ACCOUNTING CYCLE

The accounting cycle refers to a series of sequential steps or procedures performed to accomplish the accounting
process. The steps in the cycle and their aims follow:

Step 1 Identification of Events to be Recorded

To gather information about transactions or events generally through the
source documents.
During the Step 2 Transactions are Recorded in the Journal
accounting To record the economic impact of transactions on the firm in a journal,
period which is a form that facilitates transfer to the accounts.
Step 3 Journal Entries are Posted to the Ledger
To transfer the information from the journal to the ledger for
classification.
Step 4 Preparation of a Trial Balance
To provide a listing to verify the equality of debits and credits in the
ledger.
Step 5 Preparation of the Worksheet including Adjusting Entries
To aid in the preparation of financial statements.
At the end Step 6 Adjusting Journal Entries are Journalized and Posted
of the To record the accruals, expiration of deferrals, estimations and other
accounting events from the worksheet.
period Step 7 Preparation of the Financial Statements
To provide useful information to decision-makers and intended users.
Step 8 Closing Journal Entries are Journalized and Posted
To close temporary accounts and transfer profit to owner's equity.
Step 9 Preparation of a Post-Closing Trial Balance
To check the equality of debits and credits after the closing entries.
At the Step 10 Reversing Journal Entries are Journalized and Posted
start of the To simplify the recording of certain regular transactions in the next
next accounting period.
period

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DURING THE ACCOUNTING PERIOD (Steps 1-4)

The General Journal

(the book of original entry)
Shows all the effects of a transaction in
Office Equipment xx terms of debits and credits.
Cash xx
Accounts Payable xx
Posting
Transferring the amounts
from the general journal to
appropriate accounts in the
Cash ledger.

The Ledger Office Equipment

A grouping of accounts.
Used to classify and
Accounts Payable
summarize transactions and
to prepare data for basic
financial statements.

Listing of all ledger accounts, in order, Trial Balance

with their respective debit or credit
balances. Assets
Liabilities
Owner's Equity
Revenues
Expenses

Step 2. Transactions are Journalized

The Journal
The journal is a chronological record of the entity's transactions. 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. A journal is called the book of original entry. The nature and volume of transactions of the business determine
the number and type of journals needed. The general journal is the simplest journal.

After the transaction or event has been identified and measured, it is recorded in the journal. This process is known as
journalizing. The following are the transactions for Celestial Wedding Shop Inc. during the month of July. The double-
entry system will be used:

To understand the nature of the affected accounts, the letter A (for asset), L (liability) or OE (owner's equity) is inserted
after each entry. In addition, owner's equity is further classified into OE:I (income) and OE:E (expenses).

Note: The rules of double-entry system are observed in each transaction:

1. Two or more accounts are affected by each transaction.
2. The sum of the debits for every transaction equals the sum of the credits.
3. The equality of the accounting equation is always maintained.

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Initial Investment (Source of Assets)

July 1 Nhur Eden Estrellan is a social entrepreneur from the South. She is into a lot of interesting
causes. Her fine taste is preeminent such that she is considered an authority in planning
weddings. Upon the advice and prodding of an esteemed colleague, Gidelyn Samonte,
Estrellan decided to organize her wedding consultancy. She invested P250,000 into this
entity.

Analysis Assets increased. Owner's equity increased.

Rules Increases in assets are recorded by debits. Increases in owner's equity are recorded by
credits.

Entry Increase in assets is recorded by a debit to cash. Increase in owner's equity is

recorded by a credit to Nhur Eden Estrellan, Capital.
Dr. Cr.
Cash (A) 250,000
Estrellan, Capital (OE) 250,000

Rent Paid in Advance (Exchange of Assets)

July 1 Rented office space and paid two months' rent in advance, P8,000.

Analysis Assets increased. Assets decreased.

Rules Increases in assets are recorded by debits. Decreases in assets are recorded by
credits.

Entry Increase in assets is recorded by a debit to prepaid rent. Decrease in assets is

recorded by a credit to cash.

Dr. Cr.
Prepaid Rent (A) 8,000
Cash (A) 8,000

Note Issued for Cash (Source of Assets)

July 2 Nhur Eden Estrellan issued a promissory note for a P210,000 loan from Metrobank. This
availment will be used for the acquisition of a service vehicle. The note carries a 20%
interest per annum. The arrangement with the bank is that both the interest and the
principal are payable in full in one year.

Analysis Assets increased. Liabilities increased.

Rules Increases in assets are recorded by debits. Increases in liabilities are recorded by
credits.

Entry Increases in assets are recorded by debits. Increases in liabilities are recorded by
credits. Increase in assets is recorded by a debit to cash. Increase in liabilities is recorded by
a credit to notes payable.

Dr. Cr.
Cash (A) 210,000
Notes Payable (L) 210,000

July 2 Hired an office assistant and an account executive each with a P7,800 monthly salary. Or,
each is to receive P300 per day for the 26-day work month. No entry is necessary at this
point. They started work immediately.

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Service Vehicle Acquired for Cash (Exchange of Assets)

July 4 Acquired service vehicle for P420,000.

Analysis Assets increased. Assets decreased.

Rules Increases in assets are recorded by debits. Decreases by credits.

Entry Increase in assets is recorded by a debit to service vehicle. Decrease in assets is

recorded by a credit to cash.

Dr. Cr.
Service Vehicle (A) 420,000
Cash (A) 420,000

Insurance Premiums Paid (Exchange of Assets)

July 4 Paid Prudential Guarantee and Assurance, Inc. P14,400 for a one-year comprehensive
insurance coverage on the service vehicle.

Analysis An asset increased. Another asset decreased.

Rules Increases in assets are recorded by debits. Decreases in assets are recorded by
credits.

Entry Increase in assets is recorded by a debit to prepaid insurance.

Decrease in assets is recorded by a credit to cash.

Dr. Cr.
Prepaid Insurance (A) 14,400
Cash (A) 14,400

Office Equipment Acquired on Account (Exchange and Source of Assets)

July 5 Acquired office equipment from Fair and Square Emporium for P60,000; paying P15,000
in cash and the balance next month.
Note: A compound entry is needed for this transaction.

Analysis Assets increased. Assets decreased. Liabilities increased.

Rules Increases in assets are recorded by debits. Decreases in assets are recorded by
credits. Increases in liabilities are recorded by credits.

Entry Increase in assets is recorded by a debit to office equipment.

Decrease in assets is recorded by a credit to cash. Increase liabilities is recorded by a credit to
accounts payable.

Dr. Cr.
Office Equipment (A) 60,000
Cash (A) 15,000
Accounts Payable (L) 45,000

Supplies Purchased on Account (Source of Assets)

July 8 Purchased supplies on credit for P18,000 from San Jose Merchandising.

Analysis Assets increased. Liabilities increased.

Rules Increases in assets are recorded by debits. Increases in liabilities

are recorded by credits.

Entry Increase in assets is recorded by a debit to supplies. Increase in

liabilities is recorded by a credit to accounts payable.

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 Dr. Cr.
Supplies (A) 18,000
Accounts Payable (L) 18,000

Accounts Payable Partially settled (Use of Assets)

July 9 Paid San Jose Merchandising P10,000 of the amount owed.

Analysis Assets decreased. Liabilities decreased.

Rules Decreases in assets are recorded by credits.

Decreases in liabilities are recorded by debits.

Entry Decrease in liabilities is recorded by a debit to accounts payable.

Decrease in assets is recorded by a credit to cash.

Dr. Cr.
Accounts Payable (L) 10,000
Cash (A) 10,000

Revenues Earned and Cash Collected (Source of Assets)

July 10 Coordinated and finalized simple bridal arrangements for three couples and collected fees
of P8,800 per couple. Services include prospecting and selecting the church and reception
location, couturier, caterer, car service, flowers, souvenirs and invitations.

Analysis Assets increased. Owner's equity increased.

Rules Increases in assets are recorded by debits. Increases in owner's equity are recorded by
credits.

Entry Increase in assets is recorded by a debit to cash. Increase in owner's equity is

recorded by a credit to consulting revenues.

Dr. Cr.
Cash (A) 26,400
Consulting Revenues (OE:I) 26,400

Scenario 10: Salaries Paid (Use of Assets)

July 13 Paid salaries, P6,600. The entity pays salaries every two Saturdays

Analysis Assets decreased. Owner's equity decreased.

Rules Decreases in assets are recorded by credits.

Decreases in owner's equity is recorded by debits.

Entry Decrease in owner's equity is recorded by a debit to salaries expense.

Decrease in assets are recorded by a credit to cash.

Dr. Cr.
Salaries Expense (OE:E) 6,600
Cash (A) 6,600

Scenario 11: Unearned Revenues Collected (Source of Assets)

July 15 The entity is earning additional revenues by referring consulting clients to friendly hotels,
caterers, printers, and couturiers. Received P10,000 advance fees for three clients referrer

Analysis Assets increased. Liabilities increased.

Rules Increases in assets are recorded by debits.

Increase in liabilities are recorded by credits.

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Entry Increase in assets is recorded by a debit to cash.
Increase in liabilities is recorded by a credit to unearned referral revenues.

Dr. Cr.
Cash (A) 10,000
Unearned Referral Revenues (L). 10,000

Revenues Earned on Account (Source of Assets)

July 19 Coordinated and finalized elaborate bridal arrangements for three couples and billed fees
of P12,000 per couple. Additional services include documents preparation, consultation
with a feng shui expert as to the ideal wedding date for prosperity and harmony,
provision for limousine service and honeymoon trip.

Analysis Assets increased. Owner's equity increased.

Rules Increases in assets are recorded by debits. Increases in owner's equity are recorded by
credits.

Entry Increase in assets is recorded by a debit to accounts receivable. Increase in owner's

equity is recorded by a credit to consulting revenues.

Dr. Cr.
Accounts Receivable (A) 36,000
Consulting Revenues (OE:I) 36,000

Withdrawal of Cash by Owner (Use of Assets)

July 25 Estrellan withdrew P14,000 for personal expenses.

Analysis Assets decreased. Owner's equity decreased.

Rules Decreases in assets are recorded by credits.

Decreases in owner's equity are recorded by debits.

Entry Decrease in owner's equity is recorded by a debit to Estrellan, Withdrawals.

Decrease in assets is recorded by a credit to cash.

Dr. Cr.
Estrellan, Withdrawals (OE) 14,000
Cash (A) 14,000

Salaries Paid (Use of Assets)

July 27 Paid salaries, P7,200

.
Analysis Assets decreased. Owner's equity decreased.

Rules Decreases in assets are recorded by credits.

Decreases in owner's equity are recorded by debits.

Entry Decrease in owner's equity is recorded by a debit to salaries expense.

Decrease in assets is recorded by a credit to cash.

Dr. Cr.
Salaries Expense (OE:E) 7,200
Cash (A) 7,200

Expenses incurred but Unpaid (Exchange of Claims)

July 30 Received the ICC-BayanTel telephone bill, P1,400.

Analysis Liabilities increased. Owner's equity decreased.

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Rules Increases in liabilities are recorded by credits.
Decreases in owner's equity are recorded by debits.

Entry Decrease in owner's equity is recorded by a debit to utilities expense.

Increase in liabilities is recorded by a credit to utilities payable.

Dr. Cr.
Utilities Expense (OE:E) 1,400
Utilities Payable (L) 1,400

Accounts Receivable Partially Collected (Exchange of Assets)

July 30 Received P24,000 from two clients for services billed last July 19.

Analysis An asset increased. Another asset decreased.

Rules Increases in assets are recorded by debits.

Decreases as recorded by credits.

Entry Increase in assets is recorded by a debit to cash.

Decrease in assets is recorded by a credit to accounts receivable.

Dr. Cr.
Cash (A) 24,000
Accounts Receivable 24,000

Expenses incurred and Paid (Use of Assets)

July 31 Settled the electricity bill of P3,000 for the month.

Analysis Assets decreased. Owner's equity decreased.

Rules Decreases in assets are recorded by credits.

Decreases in owner’s equity are recorded by debits.

Entry Decrease in owner's equity is recorded by a debit to utilities expense.

Decrease in assets is recorded by a credit to cash.

Dr. Cr.
Utilities Expense (OE:E) 3,000
Cash (A) 3,000

The Ledger
A grouping of the entity's accounts is referred to as a ledger. Although some firms may use various ledgers 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:
1. Balance sheet or permanent accounts (assets, liabilities and owner's equity).
2. Income statement or temporary accounts (income and expenses). Temporary or nominal accounts are used to
gather information for a particular accounting period. At the end of the period, the balances of these accounts
are transferred to a permanent owner's equity account.

Each account has its own record in the ledger. Every account in the ledger maintains T-account but offers more
information (e.g. the account number basic format of the T-account of the journal reference column). Compared to a
journal, a ledger organizes information by account.

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Chart of Accounts

A listing of all the accounts and their account numbers in the ledger is known as the chart of accounts. The chart is
arranged in the financial statement order, that is, assets first, followed by liabilities, owner's equity, income and
expenses. The accounts should be numbered in a flexible manner to permit indexing and cross-referencing.

When analyzing transactions, the accountant refers to the chart of accounts to identify the pertinent accounts to be
increased or decreased. If an appropriate account title is not listed in the chart, an additional account may be added.
Presented below is the chart of accounts for the illustration:

Celestial Wedding Shop Inc.

Chart of Accounts
Balance Sheet Accounts Income Statement Accounts
Assets Income
110 Cash 410 Consulting Revenues
120 Accounts Receivable 420 Referral Revenues
130 Supplies Expenses
140 Prepaid Rent 510 Salaries Expense
150 Prepaid Insurance 520 Supplies Expense
160 Service Vehicle 530 Rent Expense
165 Accumulated Depreciation 540 Insurance Expense
170 Office Equipment 550 Utilities Expense
175 Accumuated Depreciation 560 Depreciation Expense - Service
Vehicle
Liabilities 570 Depreciation Expense - Office
Equipment
210 Notes Payable 580 Miscellaneous Expense
220 Accounts Payable 590 Interest Expense
230 Salaries Payable
240 Utilities Payable
250 Interest Payable
260 Unearned Referral Revenues
Owner’s Equity
310 Estrellan, Capital
320 Estrellan, Withdrawals
330 Income Summary

Step 3. Posting
Posting means transferring the amounts from the journal to the appropriate account in the ledger. Debits in the journal
are posted as debits in the ledger, and credits journal as credits 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 column of the ledger.
3. Post the debit figure from the journal as a debit figure in the ledger and the credit figure from the journal as a
credit figure 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.

Ledger Accounts After Posting

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

The ledger accounts of Celestial Wedding Shop Inc. after posting are shown below. The account numbers and journal
reference are purposedly omitted. The balance of each account has been determined.

Cash
July 1 250,000 July 1 8,000
2 4 420,000
210,000
10 4 14,400

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26,400
15 5
10,000 15,000
30 9
26,400 10,000
13
6,600
25
14,000
27
7,200
31
3,000

520,400 498,200
Balance 22,200

Accounts Receivable
July 19 36,000 July 31 24,000
Balance 12,000

Supplies
July 8 18,000
Balance 18,000

Prepaid Rent
July 1 8,000
Balance 8,000

Prepaid Insurance
July 14 14,400
Balance 14,400

Service Vehicle
July 4 420,000
Balance 420,000

Office Equipment
July 4 420,000
Balance 420,000

Notes Payable
July 2 210,000
Balance 210,000

Accounts Payable
July 9 10,000 July 5 45,000
8 18,000
10,000
63,000
Balance 53,000

Utilities Payable
July 30 1,400
Balance 1,400

Unearned Referral Revenues

July 15 10,000
Balance 10,000

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 Estrellan, Capital
July 1 250,000
Balance 250,000

Estrellan, Withdrawals
July 25 14,000
Balance 14,000

Consulting Revenues
July 10 26,400
19
36,000

62,400
Balance 62,400

Salaries Expense
July 13 6,600
27
7,200

13,800
Balance 13,800

Utilities Expense
July 30 1,400
31
3,000

4,400
Balance 4,400

Step 4. Trial Balance

The trial balance 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.

The procedures in the preparation of a trial balance follow:

1. List the account titles in numerical order.
2. Obtain the account balance of each account from the ledger and enter the debit balances in the debit column
and the credit balances in the credit column.
3. Add the debit and credit columns.
4. Compare the totals.
The trial balance is a control device that helps minimize accounting errors. When the totals are equal, the trial balance is
in balance. This equality provides an interim proof of the accuracy of the records but it does not signify the absence of
errors. For example, if the bookkeeper failed to record payment of rent, the trial balance columns are equal but in
reality, the accounts are incorrect since rent expense is understated and cash overstated.

The trial balance for the illustration follows:

Celestial Wedding Shop Inc.

Trial Balance
July 31, 2019

Cash P 22,200
Accounts Receivable 12,000
Supplies 18,000
Prepaid Rent 8,000
Prepaid Insurance 14,400
Service Vehicle 420,000
Office Equipment 60,000
Notes Payable P 210,000
Accounts Payable 53,000
Utilities Payable 1,400

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Unearned Referral Revenues 10,000
Nhur Eden Estrellan, Capital 250,000
Nhur Eden Estrellan, Withdrawals 14,000
Consulting Revenues 62,400
Salaries Expense 13,800
Utilities Expense 4,400
TOTAL P 586,800 P 586,800

Additional Information:
● On July 1, Celestial Wedding Shop Inc. paid P8,000 for two months’ rent in advance.

● Celestial Wedding Shop Inc. acquired a one-year comprehensive insurance coverage on the service vehicle and

paid P14,400 premiums.

● On July 8, Celestial Wedding Shop Inc. purchased supplies, P18,000. The inventory count showed that supplies

costing P15,000 are still on hand.

● Suppose that Celestial Wedding Shop Inc. estimated that the service vehicle, which was bought on July 4, will

last for seven years (eighty-four months) and with a salvage value of P84,000. The office equipment that was
acquired on July 5 will have a useful life of five years (sixty months) and will be worthless at that time.
● On July 15, Celestial Wedding Shop Inc. received P10,000 as an advance payment for referrals made. Assume

that by the end of the month one of the three couples referred has already taken their marriage vows and as a result
the amount of P4,000 pertaining to the referred event has been realized.
● Entities pay their employees at regular intervals. It can be weekly, semi-monthly or monthly. Weekly payrolls are

usually made on Fridays (for a five-day workweek) or Saturdays (for a six-day workweek). Celestial Wedding
Shop Inc. pays salaries every two Saturdays. Assume that the calendar for July appears as follows:

JULY
Su M T W Th F Sa
1 2 3 4 5 6
7 8 9 10 11 12 13
14 15 16 17 18 19 20
21 22 23 24 25 26 27
28 29 30 31

The office assistant and the account executive were paid salaries on July 13 and 27. At month-end, the employees
have worked for three days (July 29, 30 and 31) beyond the last pay period. The employees have earned the salary
for these days, but it is not due to be paid until the regular payday in July.
● On July 2, Nhur Eden Estrellan borrowed P210,000 from Metrobank. She issued a promissory note that carried a
20% interest per annum. Both the interest and principal will be payable in one year. The note issued to the bank
accrues interest at 20% annually.
● Suppose that Celestial Wedding Shop Inc. agreed to arrange a rush but simple civil wedding for a madly-in-love
couple in the afternoon of July 31. The entity intended to charge fees of P5,300 for the services, which is earned
but unbilled.

Step 5. Adjustments (Celestial Weddings Shop Inc.)

Prepaid Rent (Adjustment A). On July 1, Celestial Wedding Shop Inc. paid P8,000 for two months’ rent in advance.
This expenditure resulted in an asset consisting of the right to occupy the office for two months. A portion of the asset
expires and becomes an expense each day. By July 31, one-half of the asset had expired, and should be treated as an
expense. The analysis of this economic event is shown below:

Transaction Expiration of one month's rent.

Analysis Assets decreased. Owner's equity decreased.
Rules Decreases in assets are recorded by credits. Decreases in owner's equity are
recorded by debits.
Entries Decrease in owner's equity is recorded by a debit to rent expense. Decrease in
assets is recorded by a credit to prepaid rent.

Dr. Cr.
Rent Expense (OE:E) 4,000
Prepaid Rent (A) 4,000

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After adjustments, the prepaid rent account has a balance of P4,000 (July 1 prepayment of P8,000 less the P4,000
expired portion); the rent expense account reflects the P4,000 expense for the month.

Prepaid Insurance (Adjustment B). Celestial Wedding Shop Inc. acquired a one-year comprehensive insurance
coverage on the service vehicle and paid P14,400 premiums. In a manner similar to prepaid rent, prepaid insurance
offers protection that expires daily. The adjustment is analyzed and recorded as shown below:

Transaction Expiration of one month's insurance.

Analysis Assets decreased. Owner's equity decreased.
Rules Decreases in assets are recorded by credits. Decreases in owner's equity are
recorded by debits.
Entries Decrease in owner's equity is recorded by a debit to insurance expense; decrease
in assets as a credit to prepaid insurance.

Dr. Cr.
Insurance Expense (OE:E) 1,200
Prepaid Insurance (A) 1,200

The prepaid insurance account has a balance of P13,200 (July 4 prepayment of P14,400 less P1,200) and insurance
expense reflects the expired cost of P1,200 for the month. As a matter of company policy, the period July 4 to 31 is
considered a month.

Supplies (Adjustment C). On July 8, Celestial Wedding Shop Inc. purchased supplies, P18,000. During the month, the
entity used supplies in the process of performing services for clients. There is no need to account for these supplies
every day since the financial statements will not be prepared until the end of the month. At the end of the accounting
period, Nhur Eden Estrellan makes a careful physical inventory of the supplies. The inventory count showed that
supplies costing P15,000 are still on hand. transaction is analyzed and recorded as follows:

Transaction Consumption of supplies.

Analysis Assets decreased. Owner's equity decreased.
Rules Decreases in assets are recorded by credits. Decreases in owner's equity are
recorded by debits.
Entries Decrease in owner's equity is recorded by a debit to supplies expense. Decrease
in assets is recorded by a credit to supplies.

Dr. Cr.
Supplies Expense (OE:E) 3,000
Supplies (A) 3,000

The asset account supplies now reflect the adjusted amount of P15,000 (P18,000 less P3,000). In addition, the amount
of supplies expensed during the accounting period is reflected as P3,000.

Service Vehicle and Office Equipment (Adjustments D and E). Suppose that Celestial Wedding Shop Inc. estimated
that the service vehicle, which was bought on July 4, will last for seven years (eighty-four months) and with a salvage
value of P84,000. The office equipment that was acquired on July 5 will have a useful life of five years (sixty months)
and will be worthless at that time. Substitution of the pertinent amounts into the basic formula will yield depreciation
for service vehicle and office equipment for the month as P4,000 [(P420,000 - P84,000)/84 months) and P1,000
(P60,000/60 months), respectively. These amounts represent the cost allocated to the month, thus reducing the asset
accounts and increasing the expense accounts. As a matter of company policy, the period July 4 to 31 is considered a
month. The analysis follows:

Transaction Recording depreciation expense.

Analysis Assets decreased. Owner's equity decreased.
Rules Decreases in assets are recorded by credits. Decreases in owner's equity are
recorded by debits.
Entries Owner's equity is decreased by debits to depreciation expense-service vehicle
and depreciation expense-office equipment. Assets are decreased by credits to
contra-asset accounts accumulated depreciation-service vehicle and accumulated
depreciation-office equipment.

Dr. Cr.
Depreciation Expense-Service Vehicle (OE:E) 4,000
Accumulated Depreciation Serv. Vehicle (A) 4,000

Depreciation Expense-Office Equipt. (OE:E) 1,000

Accumulated Depreciation-Off. Equipt. (A) 1,000

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Unearned Referral Revenues (Adjustment f). On July 15, Celestial Wedding Shop Inc. received P10,000 as an
advance payment for referrals made. Assume that by the end of the month one of the three couples referred has already
taken their marriage vows and as a result the amount of P4,000 pertaining to the referred event has been realized. This
transaction is analyzed as follows:

Transaction Recognition of income where cash is received in advance.

Analysis Liabilities decreased. Owner's equity increased.
Rules Decreases in liabilities are recorded by debits. Increases in owner's equity are
recorded by credits.
Entries Decrease in liabilities is recorded by a debit to unearned referral revenues.
Increase in owner's equity is recorded by a credit to referral revenues.

Dr. Cr.
Unearned Referral Revenues (L) 4,000
Referral Revenues (OE:1) 4,000

The liability account unearned referral revenues reflects the referral revenues still to be earned, P6,000. The referral
revenues account reflects the amount of referrals already completed and considered as revenues during the month,
P4,000.

ALTERNATIVE METHODS FOR RECORDING DEFERRED EXPENSES:

1. ASSET METHOD – prepayments of expenses are initially debited to an asset account ( BS account).
At year-end, the asset account is credited ( BS account) to recognize the portion incurred or expensed during the
period ( IS account).

2. EXPENSE METHOD – prepayments of expenses are initially debited to an expense account ( IS account).
At year-end, the expense account is credited ( IS account) to recognize the portion unused or not yet expensed at
the end of the period ( BS account).

Illustration: On July 1, Celestial Wedding Shop Inc. paid P8,000 for two months’ rent in advance.

ASSET METHOD EXPENSE METHOD

July 1 Prepaid Rent (A) 8,000 July 1 Rent Expense (OE:E) 8,000
Cash 8,000 Cash 8,000
July 31 Rent Expense (OE:E) 4,000 July 31 Prepaid Rent (A) 4,000
Prepaid Rent (A) 4,000 Rent Expense (OE:E) 4,000
NOTE: After adjustments, both methods lead to the same amount of rent expense equal to P4,000
and prepaid rent equal to P4,000.

ALTERNATIVE METHODS FOR RECORDING DEFERRED REVENUES:

1. LIABILITY METHOD – advance collections of income are initially credited to a liability account ( BS
account).
At year-end, the liability account is debited ( BS account) to recognize the portion earned as revenue during the
period ( IS account).

2. INCOME METHOD – advance collections of income are initially credited to an income account ( IS account).
At year-end, the income account is debited ( IS account) to recognize the portion unearned at the end of the
period ( BS account).

Illustration: On July 15, Celestial Wedding Shop Inc. received P10,000 as an advance payment for referrals
made. Assume that by the end of the month one of the three couples referred has already taken their marriage
vows and as a result the amount of P4,000 pertaining to the referred event has been realized.

LIABILITY METHOD INCOME METHOD

July 15 Cash 10,000 July 1 Cash 10,000
Unearned RR (L) 10,000 Referral Revenues (OE:I) 10,000
July 31 Unearned RR (L) 4,000 July 31 Referral Revenues (OE:I) 6,000
Referral Revenues (OE:I) 4,000 Unearned RR (L) 6,000
NOTE: After adjustments, both methods lead to the same amount of referral revenues equal to
P4,000 and unearned referral revenue equal to P6,000.

Accrued Salaries (Adjustment g). Entities pay their employees at regular intervals. It can be weekly, semi-monthly or
monthly. Weekly payrolls are usually made on Fridays (for a five-day workweek) or Saturdays (for a six-day
workweek). Celestial Wedding Shop Inc. pays salaries every two Saturdays. Assume that the calendar for July appears
as follows:

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 JULY
Su M T W Th F Sa
1 2 3 4 5 6
7 8 9 10 11 12 13
14 15 16 17 18 19 20
21 22 23 24 25 26 27
28 29 30 31

The office assistant and the account executive were paid salaries on July 13 and 27. At month-end, the employees have
worked for three days (July 29, 30 and 31) beyond the last pay period. The employees have earned the salary for these
days, but it is not due to be paid until the regular payday in June. The salary for these three days is rightfully an expense
for July, and the liabilities should reflect that the entity owes the employees salaries for those days.

Each of the employee's salary rate is P7,800 per month or P300 per day (P7,800/26 working days). The expense to be
accrued is P1,800 (P300 x 3 days x 2 employees). This accrued expense can be analyzed as shown:

Transaction Accrual of unrecorded expense.

Analysis Liabilities increased. Owner's equity decreased.
Rules Increases in liabilities are recorded by credits. Decreases in owner's equity are
recorded by debits.
Entries Decrease in owner's equity is recorded by a debit to salaries expense. Increase in
liabilities is recorded by a credit to salaries payable.

Dr. Cr.
Salaries Expense (OE:E) 1,800
Salaries Payable (L) 1,800

The liability of P1,800 is now correctly reflected in the salaries payable account. The actual expense incurred for
salaries during the month is P15,600.

Accrued Interest (Adjustment h). On July 2, Nhur Eden Estrellan borrowed P210,000 from Metrobank. She issued a
promissory note that carried a 20% interest per annum. Both the interest and principal will be payable in one year. The
note issued to the bank accrues interest at 20% annually. At the end of July, Perez-Manalo owed the bank P3,500 (see
computation below) for interest in addition to the P210,000 loan. Interest is a charge for the use of money over time.
Interest expense is matched to a particular period during which the benefit--the use of borrowed money--is received.
The interest is a fixed obligation and accrues regardless of the results of the entity's operations.

Interest rates are expressed at annual rates, so if interest is being calculated for less than a year, the calculation must
express time as a portion of a year. Thus, the interest expense (simple) incurred on this note during the month is
determined by the following formula:

Interest = Principal x Interest Rate x Length of Time

= P210,000 x 20% per year x 1/12 of a year
= P210,000 x .20 x 1/12
= P 3,500

The adjusting entry to record the interest expense incurred in July is as follows:

Transaction Accrual of unrecorded expense.

Analysis Liabilities increased. Owner's equity decreased.
Rules Increases in liabilities are recorded by credits. Decreases in owner's equity are
recorded by debits.
Entries Decrease in owner's equity is recorded by a debit to interest expense; increase in
liabilities as credit to interest payable.

Dr. Cr.
Interest Expense (OE:E) 3,500
Interest Payable (L) 3,500

Accrued Consulting Revenues (Adjustment i) Suppose that Celestial Wedding Shop Inc. agreed to arrange a rush but
simple civil wedding for a madly-in-love couple in the afternoon of July 31. The entity intended to charge fees of
P5,300 for the services, which is earned but unbilled. This should be recorded as shown below:

Transaction Accrual of unrecorded revenue.

Analysis Assets increased. Owner's equity increased.
Rules Increases in assets are recorded by debits. Increases in owner's equity are

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 recorded by credits.
Entries Increase in assets is recorded by a debit to accounts receivable. Increase in
owner's equity as a credit to consulting revenues.

Dr. Cr.
Accounts Receivable (A) 5,300
Consulting Revenues (OE:I) 5,300

A total of P67,700 in consulting revenues was earned by the entity during the month.

Step 6. Preparation of Financial Statements

Celestial Wedding Shop Inc.
Balance Sheet
As of July 31, 2019

Assets
Current Assets
Cash P 22,200
Accounts Receivable 17,300
Supplies 15,000
Prepaid Rent 4,000
Prepaid Insurance 13,200 P 71,700
Total Current Assets
Property and Equipment (Net)
Service Vehicles P 420,000
Less: Accumulated Depreciation 4,000 P 416,000
Office Equipment P 60,000
Less: Accumulated Depreciation 1,000 59,000 475,000
Total Assets P 546,700
Liabilities
Current Liabilities
Notes Payable P 210,000
Accounts Payable 53,000
Salaries Payable 1,800
Utilities Payable 1,400
Interest Payable 3,500
Unearned Referral Revenues 6,000
Total Current Liabilities P275,700
Owner's Equity
Nhur Eden Estrellan, Capital, 5/31/2019 271,000
Total Liabilities and Owner's Equity P 546,700

Celestial Wedding Shop Inc.

Statement of Changes in Equity
For the Month Ended July 31, 2019

Nhur Eden Estrellan , Owner's Equity, P 250,000

5/1/2019
Add: Profit 35,000
Total P 285,000
Less: Withdrawals 14,000
Nhur Eden Estrellan, Owner's Equity, P 271,000
5/31/2019

Celestial Wedding Shop Inc.

Income Statement
For the Month Ended July 31, 2019

Revenues
Consulting Revenues P 67,700
Referral Revenues 4,000
Total P71,700

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 Expenses
Salaries Expense P 15,600
Utilities Expense 4,400
Rent Expense 4,000
Depreciation Expense-Service Vehicle 4,000
Interest Expense 3,500
Supplies Expense 3,000
Insurance Expense 1,200
Depreciation Expense-Office Equipment 1,000
Total 36,700
PROFIT P 35,000

Step 7. Adjustments are Journalized and Posted

Journal Page 1

Date Account Titles Debit Credit

2019
July 31 Rent Expense P 4,000
Prepaid Rent P 4,000

31 Insurance Expense 1,200

Prepaid Insurance 1,200

31 Supplies Expense 3,000

Supplies 3,000

31 Depreciation Expense-Service Vehicle 4,000

Accumulated Depreciation - Serv. 4,000
Vehicle

31 Depreciation Expense - Office Equipment 1,000

Accumulated Depreciation - Off. Equipt. 1,000

31 Unearned Referral Revenues 4,000

Referral Revenues 4,000

31 Salaries Expense 1,800

Salaries Payable 1,800

31 Interest Expense 3,500

Interest Payable 3,500

31 Accounts Receivable 5,300

Consulting Revenues 5,300

Step 8. Closing Entries are Journalized and Posted

Journal Page 1

Date Account Titles Debit Credit

2019
July 31 Consulting Revenues P 67,700
Referral Revenues 4,000
Income Summary P 71,700
Close the income accounts
31 Income Summary 36,700
Salaries Expense 15,600
Supplies Expense 3,000
Rent Expense 4,000

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 Insurance Expense 1,200
Utilities Expense 4,400
Depreciation Expense-Serv. Vehicle 4,000
Depreciation Expense-Off. Equipt. 1,000
Interest Expense 3,500
Close the expense accounts
31 Income Summary 35,000
Estrellan, Capital 35,000
Close the income summary account
31 Estrellan, Capital 14,000
Estrellan, Withdrawals 14,000
Close the withdrawal account

Step 9. Preparation of a Post-Closing Trial Balance

Celestial Wedding Shop Inc.
Post-Closing Trial Balance
July 31, 2019

Cash P 22,200
Accounts Receivable 17,300
Supplies 15,000
Prepaid Rent 4,000
Prepaid Insurance 13,200
Service Vehicle 420,000
Accumulated Depreciation - Service Vehicle P 4,000
Office Equipment 60,000
Accumulated Depreciation - Office 1,000
Equipment
Notes Payable 210,000
Accounts Payable 53,000
Salaries Payable 1,800
Utilities Payable 1,400
Interest Payable 3,500
Unearned Referral Revenues 6,000
Nhur Eden Estrellan, Capital 271,000
TOTAL P 551,700 P 551,700

Step 10. Reversing Entries

Dr. Cr.
Salaries Payable P 1,800
Salaries Expense P 1,800

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