents what it purports to show.
a. Relevance
b. Reliability
c. Understandability
d. Comparability
5. The financial accounting information is directed toward the common needs of users
and is independent of presumptions about particular needs and desires of specific.
a. Neutrality
b. Relevance
c. Completeness
d. Verifiability
6. It is the result of the standard of adequate disclosure
a. Completeness
b. Neutrality
c. Faithful Representation
d. Substance over form
7. The financial information must be comprehensible or intelligible if it is to be useful.
a. Comparability
b. Understandability
c. Relevance
d. Reliability
8. It is the ability to bring together for the purpose of noting similarities and
dissimilarities
a. Relevance
b. Reliability

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c. Comparability
d. Understandability
9. Financial reporting is concerned only with information that is significant enough to
affect evaluation or decision.
a. Materiality
b. Timeliness
c. Comparability
d. Cost and benefit
10. The purchase of an asset on account will
a. Increase total liabilities and decrease total assets
b. Have no effect on total assets or total liabilities
c. Increase total assets and increase total liabilities
d. Increase total assets and decrease owner’s equity
11. Amounts owed by a business are referred to as
a. Assets
b. Equities
c. Liabilities
d. Capital
12. Which of the following equations is the fundamental accounting equation?
a. Assets – Liabilities = Owner’s Equity
b. Assets = Liabilities + Owner’s Equity
c. Assets – Owner’s Equity = Liabilities
d. Assets – Owner’s Equity = Liabilities
13. When an owner deposits cash in an account in the name of the business, it is an
increase to
a. Cash and Accounts receivable
b. Cash and withdrawals
c. Cash and capital
d. Cash and expenses
14. Which of the following is not considered an account?
a. Equipment
b. Revenues
c. Accounts Payable
d. Cash
e. Accounts Receivable
15. If an owner invests her computer and printer in the business, there is an increase to
a. Cash and capital
b. Computer Equipment and withdrawals
c. Cash and withdrawals
d. Computer equipment and capital
16. The owner invested P50,000 in the business. What are the effects on the fundamental
accounting equation?
a. Assets increase P50,000; liabilities no effect; owner’s equity increase P50,000
b. Assets increase P50,000; liabilities decrease P50,000; owner’s equity increase
P50,000

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c. Assets increase P50,000; liabilities increase P50,000; owner’s equity no effect

d. Assets increase P50,000; liabilities no effect; owner’s equity decrease P50,000
17. The purchase of an asset for cash will
a. Increase total assets and decrease total liabilities
b. Have no effect on total assets or total liabilities
c. Increase total assets and increase total liabilities
d. Increase total assets and increase total owner’s equity
18. When the rent for the business is paid with a check
a. Cash is decreased and rent expense is decreased
b. Cash is decreased and rent income is increased
c. Cash is decreased and rent expense is increased
d. Cash is decreased and accounts payable is decreased
19. The purchase of supplies for cash will
a. Increase supplies and decrease cash
b. Increase supplies expense and decrease cash
c. Decrease cash and increase accounts payable
d. Decrease cash and increase capital
20. Which of the following transactions does not include an increase to expense?
a. Received and paid the phone bill
b. Bought office supplies on account
c. Received cash for services performed
d. Paid the week’s salaries

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ACTIVITY NO. 2

NAME: COURSE:

PROBLEM #1

Assets Liabilities Onwner’s Equity

1 760,000 360,000
2 860,000 592,000
3 108,000 760,000
4 626,600 376,240
5 800,000 (100,000)
6 600,000 450,000
7 530,000 410,000
8 473,000 153,700
9 147,000 236,500
10 624,000 237,000

 Fill the amount of the missing element of the financial position.

PROBLEM #2

Income Expense Profit (Loss)

1 840,000 360,000
2 2,400,000 540,000
3 1,300,000 860,000
4 2,000,000 720,000
5 1,800,000 (400,00)
6 750,000 500,000
7 500,000 600,000
8 700,000 150,000
9 600,000 (150,000)
10 900,000 900,000

 Fill the amount of the missing element of the financial performance.

PROBLEM #3

1. At the beginning of the year, the assets of Luke Services were P360,000 and its
owner’s equity was P200,000. During the year, assets increased by P120,00 and liabilities
increased by P20,000. What was the owner’s equity at the end of the year?
2. The liabilities of Neechee Company equal one-third of the total assets, and the
owner’s equity is P240,000. What is the amount of the liabilities?
3. At the beginning of the year, Cora Station had liabilities of P100,000 and owner’s
equity of P96,000. If assets increased by P40,000 and liabilities decreased by P30,000.
What was the owner’s equity at the end of the yaer?
 Use the accounting equation to answer each of the questions above.

ACTIVITY NO. 3

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NAME: YR.&SEC.
COURSE: DATE

PROBLEM #1

Instruction: Indicate on the space provided,(1)(X)on the element where the account belong (2)
BS if the account is Balance Sheet account and IS if the account is income statement account; Dr
(debit) or Cr (credit) to identify the normal balance of the account.
ASSE LIABILITE OWNER’S
Accounts BS or IS Dr or Cr
T S EQUITY
1. Repairs and Maintenance
Expense
2. Salaries and Wages
Expense
3. Notes Payable
4. Notes Receivable
5. Service Vehicle
6. Mortgage Payable
7. Utilities Expense
8. Furniture and Fixtures
9. Communication Expense
10. Employees’ benefits payable

11. Office Equipment

12. Prepaid Insurance
13. Owner’s Withdrawal
14. Professional fees earned

15. Accounts Receivable

16. Representation Expense
17. Salaries Payable
18. Office Supplies Expense
19. Office Supplies
20. Accounts payable
21. Cash
22. Inventory
23. Land
24. Accumulated
Depreciation
25. Miscellaneous Expense

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26. Prepaid Rent

27. Rent Expense
28. Juan, Capital
29. Insurance Expense
30. Depreciation Expense

ACTIVITY NO. 4

NAME: COURSE:

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PROBLEM #1 Identifying the effects of a transaction

Instruction: Indicate the following sign in the appropriate column; (+) for increases, (-) for
decreases, and (+/-) for both increase and decrease.

Owner’s
Assets Liabilities
Equity
1. Cash payment by the owner
(investment)
2. Payment for taxes and licenses expense
3. Repair and maintenance of office
4. payment of rent expense
5. Purchase of office supplies on account
6. Purchase of office supplies for cash
7. Payment of accounts payable
8. Provide services for cash
9. Purchase of equipment and
furniture for cash
10. Purchase of equipment and furniture
giving a 30day promissory note
11. Payment of salaries of employees
12. Personal transaction like
withdrawal of the owner
13. Provide services on account
14. Provide services for cash
15. Collection of account from a customer
16. Payment of utility bills
17. Provide services receiving a
30day promissory note
18. Payment for other expenses
19. Bought supplies paying 50% on cash, and
the remaining on account.
20. Rendered service receiving partial
payment on cash and the remaining on
account.

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CHAPTER 3
PREPARATION OF FINANCIAL STATEMENTS
Desired Learning Outcomes
1. Understand the different source documents evidencing a transaction.
2. Understand and apply the accounting cycle in day-to-day business transactions.
3. Familiarize with General Journal, Ledger and Trial Balance.
4. Deeper understand the debit and credit.

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BUSINESS TRANSACTIONS

A business transaction is any event that affects the financial position of the business and can be
recorded reliably. It involves exchange of values. There are transactions within the organization
like recognizing the used portion of supplies as expense, or with outside entities or persons like
purchasing supplies either for cash or on account.

SOURCE DOCUMENTS

Transactions and events are the starting points in the accounting cycle. By relying on source
documents, transactions and events can be analyzed as to how they will affect performance and
financial position. Source documents identify and describe transactions and events entering the
accounting process. These original written evidences contain information about the nature and
the amounts of the transactions. Some of the more source documents are:
• Sales invoice • Checks
• Cash register tapes • Purchase orders
• Official receipts • Time cards
• Bank deposit slips • Statement of accounts
 Bank statements
TRANSACTION ANALYSIS

The analysis of transactions should follow these four basic steps:

1. Identify the transaction from source documents
2. Indicate the accounts – assets, liabilities, equity, income or expenses – affected by
the transaction.
3. Ascertain whether each account is increased or decreased by the transaction.
4. Using the rules of debit or credit, determine whether to debit or credit the account
to record its increase or decrease.

ACCOUNTING CYCLE

Step 1 Documentation. Analyzing business documents which serve as a basis of

recording transactions.
Step 2 Journalizing. Recording business transactions in the journal to have chronological
records of economic activities.
Step 3 Posting. The information in the general journal is transferred to the General Ledger
to create a record of classified accounts.
Step 4 Preparation of Trial Balance. A trial balance is prepared to prove the equality of
debits and credits in the general ledger.
Step 5 Adjusting entries. Making end of period adjustments before financial statements
are prepared so that the income and expense in the income statement are reported at
their correct amounts.
Step 6 Worksheet. Work sheet is prepared to facilitate the preparation of financial
statements.
Step 7 Financial Statement. The basic financial statements are prepared after making the
necessary adjustments.

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a. Income Statement
b. Balance Sheet
c. Statement of Cash Flows
d. Statement of Changes in Equity
e. Notes to financial statement
Step 8 Journalizing and posting closing entries. The objective of closing entry is to
transfer the revenue, expense and drawing accounts to the capital account.

Step 9 Preparation of a Post-closing trial balance

Step 10 Reversing journal entries (made at the start of the next period)

CHART OF ACCOUNTS

It is a list of Assets, Liabilities, Revenue, Expense and Capital Accounts applicable to the
business enterprise. It normally includes brief description of the nature of transaction,
identification number or account number. Presented below is the chart of accounts for the
illustration.

W. KAYAYAN ACCOUNTING FIRM CHART OF ACCOUNTS

Balance Sheet Accounts Income Statement Accounts
ASSETS REVENUE
110 Cash 410 Service Revenue
120 Accounts Receivable
130 Notes Receivable EXPENSES
140 Office Supplies 510 Office Supplies Expense
150 Land 520 Utilities Expense
160 Office Equipment 530 Salaries Expense
165 Accumulated Dep. O/E 540 Telephone Expense
170 Furniture & Fixtures 550 Interest Expense
175 Accumulated Dep. F/F 560 Rent Expense
570 Depreciation Expense –O/E
LIABILITIES 580 Depreciation Expense –F/F
210 Accounts Payable 590 Miscellaneous Expense
220 Notes Payable
230 Utilities Payable
240 Salaries Payable
250 Interest Payable
260 Unearned Revenue

EQUITY
310 W. Kayayan, Capital
320 W. Kayayan, Withdrawals
330 Income Summary

JOURNALIZING

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THE JOURNAL

The journal is a chronological record of the entity’s transactions. It is called the book of
original entry. A journal entry shows all the effects of a business transaction in terms of debits
and credits. Each transaction is initially recorded in a journal rather than directly in the ledger.
The general journal is the simplest journal.

Simple and Compound Entry

In a simple entry, only two accounts are affected – one account is debited and the other account
is credited. However, some transactions require the use of more than two accounts. When three
or more accounts are required in a journal entry, the entry is referred to as a compound entry.

Format

Date: The year and month are not written for every written entry unless the year or month
changes or a new page is needed.
Account Titles and Explanation: The first line of an entry shows the account debited and the
second line is the account credited. The account credited is indented to the right. For each entry,
a brief explanation is required enough to understand the nature of the transaction.
Posting Reference: This column is filled up only when the entry is transferred to the next book
of accounts, the ledger. Posting reference column is where the account number of each account is
written.
Debit: The debit amount for each account is entered in this column.
Credit: The credit amount for each account is entered in this column.

ILLUSTRATION

Once again, let us review the transactions of the newly organized accounting firm of Mr.
Kayayan.

May 1. Mr. W. Kayayan invested P100,000 to start an accounting office. May 3. Purchased
office supplies worth P20,000 on account.
May 5. Purchased additional office supplies for cash, P10,000.
May 6. Paid the accounts payable in full.
May 8. Purchased 2 units of computer with printer for P50,000, 30 days.
May 10. Rendered accounting services for cash, P25,000.
May 15 Rendered accounting services on account, P 30,000.
May 15 Paid Meralco bills, P 3,500.
May 15 Paid salaries for the period, P15,000. May 20 Collected P10,000 from customer.
May 22 A Short term loan from a local bank was granted in the amount of P50,000, less P5,000
financing charges. Mr. W. Kayayan issued 1 year promissory note.
May 25 Paid telephone bill amounting to P 6,000.
May 27 Mr. Kayayan withdrew P20,000 for personal use.
May 30 At the end of the month, physical count of the office supplies revealed that P 5,000 had
been consumed.

GENERAL JOURNAL PAGE No. 1

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Date Account Titles and Explanation PR Debit Credit

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2014 11
1 Cash 1 0 0 0 0 0
May 0
W. Kayayan, Capital 31 1 0 0 0 0 0
0
Initial investment of the owner

3 Office Supplies 14 2 0 0 0 0
0
Accounts Payable 21 2 0 0 0 0
0
Office supplies purchased on
account.

5 Office Supplies 14 1 0 0 0 0
0
Cash 11 1 0 0 0 0
0
Office Supplies purchased.

6 Accounts Payable 21 2 0 0 0 0
0
Cash 11 2 0 0 0 0
0
Full payment of account.

8 Office Equipment 16 5 0 0 0 0
0
Accounts Payable 21 5 0 0 0 0
0
Computer units purchased

10 Cash 11 2 5 0 0 0
0
Service Revenue 41 2 5 0 0 0
0
Service revenue rendered.

15 Accounts Receivable 22 3 0 0 0 0
0
Service revenue 41 3 0 0 0 0
0

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Service revenue rendered on

account.

15 Utilities Expense 52 3 5 0 0
0
Cash 11 3 5 0 0
0
Paid meralco bill.

2014 53
15 Salaries Expense 1 5 0 0 0
May 0
Cash 11 1 5 0 0 0
0
Paid Salary of office staffs

20 Cash 11 1 0 0 0 0
0
Accounts Receivable 12 1 0 0 0 0
0
Collection of account

22 Cash 11 4 5 0 0 0
0
Interest Expense 55 5 0 0 0
0
Notes Payable 22 5 0 0 0 0
0
Proceeds of loan.

25 Telephone Expense 54 6 0 0 0
0
Cash 11 6 0 0 0
0
Paid telephone bill.

27 W. Kayayan, Withdrawals 32 2 0 0 0 0
0
Cash 11 2 0 0 0 0
0
Withdrawal by the owner.

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30 Office Supplies Expense 51 5 0 0 0

0
Office Supplies 14 5 0 0 0
0
Office Supplies consumed.

Take note that the post reference of the general journal is not filled up yet in the process of
recording. This will filled in the posting process.

POSTING

THE LEDGER

A grouping of the entity’s accounts is referred to as a ledger. Although some firms may use
various ledger to accumulate certain detailed information, all firms have a general ledger. A
general ledger is the reference book of the accounting system and is used to classify and
summarize transactions, and to prepare data for basic financial statements.

The accounts in the general ledger are classified into two general groups:
 Permanent/Real accounts –balance sheet accounts  Temporary/Nominal accounts –
income statement accounts

Posting means transferring the amounts from the journal to the appropriate accounts in the
ledger. The steps are illustrated as follows:
1. Transfer the date of the transaction from the journal to the ledger.
2. Transfer the page number from the journal to the journal reference.
3. Post the debit figure from the journal as a debit figure in the ledger and the credit
figure from the ledger as a credit figure in the ledger.
4. Enter the account number in the posting reference column of the journal once the
figure has been posted to the ledger.

Illustration:

Account: Cash Account No.: 110

Date Explanation J.R. Debit Credit Balance
2009
May 1 Initial Investment J-1 100,000.00 100,000.00
3 Office Supplies purchased J-1 10,000.00 90,000.00

Account: W. Kayayan, Capital Account No.: 310

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Date Explanation J.R. Debit Credit Balance

2009
May 1 Initial Investment J-1 100,000.00 100,000.00

Account: Office Supplies Account No.: 140

Date Explanation J.R. Debit Credit Balance
2009
May 3 Office Supplies purchased J-1 10,000.00 10,000.00

LEDGER ACCOUNTS POSTING

At the end of the accounting period, the debit and credit balance of each account must be
determined to enable us to come up with a trial balance.
• Each account balance is determine by footing (adding) all the debits and credits.
• If the sum of an account’s debit is greater than the sum of its credits, that account
has a debit balance.
• If the sum of its credits is greater, that account has a credit balance.

In the discussion of basic accounting, T-accounts is often use rather than the actual ledger to
facilitate the posting step in the accounting cycle.

TRIAL BALANCE

It is a list of all accounts with their respective debit or credit balances. It is prepared to verify the
equality of debits and credits in the ledger at the end of each accounting period or at any time the
postings are updated.
Illustration:
W. Kayayan Accounting Firm
Trial Balance
May 31, 2015
Cash 105,500
Accounts Receivable 20,000
Office Supplies 25,000
Office Equipment 50,000
Accounts Payable 50,000
Notes Payable 50,000
W. Kayayan, Capital 100,000
W. Kayayan, Withdrawals 20,000
Service Revenue 55,000
Office Supplies Expense 5,000
Utilities Expense 3,500
Salaries Expense 15,000

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Telephone Expense 6,000

Interest Expense 5,000
Total P 255,000 P 255,000

The trial balance is a control device that helps minimize accounting errors. When totals are
equal, the trial balance is in balance. It only proves the equality of debit and credit totals but not
the following errors:
1. Failure to record or post a transaction.
2. Recording the same transaction more than once.
3. Recording an entry but with the same erroneous debit and credit amounts.
4. Posting a part of a transaction correctly as a debit or credit but to the wrong
account.

INEQUALITY OF TOTALS DUE TO ERRORS

These might arise from the following circumstances:
1. Failing to post part of a journal entry
2. Posting a debit as a credit, or vice versa.
3. Incorrectly determining the balance of an account.
4. Recording the balance of an account incorrectly in the trial balance.
5. Omitting an account from the trial balance.
6. Incorrectly determining the totals of the two columns of the trial balance.
7. Listing a debit balance of an account in the credit column.

PREPARATION OF FINANCIAL STATEMENTS

All accounting reports require a heading which is written on the first three lines at the center of
the report being prepared.

1st line – name of the Company

2nd line – title of the report or statement
3rd line – Date of the report

For income statement and Statement of Changes in Equity, the date is written as: For the month
ended for the year ended u or for the six months ended .

For the balance sheet, the date is written as: As of or just the date itself.

W. Kayayan Accounting Firm

Income Statement
For the month ended May, 31, 2014

Service Revenue P 55,000

Less: Expenses

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Office Supplies Expense P 5,000

Salaries Expense 15,000
Utilities Expense 3,500
Telephone Expense 6,000
Interest Expense 5,000 34,500
Net Profit P 20,500

W. Kayayan Accounting Firm

Statement of Changes in Capital
For the month ended May 31, 2014

W. Kayayan, Capital Beg. P 100,000

Add: Net profit 20,500
Total 120,500
Less: W. Kayayan withdrawals 20,000
W. Kayayan, Capital End. P 100,500

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REPORT FORM
W. Kayayan Accounting Firm
Balance Sheet May 31, 2014

Assets
Current Assets
Cash P 100,500
Accounts Receivable 20,000
Office Supplies 25,000
Total Current Assets P 150,000
Non-current Assets
Office Equipment P 50,000
Total Assets P 200,500

Liabilities and Owner’s Equity

Current Liabilities
Accounts Payable P 50,000
Notes Payable 50,000
Total Liabilities P100,000
Capital
W. Kayayan, Capital 100,500
Total Liabilities and Owner’s Equity P200,500

ACCOUNT FORM
W. Kayayan Accounting Firm
Balance Sheet May 31, 2014

Assets Liabilities and Owner’s Equity

Current Assets Current Liabilities
Cash P 100,500 Accounts Payable P 50,000
Accounts Receivable 20,000 Notes Payable 50,000
Office Supplies 25,000 Total Liabilities P100,000
Total Current Assets P 150,000
Capital
Non-current Assets W. Kayayan, Capital 100,500
Office Equipment P 50,000 Total Liabilities
Total Assets P 200,500 and Owner’s Equity P200,500

References:
Ballada, Win and Susan Ballada. (2009). Basic Accounting Made Easy 14th Edition. Manila:
Domdane Publishers and Made Easy Books.
Rante, Gloria Aradaniel.(2013). Accounting for Service Entities. Mandaluyong City: Millenium
Books, Inc.

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ACTIVITY NO. 1

NAME: YR.&SEC.
COURSE: DATE

MULTIPLE CHOICE
1. The normal balance of an account is on the
a. Plus side
b. Left side
c. Debit side
d. Credit side
2. When a T-account has several items on both sides, the balance of the account is
written
a. On the side with the greatest number of items.
b. On the side with the least number of items.
c. On the side with the larger total.
d. On the side with the similar total.
3. A debit may signify a decrease in
a. A liability account
b. A revenue account
c. A liability and a revenue account
d. An asset and a revenue account
4. A debit may result in
a. An increase in an expense account
b. An increase in an asset account
c. A decrease in a liability account
d. A decrease in a revenue account
5. A purchase is recognized in the accounting records when
a. Payment is made for the item purchased
b. The purchase requisition is sent to the purchasing department
c. The buyer receives the seller’s bill
d. Title transfer from the seller to the buyer
6. Which of the following accounts will not affect owner’s equity?
a. Owner’s withdrawals
b. Land
c. Advertising Expense
d. Revenues
7. Which of the following errors will not cause the debit and credit columns of a trial
balance to be unequal?
a. Only part of a journal entry was posted
b. A debit was posted to an account as a credit
c. A journal entry was accidentally posted twice
d. The trial balance was incorrectly summed.
8. Which of the following errors will cause a trial balance to be out of balance?
a. The bookkeeper forgot to journalize a transaction

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b. The bookkeeper forgot to post a journal entry to the ledger.

c. A journal entry was accidentally posted twice.
d. A credit was posted to an account as a debit.
9. The general journal does not have a column titled
a. Description
b. Posting reference
c. Account balance
d. Date
10. To find explanation for a transaction, one should look at the
a. Journal
b. Ledger
c. Chart of accounts
d. Trial balance
11. An entry with more than one debit or credit is called a
a. Double entry
b. Compound entry
c. Dual entry
d. Multiple entry
12. The term footing refers to the
a. Addition of a column of figures
b. Process of obtaining the top number in an account
c. Process of obtaining the bottom number in an account
d. Process of posting
13. Balance sheet accounts are
a. Temporary accounts
b. Accounts with debit balances only
c. Adjusting accounts
d. Permanent accounts
14. Posting is the process of transferring information from the
a. Journal to the trial balance
b. Ledger to the financial statements
c. Ledger to the trial balance
d. Journal to the ledger
15. Typically, the chart of accounts begins with
a. Asset accounts
b. Liability accounts
c. Revenue accounts
d. Expense accounts
16. All of the following are examples of source documents except
a. Check
b. Sales invoice
c. Statement of account
d. General journal

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17. The equality of debits and credits in the ledger should be verified at the end of
each accounting period by preparing
a. An accounting statement
b. An account verification report
c. A trial balance
18. A balance report Of the following errors, the one that will cause an inequality in
the trial balance totals is
a. Incorrectly computing an account balance
b. Failure to record a transaction
c. Recording the same transaction more than once
d. Posting a transaction to the wrong account with the same normal balance.
19. An entity’s trial balance
a. Shows a financial position
b. Establishes whether its accounting records are correct
c. List of all of the entries in its double-entry accounting records
d. Is a list of all of the accounts with their respective debit or credit balances
20. If a P4,700 cash purchase of supplies is recorded as a P5,700 debit to supplies
expense and a P5,700 credit to cash, the result will be that
a. The trial balance will be out of balance
b. The supplies expense account will be understated
c. The cash account will be overstated
d. Supplies expense will be overstated and cash will be understated
21. If Accounts receivable has debit postings of P580,000, credit postings of
P440,000, and a normal ending balance of P480,000, which of the following was its
beginning.
a. P620,000 cr
b. P620,000 dr
c. P340,000 cr
d. P340,000 dr
22. If account payable has debit postings of P170,000, credit postings of P140,000,
and a normal balance ending balance of P60,000, which of the following was its
beginning balance?
a. P30,000 dr
b. P90,000 cr
c. P90,000 dr
d. P30,000 cr
23. A P800 credit item is accidentally posted as a debit. The trial balance column
totals will therefore differ by
a. P0
b. P400
c. P800
d. P1,600
24. If Accounts Payable has debit postings of P85,000, credit postings of P70,000,
and a normal ending balance of P30,000. What was its beginning balance?

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a. P45,000 cr
b. P15,000 dr
c. P45,000 dr
d. P15,000 cr
25. If accounts receivable has debit postings of P290,000, credit postings of P220,000
and a normal ending balance of P240,000, which of the following was its beginning?
a. P170,000 dr
b. P310,000 cr
c. P170,000 cr
d. P310,000 dr
Use of the following information to answer the questions below. The following is the trial
balance for Manabat Company.
Manabat Company
Trial Balance
Jan. 31, 2014

Cash P30,000
Accounts Receivable 20,000 Art Supplies 30,000 Office
Supplies 50,000
Prepaid rent 70,000 Prepaid insurance 50,000 Art Equipment 50,000 Office Equipment
30,000
Accounts Payable P 50,000 V. Manabat, Capital 150,000
V. Manabat, withdrawals ?
Advertising revenues ? Wages Expense ?
Utilities Expense 50,000
Telephone Expense 30,000
Total PA P B

26. If the balance of the Manabat, 28. In the trial balance, total withdrawals account
were assets equal P120,000 and the balance of a. P330,000 the Wages Expense account
were b. P230,000 P50,000, what would be the c. P430,000 amount of B? d.
P410,000
a. P180,000 29. If the total debits equals to
b. P580,000 490,000, what would be the
c. P370,000 balance of Advertising
d. P380,000 revenue?
27. If the trial balance showed a a. P290,000 balance of 70,000 in the b. P330,000
Manabat, withdrawals account c. P190,000 and a balance of P50,000 in d. P690,000 the
Wages Expense account, 30. If the trial balance showed a what would be the amount of
balance of P80,000 in the Advertising revenues for the wages expense and a balance of
period? P350,000 in the Advertising a. P330,000 Revenue, what would be the
b. P480,000 amount of A?
c. P180,000 a. P500,000
d. P430,000 b. P550,000
c. P450,000

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d. P600,000

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ACTIVITY NO. 2

NAME: COURSE:

PROBLEM #1

The following accounts were taken from the General Ledger of Kapit Tuko Law Office at the
end of its 1st year of operation, December 31, 2014.

Cash P 85,000
Accounts Receivable 60,000
Office Supplies 5,000
Office Equipment 100,000
Office Furniture 40,000
Service Vehicle 400,000
Accounts Payable 25,000
WHT Payable 8,000
SSS Payable 10,000
Philhealth Payable 2,000
K. Tuko, Capital 500,000
K. Tuko, withdrawals 20,000
Professional fees earned 959,000
Salaries and Wages 350,000
Rent Expense 240,000
Advertising Expense 12,000
Supplies Expense 10,000
Light and Water Expense 24,000
Gas and Oil Expense 75,000
Repairs and Maintenance 6,000
Telephone Expense 36,000
Representation Expense 30,000
Insurance Expense 6,000
Taxes and Licenses 5,000
Required:
Prepare a Trial Balance.

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CHAPTER 4
ADJUSTING THE ACCOUNTS
Desired Learning Outcomes
1. Understand the Accounting period.
2. Differentiate Accrual to Cash Accounting.
3. Appreciate the importance of Adjusting entries in the preparation of financial statements.
4. Items that needed Adjustments.
5. The Effects of not making the necessary adjusting entries to financial statements.

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THE ACCOUNTING PERIOD

The activities of an enterprise can be divided into specific periods such as a month, a quarter, a
semester, or a year. The accounting period is usually s span of 12 months. It may be a calendar
year or fiscal year. Calendar year is the normal year which ends December 31 of each year.
Fiscal year is an accounting year of 12 consecutive months that may or may not coincide with
the calendar yaer.

ACCRUAL VERSUS CASH ACCOUNTING

Accrual Accounting requires that all revenue earned whether payment is received or not should
be recognized in the period the goods or services are delivered re rendered and that all related
costs to deliver the goods or to render the whether paid or not should be recognized as expense to
match the revenue.

Cash-basis Accounting requires that all revenue is recognized only when cash is received while
expenses are recognized only when cash is paid.

IMPORTANCE OF ADJUSTING ENTRIES

Adjusting Entries are entries made at the end of the period to assign revenues to the period in
which they are earned and expenses to the period in which they are incurred.

Many accounts need adjustments to reflect the current conditions as of time of reporting in order
for the statements to be meaningful. There may be financial data not previously recognized that
need to be recorded to make the books of accounts up to date like the expenses already incurred
but no payment until sometime in the subsequent period, and revenues already earned but no
cash is collected yet.

ITEMS THAT NEED ADJUSTMENTS

PREPAID EXPENSES

Prepaid Expenses are expenditures paid for goods that are not yet consumed like supplies,
insurance and rent.

METHODS OF RECORDING PREPAYMENTS

Asset Method

1. Example for Supplies

a. Purchase of supplies worth P 5,000 is recorded as
Supplies 5,000
Cash 5,000
b. At the end of a period, physical count of unused supplies showed a total of
P3,500. This shows that if P 3,500 is unused, then P 1,500 worth of supplies is used
or consumed.
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Supplies Expense 1,500

Supplies 1,500

2. Example for Insurance

a. On October 1, 2013, a company paid P12,000 as insurance premium for
one year. The entry to record the payment under the asset method is:
Prepaid Insurance 12,000
Cash 12,000

b. With the passage of time, the prepaid insurance gradually expires, that’s
why on Dec. 31, an adjusting entry is required to recognize the expired portion of
the insurance premium as expense.
Insurance Expense 3,000
Prepaid Insurance 3,000

3. Example for Rent

a. On Dec. 1, the company paid P18,000 as rent for one year. The entry to
record the payment under the asset method is:
Prepaid Rent 18,000
Cash 18,000

b. On Dec. 31, the entry will be (18,000/12 mons.)x 1 mons.=1,500.00

Rent Expense 1,500
Prepaid Rent 1,500

EXPENSE METHOD
This method of recording prepayments requires an entry debiting an expense account upon
payment.

1. Example for supplies

a. In the previous example, if the supplies purchased were recorded, the entry
would be:
Supplies Expense 5,000
Cash 5,000
b. The adjusting entry required to reflect the unused portion would be
Supplies 3,500
Supplies Expense 3,500

2. Example for Insurance

a. If the Expense Method is used to record the prepayment, the entry made
upon payment is:
Insurance expense 12,000
Cash 12,000

b. The adjusting entry on Dec. 31, would be:

Prepaid Insurance 9,000

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Insurance Expense 9,000

3. Example for Rent

a. If the Expense Method is used to record the prepayment, the entry made
upon payment is:
Rent expense 18,000
Cash 18,000

b. The adjusting entry on Dec. 31, would be:

Prepaid Rent 16,500
Rent Expense 16,500

ACCRUED EXPENSES
These are items already recorded as expenses but not yet paid, thus creating an obligations to
make payments in the future. The most common examples are salaries of employees and utilities
expenses like bills from Meralco and Manila Waters.

On June 15, when the company pays the salaries of employees, the payment will be recorded as:

Salaries Expense P xxx

Cash P xxx

No accrual for salary payment on June 15 because this date is a regular working day. The salary
for the 2nd half of the month which is due June 30 will not be paid on that day because it is a non-
working day. So the salary of the employees will be paid the following Monday, July 2. The
bookkeeper will recognize the expense on June 30 with the following entry:

Salaries Expense P xxx

Accrued Salaries or
Salaries Payable P xxx

ACCRUED INTEREST ON NOTES RECEIVABLE

A company issued a 90-day 10% note on Dec. 1 for P100,000. The notes payable is due 90 days
from date of issue including interest earned for 90 days. If financial statements are prepared on
Dec. 31, which are normally the case, then the company must record the interest for 30 days as:
Interest Expense 833.33
Accrued Interest 833.33

ACCRUED REVENUE

These are revenues already earned but no payment is received yet.

Interest Receivable P xxx
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Interest Revenue P xxx

DEFERRED REVENUE OR UNEARNED REVENUES

This is the exact opposite of accrued revenues. In this case, payment is received in advance prior
to delivery of services, or delivery of goods, thus, creating a liability for the amount collected in
advanced; however, as the company renders the service, the unearned revenue becomes earned
revenue.

Revenue method
For example, on Aug. 1, a tenant paid its rent for one year in advance in the amount of P 24,000.
At the time cash is received, the entry is:

Cash 24,000
Rent Revenue 24,000

When financial statement is prepared on Dec. 31, an adjustment is necessary to reflect the
unearned portion of the rent that corresponds to the period Jan. 1 2013 – July 31, 2014. The
adjusting entry would be:

Rent Revenue (7/12 x 24,000) 14,000

Unearned Rent 14,000

Liability Method
If the liability method is used to record the receipt of P24,000, the entry upon receipt would be:

Cash 24,000
Unearned Rent 24,000

On Dec. 31, the amount earned must be recognized as revenue through an adjusting entry.

Unearned rent 10,000

Rent Revenue 10,000

UNCOLLECTIBLE ACCOUNT EXPENSE OR DOUBTFUL ACCOUNTS

In any enterprise selling on account to its customers, experience show that some customers will
not be able to pay their accounts as they fall due. Uncollectible accounts or bad debts are
accounts of customers who do not pay what they have promised to pay. The enterprise should
provide allowance for uncollectible accounts and recognize an expense or loss from these
accounts. Other terms for uncollectible accounts are Bad Debts and Doubtful accounts.

a. Based on Percentage of Sales on Account or service revenue on account For

example, the company estimates that 2% of sales on account are proven to be
uncollectible. The entry would be:
Uncollectible account expense xxx
Allowance for uncollectible accounts xxx

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The allowance for doubtful accounts is a contra account which is deducted from the accounts
receivable in the balance sheet to arrive at its net realizable value.

b. Based on Accounts Receivable Balance

Example 1: The following balances are available from the records of Manila Premier Hotel at
December 31, 2013:

Accounts Receivable, 12/31 P 800,000

Allowance for uncollectible accounts,1/1 12,000 Cr.
Service Revenue on account 2,500,000

The company’s estimate for uncollectible accounts is 2% of accounts receivable.

The adjusting entry required to reflect the expense for the year is:

Uncollectible account expense 4,000

Allowance for uncollectible accounts 4,000

Example 2: Assume the following balances:

Accounts Receivable, 12/31 800,000
Allowance for uncollectible accounts 22,000 Cr.
Service revenue on account 2,500,000

Since the required allowance is only P16,000, and the balance of the allowance account is
P22,000, the allowance for uncollectible accounts should be reduced by P 6,000. The adjusting
entry would be:

Allowance for uncollectible accounts 6,000

Uncollectible accounts expense 6,000

DEPRECIATION

Depreciation is the systematic means of allocating the cost of long lived asset over its estimated
economic life. Depreciation does not necessarily measure the decline in the value of an asset but
it shows only the portion of the cost of the asset that has expired due to using up the asset. The
assets that are subject to depreciation are called depreciable assets. The formula:

Depreciation Expense = Cost of Asset – Scrap value/residual value/salvage value

Estimated economic life

Cost of asset is the amount of company paid to purchase the asset. It includes the invoice price
plus transportation charges and installation fees.

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Scrap value is the amount expected to be recovered at the end of an asset’s useful life. It is also
called residual value or salvage value. Estimated economic life is the same as the estimated
useful life of an asset.
Depreciation cost or value is the difference between the cost of an asset and its scrap value.

Example: A delivery equipment was purchased on Jan. 3, 2013 for P600,000. It is estimated that
the vehicle’s salvage value at the end of 10 yrs. Is P50,000.

Dep. Expense = 600,000 – 50,000 = 55,000/yr.

10 yrs.

The adjusting entry on Dec. 31, 2013 will be:

Depreciation Expense 55,000

Accumulated Depreciation-D/E 55,000

Accumulated Depreciation is a contra account, which is reported as a deduction from the

related asset account.

The presentation of the asset and its related accumulated depreciation in the balance follows:

Delivery Equipment P 600,000

Less: Accumulated Depreciation 55,000
Book value P 545,000

Book value is the part of the cost of the asset that is not yet allocated to an expense account.

References:
Ballada, Win and Susan Ballada. (2009). Basic Accounting Made Easy 14th Edition. Manila:
Domdane Publishers and Made Easy Books.
Rante, Gloria Aradaniel.(2013). Accounting for Service Entities. Mandaluyong City: Millenium
Books, Inc.

ACTIVITY NO. 1

NAME: YR.&SEC.
COURSE: DATE

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MATCHING TYPE

Below are terms pertinent to adjusting entries. Match each definition with its related term. There
are two answers for each term.

Terms Definitions

1. Accrued Expense a. Revenue not yet earned; collected in advance.

2. Deferred Expense 3. Accrued b. Office supplies on hand; used next accounting
Revenue period.
4. Deferred Revenue c. Rent revenue collected; not yet earned.
d. Rent not yet collected; already earned.
e. An expense incurred; not yet paid or
recorded.
f. Revenue earned; not yet collected.
g. An expense not yet incurred; paid in advance.
h. Property taxes incurred; not yet paid.

Match each transaction with its related term:

Terms Definitions

1. Deferred Revenue a. At the end of the year, salaries payable of P3,600 had not been recorded
or paid.
b. Supplies for office use were purchased
during the year for P500, and P100 of the office
supplies remained on hand (unused) at year-end.
c. Interest of P250 on a note receivable was
earned at year-end, although collection of the
interest is not due until the following year.
d. At the end of the year, service revenues of
P2,000 was collected in cash but was not yet
earned.

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ACTIVITY NO. 2

NAME: YR.&SEC.

COURSE: DATE

Journal Entries

Prepare Adjusting Entries required on December 31 for each item with your supporting
computations after each entry.

a. On March 1, 2013, XYZ Company paid P54,000 for 2 year insurance premium on
property. The bookkeeper debited Prepaid Insurance account at the time of payment.
b. On December 1, 2013, ABC Company received P120,000 as advance payment for
professional services to be rendered starting 1st quarter of 2014. Unearned revenue
account was credited at the time of deposit.
c. Miscellaneous office supplies were purchased in the last quarter of 2014
amounting to P6,500. On December 31, inventories showed that P3,200 were on hand.
The purchase was debited to Office Supplies account.
d. The company’s office equipment costing P100,000 is expected to have 10 years
economic life with no salvage value. This was purchased by the company on Aug. 1,
2013.
e. ZTE company owes a bank a 10%, 90-day note for P 150,000 dated Nov. 1, 2013.

Use the journal provided on the other page for your answer.

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CHAPTER 5
COMPLETING THE ACCOUNTING CYCLE
Desired Learning Outcomes
1. Understand and apply the remaining steps in completing cycle; closing entries, post-
closing entries and reversing entries.
2. Deeper understanding the reasons and importance of the remaining steps.

CLOSING ENTRIES

Closing entries are usually prepared at the end of an accounting period like adjusting entries. Not
all accounts are closed. Only the nominal accounts, often called temporary accounts and the
drawing account are closed at the end of the accounting period. Nominal accounts are the
accounts that appear in the income statement like revenue and expense accounts.

A temporary account is said to be closed when an entry is made such that its balance becomes
zero. Closing simply transfers the balance of one account to another account. In this case, the
balances of the temporary accounts are transferred to the capital account. A summary account –
Income and Expense Summary is used to close the income and expense accounts.

1. Close the income accounts

Income accounts have credit balances before the closing entries are posted. For this reason, an
entry debiting each revenue account in the amount of its balance is needed to close the account.

Dec 31 Revenues 67,700.00

Income & Expense Summary 67,700.00

2. Close the expense accounts

Expense accounts have debit balances before the closing entries are posted. For this reason, a
compound entry is needed crediting each expense account for its balance and debiting the
income and expense summary for the total.

Dec 31 Income & Expense Summary 36,700.00

Salaries Expense 15,600.00
Supplies Expense 3,000.00 Rent Expense 4,000.00 Insurance Expense 1,200.00
Utilities Expense 4,400.00 Depreciation Expense-S.V. 4,000.00 Depreciation
Expense-Off.Equp. 1,000.00
Interest Expense 3,500.00

3. Closing the income and expense summary

After closing entries involving the income and expense accounts, the balance of the income
summary account will be equal to the profit or loss for the period. A profit is indicated by a
credit balance and a loss by a debit balance.

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Dec 31 Income & Expense Summary 35,000.00

XYZ, Capital 35,000.00

4. Close the withdrawal account

The withdrawal account shows the amount by which capital is reduced during the period by
withdrawals of cash or other assets of the business by the owner for personal use.
Dec. 31 XYZ, Capital 14,000.00
XYZ, withdrawals 14,000.00

POST-CLOSING TRIAL BALANCE

After posting the closing entries to the general ledger another trial balance is prepared. This time,
the accounts left with balances are all balance sheet accounts or permanent accounts because all
nominal accounts including the drawing accounts have zero balances. This post-closing trial
balance is prepared to check the equality of the accounting equation before the balances of the
assets; liabilities and capital are forwarded to the next accounting period. This is the end of the
accounting period.
XYZ Company
Post-closing Trial Balance Dec. 31,2014

Cash 22,200
Accounts Receivable 17,300
Supplies 15,000 Prepaid Rent
4,000 Prepaid Insurance 13,200
Service Vehicle 420,000
Accumulated Depreciation-S.V. 4,000 Office
Equipment 60,000
Accumulated Depreciation-O.E. 1,000 Notes Payable 210,000 Accounts Payable
53,000
Salaries Payable

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