ACCOUNTING is a basic language of business.

We can use this language to communicate financial

transactions and their result.
Accounting is comprehensive systems to collect, analyze, and communicate financial information.
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 decision. (Accounting
Standard Council)
Accounting is the art of Recording, Classifying, and Summarizing in a significant manner and in terms of
money, transactions and events which are in part at least of a financial character and interpreting the result
thereof. (American Institute of Certified Public Accountants)
Accounting is the process of Identifying, Measuring, and Communicating economic information to permit
informed judgment and decision by users of the information. (American Accounting Association)
Bookkeeping is the recording of all financial transactions undertaken by a business (or an individual). A
bookkeeper (or book-keeper), sometimes called an accounting clerk in the business, itis a person who
keeps the books of an organization. The organization might be a business, a charity or even a local sports
club.

The three important activities in the accounting process

IDENTIFYING– means the recognition or nonrecognition of “accountable” events. Not all business activities
are accountable. An event is accountable or quantifiable when it has an effect on Asset, Liabilities, and
Equity.
Only economic activities are emphasized and recognized is financial accounting.
ECONOMIC ACTIVITIES of an enterprise are referred to as transaction which may be classified as:
EXTERNALTRANSACTION economics events involving one enterprise and another enterprise (Purchase of
merchandise from a supplier, borrowing money from a bank, sale of merchandise to customer and payment of
salaries to employees).
INTERNALTRANSACTION economic events involving the enterprise only (production, casualty such as fire,
flood, earthquake and other events ordinarily termed as an act of God.
MEASURING – is the process of determining the monetary amounts at which the elements of the financial
statements are to be recognized and carried in the balance sheet and income statement.
COMMUNICATING – is the process of preparing and distributing accounting reports to potential users of
accounting information.
Identifying and measuring are pointless of the information contained in the accounting records cannot be
communicated in some form to potential users, like investors, owners, managers, creditors, and other interest
parties. Actually it is for this reason that accounting has been called the “language of business”.

Implicit communicating process are:

RECORDING or journalizing is the process of systematically maintaining a record of all economic business
transactions after they have been identified and measured.
CLASSIFYING is the sorting or grouping of similar and interrelated economic transactions into their
respective class. Actually, classifying is accomplished by posting to the ledger.
SUMMARIZING is the preparation of financial statements which include the Balance Sheet, Income
Statement, Cash Flow Statement, Statement of Changes in Equity and Statement of recognized gains and
losses.

Bookkeeping is the recording of all financial transactions undertaken by a business (or an individual). A
bookkeeper (or book-keeper), sometimes called an accounting clerk is a person who keeps the books of an
organization. The organization might be a business, a charity or even a local sports club.

OBJECTIVE AND SCOPE OF ACCOUNTING

 To keep systematic records: accounting is done to keep systematic record of financial transaction.
The primary objective of accounting is to help us collect financial data and to record it systematically
to derived correct and useful result of financial statement.
 To ascertain profitability: with the help of accounting, we can evaluate the profits and losses
incurred during specific accounting period. With the help of a trading and profit and loss account we
can easily determine the profit or loss of a firm.
 To ascertain the financial position of the business: a balance sheet or a statement of affairs indicates
the financial position of a company as a particular date. A property drawn balance sheet gives us an
indication of the class and value of asset, the nature and value of liability, and also the capital position
of the firm. With the help of that we can easily ascertain the soundness of any business entity.
 To assist in decision making: to make decision for the future one requires accurate financial
statements. One of the main objectives of accounting is to take right decisions at right time. Thus,
accounting gives you the platform to plan for the future with the help of past records.
 To fulfill compliance of law: business entities such as companies, trust, and societies are being run
and governed according to different legislative acts. Similarly, different taxation laws
(direct/indirect tax) are also applicable to every business house. Everyone has to keep and maintain
Page 1 of 23
 different types of accounts and records as prescribed by corresponding laws of the land. Accounting
helps in running a business in compliance with the law.

Business is the social science of managing people to organize and maintain collective productivity toward
accomplishing particular productive goals, which is usually to generate profit.

BASIC PURPOSE OF ACCOUNTING

Accounting identifies, measures, and communicates information about entities for use in making judgment
and decision.
An accountant primary task therefore is to supply information to statement users so that they could make
informed judgment and better decision.

ACCOUNTING

PROVIDES FINANCIAL INFORMATION

TO

INVESTORS CUSTOMERS

SUPPLIERS EMPLOYEES

LENDERS GOVERNMENT

FOR MAKING DECISIONS

USERS OF FINANCIAL STATEMENT

A. INVESTORS – the providers of risk capital and their advisers are concerned with the risk inherent in
and return provided by their investment.
Investors need information to help them determine whether they should buy, hold or sell.
Shareholders are also interested in information which enables them to assess the ability of the entity
to pay dividends.
B. EMPLOYEE – employees are interested in information about the stability and profitability of the
entity.
The employees are interested in information which enables them to assess the ability of the entity to
provide remuneration retirement benefits, and employment opportunities.
C. LENDERS –lenders are interested in information which enables them to determine whether their loans
and interest thereon will be paid when due.
D. SUPPLIERS AND OTHER TRADE CREDITORS – these users are interested in information which
enables them to determine whether amounts owing to them will be paid on maturity.
E. CUSTOMERS – customers have an interest in information about the continuance of an entity
especially when they have a long-term involvement with or are dependent on the entity.
F. GOVERNEMNT AND ITS AGENCIES – are interested in the allocation of resources and therefore the
activities of the entity.
These users require information to regulate the activities of the entity, determine taxation policies and
as a basis for national income and similar statistics.

FORMS OF BUSINESS ORGANIZATION

SOLE PROPRIETORSHIP – is a business enterprise owned by one person. The business may employ a few
or even many people, but there is only one owner who realizes the profits and suffers the losses.

PARTNERSHIP – is 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.
Page 2 of 23
CORPORATION – is 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 authorized by law or incident
to its existence.

CLASSIFICATION OF BUSINESS ORGANIZATION ACCORDING TO THE NATURE OF HEIR OPERATIONS

SERVICE BUSINESS–business enterprise that renders personal service like beauty parlors, barbershops,
tailoring shops, optical clinics, auditing/accounting and law firms, etc.

TRADING OR MERCHANDISING - companies purchase goods, which are ready for sale and then sell these
to customers. (Drugstores, department stores, bookstores, groceries, etc.)

MANUFACTURING FIRMS – companies that are engage in the production of goods or the conversion of
raw materials into finished goods (car manufactures, steel mills, and drug manufacturers)

UNDERLYING ACCOUNTING ASSUMPTIONS

Accounting assumptions are the basic notions or fundamental premises on which the accounting process
is based.

Accounting assumptions served as the foundation or bedrock of accounting in order to avoid

misunderstanding but rather enhance the understanding and usefulness of the financial statements.
Accounting assumptions are also known as postulates.

Accrual accounting means that income is recognized when earned regardless of when received and
expenses is recognize when incurred regardless of when paid.
Under this basis, the effects of transactions and other events are recognized when they occur and not as cash
or its equivalent is received or paid, and they are recorded in the accounting records and reported in the
financial statements of the periods to which they relate.
The essence of accrual accounting is the recognition of accounts receivable, account payable, prepaid
expenses, deferred income, and accrued income.

Going Concern assumption means that the accounting entity is viewed as continuing in operation
indefinitely in the absence of evidence to the contrary.
In other words, financial statements are prepared normally on the assumption that the entity shall continue in
operation for the foreseeable future.
Thus, assets are normally recorded at original acquisition cost. As a rule, market values are ignored. However,
the new standards require measurement of certain assets at fair value.
This postulate is the very foundation of the cost principle. It is also known as the continuity assumption.

Accounting Entity is the specific business enterprise, which may be a proprietorship, partnership or
corporation.
Under this assumption, the entity is separate from the owners, managers, and employees who constitute the
entity. Accordingly, the transactions of the entity should not be merged with the transactions of the owners.
The reason for this assumption is to have a fair presentation of financial statements.
The personal transactions of the owners should not be allowed to distort the financial statements of the entity.
However, where parent and subsidiary relationship exist, consolidatedstatements for the affiliates are
usually prepared because for practical and economic purposes the parent and subsidiary are viewed as a
“single economic entity”.
However, the consolidation does not eliminate the legal boundary segregating the affiliated entities.
Accounting will continue to be done separately for each entity.

Implicit assumptions

Separate Entity (Business Entity Concept/Entity Concept) the entity is treated separately from owners.
This concept defines the area of interest of the accountant. Only the pertaining to the entity are accounted
for and included in the financial records. The personal assets, obligations, and transactions of owners are
excluded. It is the specific business enterprise, which may be a proprietorship, partnership or corporation.

Stable Monetary Unit (Monetary unit)

a. Assets, liabilities, equity, income, and expense are stated in terms of a common unit of measure,
which is the peso in the Philippines.
The quantifiability aspect means that the assets, liabilities, equity, income and expenses should be
stated in terms of a unit of measure which is the peso in the Philippines.
b. The purchasing power of the peso is regarded as stable or constant and that its instability and
therefore ignored.

Page 3 of 23
 The stability of the peso assumption means that the purchasing power of the peso is stable or constant
and that its instability is insignificant and therefore may be ignored.
The stable peso postulate is actually an amplification of the going concern assumption so that
adjustments are unnecessary to reflect any changes in purchasing power.

Monetary unit assumption has two aspects, namely quantifiability and stability of the peso. The
quantifiability aspect means that the assets, liabilities, equity, income and expenses should be stated in
terms of a unit of measure which is the peso in the Philippines.
How awkward to see financial statements without any common unit of measure. Such statements would be
largely unintelligible and incomprehensive.
The stability of the peso assumption means that the purchasing power of the peso is stable or constant and
that its instability is insignificant and therefore may be ignored.
The stable peso postulate is actually an amplification of the going concern assumption so that adjustments are
unnecessary to reflect any changes in purchasing power.
The accounting function is to account for pesos only and not for changes in purchasing power.

The Time period assumption requires that “the indefinite life of an entity is subdivided into time periods
or accounting periods which are usually of equal length for the purpose of preparing financial reports on
financial position, financial performance and cash flows”
The accounting period or fiscal period is one year or a period of twelve months. The “one-year period” is
traditionally the accounting period because usually it is after one year that government reports are required.
The accounting period may be a calendar year or a natural business year. A calendar year is a twelve-month
period that ends on December 31. A natural business year is a twelve-month period that ends on any month
when the business is at the lowest or experiencing slack season.

The FINANCIAL POSITION of an entity comprises its assets, liabilities, and equity at a particular date. It
pertains to the economic resources, liquidity, solvency, financial structure, and capacity for adaption of an
entity such information is pictured in the statement of financial position.

The FINANCIALPERFORMANCE of an entity comprises its revenue, expenses, and net income or loss for a
period of time.
Financial performance is the level of income earned by the entity through the efficient and effective user of its
resources.
The financial performance of an entity is also known as results of operations and is portrayed in the income
statement and statement of comprehensive income.

Information about performance is useful in predicting the capacity of the entity to generate cash flows from
its operations. It is also useful in forming judgment about the effectiveness of the entity in employing
additional resources.
Financial reporting is the provision of financial information about an entity to external users that is useful to
them in making economic decisions and for assessing the effectiveness of the entity’s management.
The principal way of providing financial information to external users is through the annual financial
statement.

The basic summary device of accounting is the ACCOUNT. An account may be defined as a detailed record
of the increases, decreases, and balance of each item that appears in an entity’s financial statements.
An account is the accounting device used in summarizing the effects of transactions on each asset, liability,
equity, revenue, and expense.
The accounts used by a particular entity are usually expressed in the form of chart of accounts.

The simplest form of the account is known as “T” account because of its similarity to the letter “T”. The
account has three parts:
ACCOUNT TITLE

Left side or Right side or

DEBIT side CREDIT side

Recognition is a term which means the process of reporting an asset, liability, income or expense on the
face of the financial statements of an entity.
In other words, recognition involves the inclusion of peso amount in the entity’s financial statements.

ELEMENTS OF FINANCIAL STATEMENTS

Page 4 of 23
 A. ASSET – resources controlled by the entity as a result of past transaction or events and from which
future economic benefits are expected to flow to the entity.

B. LIABILITIES – present obligation of the entity arising from past transactions or events the
statements of which is expected to result in an outflow from the entity of resource embodying
economic benefits. (PAYABLE)

C. EQUITY/CAPITAL – residual interest in the assets of the entity after deducting all of its liabilities
In sole proprietorship, there is only one owner’s equity account, because there is only one owner.
In partnership, an owner’s equity accounts exist for each partner.
In corporation, owner’s equity or stockholders’ equity consist of capital stock, additional paid-in
capital and retained earnings among others.

D. INCOME – increase in economic benefit during the accounting period in the form of an inflow or
increase of asset or decrease of liabilities that results in increase in equity, other than contribution
from equity participants.

Result of the performance of service or the sale of merchandise by the business.

Revenue arises in the course of the ordinary regular activities of an entity and is referred to by a
variety of different names including sales, fees, interest, dividends, royalties and rent.
Gains represent other items that meet the definition of income and do not arise in the course of the
ordinary regular activities of an entity. For example, gains include gain from disposal of noncurrent
assets, unrealized gains on trading securities and gain from expropriation.

E. EXPENSE–decrease in economic benefit during the accounting period in the form of an outflow or
decrease of asset or increase of liability that results in decrease in equity, other than distribution to
equity participants.

Expense that arise in the course of ordinary activities of the entity include, for example, cost of sales,
wages and depreciation.
Losses represent other items that meet the definition of expense and do not arise in the course of the
ordinary regular activities of the entity.

ACCOUNTING EQUATION

ASSET = LIABILITIES + OWNER’S EQUITY

RULES OF DEBIT AND CREDIT

BALANCE SHEET ACCOUNT

ASSET LIABILITIES AND OWNER’S EQUITY

DEBIT CREDIT DEBIT CREDIT
(+) (-) (-) (+)
INCREASES DECREASES DECREASES INCREASES

INCOME STATEMENT ACCOUNT

Debit for decreases in Credit for increases in

Owners Equity Owners Equity

EXPENSES REVENUES
DEBIT CREDIT DEBIT CREDIT
(+) (-) (-) (+)
INCREASES DECREASES DECREASES INCREASES

EFFECTS OF TRANSACTIONS
1. Increase in Asset = Increase in Liabilities
2. Increase in Asset = Increase in Owner’s Equity
3. Increase in one Asset = Decrease in another Asset
4. Decrease in Asset = Decrease in Liability
Page 5 of 23
 5. Decrease in Asset = Decrease in Owner’s Equity
6. Increase in Liabilities = Decrease in Owner’s Equity
7. Increase in one Liability = Decrease in another Liability
8. Increase in Owner’s Equity = Decrease in Liabilities
9. Increase in one Owner’s Equity = Decrease in another Owner’s Equity

ACCOUNT TITLE USED

BALANCE SHEET
ASSET

CURRENTASSETS
CASH – medium of exchange that a bank will accept at face value. It includes coins, currency, checks, money
orders, bank deposit and drafts.
CASH EQUIVALENT – short-term, highly liquid investment which are readily convertible to cash and with
original maturities of three months or less.Examples are (a) three-month BSP treasury bill, (b) Three-year
BSP treasury bill purchased three months before date of maturity, (c) Three-month time deposit, and (d)
Three-month money market instrument
SHORT-TERM INVESTMENT – investments which are readily marketable and represent temporary
investment of funds available for current operations and are intended to meet working capital
requirements.
NOTES RECEIVABLE – is a written pledge that the customer will pay the business a fixed amount of money
on a certain date.
ACCOUNTS RECEIVABLE – these are claims against customers arising from sale of services or good on
credit. This type of receivable offers less security than a promissory note.
INVENTORY – these constitute items of tangible personal property which are (a) held for sale in the
ordinary course of business, (b) in the process of production for such sale, or (c) to be currently consumed
in the production of goods or services to be available for sale.
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. These include insurance and rent. These
prepaid items present future economic benefits – assets – until the time these start to contribute to the
earning process: these, then, become expense.

NON-CURRENT ASSETS
LONG-TERM INVESTMENT – these are assets not directly identified with the operating activities of the
company or involved in the sale or production of goods and services. Long-term investments are those
usually acquired for regular income, control, meeting business requirements, value appreciation and
protection.
EQUIPMENT – this account records the acquisition and disposition
BUILDINGS–included in this account are factories, warehouses, and office buildings. These long-lived
structures are subject to depreciation over a number of years.
LAND–land owned and used by the business entity. No depreciation is recorded.
INTANGIBLES–these are relatively long-lived assets without physical characteristics, which value lies in
right, privileges and competitive advantages, which they give the owner. These include patents, copyrights,
licenses, franchises, goodwill, trademarks, secret processes, subscription lists and non-competition
agreements.

LIABILITIES
CURRENT LIABILITIES
NOTES PAYABLE – these business entity is the maker of the note; that is, the business entity is the party
who promises to pay the other party a specified amount of money on a specified future date.
ACCOUNTS PAYABLE – by accepting the goods or services, the buyer agrees to pay for them in the near
future.
ACCRUED LIABILITIES – amount owed to others for unpaid expenses. This accounts includes salaries
payable, wages payable, interest payable and taxes payable.
UNEARNED REVENUE – 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 revenue is
recognized.
LONG-TERM LIABILITIES
MORTGAGE PAYABLE – this account records long-term debt of the business entity for which the business
entity has pledged certain assets as security to the creditor. In the event that the debt payments are not
made, the creditor can foreclose or cause the mortgaged asset to be sold to enable the entity to settle the
claim.
Page 6 of 23
BONDS PAYABLE – business organization often obtain substantial sums of money from lenders to finance
the acquisition of equipment and other needed assets. They obtain these funds by issuing bonds. The bond
is a contact between the issuer and the lenders specifying the terms of repayment and the interest to be
charged.
OWNER’S EQUITY
CAPITAL – this account is used to record the original and additional investments of the owner of the
business entity. It is increased by the amount of net income earned during the year or is decreased by a net
loss. Cash or other assets that the owner may withdraw from the business ultimately reduced it. This account
title nears the name of the owner.
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.

INCOME STATEMENT
REVENUE
SERVICE REVENUE – revenues earned by performing services for a customer or client; for example,
accounting services by a CPA firm, laundry services by a laundry shop.
SALES REVENUE – revenue earned as a result of sale of merchandise; for example, sale of building
materials by a construction supplies firm.
EXPENSES
COST OF SALES – the cost incurred to produce the products sold to customers during the period; also
called cost of goods sold.
SALARIES AND WAGES EXPENSE – includes all payments as a result of an employer-employee
relationship such as salaries or wages, 13 th month pay, cost of living allowances and other related fringe
benefits.
TELECOMMUNICATIONS, ELECTRICITY, FUEL AND WATER EXPENSES – expenses related to use of
telecommunications facilities, consumption of electricity, fuel, and water.
RENT EXPENSE–expense for space, equipment or other asset rentals.
SUPPLIES EXPENSE – expense using supplies (e.g. office supplies) in the conduct of saily business.
DEPRECIATION EXPENSE – the portion of the cost of a tangible assets (e.g. buildings, and equipment)
allocated or charged as expense during an accounting period.
UNCOLLECTIBLE ACCOUNTS EXPENSE – the amount receivables estimated to be doubtful of collection
and charged as expense during an accounting period.
INTEREST EXPENSE –an expense related to use of borrowed funds.

ACCOUNTING CYCLE/PROCESS

1. ANALYZING the business documents or transactions. This means that the accountant determines the
impact of the transactions on the financial position as represented by the basic equation “assets equals
liabilities plus equity”.
To gather information about transactions or events generally through the source document.
2. JOURNALIZING – this is the process of recording the transactions in a journal.
To record the economic impact of transactions on the firm in a journal, which is a form that facilitates
transfer to the accounts.
3. POSTING/LEDGER – transactions are classified and recorded in the journal are transferred to the
appropriate accounts in the general ledger and subsidiary ledger, if applicable.
Page 7 of 23
 To transfer the information from the journal to the ledger for classification.
4. PREPARING THE TRIAL BALANCE. To provide a listing to verify the equality of debits and credits in
the ledger.
5. PREPARING THE ADJUSTING ENTIES. To aid in the preparation of financial statements.
6. PREPARING THE ADJUSTED TRIAL BALANCE.
7. PREPARING THE FINANCIAL STATEMENTS.To provide useful information to decision-maker.
8. PREPARING THE CLOSING ENTRIES. To close temporary account and transfer net income to owner’s
equity.
9. PREPARING A POST-CLOSING TRIAL BALANCE. To check the equality of debits and credits after the
closing entries.

FINANCIAL TRANSACTION WORK SHEET

Every financial transaction can be analyzed or expresses in terms of its effects on the accounting equation.
A financial transaction worksheet is used to analyze increase and decreases in asset, liabilities or owners’
equity.

Illustrative problem:
Mario Dimagiba decide to open a tailoring shop called MADI TAILORING
1. On August 1, 2016, he invested p16,000 cash to start his tailoring shop.
2. On August 3, Mario acquire equipment worth P12,000 from Singer Sewing Machines. Singer allows
Mario to pay for the acquisition later.
3. On August 5, Mario acquired supplies by paying P1,000 cash.
4. On August 10, Mario paid Singer P3,000.
5. On August 12, Mario received P4,800 cash from customer for tailoring services.
6. On August 14, Mario provided tailoring services of P4,600 to customers on account.
7. Expenses paid in cash for August are salaries of employees, P2,400.
8. The sum of P4,600 was received from customers who have been billed for services on August 14.
9. Mario withdraws P600 for personal use.
10. A count of supplies on August 31 indicates that a P200 sewing supply has been used.

MADI TAILORING
Financial Transaction Worksheet
Month of August 2016

Accounts Accounts
Transaction Cash + Equipment + Supplies + Receivable = Payable + Dimagiba, Capital
1. 16,000 16,000
2. 12,000 12,000
3. (1,000) 1,000
4. (3,000) (3,000)
5. 4,800 4,800
6. 4,600 4,600
7. (2,400) (2,400)
8. 4,600 (4,600)
9. (600) (600)
10. (200) (200)
18,400 + 12,000 + 800 + 0 = 9,000 + 22,200
31,200 = 31,200

Required: Make a T Account of MADI TAILORING. Cash, Equipment, Supplies, Account Receivable, Accounts
Payable, Dimagiba, Capital, Salaries, and Service Revenue.

Illustrative Problem 2
August 1 Mr. Nisperos opened a catering services and named it “SFORK CATERING”.
He invested P100,000 cash and equipment , P10,000.
3 He purchased kitchen utensils, tools, and additional equipment from East
Trading on credit, P40,000.
7 Paid for advertisement announcing the opening of this business, P1,000.
9 Paid one-half of the amount due to East Trading.
11 Rendered catering service to Jose Manuel’s Wedding and received cash of P50,000.
13 Paid for the food supplies used in Jose Manuel’s Wedding party, P25,000.
Page 8 of 23
 17 Billed Ben Marcos, P30,000 for catering service rendered in his birthday party.
20 Paid salary of the assistant cook, P5,000.
22 Received from Ben Marcos the amount of P15,000 as partial payment.
25 Mr. Nisperos withdrew P7,000 for his personal use.

Required: record the transactions listed above. Use the following accounts. Cash; Accounts Receivable;
Equipment; Accounts Payable; Nisperos, Capital; and Nisperos, Withdrawal. Make a worksheet and T-
Accounts of the transactions.

SFORK CATERING
Financial Transaction Worksheet
Month of August 2016
August Cash + A/R + Equipment = A/P + Nisperos Capital
1 100,000 10,000 110,000
3 40,000 40,000
7 (1,000) (1,000)
9 (20,000) (20,000)
11 50,000 50,000
13 (25,000) (25,000)
17 30,000 30,000
20 (5,000) (5,000)
22 15,000 (15,000)
25 (7,000) (7,000)
107,000 15,000 50,000 = 20,000 152,000
172,000 = 172,000
DEBIT TO CREDIT TO
1. Increase assets 1. Decrease assets
2. Decrease liabilities 2. Increase liabilities
3. Decrease equity due to 3. Increase in equity due to
a. Withdrawal by the owner a. Investment by the owner
b. Increase in expense and losses b. Decrease in expense and losses
c. Decrease in income c. Increase in income
SOURCE DOCUMENTS
These documents provide original written evidences that transaction have occurred and contain
information about the nature and the amounts of the transactions. These are the bases for the journal
entries; some of the more common source documents are sales invoice, official receipts, bank deposit slips,
cash register tapes, and statement of account.

SALES INVOICE – prepared by the seller of goods and sent to the buyer.

BILL OF LADING – a document issued by the carrier – a trucking, shipping or airline – that specifies
contractual conditions and terms of delivery such as freight terms, time, place, and the person named to
received the goods.

THE STATEMENT OF ACCOUNT – is a formal notice to the debtor detailing the accounts already due.

OFFICIAL RECEIPT – evidences the receipt of cash by the seller or the authorized representative. It notes
the invoices paid and other details of payment.

DEPOSIT SLIP – are printed forms with depositor’s name, account number, and space for details of the
deposit. A validated deposited slip indicates that cash and checks with the supplied details where actually
deposited or credited to the name of the account holder.

CHECK – is a written order to the bank by a depositor to pay the amount specified in the check from the
checking account to the person named in the check. The entity issuing the check is the payor while the
receiver is the payee.

PURCHASE REQUISITION – is a written request to the purchaser of an entity from an employee or user
department of the same entity that goods be purchased.

PURCHASE ORDER – is an authorization made by the buyer to the seller to deliver the merchandise as
detailed in the form.

RECEIVING REPORT – is a document containing information about goods received from a vendor. It
formally records the quantities and description of the goods delivered.

Page 9 of 23
CREDIT MEMORAMDUM – is a form used by the seller to notify the buyer that his account is being
decreased due to errors or other factors requiring adjustments.

Voucher System
1. Voucher – is the business document or written authorization for every cash disbursement.
2. Voucher Register – is the journal where all vouchers are recorded in numerical sequence. The
voucher register is similar to an expanded purchases journal and thus, replaces the purchase
journal.
The proforma entry to record a voucher is debit asset, expenses, equipment or any appropriate
account and credit voucher payable.
3. Check Register – is the journal where all checks issued for payment are recorded. Since the checks
are entered in the check register in numerical sequence, this record provides a convenient
reference for cash payment.
The check register is a modified cash disbursements journal and thus replace the cash
disbursements journal in a voucher system.
The proforma entry to record a cash payment in the check register is debit vouchers payable and
credit cash in bank.
4. Unpaid Vouchers file – after the vouchers are entered in the voucher register, they are filed in an
unpaid vouchers file in the order of required date of payment so that the company will not miss
discounts. The file serves as the subsidiary for the vouchers payable account.
5. Paid Voucher file – after a voucher is paid, it is removed from the unpaid voucher file and placed in
the paid vouchers file. This file is useful in the case of an audit and where a question on payment
arises.

TRANSACTION ANALYSIS
The analysis of transactions should follow these four basic steps:
1. Identify the transaction from source documents.
2. Indicate the accounts affected by the transaction.
3. Ascertain whether each account is increased or decreased by the transaction.
4. Using the rules of debit and credit, determine whether to debit or credit the account to record its
increase or decrease.

THE JOURNAL
The journal is a chronological record of the entity’s transaction. A journal entry consists of the transaction
date, the accounts and amounts to be debited or credited, and a brief explanation of the transaction.
A simple journal entry consists of one debit and one credit. A compound journal entry consists of two or
more debits or two or more credits.

GENERAL JOURNAL – transactions to be recorded in the general journal are substantially reduced but not
limited. Transaction that do not involve the sale and purchase of merchandise, cash receipts and cash
payments are recorded in the general journal. These transactions include sales returns and purchases
returns, and routine year-end entries like adjusting entries and closing entries.
Date Account Title PR Debit Credit

SPECIAL JOURNALS
1. Sales Journal – only sales of merchandise on credit are recorded. Used to record all sales of
merchandise on account.
Accounts Receivable –
Invoice
Date Customer Terms Debit
Number
Sales – Credit

2. Cash Receipt Journal – receipts of cash from any source are recorded. Is a special journal designed
to record all transactions involving the receipt of cash. Every entry that requires a debit to the cash
account is recorded in the cash receipt journal.
Debit Credit
Date Received From Sales Accounts Other
Cash Sales PR Debit
Disc. Receivable Accounts

Page 10 of 23
 3. Purchase Journal – as a rule, purchase of merchandise on credit are recorded.
However, sometimes a purchases journal is expanded to record all credit purchases, including
merchandise, equipment and supplies.
RR Purchases – Debit
Date Supplier PR Terms
No. Accounts Payable – Credit

4. Cash Disbursement Journal – all payments of cash for any purpose are recorded. Designed to
record all transactions involving cash payment. Each entry that requires credit to the cash account is
recorded in the cash payment journal.
Debit Credit
Check
Date Payee Accounts Purchase Other
No. Purchases Debit Credit Cash
Payable Disc Accounts

It is to be pointed out that when an entity uses special journals, it uses the general journal to record all
transactions that do not fit into the special journal.
Moreover, adjusting entries, closing entries and reversing entries are recorded in the general journal.

FORMAT
The standard contents of the general journal are as follows:
1. Date – the year and month are not rewritten for every entry unless the year or month changes or a
new page is needed.
2. Account Titles and Explanation – the account to be debited is entered at the extreme left of the first
line while the account to be credited is entered slightly indented on the next line. A brief description
of the transaction is usually made on the line below the credit. Generally, a blank line is left between
the explanation and the next entry.
3. P. R. (Posting Reference) – this will be used when the entries are posted, that is, until the amounts
are transferred to the related ledger accounts. The posting process will be described later. The
posting dereference column is used to indicate the page number of the ledger in which the entry is
transferred.
4. Debit – the debit amount for each account is entered in this column.
5. Credit – the credit amount for each account is entered in this column.

JOURNALIZING
This is the process of recording the transactions in a journal. To record the economic impact of transactions
on the firm in a journal, which is a form that facilitates transfer to the accounts.
Rules of double entry system:
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.

THE LEDGER
The ledger is a group of the entity’s account. Although some firms may use various ledger to accumulate
certain detailed information, all firms have a general ledger. A general ledger is a “reference book” of the
accounting system and is used to classify and summarize transactions, and to prepare date for basic
financial statements. The accounts in the ledger are classified into two general groups:
1. Balance sheet or permanent accounts (asset, liabilities and owner’s equity)
2. Income statement or temporary accounts (revenues 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.

Subsidiary Ledger is the device used in storing the details of certain general ledger accounts.
The general ledger accounts are actually the controlling or main accounts supported by the details in the
subsidiary ledgers.
Examples include:
1. A single accounts receivable account is carried in the general ledger, with the individual customers’
accounts recorded in the accounts receivable subsidiary ledger.
2. A single accounts payable account is carried in the general ledger, with the individual creditors’
accounts recorded in the accounts payable subsidiary ledger.
3. Share capital account in the general ledger is supported by individual shareholders’ accounts in a
shareholders’ subsidiary ledger.
Page 11 of 23
 4. Cash account may be carried in the general ledger supported by individual depository bank
accounts in the subsidiary ledger.

Three classes of Accounts

1. Real Accounts – represent asset, liabilities and equity.
These are also known as permanent account because they are carried from one accounting period
to another.
2. Nominal Accounts – represent revenues and expenses.
These are also called temporary accounts because they are closed at the end of every accounting
period.

3. Mixed Accounts – represents those with real and nominal element.

For instance, an entity pays P100,000 one-year insurance premium on July 1, 2016 and the same is
originally debited to insurance expense account. The insurance expense account is mixed on
December 31, 2016, because it is composed of two elements, namely expired and unexpired.
Contra accounts are offset accounts or accounts which are deducted from the related accounts. Examples
include allowance for doubtful accounts, accumulated depreciation, discounts on bond payable and sales
returns and allowances.
Adjunct accounts are accounts which are added to the related account. Examples are freight in and premium
on ponds payable.

THE CHART OF ACCOUNTS

The Chart of account is a listing of all the accounts and their account numbers in the ledger. The chart is
arranged in the financial statement order, that is, asset first, followed by liabilities, owner’s equity,
revenues, and expenses. The accounts should be numbers in a flexible manner to permit indexing and cross-
referencing.
Example:

Del Mundo Advertising Agency

Chart of Accounts

Balance Sheet Accounts Income Statement Accounts

Assets Revenue
110 Cash 410 Advertising Revenue
120 Accounts Receivable 420 Art Revenues
130 Fees Receivable
140 Art Supplies
150 Office Supplies
160 Prepaid Rent Expenses
170 Prepaid Insurance 510 Salaries Expense
180 Art Equipment 520 Art Supplies Expense
185 Accumulated Depreciation 530 Office Supplies Expense
Liabilities 540 Rent Expense
210 Notes Payable 550 Insurance Expense
220 Accounts Payable 560 Electricity Expense
230 Salaries Payable 570 Telecommunications Expense
240 Interest Payable 580 Depreciation Expense-
250 Unearned Art Revenues Office Equipment
Owner’s Equity 600 Interest Expense
310 Del Mundo, Capital
320 Del Mundo, Withdrawals
330 Income Summary

NORMAL BALANCE OF AN ACCOUNT

The normal balance of any account refers to the side of the account – debit or credit – where increases are
recorded. Asset, owner’s withdrawal and expense accounts normally have debit balances; liability, owner’s
equity and revenue accounts normally have credit balances. This result occurs because increases in an
account are usually greater than or equal to decreases.
ACCOUNT NORMAL BALANCE BALANCE INCREASED BY BALANCE DECREASED BY
ASSET DEBIT DEBIT CREDIT
LIABILITY CREDIT CREDIT DEBIT
EQUITY CREDIT CREDIT DEBIT

Page 12 of 23
 REVENUE CREDIT CREDIT DEBIT
EXPENSE DEBIT DEBIT CREDIT

POSTING
Transactions are classified and recorded in the journal are transferred to the appropriate accounts in the
general ledger and subsidiary ledger, if applicable.
To transfer the information from the journal to the ledger for classification.

Procedure in posting
1. Locate the corresponding account title in the ledger.
2. Transfer to the ledger the following information from the journal:
a. Date
b. Explanation/Description
c. Amount
Debit accounts from the journal are posted on the debit side of the ledger and credit accounts are
posted on the credit side of the ledger.
3. Place the page number of the journal in which the information was taken to the PR column of the
ledger.
4. Place in the PR column of the journal the page number of the ledger in which the information was
posted.

The Journal
Page 12
Date Account Title and Explanation P.R. Debit Credit
1 2016
2 Aug 1 Cash 1104 100,0003
3 Del Mundo, Capital 3104 100,0003
4 To record Initial Investment.

The Ledger
Account: CASH Account No. 1104
Date Explanation J.R. Debit Credit Balance
1 2016
2 Aug 1 Galicano Del Mundo invested J-12 100,0003 100,0003
P100,000 in his new
advertising agency

Account: DEL MUNDO, CAPITAL Account No. 3104

Date Explanation J.R. Debit Credit Balance
1 2016
2 Aug 1 Galicano Del Mundo invested J-12 100,0003 100,0003
P100,000 in his new advertising
agency

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
posting are updated. Every account in the general ledger will have either debit, credit, or zero balance.

The procedure in the preparation of Trial Balance follow:

1. Write the heading of the trial balance. The heading includes the following
a. The name of the business or the owner
b. Trial balance
c. Date of the trial balance
2. List the account titles in numerical order from the ledger and record the debit or credit balance in
the debit or credit columns of the trial balance.
3. Obtain the account balance each account from the ledger and enter the debit balances in the debit
column and the credit balances in the credit column.
4. Add the debit and the credit column.
5. Compare the totals to prove the equality. Double rule the totals.

A trial balance is prepared at the end of every accounting period after all transactions for the period have
been recorded and posted to the general ledger.

Page 13 of 23
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. When total debits do not equal total credit, the trial balance is out of balance.
This condition alerts the accountant that one or more errors have been made. The accountant must find these
errors before preparing financial statements.
On the other hand, if the total debits equals total credits, the trial balance is said to be in balance. However,
this condition does not necessarily signify the absence of errors.
For example, the trial balance does not indicate the failure to record a transaction or the recording of a
transaction in the wrong accounts or if the bookkeeper failed to record payment of rent, the trial balance
columns are equal but in reality, the accounts are incorrect since rent expenses is understated and cash
overstated.

The purpose of a trial balance are:

1. It provides evidence that the total debits in the general ledger equal credits.
2. It provides information that helps the accountant to formulate adjustments.

Illustrative problem:
August 1 Galicano Del Mundo invested P100,000 in his advertising agency.
2 Rented office space paying two months’ rent in advance, P8,000.
2 Hired a secretary with a pay of P6,000 every two weeks.
4 Acquired art equipment for P42,000.
5 acquired office equipment from K Servico for P30,000; paying P15,000 in cash and the balance next
month.
8 Purchase on credit art supplies for P18,000 and office supplies for P8,000 from
Batangas Supply Company
8 Paid P4,800 to Malayan Insurance for a one-year insurance policy with coverage effective August 1.
9 Paid Batangas Supply Company P10,000 of the amount owed.
10 Performed services for a car dealer by making ad placements in the Buy and Sell magazine and collected
fees of P14,000.
12 Paid the secretary’s salary, P6,000.
19 Performed services by placing print advertisements for Laurel Mega Arcade, P28,000.
25 Del Mundo withdrew P14,000 for personal expenses.
26 Paid the Secretary two more weeks’ salary, P6,000.
29 Paid the electric bill of P1,000.
30 Received the ICC-Bayan Tel telephone bill, P700.
31 Collected P10,000 on account from Laurel Mega Arcade for services already rendered.
Required:
a. Journalize each transaction b. Post to T-Accounts c. Prepare trial balance

Correction of error
Erasures in the records are not advisable because they destroy the neatness of work. Erasures may indicate
an attempt to conceal something. To correct errors committed, draw a single straight line through the
wrong item or amount and write immediately above the cancelled item or amount the correct one.

1. Transposition – the figures are interchanged. For example, P1,234 is written as P4,123.
2. Transplacement – error in placing the decimal point. For example, P12,000 is written as P1,200.
3. Error of omission – a transaction is not recorded. For example, a sale of P10,000 is not journalized.
4. Counterbalancing error – error which, if not detected, automatically counterbalanced or corrected
in the following accounting period. Thus type of error includes misstatement of inventories,
prepaid expenses, accrued expenses, deferred income, and accrued income.
5. Noncounterbalancing error – error which, if not detected, is not automatically counterbalanced or
corrected in the following accounting period. The best example of this error is understatement or
overstatement of depreciation.

ADJUSTING ENTRIES
The following methods are commonly used in practice in accounting from income and expenses.
1. Cash basis – income is recognized when received regardless of when earned, and expense is
recognized when paid regardless of when incurred. This approach does not recognize accrued
income, deferred income, accrued expense and prepaid expense.
2. Accrual basis – income is recognized when earned regardless of when received, and expense is
recognized regardless of when paid.
At the end of each accounting period, financial reports are prepared to show the results of the business
operations. Such reports, which always include the income statement and balance sheet, should reflect the
Page 14 of 23
revenues realized and expenses incurred applicable to the period covered. The effect of transactions affecting
more than one accounting period should be properly apportioned among the periods concerned. Hence,
adjustments are needed to ensure that the revenue recognition and matching principles are followed.

Accounts that need to be adjusted

1. Adjustment for the expiration of prepayments of expenses.
Prepaid expenses – expenses paid in advance like prepaid rent, prepaid insurance, supplies, etc. At
the time of payment, the account is an asset and as it is used it becomes an expense. The adjusting
entry for this account depends on the original entries when it was paid.
a. Asset Method – the original entry made is debited to an asset account. For instance, the
payment for one year insurance premium is debited to prepaid insurance account.
On Nov 1, J Valdez paid P12,000 for a three month rental for her office. Give the adjusting entry
on December 31.
Original Entry Adjusting Entry
Nov 1 Prepaid Rent 12,000 Dec 31 Rent Expense 8,000
Cash 12,000 Prepaid Rent 8,000
b. Expense Method – the original entry is debited to an expense account. For instance, the
payment for one-year insurance premium is debited to insurance expense account.
Original Entry Adjusting Entry
Nov 1 Rent Expense 12,000 Dec 31 Prepaid Rent 4,000
Cash 12,000 Rent Expense 4,000

2. Adjustment for the realization of income collected in advance.

Unearned Income arises when payment is received before goods are delivered or before service are
rendered. Unearned income is a liability since it represent an obligation to deliver merchandise or
render services for the money received.

a. Income Method – an income account is credited for the receipt of the income.
The remedy of this is to prepare an adjusting entry debiting the Income account and crediting the
Unearned Income account.
Unearned Income always has a liability-income component. It is composed of two portions at the
end of the accounting period, the earned portion and the unearned portion. The earned portion is
recognized as income while the unearned portion is considered as a liability.
For instance, on November 1, The J&J Enterprises received P90,000 from a tenant as rental
payment for six months. Assuming the accounting periods ends on December 31, what
adjusting entry should be prepared on such date?

Original Entry Adjusting Entry

Nov 1 Cash 90,000 Dec 31 Rent Income 60,000
Rent Income 90,000 Unearned Rent Income 60,000

b. Liability Method – a liability account is credited for the receipt of the income.
The unearned income becomes income once merchandise has been delivered or services have
been rendered. Therefore under this method, the original amount of unearned income may be
overstated and income may be understated at the end of the accounting period. The remedy for
this is to prepare an adjusting entry debiting the unearned income account and crediting the
income account.
Original Entry Adjusting Entry
Nov 1 Cash 90,000 Dec 31 Unearned Rent Income 30,000
Unearned Rent Income 90,000 Rent Income 30,000

3. Adjustment for the accrual of expenses.

Accrued Expenses are those expenses already incurred during the period but are not yet paid or
recorded. At the end of th.e accounting period, the income statement should reflect such expense
and the balance sheet should reflect a liability account. The adjusting entry to record accrual of
expenses is debit expense account and credit the liability account.

Accrued Salaries
Valdez Enterprise pays salaries in the amount of P4,800 for six-day week every Saturday. Valdez
accounting period ends on December 31. Assume further that December 31 falls on a Thursday.
What adjusting entry should be prepared on such date.
Salaries Expense 3,200
Salaries Payable 3,200

Accrued Interest on Notes Payable is usually recorded when it is paid. Interest is the cost of usin
money. Sometimes the terms of a note may cover two accounting periods, therefore, the interest on
Page 15 of 23
 such note must be allocated between these two periods. At the end of the accounting period, the
total unpaid interest on notes payable for the current period is recorded by debiting Interest
Expense and crediting Interest Payable.

At the end of the accounting period on December 31, Valdez Enterprises has a 90-day, 12% note for
P6,000 issued December 16. Interest on the note will be paid only at the maturity date. What
adjusting entry should be prepared on December 31?

I = Principal x Rate x Time Interest Expense 30

= 6,000x.12 x 15/360 Interest Payable 30
I = 30
On September 1, Dimagiba borrowed PhP 60,000 from Keppel Monte Bank. He issued a promissory
note that carried a 20% interest per annum. Both interest and principal will be payable in one year.
Solution:
Interest = Principal x Interest Rate x Length of Time
= 60,000 x 20% x 1/12
= 60,000 x .20 x 1/12
= 1,000
Entry: Interest Expense 1,000
Interest Payable 1,000

4. Adjustment for the accrual of income.

Accrued Income is income already earned but not yet been collected. Under the accrual concept,
revenue is recognized when goods are sold when services have been rendered regardless of
whenever cash has been received or not. Therefore an uncollected income that has been recorded
should be taken up and recorded in the books by an adjusting an accrued Income Receivable account
and crediting the Income account.

5. Provision for uncollectible accounts.

No matter how efficient the credit department is in screening customers, some accounts may still
prove uncollectible. Such uncollectible accounts are considered normal and should be recognized as
one of the company’s operating expenses.
Percentage of Receivable method
Under this method, the uncollectible accounts expense is computed as follows:
Required Allowance (Accounts Receivable)
Balance x% estimated to be collectible) xx
Deduct: Credit Balance of allowance of Uncollectible Accounts xx
Uncollectible Account Expense xx

Two methods of Accounting for Bad Debts

a. ALLOWANCE METHOD – this requires recognition of bad debts loss if the accounts are
doubtful of collection. The doubtful accounts are recorded by debiting Doubtful Accounts
and crediting Allowance Doubtful Accounts.
b. DIRECT WRITE-OFF METHOD – this requires recognition of a bad debts loss only when the
account are worthless or uncollectible, worthless accounts are recorded by debiting Bad
Debts and crediting Accounts Receivable.

6. Provision for depreciation.

Assets that are permanent in nature, used by the business, and are not intended for sale eventually
wear out by constant use or inadequate or obsolete, thus decreasing its value. An asset is said to be
inadequate for the business expansion and the asset can no longer fulfill the needs of the business.
An asset is said to be obsolete if in the introduction of new models or interventions and the
business desires to replace the old asset with a new one.
The decrease in value of an asset is charged to an expense account called depreciation expense.
Depreciation means the systematic allocation of the cost of property and equipment to expense
over the accounting periods benefited by its use. These asset helps generate revenues for the entity.
Therefore, a portion of the cost of the assets should be reported as expense in each accounting period.

Straight Line Method

Annual Depreciation = Cost of Asset – Salvage Value

Estimated Useful Life

Output or Production Method – results in a charged based on the expected use or output. Under
this method, a depreciation rate per unit is computed by dividing the depreciable amount by the

Page 16 of 23
 estimated life in terms of units of output. It provides higher depreciation in the earlier years and lower
depreciation in the later years of the life of an asset. This is on the philosophy that the new asset are
generally capable of producing more revenue in the earlier years than in the later years.
Sum of the Years’ Digit Method – the depreciation is computed by multiplying the depreciable
amount by a series of fractions whose denominator is the sum of the digits in the life of the asset.
For instance, if the life is 4 years, the sum of years’ digit is 1+2+3+4=10. Thus, the depreciation would
be 4/10 for the first year, 3/10 for the second year, 2/10 for the third year, and 1/10 for the fourth
and last year.

Declining Balance Method – a fixed or uniform rate is multiplied by the declining carrying amount
of the asset in order to arrive at the annual depreciation. Because of the fixed rate, this method is
also known as fixed rate or percentage on diminishing carrying amount method.

Rate = 1- n√ Residual Value /Cost (n – the life of the asset)

Double Declining Method – is the same as the declining balance method in that a fixed rate is also
multiplied by the declining carrying amount of the asset to arrive at the annual depreciation.
However, under double declining balance, the straight line rate is simply “doubled’ to get the fixed
rate. For instance, if the life is 5 years, the straight line rate is 20% (100% divided by 5 years). Thus,
the fixed or double rate is 40% (20%x2)

Retirement Method – the amount of the depreciation is equal to the original cost of the asset
retired minus salvage value proceeds.

Replacement Method – no depreciation is recorded until the asset is retired and replaced. The
amount of the depreciation is equal to the replacement cost of the asset retired minus salvage
proceeds. If the asset retired is not replaced, the original cost of the asset retired but not replaced is
charged off as depreciation.

Factors of Depreciation
a. Depreciable Amount – is the cost of an asset or other amount substituted for cost less its
residual value
b. Salvage or Residual Value – is an estimate of what an asset will be worth at the end of its
useful life. After deducting the estimated cost of disposal, if the asset were already of the age and
condition expected at the end of its useful life.
c. Useful Life – is either the period of time over which an asset is expected to be used by the
entity, or the number of production or similar units expected to be obtained from the asset by
the entity. Accordingly useful life of an asset is expressed as follows: (i) Time periods as in years
(ii) units of output or production (iii) service hours or working hours.
When recording depreciation expense, the asset account is not directly reduced. Instead, the
reduction is recorded in a contra account called Accumulated Depreciation. A Contra Account is
used to record reductions in a related account and its normal balance is opposite that of the related
account. Use of the contra account – accumulated depreciation – allows the disclosure of the original
cost of the related asset in the balance sheet. The balance of the contra account is deducted from the
cost to obtain the book value of the property and equipment.
Illustration:
Supposed that MADI Tailoring estimated that the Sewing Machine which it brought on August 3 will
last 5 years and it will be worthless at the end of that time.
Solution:
Equipment: 12,000/5years = 2,400 yearly Entry: Depreciation Expense – Equipment 200
2,400/12months = 200 monthly Accumulated Depreciation 200
Adjusting Entries: Illustration of proforma entries
1. Prepayment of Expenses
Asset Method
Expense xx
Prepaid Expense xx
Expense Method
Prepaid Expense xx
Expense xx
2. Unearned Income
Income Method
Income xx
Unearned Income xx
Liability Method
Unearned Income xx
Income xx
Page 17 of 23
 3. Accrued Expense
Expense xx
Accrued Expense Payable xx
4. Accrued Income
Receivable xx
Income xx
5. Provision for doubtful accounts
Doubtful accounts xx
Allowance for Doubtful Accounts xx
6. Provision for Depreciation
Depreciation-Asset xx
Accumulated Depreciation – Asset xx
7. Ending Inventory
Inventory End xx
Income Summary xx

THE WORKSHEET
A worksheet is used to help transfer data from the unadjusted trial balance to the financial statements. This
multi-column document provides an efficient way to summarize the date for financial statements. The
accountant generally prepares a worksheet when it is time to adjust the accounts and prepares financial
statements. The worksheet simplifies the adjusting and closing process. It can also reveal errors. The
worksheet is not part of the ledger or the journal, nor is it a financial statement. It is a summary device used
by the accountant for convenience.

Preparing the Worksheet

1. Enter the account balances in the unadjusted trial balance columns and the total amounts.
2. Enter the adjusting entries in the adjustments columns and total the amounts.
3. Compute each account’s adjusted balance by combining the unadjusted trial balance and the
adjustment figures. Enter the adjusted amounts in the adjusted trial balance column.
4. Extend the asset, liability, and owner’s equity amounts from the adjusted trail balance columns to
the balance sheet columns. Extend the revenue and expense accounts to the income statement
columns. Total the statement columns.
5. Compare net income or net loss as the difference between total revenues and total expenses in the
income statement. Enter net income or net loss as a balancing amount in the income statement and
in the balance sheet, and compute the final column totals.
6. Write the final totals and double rule.
Worksheet is only tool of an accountant in the preparation of financial statement.

Trial Balance Adjustments Income Statement Balance Sheet

Account Title Debit Credit Debit Credit Debit Credit Debit Credit

Closing Entries
Closing entries are made at the end of the accounting period after adjusting entries and financial
statements have been prepared for the purpose of closing all nominal account means to reduce its balance
to zero.
Nominal Accounts have served their purpose. Thus, their balances must be reduced to zero so that the new
nominal accounts can be used to measure activities in the next accounting period, their balances may be
transferred directly to an entity account during closing.
However, most accountants transfer nominal accounts to a clearing account known as Income Summary.
The Income Summary accounts summarizes the net income or net loss for the period and its balance is
ultimately closed to capital in the case of a proprietorship or retained earnings in the case of a corporation.

PREPARATION OF CLOSING ENTRIES IN MERCHANDISING

1. To close Nominal Accounts with Credit Balances
Sales xx
Interest Income xx
Rent Income xx
Gain on Sale of Equipment xx
Purchase Discounts xx
Purchase Returns and Allowances xx
Income Summary xx
To close temporary accounts with credit balances.

Page 18 of 23
 2. To close Nominal Accounts with Debit Balances
Income Summary xx
Merchandise Inventory, Beginning xx
Purchases xx
Freight In xx
Sales Discounts xx
Sales Returns and Allowances xx
Salaries Expense xx
Other Expenses xx
To close temporary accounts with debit balances.

3. To close Income Summary Account is extracted

Credit Balance- For Corporation
Income Summary xx
Retained Earnings xx
To close Income Summary Account.

 For Proprietorship or Partnership

Income Summary xx
Capital Account xx
To close Income Summary Account.
Debit Balance- For Corporation
Retained Earnings xx
Income Summary xx
To close Income Summary Account.
 For Proprietorship or Partnership
Capital Account xx
Income Summary xx
To close Income Summary Account.

4. Some corporation, especially those that declare quarterly dividends, records the declaration of
a dividend by debiting dividends declared account and crediting dividends payable. The
dividends declared account is nominal and closed directly to retained earnings at the end of the
accounting period as follows:
Retained Earnings xx
Dividends Declared xx
To close Dividends Declared Account.

5. In the case of proprietorship or partnership, drawing account are directly closed to capital
account as follows:
Capital Account xx
Drawing Account xx
To close Withdrawal Account.

POST CLOSING TRIAL BALANCE

Post Closing Trial Balance is simply a listing of general ledger accounts and their balances after the closing
entries have been made.
Accordingly, the post closing trial balance consists entirely of real or permanent accounts.
The main purpose of post closing trial balance is to provide evidence that equal debits and credits exist in
the general ledger after closing. Thus, it ensures that the closing process has been performed correctly. The
post closing trial balance is not required step in the accounting cycle, it is optional.

Del Mundo Advertising Agency

Post Closing Trial Balance
January 31, 2017
Cash P 57,200.00
Accounts Receivable 18,000.00
Fees Receivable 2,000.00
Art Supplies 13,000.00
Office Supplies 6,000.00
Prepaid Rent 4,000.00

Page 19 of 23
 Prepaid Insurance 4,400.00
Art Equipment 42,000.00
Accumulated Depreciation P 700.00
Art Equipment 30,000.00
Accumulated Depreciation 500.00
Notes Payable 30,000.00
Accounts Payable 31,700.00
Salaries Payable 1,800.00
Interest Payable 500.00
Unearned Art Revenues 6,000.00
Del Mundo, Owner's Equity 1/31/2017 105,400.00
176,600.00   176,600.00
Preparing the Financial Statements
Once the worksheet is completed, it is easy to prepare the financial statements for the account balances
have been extended to the appropriate income statement and balance sheet columns. Most of the
information needed to prepare the income statement, statement of owner’s equity and balance sheet are
available from the worksheet. The statements presented are those of Del Mundo Advertising Agency.

INCOME STATEMENT
The income statement presents the revenues, expenses and net income or net loss of an entity for a specific
period. This may also be called a statement of operations.
The Elements of Income Statement are as follows:
Revenues are the increases in the owner’s equity as a result of the performance of services or the sale of
merchandise by the business. It is the result of the profit-directed activities of an entity that can change
owner’s equity.
Expenses are the decreases in the owner’s equity caused by the revenue generating activities of the
business. These include cost of services rendered or goods sold, selling expenses, general and
administrative expenses, and other expenses.
Net Income is the amount by which total revenues exceed total expenses for the period. When expenses
exceed revenues, the result is a net or loss.
Del Mundo Advertising Agency
Income Statement
For the Month Ended January 31, 2017
Revenue
Advertising Revenues P 44,000
Art Revenues 4,000
Total Revenue P 48,000
Expenses
Salaries Expense P 13,800
Art Supplies Expense 5,000
Rent Expense 4,000
Office Supplies Expense 2,000
Electricity Expense 1,000
Telecommunication Expense 700
Depreciation Expense-Art Equipment 700
Depreciation Expense-Office Equipment 500
Interest Expense 500
Insurance Expense 400
Total Expenses 28,600
Net Income P 19,400

STATEMENT OF OWNER’S EQUITY

The statement of owner’s equity summarizes the changes that occurred in the owner’s capital account.
Increases in owner’s equity arise from additional investments by the owner’s and net income during the
period. Deceases result from the withdrawals by the owner and from a net loss for the period. The
beginning balance and additional investment taken from the owner’s capital account in the general ledger.
The net income or net loss figure comes directly from the income statement while the withdrawals from
the balance sheet columns in the worksheet.

In summary, the preparation of the statement of owner’s equity will achieve the following objectives:
 To report all the changes in owner’s equity during the accounting period.
Page 20 of 23
  To reconcile the beginning and ending balances of owner’s equity.
 To provide a connecting link between the income statement and the balance sheet.

Del Mundo Advertising Agency

Statement of Owner's Equity
For the Month Ended January 31, 2017

Del Mundo, Owner's Equity 1/1/2017 P 100,000

Add: Additional Investments by Del Mundo P -
Net Income 19,400   19,400
Total P 119,400
Less: Withdrawals 14,000
Del Mundo, Owner's Equity 1/31/2017 P 105,400

BALANCE SHEET
The Balance Sheet is a statement of that shows the financial position or condition of an entity by listing the
assets, liabilities, and owner’s equity at a specific date. The information needed for the balance sheet items
are the net balances at the end of the period, rather than the total for the period as in the income statement.
This statement is also called statement of financial position.

Format
The Balance Sheet can be presented in either the report format or the account format. The Report Format
simply lists the assets, followed by the liabilities then by the owner’s equity in vertical sequence. The
Account Format lists the assets on the left and the liabilities and owner’s equity on the right.
Classification
It is proper to present a classified balance sheet; that is, the assets and liabilities are separated into various
categories. Assets are sub classified as current assets and non-current assets; while liabilities as current
liabilities and long-term liabilities. Classifying a balance sheet aids in the analysis of financial statement
data.
To make accounting information useful to decision makers, the items in the balance sheet are grouped and
arranged in accordance with the following guidelines:
 Assets are classified and presented in decreasing order of liquidity. Liquidity is a measure of how
quick an item can be converted to cash. Cash is the most liquid. Asset that are least likely to be
converted to cash are listed last.
 Liabilities are generally classified and presented based on time of maturity such that obligations
which are currently due are listed first.

Del Mundo Advertising Agency

Balance Sheet
January 31, 2017

Assets
Current Asset
Cash P 57,200
Accounts Receivable 18,000
Fees Receivable 2,000
Art Supplies 13,000
Office Supplies 6,000
Prepaid Rent 4,000
Prepaid Insurance 4,400
Total Current Assets P 104,600

Non-Current Asset
Art Equipment P 42,000

Less: Accumulated Depreciation 700 P 41,300

Art Equipment P 30,000

Less: Accumulated Depreciation 500 29,500

Total Non-Current Assets 70,800

Page 21 of 23
 Total Assets P 175,400

Liabilities
Curent Liabilities
Notes Payable P 30,000
Accounts Payable 31,700
Salaries Payable 1,800
Interest Payable 500
Unearned Art Revenues 6,000
Total CurrentLiabilities P 70,000

Owner's Equity
Del Mundo, Owner's Equity 1/31/2017 105,400
Total Liabilities and Owner's Equity P 175,400

STATEMENT OF CASH FLOW

The Statement of Cash Flows provides information about cash receipts and cash payments of an entity
during a period. It is a formal statement that classifies cash receipts (inflows) and cash payment (outflows)
into operating, investing and financing activities. This statement shows the net increase or decrease in cash
during the period and the cash balance at the end of the period; it also helps project the future net cash
flows of the entity.

CASH FLOWS FROM OPERATING ACTIVITIES

Operating Activities generally involve providing services, and providing and delivering goods. Cash flows
from operating activities are generally the cash effects of transactions and other events that enter into the
determination of net income. This cash flow can be presented using either the direct or the indirect
method. Using the direct method, the entity’s net cash provided by (used in) operating activities is
obtained by adding the individual operating cash inflows and then subtracting the individual operating
cash outflows.
The indirect method derived the net cash provided by (used in) operating activities by adjusting net
income for revenue and expense items not resulting from cash transactions. The adjustment begins with net
income followed by the addition of expenses and charges (e.g. depreciation) that did not entail cash payment.
Then, increases in current assets and decreases in current liabilities involved in the determination of net
income but which did not actually increase or decrease cash, are subtracted from net income. Finally,
decreases in current assets and increases in current liabilities are added to net income to obtain net cash
provided by (used in) operating activities.
The following are the major classes of operating cash flows using the direct method:
Cash Inflows
 Receipts from sale of goods and performance of services
 Receipts from interest on receivables
Cash Outflows
 Payments to suppliers of goods and services
 Payments to employees
 Payments for taxes
 Payments for Interest Expense
 Payments for other operating Expenses

CASH FLOWS FROM INVESTING ACTIVITIES

Investing Activities include making and collecting loans; acquiring and disposing of investments in debt or
equity securities; obtaining and selling property and equipment and other productive assets.
Cash Inflows
 Receipts from sale of property and equipment
 Receipts from sale of investments in debt or equity securities
 Receipts from collections on notes receivable
Cash Outflows
 Payments to acquire property and equipment
 Payments to acquire debt or equity securities
 Payments to loans to others generally in the form of notes receivable

CASH FLOWS FROM FINANCING ACTIVITIES

Financing Activities includes obtaining resources from owner’s and creditors.
Cash Inflows
Page 22 of 23
  Receipts from investments by owners
 Receipts from issuance of notes payable
Cash Outflows
 Payments to owners in the form of withdrawals
 Payments to settle notes payable

Del Mundo Advertising Agency

Statement of Cash Flows
For the Month Ended January 31, 2017

Cash Flows from Operating Activities

Cash received from clients 34,000.00
Payments to suppliers (10,000.00)
Payments to employee (12,000.00)
Payments for office rent (8,000.00)
Payments for insurance (4,800.00)
Payments for electricity (1,000.00)
Net Cash provided by (used in) operating activities P (1,800.00)
Cash Flows from Investing Activities
Payments to acquire art equipment (42,000.00)
Payments to acquire office equipment (15,000.00)
Net Cash provided by (used in) investing activities (57,000.00)
Cash Flows from Financing Activities
P
Cash received as investment by owner 100,000.00
Cash received from borrowings 30,000.00
Payments for withdrawals by owner (14,000.00)
Net Cash provided by (used in) Financing activities 116,000.00
Net Increase (Decrease) in Cash P 57,200.00
Cash balance at the beginning of the period
Cash balance at the end of the period 57,200.00

RELATIONSHIP AMONG THE FINANCIAL STATEMENTS

The financial statements are based on the same underlying data and are fundamentally related. The
following shows the basic interrelationships among the financial statements:
1. The income statement reports all revenues and expenses during the period. The results of
operations–net income or net loss are the final figure in this statement.
2. The statement of owner’s equity considers the net income or net loss figure from the income
statement as one of the determining factors that explains the change in owner’s equity.
3. The balance sheet reports the ending owner’s equity, taken directly from the statement of owner’s
equity.
4. The statement of cash flows reports the net increase or decrease in cash during the period and ends
with the cash balances reported in the balance sheet. This statement is prepared based on
information from the income statement and the balance sheet.

Page 23 of 23