Chapter 4: Identifying and Journalizing Transactions

Learning Outcomes:

 Understand that by knowing the source documents as the first sequential step prior to journalizing process,
we would be able to determine the value received and value parted with, leading to the journalizing process.
 Know what are the books of accounts, the use of a General Journal and a General Ledger.
 Find out that the charts of accounts are the same with accounts that are found in the General Ledger.
 Increase learning through Illustrative Problem wherein the students are able to see the actual journalizing
procedures and the correction of an erroneous journal entry.

4.1 Source Documents

Source documents are the physical basis upon which business transactions are recorded. Source
documents are typically retained for use as evidence when auditors later review a company's financial
statements, and need to verify that transactions have, in fact, occurred. They usually contain the
following information:

 A description of a business transaction

 The date of the transaction
 A specific amount of money
 An authorizing signature

Many source documents are also stamped to indicate an approval, or on which to write down the
current date or the accounts to be used to record the underlying transaction. 

A source document does not have to be a paper document. It can also be electronic, such as an
electronic record of the hours worked by an employee, as entered into a company's timekeeping
system through a smartphone.

Examples of source documents, and their related business transactions that appear in the financial
records, are:

 Bank statement. This contains a number of adjustments to a company's book balance of cash on
hand that the company should reference to bring its records into alignment with those of the
bank.
 Cash register tape. This can be used as evidence of cash sales, which supports the recordation of
a sale transaction.
 Credit card receipt. This can be used as evidence for a disbursement of funds from petty cash.
 Lockbox check images. These images support the recordation of cash receipts from customers.
  Packing slip. This describes the items shipped to a customer, and so supports the recordation of
a sale transaction.
 Sales order. This document, when coupled with a bill of lading and/or packing list, can be used
to invoice a customer, which in turn generates a sale transaction.
 Supplier invoice. This is a source document that supports the issuance of a cash, check, or
electronic payment to a supplier. A supplier invoice also supports the recordation of an
expense, inventory item, or fixed asset.
 Time card. This supports the issuance of a paycheck or electronic payment to an employee. If
employee hours are being billed to customers, then it also supports the creation of customer
invoices.

For example, a company is in the consulting business. it accumulates hours-worked information

from employee timesheets, which is then included in customer invoices that in turn result in the
creation of a sale and accounts receivable transaction. Thus, in this situation, the timesheet is the
source document for a sale transaction.

There are a number of possible controls that can be used to reduce the risk that source documents
are not properly recorded in an accounting system. One of the more common controls is to pre-
number documents, so that missing documents are easier to track down. Another control is to
reconcile the balances in accounts to the supporting source documents to see if either some
documents have not been recorded, or if some transactions recorded in the accounts do not
appear to have any supporting source documents.

Various regulations mandate that some source documents be retained for a number of years. It
may also be prudent to retain these documents irrespective of regulations, if only to provide
evidence in the event of a lawsuit, or to provide better customer service. For these reasons, a
company should adopt a document destruction policy that strictly controls the shredding or other
form of elimination of source documents until a certain number of years have passed.

4.2 Books of Accounts

All business establishments and taxpayers are required to keep a record of their day to day business
transactions in order to know the result of their operations. The said record is referred to as “book of
accounts”.
Whenever a business establishment or taxpayer applies for certificate of registration (COR) with the BIR,
it also required to register the book of accounts. Also, the books of account should also be registered
annually on or before January 31 of each year.
Registration of book of accounts can be any of the following type

Manual Books of Account

Manual books of account are the traditional journal, ledger and columnar books you can buy in the
book and office supplies store. Recording in the manual books of account is handwritten. This is the
most of popular type of books of account for small enterprises since it is less costly and easy to register
with the BIR.

Loose-leaf Books of Account

Loose-leaf books of account are printed and bounded journals and ledgers. Recording can be done using
Microsoft Excel.

Computerized Books of Account

Computerized book of account is an accounting program that facilitate efficient and fast record keeping.

Books of Accounts – Minimum Requirements

The type of books the business will maintain depends on many factors such as the size of the business
and financial capacity. However, regardless of the type of book of accounts the company would
maintain, below are the minimum requirement:

 General Journal. General journal is referred to as the book of original entry. It records business
transaction in order of date using the principle of “debit and credit”.

 General Ledger. General ledger is referred to as the book of final entry.  It summarized all the
journal entries of an account to get the ending balances.

 Cash Receipt Journal. Cash receipt journal is a special journal used to record cash sales and/or
collection of receivables.

 Cash Disbursement Journal. Cash disbursement journal is a special journal used to record cash
payments of expenses and/or payables.

 Sales Journal. Sales journal is a special journal used to record sales on credit (receivable from
customer)

 Purchase Journal. Purchase journal is a special journal used to record purchases on credit
(payable to supplier)
 Books of Accounts for Service Business

For business or taxpayer engaged in sale of services, it is required to maintain at least four which are the
following:

 General Journal

 General Ledger

 Cash Receipt Journal

 Cash Disbursement Journal

Books of Accounts for Businesses Engaged in the Sale of Goods or Properties

For business or taxpayer engaged in sale of goods or properties, it is required to maintain at least six,
which are the following:

 General Journal

 General Ledger

 Cash Receipt Journal

 Cash Disbursement Journal

 Sales Journal

 Purchase Journal

4.3 Chart of Accounts

What is Chart of Accounts?

A chart of accounts is a list of all your company’s “accounts,” together in one place. It provides you with
a birds eye view of every area of your business that spends or makes money. The main account types
include Revenue, Expenses, Assets, Liabilities, and Equity.

Companies in different lines of business will have different looking charts of accounts. The chart of
accounts for a major airline will have a lot more references to “aircraft parts” than your local cat cafe.
The chart of accounts should give anyone who is looking at it a rough idea of the nature of your business
by listing all the accounts involved in your company’s day-to-day operations.

Sample Chart of Accounts

As you can see on the right, there are different financial statements that each account corresponds to:
the balance sheet and the income statement.

The Balance Sheet Accounts

We call these the “balance sheet” accounts because we need them to create a balance sheet for your
business, which is one of the most commonly used financial statements. There are three kinds of
balance sheet accounts:

 Asset Accounts record any resources your company owns that provide value to your company.
They can be physical assets like land, equipment and cash, or intangible things like patents,
trademarks and software.
 Liability Accounts are a record of all the debts your company owes. Liability accounts usually
have the word “payable” in their name—accounts payable, wages payable, invoices payable.
“Unearned revenues” are another kind of liability account—usually cash payments that your
company has received before services are delivered.
 Equity Accounts are a little more abstract. They represent what’s left of the business after you
subtract all your company’s liabilities from its assets. They basically measure how valuable the
company is to its owner or shareholders.

The Income Statement Accounts

We use the income statement accounts to generate the other major kind of financial statement:
the income statement.

 Revenue Accounts keep track of any income your business brings in from the sale of goods,
services or rent.
 Expense Accounts are all of the money and resources you spend in the process of generating
revenues, i.e. utilities, wages and rent.

The way that the balance sheet and income statement accounts interact with each other is complex, but
one general rule to remember is this: revenues increase your company’s equity and asset accounts,
while expenses decrease your assets and equity.

Why is the Chart of Accounts Important?

Unless you have the name of every single account in your books memorized, you need to have all of
them laid out in front of you, like a map.

The chart of accounts is designed to be a map of your business and its various financial parts.
 A well-designed chart of accounts should separate out all the company’s most important accounts, and
make it easy to figure out which transactions get recorded in which account.

It should let you make better decisions, give you an accurate snapshot of your company’s financial
health, and make it easier to follow financial reporting standards.

How to Adjust Your Chart of Accounts?

The rules for making tweaks to your chart of accounts are simple: feel free to add accounts at any time
of the year, but wait until the end of the year to delete old accounts. If you delete an account in the
middle of the year, it might mess up your books.

4.4 Journalizing Transactions

How to Adjust Your Chart of Accounts?

Journalizing is the practice of documenting a business transaction in accounting records. Record

keeping, especially for accountants, is a detail-oriented skill that requires commitment. Every business
transaction is recorded in a journal, also known as a Book of Original Entry, in chronological order. It is a
process initiated each time a transaction occurs.

If a client is closing out an account, you will want to record the payment as it occurs in the Book of
Original Entry. Typical information to include is the date, the amount, the account being credited, and a
brief description of the transaction itself. 

Recording each entry will facilitate the end-of-year taxes and business responsibilities in reporting to
financial agencies. It will also prove important when analyzing your own business for leaks to create a
more cost-effective business plan.

Why is Journalizing Important?

An accountant is tasked with keeping a ledger of all business transactions, which proves crucial to
protecting the business and clients. A strategic plan in keeping records accurate and consistently
journalizing transactions will ensure fidelity and protect the assets of your clients.

Types of Journalizing Transactions

For accounting, there are a selection of seven different methods to journalize transactions which serve a
different purpose.

Below are the basic methods used to journalize transactions:

 Purchase journal – You will use this to record all purchases of inventory made on credit
 Sales journal – This is where to record the credit sale of merchandise only
  Cash receipts journal – You will record all types of cash receipts here. Cash shows cash only
transactions and cash from accounts receivable. 
 Cash payment/disbursement journal – This is typically payments by check that are often made
on a monthly basis. 
 Purchase return journal – You will use this to show all purchases on credit by your business.
This is only necessary if a business has inventory in the form of trading or manufacturing goods. 
 Sales or purchase return journal – This is traditionally where any returns of merchandise will be
documented. A reason for return will be recorded for future reference. 
 Journal proper/general journal – You will use this journal to record anything not recorded in
the other journals. Something like equipment purchases would be recorded here as would
similar company expenditures. 

How to Journalize Transactions

Each time your company earns or spends money, post the transaction in at least two different accounts
– a debit and a credit account. This is called the double-entry method. 

Describe the transaction. Your attention to the details of each transaction with thorough documentation
is the key to quality bookkeeping. 

1. Identify transactions – Identify the type of transaction that has occurred. If you are not the sole
individual responsible for the transactions, receipts will be submitted to you. Sales, purchases,
receipts, and payments will all fall under different categories depending on the situation.
2. Analyze transactions – This is where the identified transaction is scrutinized to understand how
the transaction altered the accounting equation.
3. Journalize transactions – This is the process of recording. A system of debits and credits is
utilized to record changes in the balancing of accounts and the equation in the general journal.
Traditional journal entry format dictates that debited accounts are listed before credited
accounts. For each entry you will record the transaction date, title, and description of the
event. 

Sample Transactions

During March 2020 the following transactions occurred in the business of F & W Samray, a general
dealer:

March  
Mr Samray deposited an additional P20,000 cash in the bank account
1 of the business.

Paid for an advertisement in the Cape August (newspaper) per

2 check, P75.
 Sold inventory on credit to R. Maposa, P10,000 (cost price
6 P8,000). It follows Perpetual Inventory System.
Received an account for repairs to the vehicle of the owner, P800.
7 This amount is still payable by the business.
Received a credit invoice from E. Terror for goods purchased,
10 P15,000
Received a cheque from S. Vink in full settlement of his account,
12 P800. S. Vink owed the business P850.
Paid a creditor, J. Van, P1,200 by cheque, after he granted the
13 business a discount of P20
Received a credit note from E. Terror for damaged goods sent back
20 to him, P2,000.
25 Cash sale, P8,000 (cost price P6,000)
Received interest on a fixed deposit at the Uno Building Society,
30 P2,000.

Solution:
 Date Particulars Ref Dr Cr
2020
March 1 Cash ₱ 20,000.00
Samray, Capital ₱ 20,000.00
To record additional investment.

2 Advertising Expense ₱ 75.00

Cash ₱ 75.00
Payment of Ad fee - Cape August.

6 Accounts Receivable ₱ 10,000.00

Sale ₱ 10,000.00
Sale of goods on Credit - R. Maposa.

6 Cost of Goods Sold ₱ 8,000.00

Inventory ₱ 8,000.00
To record COGS from Sale to R. Maposa.

10 Inventory ₱ 15,000.00
Accounts Payable ₱ 15,000.00
Purchase on Credit-E. Terror.

12 Cash ₱ 800.00
Accounts Receivable ₱ 800.00
Receipt of Payment - S. Vink.

12 Bad Debts Expense ₱ 50.00

Accounts Receivable ₱ 50.00
Recognition of Write-off of Receivable - S. Vink.

13 Accounts Payable ₱ 1,220.00

Cash ₱ 1,200.00
Inventory ₱ 20.00
To record discount upon payment- J. Van.

20 Accounts Payable ₱ 2,000.00

Inventory ₱ 2,000.00
To record returned damage goods- E. Terror.

25 Cash ₱ 8,000.00
Sale ₱ 8,000.00
To record Sales.

25 Cost of Goods Sold ₱ 6,000.00

Inventory ₱ 6,000.00
To record COGS from Sale to R. Maposa.

30 Cash ₱ 2,000.00
Interest Revenue ₱ 2,000.00
Receipt of interest on a fixed deposit - Uno Building Society

March 10 transaction was not journalized in the books of the business following the Business Entity
Assumption.

Assessment No.4
Journalize the following transactions. (2 Pts Each)

2020
March  
The owner withdrew P4 000 from the bank account of the business for his
1 own use
5 Paid a creditor P1 600 in full settlement of his account of P1 700.
8 Paid the wages of P11 000 for the month.
10 Interest paid on bank statement amounts to P56.
12 Sold inventories for P12 000 cash.
11 Bought equipment on credit from Gauteng Stationers for P4 000
15 Paid P1 000 interest on the loan to NSS bank.
16 Received P3 500 from a debtor in full settlement of an account of P3 560.
18 Sold inventory for cash, P2 200
20 Invested P50 000 in the business.

Chapter 5: Posting to Ledger and Trial Balance Preparation

Learning Outcomes:

 Acquaint student the proper use of a ledger under manual accounting systems and develop skills in the
posting process.
 Prepare a trial balance and learn how to locate errors in the trial balance.

5.1 General Ledger

Posting from general journal to general ledger (or simply posting) is a process in which entries from
general journal are periodically transferred to ledger accounts (also known as T-accounts). It is the
second step of accounting cycle because business transactions are first recorded in the journal and then
they are posted to respective ledger accounts in the general ledger.

Ledger accounts are a way of presenting and grouping transactions relating to a particular account at
one place. The book in which ledger accounts are maintained is known by various names such as
ledger, ledger book or general ledger.

The Format of Ledger Account and Posting Process

The process of posting journal entries to ledger accounts is very simple. No new information is needed
to prepare ledger accounts. The information that has already been recorded in the journal is just
transferred to the relevant ledger accounts in the general ledger.

For the purpose of posting to general ledger, we can divide a journal entry into two parts – a debit part
and a credit part. Both the parts essentially contain one or more accounts. The amount of the account
(or accounts) in the debit part of the entry is written on the debit side of the respective account and the
amount of the account (or accounts) in the credit part of the entry is written on the credit side of the
respective account in the general ledger.

To have a better understanding of the posting process and to illustrate the format of ledger
accounts, we need to take a transaction, prepare a journal entry and then transfer it to the relevant
ledger accounts.

Transaction: On January 1, 2015, ABC Company sold goods to customers for cash P25,000.
The journal entry of the above transaction and its posting to ledger accounts is illustrated below:

The debit part of the above journal entry is “cash account” and the credit part is “sales account”. So the
amount of the journal entry (P25,000) is written on the debit side of the cash account and credit side of
the sales account. All journal entries are similarly posted to accounts in general ledger.

Provided series of journal entries were made for the month, below are example of how it looks like
when posted to ledgers. Periodic (monthly) net balances are usually computed. The net balance is
placed on the side which has the higher totals.
5.2 Trial Balance

Trial Balance is a list of closing balances of ledger accounts on a certain date and is the first step towards
the preparation of financial statements. It is usually prepared at the end of an accounting period to
assist in the drafting of financial statements. Ledger balances are segregated into debit balances and
credit balances. Asset and expense accounts appear on the debit side of the trial balance whereas
liabilities, capital and income accounts appear on the credit side. If all accounting entries are recorded
correctly and all the ledger balances are accurately extracted, the total of all debit balances appearing in
the trial balance must equal to the sum of all credit balances.

Purpose of Trial Balance

 Trial Balance acts as the first step in the preparation of financial statements. It is a working
paper that accountants use as a basis while preparing financial statements.
 Trial balance ensures that for every debit entry recorded, a corresponding credit entry has been
recorded in the books in accordance with the double entry concept of accounting. If the totals
of the trial balance do not agree, the differences may be investigated and resolved before
financial statements are prepared. Rectifying basic accounting errors can be a much lengthy task
after the financial statements have been prepared because of the changes that would be
required to correct the financial statements.
 Trial balance ensures that the account balances are accurately extracted from accounting
ledgers.
 Trail balance assists in the identification and rectification of errors.

From the above ledger balances, below is a sample of pre-closing trial balance.

GGG Company
Trial Balance
As of November 30, 20XX
Dr Cr
Cash 401,570.00
Accounts Receivable 4,000.00
Office Supplies 250.00
Office Equipment 4,500.00
Vehicles 25,000.00
Accounts Payable 4,500.00
Notes Payable 15,000.00
Dividends Payable 3,000.00
Capital Stock 400,000.00
Service Revenue 24,000.00
Salaries Expense 7,500.00
Office Rent Expense 500.00
Utilities Expense 180.00
Dividends 3,000.00
Total 446,500.00 446,500.00
Note:

 For purposes of presentation, accounts are presented in this order Assets (Current then Non-
Current), Liabilities (Current then Non-Current), Equity, Revenue, Expenses.
  It is important to note the normal balances of the accounts, there is an error if the account
shows abnormal balances.
 Trial balance should have equal debits and credits.
 Equal debits and credits does not always justify a correct trial balance. An error in identifying
the nature of the transaction may result to an erroneous trial balance although debits and
credits are balanced.

Assessment No.5
GGG Company
Trial Balance
 As of November 30, 20XX
Dr Cr
Cash 401,570.00
Accounts Receivable 4,000.00
Office Supplies 250.00
Office Equipment 4,500.00
Vehicles 25,000.00
Accounts Payable 4,500.00
Notes Payable 15,000.00
Dividends Payable 3,000.00
Capital Stock 400,000.00
Service Revenue 24,000.00
Salaries Expense 7,500.00
Office Rent Expense 500.00
Utilities Expense 180.00
Dividends 3,000.00
Total 446,500.00 446,500.00

1. With reference to the account balances of GGG Company, journalize the following December transactions. (10 Pts)

20XX
December  
1 Paid in full the outstanding accounts payables.
Paid in advance warehouse rent with starting terms on January of the
following year. It is the practice of the Company not to directly record
5 expenses for prepaid expenses.
Purchased Inventory on credit, P50,000. Consider perpetual inventory
8 method.
10 Paid taxes amounting to P5,000
12 Paid Utilities amounting to P2,000
11 Purchase Computer Equipment for the owner's son using company funds.
Interest on the outstanding Notes Payable with an annual rate of 10%.
16 Notes were issued November 16 of the same year.
17 Sold inventory costing P10,000 on account for P12,500
18 Agreed with Mr. X to buy inventory costing P20,000 on account for P25,000
31 Interest on the outstanding Notes Payable with an annual rate of 10%.

2. Post the transactions to the ledger. (20 Pts)

3. Prepare Trial Balance. (10 Pts)

Chapter 6: Adjusting Journal Entries

Learning Outcomes:
  Know the reasons why adjusting entries are necessary to come-up with correct and reliable financial
statements.
 Understand further the revenue and expense recognition principles and the periodicity concept.
 See the effects on financial statements if adjusting entries are not prepared and to apply the common
procedure on systematic and rational allocation in depreciating fixed assets.

6.1 Year- End Adjustments

At the end of each financial period a business will prepare financial statements (statement of profit or
loss and other comprehensive income and statement of financial position) to determine its financial
results and financial position, respectively. Before these financial statements can be drawn up, all the
year-end adjustments must be taken into account. Therefore:

 Year-end adjustments will only be taken into account at the end of the financial year.
 Year-end adjustments will be recorded by means of general journal entries

Before we discuss the year-end adjustments, it is important that we first discuss the following
accounting concepts.

The Going Concern Concept. The ‘‘going concern concept’’ means that ‘‘the business entity will continue
in operational existence for the foreseeable future’’. This means that the business will continue with its
operations as is and will continue existing in the foreseeable future.

The Matching or Accruals Concept. The matching concept means that ‘‘revenue and costs are accrued
(that is, recognized as they are earned or incurred, not as money is received or paid), matched with one
another so far as their relationship can be established or justifiably assumed, and dealt with in the
statement of profit or loss and other comprehensive income for the period to which they relate’’. This
means that income and expenses are recognized as they are earned or incurred and recorded in the
financial statements of the period to which they relate.

The Consistency Concept. The consistency concept means that ‘‘there is consistency of accounting
treatment of items within each accounting period and from one period to the next’’.

The Prudence Concept. The prudence concept means that ‘‘revenue and profits are not anticipated, but
are recognized by inclusion in the statement of profit or loss and other comprehensive income only
when realized in the form of cash or of other assets, the ultimate cash realization of which can be
assessed with reasonable certainty. Provision is made for all known liabilities (expenses and losses)
whether the amount of these is known with certainty or is a best estimate in the light of the information
available’’.

This means that income is not brought into account until it is realized, whilst expenses will be brought
into account as soon as they are known.
Year-End Adjustments

Prepaid Expenses

Prepayments are payments you have made in one accounting period even though some of it is only
due in the next accounting period. Even though the expense was paid in full, only the part due for
payment in the current accounting period should be matched against the income of the current
accounting period.

Example: As of year-end December 31, 2019, ABC Company records shows paid rent amounting to
P13,000. The expense was paid January 1, 2019 up to January 31, 2020. What is the Journal entry for
the adjustment of the paid rent?

Date Particulars Ref Dr Cr

2020        
3 ₱
Dec 1 Prepaid Rent   1,000.00  
₱
    Rent Expense     1,000.00
To record unused portion of the rent
    paid.      

Explanation:

 The amount of P1,000 which relates to the next accounting period, but has been paid in the
current accounting period, is the prepaid expense. It is an expense that has been paid before
the benefit of the payment had been received.
 Rent Expense, an expense account, is credited because it must decrease, while PREPAID
RENT is debited because it is an ASSET account which increased.
 After the adjustment, the amount for rent paid in the Statement of Financial Performance
will be P12,000 only, whilst the asset account, prepaid expenses of P1,000, will appear in the
statement of financial position under current assets.

Accrued Expenses

Accrued expenses are expenses that were incurred in the current accounting period but, due to
certain circumstances, have not been paid. These expenses have to be written off against the income
of the current accounting period even though they have not yet been paid.

Example: As of year-end December 31, 2019, ABC Company records shows a balance of P2,800 for
Telephone Expenses. However, it still has unpaid telephone bills amounting to P1,500. What is the
Journal entry for the adjustment of the expense?

Date Particulars Ref Dr Cr

2020        
 3 ₱
Dec 1 Telephone Expense   1,500.00  
₱
    Accounts Payable     1,500.00
    To record accruals of expense.      

Explanation:

 The telephone expense account is debited because it is an expense account that increased.
 Accounts Payable are credited because it is a liability account that increased.
 After the adjustment, the amount for the Telephone Expense in the Statement of Financial
Performance will be P4,300 whilst the liability account, Accounts Payable of P1,500, will
appear in the statement of financial position under current liabilities.

Accrued Income

Accrued income is income earned during a specific accounting period but not yet received. Accrued
income falls into the same category as trade receivables, where you have delivered value but have
not received your earnings from it. Like trade receivables, however, it is treated as a current asset in
the statement of financial position and will be included with debtors under trade receivables.

Example: As of year-end December 31, 2019, ABC Company records shows a balance of P11,000 for
rent income collected. However, it still has uncollected rent amounting to P1,000. What is the
Journal entry for the adjustment of the income?

Date Particulars Ref Dr Cr

2020        
3 ₱
Dec 1 Accounts Receivable   1,000.00  
₱
    Rent Revenue     1,000.00
    To record accrued income.      

Explanation:

 Accounts Receivable is debited because it is an asset account that increased.

 Rent Revenue is credited because it is an income account that increased.
 After the adjustment, the amount for Rent Revenue in the Statement of Financial
Performance will be P12,000, whilst the asset account, Accounts Receivable of P1,000, will
appear in the statement of financial position under current assets.

Deferred Income
Deferred Income is when the business has received money before it has delivered the benefit of the
payment. This places a burden on the business and actually becomes a liability to the business.

Example: As of year-end December 31, 2019, ABC Company records shows a balance of P14,000 for
rent income collected. The rent was collected January 1, 2019 with terms of 14 months. What is the
Journal entry for the adjustment of the income?

Date Particulars Ref Dr Cr

2020        
3 ₱
Dec 1 Rent Revenue   2,000.00  
₱
    Unearned Revenue     2,000.00
    To record unearned income.      

Explanation:

 Rent Revenue is debited because it is an income account that decreased

 Unearned Revenue is credited because it is a liability account that increased.
 After the adjustment, the amount for rent revenue in the Statement of Financial
Performance will be P12 000 whilst the liability account, Unearned Income of P2 000, will
appear in the statement of financial position under current liabilities.

Inventory on Hand (not trading inventory)

Inventory on hand is when, during an inventory-taking at the end of a financial year, it is determined
that there are still some consumable stores like stationery or packing materials on hand. These
consumable stores on hand must be treated as inventory on hand, which is classified as a current
asset.

Example: As of year-end December 31, 2019, ABC Company records shows a balance of P2,000 for
Office Supplies Expense. However, during the year-end inventory count it was determine that there
was still Office Supplies on hand amounting to P500. What is the Journal entry for the adjustment of
the asset?

Date Particulars Ref Dr Cr

2020        
3
Dec 1 Office Supplies   ₱ 500.00  
    Office Supplies Expense     ₱ 500.00
    To record Supplies at year-end.      

Explanation:

 Office Supplies is debited because it is an asset account that increased.

  Office Supplies Expense is credited because it is an expense account that decreased. The
actual expense applicable for the financial year to be disclosed in the Statement of Financial
Performance is only P1 500, whilst the P500 will be disclosed in the statement of financial
position as a current asset.

Bad Debts

When a debtor cannot pay his debt it must be written off.

Example: As of year-end December 31, 2019, ABC Company records shows a balance for the
following accounts:

  Dr Cr
60,0
Accounts Receivables 00  
5
Bad Debts 00  

A debtor, M. Mambo, cannot pay his debt of P2 000. It must be written off as credit losses
irrecoverable. What is the adjusting entry for this transaction?

Date Particulars Ref Dr Cr

2020        
3 ₱
Dec 1 Bad Debts   2,000.00  
₱
    Accounts Receivable     2,000.00
    To record write-off of receivables.      

Explanation:

 Bad Debts are debited because it is an expense account that increased.

 Accounts receivable are credited because it is an asset account that decreased.
 After the adjustment, the amount for bad debts in the Statement of Financial Performance
will be P2 500, whilst Accounts receivable will appear in the statement of financial position
under current assets as P58 000
 The method used was a direct write-off method since the credit losses are assumed to be
irrevocable. However, if it cannot be ascertained that the losses are irrevocable, Allowance
Method, or setting-up an Allowance for Bad Debts account, should be made instead of direct
write-off. Thus, instead of crediting Accounts Receivable, we use Allowance for Bad Debts

Depreciation

Depreciation is the steady reduction of the original value of a fixed asset due to the normal wear and
tear of everyday usage over a long period of time. Depreciation can be calculated according to
various methods. We are not going to discuss these methods in this module. All you need to know is
the general journal entry for the adjustment for depreciation.

The same two accounts will always be involved, namely:

  Dr Cr
Depreciation xxx  
Accumulated Depreciation - (Name of
Asset)   xxx

Explanation:

 Depreciation is an expense account and accumulated depreciation is a NEGATIVE ASSET.

 Depreciation will be disclosed in the Statement of Financial Performance, whilst accumulated
depreciation will be subtracted from the cost price of fixed assets in the statement of
financial position.
Assessment No.6
Part 1. The following adjustments appeared in the books of Fatima Traders for the financial year ending 28 February
20XX.

1. Accrued salaries, P10 000.

2. Insurance paid in advance, P3 000.
3. Rent received in advance, P2 000.
4. Nkomo Financial Services still owes us interest to the amount of P5 000 on our investment.
5. Create allowance for bad debts of P2 000.
6. Depreciation to the amount of P12 500 must be written off for vehicles

Record the above-mentioned adjustments in the general journal of Fatima Traders. (2 Pts each)

Part 2. You receive the following pre-adjustment trial balance from Mavuzo Traders, as well as some additional
information at the end of their financial year.

Mavuzo Traders
Trial Balance
As of November 30, 20XX

Dr Cr
Cash 50,000.00
Accounts Receivable 60,000.00
Furniture & Equiment 360,000.00
Accumulated Depreciation- Furniture & Equipment 60,000.00
Notes Payable
Accounts Payable
Notes Payable 120,000.00
Dividends Payable
Capital: Mavuzo 95,000.00
Sales 398,000.00
Rent Revenue 70,000.00
Commission Revenue 20,000.00
Cost of Sales 140,000.00
Salaries Expense 115,000.00
Office Supplies Expense 24,000.00
Telephone Expense 3,000.00
Insurance Expense 8,000.00
Bad Debts 3,000.00
Total 763,000.00 763,000.00

Additional Information:

1. Accrued salaries, P20 000.

2. Prepaid insurance, P2 000.
3. Office Supplies on hand, R3 000.
4. A provision for bad debts of 2% of Accounts receivables must be created.
 5. Commission received in advance, P5 000.
6. Accrued rent received, P8 000 (rent received in arrears).
7. Depreciation of 10% on the cost price of furniture and equipment must be taken into account.

Required:

 Show the general journal entries for the above-mentioned adjustments. (2 pts each)
 Prepare a post-adjustment trial balance. (10 pts)
Chapter 7: Worksheet and Financial Statements
Learning Outcomes:

 Learn and understand how worksheet becomes a tool in preparing the financial statements.
 Understand the relationships among financial statements.
 Understand the relationship between controlling accounts and subsidiary ledgers.

7.1 Accounting Worksheet

An accounting worksheet is a tool used to determine the accuracy of the financial statements prepared
by a company at the end of the accounting period. It also assists in keeping track of the steps involved in
the accounting cycle.

It’s essentially a spreadsheet used specifically for internal purposes and not meant to be seen or used by
external stakeholders like shareholders, creditors, etc.

Accounting Worksheet Benefits

The accounting worksheet simplifies the process of creating financial statements for each accounting
period. Additionally, for already created financial statements, an accounting worksheet can be used to
investigate why they might not be balancing.

It serves as an analytical and a summary tool to reflect how the accounts had been initially posted, the
adjustment entries made and the final presentation in the form of financial statements.

Using an accounting worksheet is a reliable process to determine the financial health of a company even
before the financial statements have been prepared.

Due to the internal nature of this spreadsheet, the format of it can vary from company to company as
per requirements—there is no standard format.

Accounting Worksheet Limitations

We have looked into the several advantages that an accounting worksheet provides. However, some
limitations can exist as well:

 Since it is a labor-intensive process and requires human effort (if not automated), there are
always chances of errors or inconsistencies.
 It cannot avoid errors of omissions.
 Duplicate entries are possible.
 Other others could exist too.
Accounting Worksheet Preparation

There are usually five columns of data with each column sub-divided into a debit and a credit column.

Unadjusted Balance

This is the first column in an accounting worksheet and will include all the components that are part
of the unadjusted trial balance such as revenue accounts, expense accounts, assets accounts, etc.
The total of the debit columns for this should be equal to the total of the credit column. If not, this
would mean there has been an error in the preceding steps of the accounting cycle.

Adjusting Entries

Adjusting items would make up the second column. The debit and credit column should match here
again.

Adjusted Trial Balance

The adjusted trial balance is simply a combination of the unadjusted trial balance and the adjusting
entries.

Income Statement

This income statement column will contain values pertaining to only the revenues and expenses
accounts. If the total revenues exceed the expenses, then the difference will be recorded as net
income for the year. The opposite will hold if expenses are more than revenues and a net loss would
be recorded. In either case, a balancing entry is needed to be passed by the company.

Balance Sheet

This is the last column on the accounting worksheet and will include the assets, liabilities and equity
accounts. Like the other columns, the total of debit and credit should match here as well.
 Accounting Worksheet Example

Below are some important points regarding this accounting worksheet:

 This accounting worksheet is an internal document and has been prepared for internal management consumption only. External shareholders, creditors or
prospective investors can use the financial statements for their decision making.
 It begins with a list of all accounts such as revenue, expense, assets, liabilities and equity in the unadjusted trial balance. These have been compiled by
posting journal entries to their ledgers and from there the balances have been transferred to the unadjusted trial balance report.
 Adjusting entries are then prepared for Bob’s company to account for revenue and expenses that are related to this period but haven’t been paid out yet.
This follows the accounting concept of match and accrual accounting.
 After adjusting entries have been made, the ledger balances are recalculated and posted to the adjusted trial balance. This report would include additional
accounts such as depreciation expense, accumulated depreciation, prepaid rent, unearned income, etc.
 The income statement for Bob is the combination of operating revenues, operating expenses, non-operating revenues and non-operating expenses. You will
usually find the revenue and expense accounts related to the incomes statement at the very end as per chronological order defined by the accounting
worksheet.
 The balance sheet for Bob includes asset accounts like renovations and improvements, cash, accounts receivable, prepaid rent and inventory. The liability
accounts for Bob and his company include accounts payable, accrued expenses, unearned income and long-term liabilities. The equity accounts consist of
common stock, dividend and retained earnings.
7.2 How Does Financial Statements Relate To Each Other?

Statement of Financial
  Performance Statement of Owner's Equity Statement of Cash Flows Statement of Financial Position
Statement of Financial   The net profit/loss reflected in Using the Indirect method of From the effect of Statement of
Performance the Financial Performance will presenting cash, flows for operating Financial Performance to the
also be reflected in the activities, the net profit/loss is used Statement of Owner's Equity, see how
Statement of Owner's Equity. as the starting point. the Statement of Owner's Equity
affects the Statement of Financial
Position.
Statement of Owner's The net profit/loss reflected   Additional Cash Investments and The Summary of significant balances
Equity in the Financial Performance Cash Withdrawals as reflected in in the Statement of Owner's Equity
will also be reflected in the the Statement of Owner's Equity will be reflected in the Statement of
Statement of Owner's will be reflected in the Financing Financial Position.
Equity. Activities of the Statement of Cash
Flows.
Statement of Cash Flows Using the Indirect method Additional Cash Investments   -Using the Indirect Method of cash
of presenting cash, flows for and Cash Withdrawals as flows under operating activities, the
operating activities, the net reflected in the Statement of changes in current assets and
profit/loss is used as the Owner's Equity will be liabilities will increase/decrease the
starting point. reflected in the Financing balance of the starting balance of net
Activities of the Statement of profit/loss,
Cash Flows. -Acquisition/disposal of non-current
assets such as non-current
investments and Fixed Assets will be
reflected under the investment
activities of the Statement of Cash
Flows.
Statement of Financial From the effect of The Summary of significant -Using the Indirect Method of cash  
Position Statement of Financial balances in the Statement of flows under operating activities,
Performance to the Owner's Equity will be the changes in current assets and
Statement of Owner's reflected in the Statement of liabilities will increase/decrease the
Equity, see how the Financial Position. balance of the starting balance of
Statement of Owner's net profit/loss,
Equity affects the Statement -Acquisition/disposal of non-
of Financial Position. current assets such as non-current
investments and Fixed Assets will
be reflected under the investment
activities of the Statement of Cash
Flows.
7.3 Subsidiary Ledgers and Control Account

A subsidiary ledger is a detailed list to support a control account.  A control accounts appear
on the balance sheet in summary or in total, and are accounts like accounts receivable,
accounts payable, and inventory.

Accounts Receivable Subsidiary Ledger

The accounts receivable subsidiary ledger will contain an account for each individual
customer.  The sales, payments, and returns and allowances are recorded into the
individual customer accounts as well as the bigger picture (control account) accounts
receivable account.  For Fooz Ball Town, the sales entries were:

 July 5 Sold P5,000 of merchandise inventory, terms 1/15, n 30, FOB Destination
with a cost of goods sold of P3,000 to Robby Red.
 July 10  Sold P1,500 of merchandise inventory for cash, FOB Shipping Point, with a
cost of goods sold of P1,000.
 July 15 Received payment from Robby Red from July 5 sale less the discount.
 July 30 Sold P7,000 of merchandise inventory, terms 1/15, n 30, FOB Shipping point
with cost of goods sold P5,000 to Bobby Blue.

These entries were recorded in the sales journal and cash receipts journal as follows:

Sales Journal
DR Accounts Receivable DR Cost of Goods Sold
Date Customer CR Sales CR Inventory
July 5 Robby Red ₱ 5,000.00 ₱ 3,000.00
July 30 Bobby Blue 7,000.00 5,000.00
Totals   ₱ 12,000.00 ₱ 8,000.00

Cash Receipts Journal

DR DR Cost of Goods
Sales CR Sold
Discoun Accounts
Date Customer DR Cash ts Receivable CR Sales CR Inventory
1,5 1,500. 1
July 10 Cash Sale 00.00     00 ,000.00
July 15 Robby Red 4,9 5 5,000    
 50.00 0.00 .00
6,4 5 5,000 1,500. 1
Totals   50.00 0.00 .00 00 ,000.00

These journals would be posted to the Accounts Receivable control account like this:

Accounts Receivable

Date Customer DR CR Balance

July 31 from Sales Journal 12,000.00   12,000.00

from Cash Receipts
July 31 Journal   5,000.00 7,000.00

The customer (subsidiary) ledger would be updated for Robby Red and Bobby Blue as:

At the end of the period, a schedule is prepared to verify (or prove) the Accounts
Receivable (control account) balance reported on the balance sheet.  This schedule is a
listing of all customers with the ending amounts owed and should always match the ending
balance in Accounts Receivable.

Accounts Payable Subsidiary Ledger

The accounts payable subsidiary ledgers works the same way as accounts receivable with
the control account of accounts payable and the subsidiary ledger a vendor ledger to
provide a listing of everyone we owe.  The purchases, payments, returns and allowances
are recorded in the individual vendor accounts as well as in the accounts payable account. 
The purchase transactions for Fooz Ball Town are:

 July 12 Purchased P10,000 of merchandise inventory, terms 2/15, n 45, FOB

Destination from Gus Grass.
 July 16 Returned P2,500 of merchandise damaged in shipment from July 12
purchase.
 July 25  Paid for the July 15 purchase from Gus Grass less the return and discount.

These transactions were recorded, under the perpetual inventory method,  in the following
journals:

These journals would be posted to the Accounts Payable control account like this:
 The vendor (subsidiary) ledger would be updated for Gus Grass:

The vendor balance for Gus Grass is P0 and the accounts payable balance is P0.  Since both
are zero and match, it would not be necessary to prepare a schedule of accounts payable. 
If there is a balance, a schedule of accounts payable would be prepared in the same manner
as accounts receivable.

Assessment No.7
Y2D Company
Unadjusted Trial Balance
 As of December 31, 20XX

Cash 10,000.00
Accounts Receivable 35,000.00
Inventory 45,000.00
Plant & Machinery 45,000.00
Accumulated Depreciation -Plant &
Machinery 15,000.00
Accounts Payable 20,000.00
Other Liabilities 15,000.00
Loans Payable 75,000.00
Equity 51,000.00
Revenue 100,000.00
Cost of Goods Sold 75,000.00
Rent Expense 10,000.00
Utility Expense 5,000.00
Salaries 45,000.00
Other Expenses 6,000.00
Totals 276,000.00 276,000.00

Additional information:

 Y2D paid rent November 1, good for 10 months, P10,000

 Electric bills not yet recorded, P1,200
 Loans were applied August 15 of the same year at 10% per annum.
 Unrecorded check receipts from customers for undelivered goods, P50,000.
 Plant & Machinery was acquired January 1 of the previous year with an estimated useful life of 3
years.
 Taxes are computed at 32%.

Requirement:

Prepare an accounting worksheet using the information above. (50 pts).

Chapter 8: Closing Entries and Post Closing Trial Balance
Learning Outcomes:

 Know the reasons why is there a need to close to close the books of accounts at the end of the
year.
 Know what accounts are to be closed and closing procedures as well.
 Prepare a post- closing trial balance and re ready for opening of a new set of accounting period.

8.1 Closing Entries

A closing entry is a journal entry that is made at the end of an accounting period to transfer
balances from a temporary account to a permanent account.

Companies use closing entries to reset the balances of temporary accounts − accounts that
show balances over a single accounting period − to zero. By doing so, the company moves
these balances into permanent accounts on the balance sheet. These permanent accounts
show a company’s long-standing financials.

Temporary Accounts

Temporary accounts are accounts in the general ledger that are used to accumulate

transactions over a single accounting period. The balances of these accounts are eventually
used to construct the income statement at the end of the fiscal year.

The income statement is a financial statement that is used to portray a company’s financial
performance and activities over a single fiscal year. It is for this reason that the date line in
the annual income statement is written as “Year ended.”

As mentioned, temporary accounts in the general ledger consist of income statement

accounts such as sales or expense accounts. When the income statement is published at
the end of the year, the balances of these accounts are transferred to the income summary,
which is also a temporary account.

The income summary is used to transfer the balances of temporary accounts to retained
earnings, which is a permanent account on the balance sheet.

Income Summary

The income summary is a temporary account used to make closing entries.

All temporary accounts must be reset to zero at the end of the accounting period. To
do this, their balances are emptied into the income summary account. The income
summary account then transfers the net balance of all the temporary accounts to
retained earnings, which is a permanent account on the balance sheet.

Permanent Accounts

Permanent accounts are accounts that show the long-standing financial position of a
company. Balance sheet accounts are permanent accounts. These accounts carry forward
their balances throughout multiple accounting periods.

Examples of Closing Entries:

Close Revenue Account

2019 Particulars Dr. Cr.

Dec 31 Sales 100,000.00

Income Summary 100,000.00
To close revenue Account.

Close Expense Accounts

2019 Particulars Dr. Cr.

Dec 31 Income Summary 82,000.00
Cost of Goods Sold 75,000.00
Rent Expense 2,000.00
Depreciation 4,000.00
Other Expense 1,000.00
 To close expense account.

Close Income Summary Account

2019 Particulars Dr. Cr.

Dec 31 Income Summary 8,000.00
Retained Earnings 8,000.00
To close income summary
account.

Close Dividends

2019 Particulars Dr. Cr.

Dec 31 Retained Earnings 4,000.00
Dividends 4,000.00
To close dividends account

8.2 Post Closing Entries

A post-closing trial balance is a listing of all balance sheet accounts containing non-zero
balances at the end of a reporting period. The post-closing trial balance is used to verify
that the total of all debit balances equals the total of all credit balances, which should net
to zero. The post-closing trial balance contains no revenue, expense, gain, loss, or summary
account balances, since these temporary accounts have already been closed and their
balances moved into the retained earnings account as part of the closing process.

Once the accountant has ensured that the total of all debits and credits in the report are
the same number, the next step is to set a flag to prevent additional transactions from
being recorded in the old accounting period, and begin recording accounting transactions
 for the next accounting period. This is one of the last steps in the period-end closing
process.

If any revenue, expense, gain, loss, or summary account balances appear in the trial balance
subsequent to the closing process, it is because they are associated with the next
accounting period.

Example of Post Closing Trial Balance

Note that there are no temporary accounts listed in the following post-closing trial balance:

Y2D Company
Adjusted Trial Balance
As of December 31, 20XX

Cash 10,000.00
Accounts Receivable 35,000.00
Inventory 45,000.00
Plant & Machinery 45,000.00
Accumulated Depreciation -Plant & Machinery 15,000.00
Accounts Payable 20,000.00
Other Liabilities 15,000.00
Loans Payable 75,000.00
Equity 10,000.00

Totals 135,000.00 135,000.00

Assessment No. 8
PPD Company
 Adjusted Trial Balance
As of December 31, 20XX

Cash 400,000.00
Accounts Receivable 30,000.00
Office Supplies 45,000.00
Office Equipment 15,000.00
Vehicle 100,000.00
Accum. Dep.- Vehicle 60,000.00
Building 400,000.00
Accum. Dep.- Building 100,000.00
Notes Payable 50,000.00
Comon Stock 500,000.00
Retained Earnings 155,000.00
Sales Revenue 700,000.00
Cost of Goods Sold 400,000.00
Salaries Expense 50,000.00
Rent Expense 20,000.00
Supplies Expense 10,000.00
Advertising Expense 30,000.00
Insurance Expense 30,000.00
Depreciation Expense 35,000.00
Totals 1,565,000.00 1,565,000.00

Additional Information:

The Board of Directors declared dividends for outstanding shareholders as of December 31, 20XX at
P1.50 per share of the outstanding common stock of 25,000 shares.

Requirement:

1. Prepare Closing Entries.

2. Prepare Post Closing Trial Balance.
Chapter 9: Reversing Entries
Learning Outcomes:

 Understand why there is a need to reverse an adjusting entry.

 Find out that all accrued item adjustments are revered and only deferred item adjustments
whose original entries used to expense and income methods of recording prepayment and pre
collection are also reversed.

9.1 Reversing Entries

Reversing entries, or reversing journal entries, are journal entries made at the beginning of
an accounting period to reverse or cancel out adjusting journal entries made at the end of
the previous accounting period. This is the last step in the accounting cycle.

Reversing entries are made because previous year accruals and prepayments will be paid
off or used during the new year and no longer need to be recorded as liabilities and assets.
These entries are optional depending on whether or not there are adjusting journal
entries that need to be reversed.

Why are Reversal Entries Used?

Reversing entries are usually made to simplify bookkeeping in the new year. For example, if
an accrued expense was recorded in the previous year, the bookkeeper or accountant can
reverse this entry and account for the expense in the new year when it is paid. The
reversing entry erases the prior year’s accrual and the bookkeeper doesn’t have to worry
about it.

If the bookkeeper doesn’t reverse this accrual enter, he must remember the amount of
expense that was previously recorded in the prior year’s adjusting entry and only account
for the new portion of the expenses incurred. He can’t record the entire expense when it is
paid because some of it was already recorded. He would be double counting the expense.
Example

In December, XYZ Company accrued 250 of wages payable for the half of his employee’s
pay period that was in December but wasn’t paid until January. This end of the year
adjusting journal entry looked like this:

Accounting with Reversing Entry

XYZ Company can reverse this wages accrual entry by debiting the wages payable account
and crediting the wages expense account. This effectively cancels out the previous entry.

But wait, didn’t we zero out the wages expense account in last year’s closing entries? Yes,
we did. This reversing entry actually puts a negative balance in the expense. You’ll see why
in a second.

On January 7th, XYZ Company pays his employee 500 for the two week pay period. Paul can
then record the payment by debiting the wages expense account for 500 and crediting the
cash account for the same amount.
 Since the expense account had a negative balance of 250 in it from our reversing entry, the
500 payment entry will bring the balance up to positive 250– in other words, the half of the
wages that were incurred in January.

Accounting without the reversing entries

If XYZ Company does not reverse last year’s accrual, he must keep track of the adjusting
journal entry when it comes time to make his payments. Since half of the wages were
expensed in December, XYZ Company should only expense half of them in January.

Date Particulars Dr. Cr.

Jan 7 Wages 250.00
Accrued Expense 250.00
Cash 500.00
To record wages
expense.

The net effect of both journal entries has the same overall effect. Cash is decreased by 250.
Accrued Expense is zeroed out and wages expense is increased by 250. Making the
reversing entry at the beginning of the period just allows the accountant to forget about
the adjusting journal entries made in the prior year and go on accounting for the current
year like normal.

Note: This can also be applied to accrued income.

Assessment No. 9
1. Are reversing entries required? Provide your justification. (5 pts)
2. Incorporate reversing entries in journalizing the following transactions: (2 pts each entry)

Dec 31 2019 Accrued Rent Income amounting to P2,500 for Rent Services for the period Dec
16-31, 2019.

Rendered but not yet paid.

 Dec 31 2019 Wages are paid every 10th and 20th of the month. Accruals are to be paid for
salaries not yet

paid. Daily rate of P350 each for 10 employees. Day-off during Saturdays and
Sundays.

Jan 10 2020 Paid Wages.

Jan 31 2020 Received Rental Payment due.

Chapter 10: Promissory Notes
Learning Outcomes:

 Define what a promissory note

 Know various terminologies concerning promissory notes.

 Determine the interest computation on notes.

 Understand from whose point of view note is being referred to..

10.1 Promissory Notes

A promissory note is a financial instrument that contains a written promise by one party
(the note's issuer or maker) to pay another party (the note's payee) a definite sum of
money, either on demand or at a specified future date. A promissory note typically contains
all the terms pertaining to the indebtedness, such as the principal amount, interest rate,
maturity date, date and place of issuance, and issuer's signature.

Although financial institutions may issue them, promissory notes are debt instruments that
allow companies and individuals to get financing from a source other than a bank. This
source can be an individual or a company willing to carry the note (and provide the
financing) under the agreed-upon terms. In effect, anyone becomes a lender when he
issues a promissory note. For instance, although it isn't a given, you might be required to
sign a promissory note in order to take out a small personal loan.

A loan promissory note sets out all the terms and details of the loan.

The promissory note form should include:

 The names and addresses of the lender and borrower

 The amount of money being borrowed and what, if any, collateral is being used
 How often payments will be made in and in what amount
 Signatures of both parties, in order for the note to be enforceable

The collateral referenced above is property that the lender can seize if the note is not
repaid; for example, when you buy a home, the house is the collateral on the mortgage.
Key Takeaways:

 A promissory note is a financial instrument that contains a written promise by one

party (the note's issuer or maker) to pay another party (the note's payee) a definite
sum of money, either on demand or at a specified future date.
 A promissory note typically contains all the terms pertaining to the indebtedness,
such as the principal amount, interest rate, maturity date, date and place of
issuance, and issuer's signature.
 In terms of their legal enforceability, promissory notes lie somewhere between the
informality of an IOU and the rigidity of a loan contract.

Understanding Promissory Notes

Promissory notes, as well as bills of exchange, are governed by the 1930s international
convention, which also stipulates that the term "promissory note" should be inserted in the
body of the instrument and should contain an unconditional promise to pay.

In terms of their legal enforceability, promissory notes lie somewhere between the
informality of an IOU and the rigidity of a loan contract. A promissory note includes a
specific promise to pay, and the steps required to do so (like the repayment schedule),
while an IOU merely acknowledges that a debt exists, and the amount one party owes
another.

A loan contract, on the other hand, usually states the lender's right to recourse—such
as foreclosure—in the event of default by the borrower; such provisions are generally
absent in a promissory note. While it might make note of the consequences of non-
payment or untimely payments (such as late fees), it does not usually explain methods of
recourse if the issuer does not pay on time.

Promissory notes that are unconditional and salable become negotiable instruments that

are extensively used in business transactions in numerous countries.

Student Loan Promissory Notes

Many people sign their first promissory notes as part of the process of getting a student
loan. Private lenders typically require students to sign promissory notes for each separate
loan that they take out. Some schools, however, allow federal student loan borrowers to
sign a one-time, master promissory note. After that, the student borrower can receive
multiple federal student loans as long as the school certifies the student's continued
eligibility.

Student loan promissory notes outline the rights and responsibilities of student borrowers
as well as the conditions and terms of the loan. By signing a master promissory note
for federal student loans, for instance, the student promises to repay the loan amounts plus
interest and fees to the U.S. Department of Education. The master promissory note also
includes the student's personal contact information and employment information as well as
the names and contact information for the student's personal references.

A Brief History of Promissory Notes

Promissory notes have had an interesting history. At times, they have circulated as a form
of alternate currency, free of government control. In some places, the official currency is in
fact form of promissory note called a demand note (one with no stated maturity date or
fixed term, allowing the lender to decide when to demand payment).

In the United States, however, promissory notes are usually issued only to corporate clients
sophisticated investors. Recently, however, promissory notes have also been also seeing
increasing use when it comes to selling homes and securing mortgages.

Types of Promissory Notes

Corporate Credit Promissory Notes

Promissory notes are commonly used in business as a means of short-term financing. For
example, when a company has sold many products but not yet collected payments for
them, it may become low on cash and unable to pay creditors. In this case, it may ask them
to accept a promissory note that can be exchanged for cash at a future time after it collects
its accounts receivables. Alternatively, it may ask the bank for the cash in exchange for a
promissory note to be paid back in the future.
Promissory notes also offer a credit source for companies that have exhausted other
options, like corporate loans or bond issues. A note issued by a company in this situation is
at a higher risk of default than, say, a corporate bond. This also means the interest rate on a
corporate promissory note is likely to provide a greater return than a bond from the same
company—high-risk means higher potential returns.

These notes usually have to be registered with the government in the state in which they
are sold and/or with the Securities and Exchange Commission. Regulators will review the
note to decide whether the company is capable of meeting its promises. If the note is not
registered, the investor has to do his or her own analysis as to whether the company is
capable of servicing the debt. In this case, the investor's legal avenues may be somewhat
limited in the case of default. Companies in dire straits may hire high-commission
brokers to push unregistered notes on the public.

Investment Promissory Notes

Investing in promissory notes, even in the case of a take-back mortgage, involves risk. To
help minimize these risks, an investor needs to register the note or have it notarized so that
the obligation is both publicly recorded and legal. Also, in the case of the take-back
mortgage, the purchaser of the note may even go so far as to take out an insurance policy
on the issuer's life. This is perfectly acceptable because if the issuer dies, the holder of the
note will assume ownership of the house and related expenses that they may not be
prepared to handle.

These notes are only offered to corporate or sophisticated investors who can handle the
risks and have the money needed to buy the note (notes can be issued for as large a sum as
the buyer is willing to carry). After an investor has agreed to the conditions of a promissory
note, they can sell it (or even the individual payments from it), to yet another investor,
much like a security.

Notes sell for a discount from their face value because of the effects of  inflation eating into
the value of future payments. Other investors can also do a partial purchase of the note,
buying the rights to a certain number of payments—once again, at a discount to the true
value of each payment. This allows the note holder to raise a lump sum of money quickly,
rather than waiting for payments to accumulate.
How to customize a Promissory Note?

Promissory notes should be created to fit the transaction that you are involved in. It's
always good to refer to a sample promissory note when you are writing one so that you can
be sure to include the right language. There also are different types of promissory notes.

A simple promissory note might be for a lump sum repayment on a certain date. For
example, you lend your friend P1,000 and he agrees to repay you by December 1. The full
amount is due on that date, and there is no payment schedule involved. There may or may
not be interest charged on the loan amount, depending on what you've agreed.

A demand promissory note is one in which payment is due when the lender asks for the
money back. Usually, a reasonable amount of notice is required.

More complicated promissory notes for transactions like mortgages and car loans will also
include interest rates, amortization schedules, and other details.

How to collect on a Promissory Note?

If you've lent money to someone using a promissory note, the plan is for them to repay you
according to the terms of the note, which in most cases is what happens. But what if they
don't meet the terms of the note?

The first thing to do is actually to ask for the repayment in writing. A written reminder or
request is often all that is needed. You could send past due notices at 30, 60, and 90 days
after the due date.

Be sure to talk to your borrower. Can they make a partial payment? Would an extended
payment plan allow them to pay up? If you decide to accept a partial repayment of the
debt, then you can create a debt settlement agreement with your borrower.

Another option is to use a debt collector. This business will work to collect your note and
will usually take a percentage of the debt. You also can sell the note to a debt collector,
meaning they own the loan and collect the full amount (this is similar to what happens
when banks sell loans to each other). If all else fails, you can sue the borrower for the full
amount of the debt.
Promissory notes are a useful way to establish a clear record of a loan—whether between
entities or individuals—and to put all the relevant terms in writing, so that there can be no
question about the amount of money lent and when payments are due.