INTRODUCTION

As established in Chapter 1, financial statements are necessary to show the true picture of the financial status of the
business as managed by its owners or management. This is important since a variety of interested users depend on what
these financial statements contain and disclose to make sound economic decisions. It is for this reason that prudence
should be exercised in preparing these financial statements. Preparing financial statements require the observance and
application of the generally accepted accounting principles. The fact that financial statements are the outputs of the
accounting process, it is imperative to note that each step of the accounting cycle should be followed.

DEFINITION OF ACCOUNTING CYCLE

Before we proceed to discussing the accounting cycle, let us first examine the generally accepted accounting principle
that compels us to observe the accounting cycle. Recall that in Chapter 5, the time period assumption was discussed. It is
this principle that dictates dividing the life of the business into accounting periods which could either be a calendar year
or fiscal year. Accounting periods may also be shorter than one year, say six months, one quarter, or one month, which
we refer to as interim periods. Just the same, preparing financial statements for the periods mentioned require a strict
observance of the accounting cycle.

The accounting cycle is a series of recurring accounting steps or processes that span from the start to the end of a
particular accounting period. The accounting cycle is composed of the following steps:

1. Analyzing business transactions from source documents

2. Journalizing the business transactions
3. Posting journal entries to the ledger
4. Preparing trial balance
5. Journalizing and posting adjusting journal entries
6. Preparing adjusted trial balance
7. Preparing financial statements
8. Journalizing and posting closing journal entries
9. Preparing post-closing trial balance
10. Journalizing and posting reversing journal entries

TRANSACTIONS IN A SERVICE BUSINESS

Transactions in a service business are usually straightforward. The business renders service to clients or customers to
generate revenues. This is the reason why the main revenue account used for a service business is a Service Revenue
account. In the case of JM Photocopying Center, revenues are generated when photocopying services are rendered. A
more specific account such as Photocopying Revenues can therefore be used instead of Service Revenue.

In generating revenues, service businesses incur expenses. In the case of JM Photocopying Center, expenses can be in
the form of salaries paid to staff, bond papers used in photocopying, electricity needed to operate the photocopying
machine, and others. The interplay between revenues and expenses may result in either profit or loss.

Just like any business, a service business begins with an investment by a sole proprietor or proprietors. Recall that in
Chapter 1, Mr. Mercado invested total assets of $60,000. From this investment transaction, a number of transactions
followed. These transactions may be business or nonbusiness transactions. A business transaction results in an
accounting transaction that requires a journal entry, while nonbusiness transactions do not require journal entries.
Simply put, a transaction that has an effect on the accounting equation, is a business transaction. Otherwise, it is a
nonbusiness transaction.

Examples of business transactions include investment of the owner, purchase of office supplies, payment of liabilities,
rendition of services, and withdrawal of the owner, among others. On the other hand, nonbusiness transactions include
hiring of office staff, appointment of an office supervisor, and operating of the business on a weekend or during a
holiday.

Before we proceed with the first step of the accounting cycle, let us first establish the following chart of accounts of JM
Photocopying Center, which will be very helpful in identifying the affected accounts in our transaction analysis:

STEP 1
Analyzing business transactions from source documents. As introduced in Chapter 6, the accounting equation is
fundamental in analyzing business (or accounting) transactions from source documents. Transaction analysis entails a
thorough understanding of the business transaction itself and its implication on assets, liabilities, and owner's equity.
Many students may find transaction analysis challenging at the start, but ease and comfort will follow once a full
appreciation of how this process is done is achieved. The succeeding steps (especially journalizing and posting) in the
accounting cycle will become less difficult once transaction analysis is understood. Taken from Chapter 6, the summary
of normal balances, the increases, and the decreases below will be very helpful as we begin analyzing the business
transactions.
Analyzing business transactions from source documents requires familiarity with business documents. Common business
documents are official receipts (usually for service businesses), sales invoices (usually for merchandising business),
statements of account or billing statements (an example is an electricity bill), deposit slips and withdrawal slips (for
banks), payroll sheets (for salaries and wages), debit memoranda, and credit memoranda, among others. You may
search the Internet, ask your parents, or visit a business near your school for some examples of these documents.

Nevertheless, transaction analysis only involves three simple steps.

These are:

1. Classify whether the transaction is a business or a nonbusiness transaction. If the transaction is nonbusiness, then
there is no need to proceed to step 2.
2. Identify the major account/s and the account title/s affected and the movements with respect to its/their normal
balance/s.
3. Determine the amount/s to be credited or debited.

Let us illustrate transaction analysis using the following related transactions:

Transaction 1

Mr. Mercado invested cash of P10,000 in his business to be known as JM Photocopying Center. Following the three
simple steps, our analysis shall be:

1. The transaction is a business transaction since it affects the accounting equation

2. The major accounts affected are assets and owner's equity. More specifically, the account titles affected are Cash
(increase through a debit) and Mercado, Capital (increase through a credit).

3. The amount to be debited is P10,000 for Cash (accounts with no debit balances are increased through a debit) and the
amount credited is P10,000 for Mercado, Capital (accounts with normal credit balances are increased through a credit).

Transaction 2

Mr. Mercado invested a photocopying machine amounting to P30,000 (with sales invoice) in his business to be known as
JM Photocopying Center. Following the three simple steps, our analysis shall be:
1. The transaction is a business transaction since it affects the accounting equation.

2. The major accounts affected are assets and owner's equity. More specifically, the account titles affected are
Photocopying Equipment (increase through a debit) and Mercado, Capital (increase through a credit)

3. The amount to be debited is P30,000 for Photocopying Equipment (accounts with debit normal balances are increased
through a debit) and the amount to be credited is P30,000 for Mercado, Capital (accounts with credit normal balances
are increased through a credit).

For transaction 3, let us combine transactions 1 and 2 and add an accounts payable in preparation for the compound
journal entry which we will do in a short while (in Step 2).

Transaction 3

Mr. Mercado invested the following in his business to be known as JM Photocopying Center: Cash, P30,000; and
Photocopying Equipment, #30.000 (with sales invoice). In addition, his Accounts Payable of $50,000 would be assumed
by the business. Following the three simple steps, our analysis shall be:

1. The transaction is a business transaction since it affects the accounting equation.

2. The major accounts affected are assets, liabilities, and owner's equity. More specifically, the account titles affected
are Cash (increase through a debit), Photocopying Equipment (increase through a debit), Accounts Payable (increase
through a credit), and Mercado, Capital (increase through a credit).

3. The amounts to be debited are F30,000 for Cash (accounts with debit normal balances are increased through a debit)
and P 30,000 for Photocopying Equipment (accounts with debit normal balances are increased through a debit) and the
amounts to be credited are P50,000 for Accounts Payable (accounts with credit normal balances are increased through a
credit) and P10,000 for Mercado, Capital (accounts with credit normal balances are increased through a credit).

Transaction 4

JM Photocopying Center paid P10,000 for the purchase of bond paper (with sales invoice). Following the three simple
steps, our analysis shall be:

1. The transaction is a business transaction since it affects the accounting equation.

2. Assets are affected by this transaction. More specifically, the account titles affected are Unused Supplies (increase
through a debit) and Cash (decrease through a credit).

3. The amount to be debited is P10,000 for Unused Supplies (accounts with debit normal balances are increased through
a debit) and the amount to be credited is P10,000 for Cash (accounts with debit normal balances are decreased through
a credit).

Transaction 5

Mr. Mercado hired one personnel with a weekly salary of P1,000 to look after the business (with employment contract).

Following the three simple steps, our analysis shall be:

The transaction is a nonbusiness transaction since it does not affect the accounting equation. Mr. Mercado just hired a
personnel with an agreed weekly salary of P1,000.

Transaction 6
JM Photocopying Center paid salary of the personnel for the week, P1,000 (with payroll sheet). Following the three
simple steps, our analysis shall be:

1. The transaction is a business transaction since it affects the accounting equation.

2. The major accounts affected are expenses and assets. More specifically, the account titles affected are Salaries
Expense (increase through a debit) and Cash (decrease through a credit).

3. The amount to be debited is P1,000 for Salaries Expense (accounts with debit normal balances are increased through
a debit) and the amount to be credited is P1,000 for Cash (accounts with debit normal balances are decreased through a
credit).

Transaction 7

JM Photocopying Center received P8,000 cash for services rendered (with official receipt). Following the three simple
steps, our analysis shall be:

1. The transaction is a business transaction since it affects the accounting equation.

2. The major accounts affected are assets and revenues. More specifically, the account titles affected are Cash (increase
through a debit) and Photocopying Revenues (increase through a credit).

3. The amount to be debited is P8,000 for Cash (accounts with debit normal balances are increased through a debit) and
the amount to be credited is P8,000 for Photocopying Revenues (accounts with credit normal balances are increased
through a credit).

Transaction 8

JM Photocopying Center billed a customer for services rendered during the week, P2,000 (with billing statement).

Following the three simple steps, our analysis shall be:

1. The transaction is a business transaction since it affects the accounting equation.

2. The major accounts affected are assets and revenues. More specifically, the account titles affected are Accounts
Receivable (increase through a debit) and Photocopying Revenues (increase through a credit).

3. The amount to be debited is P2,000 for Accounts Receivable (accounts with debit normal balances are increased
through a debit) and the amount to be credited is P2,000 for Photocopying Revenues (accounts with credit normal
balances are increased through a credit).

Transaction 9
Mr. Mercado made a P500 cash withdrawal for personal use. Following the three simple steps, our analysis shall be:
1. The transaction is a business transaction since it affects the accounting equation.

2. The major accounts affected are equity and assets. More specifically, the account titles affected are Mercado, Drawing
(increase through a debit) and Cash (decrease through a credit). 3. The amount to be debited is P500 for Mercado,
Drawing (accounts with debit normal balances are increased through a debit) and the amount to be credited is $500 for
Cash (accounts with debit normal balances are increased through a debit).

Transaction 10
JM Photocopying Center collected the amount billed to a customer, P2,000 (with official receipt). Following the three
simple steps, our analysis shall be:

1. The transaction is a business transaction since it affects the accounting equation.

2. Assets are affected by this transaction. More specifically, the account titles affected are Cash (increase through a
debit) and Accounts Receivable (decrease through a credit).

3. The amount to be debited is P2,000 for Cash (accounts with debit normal balances are increased through a debit) and
the amount to be credited is P2,000 for Accounts Receivable (accounts with debit normal balances are decreased
through a credit).

JM Photocopying Center paid rent for two months amounting to P10,000 (with statement of account). Following the
three simple steps, our analysis shall be:

1. The transaction is a business transaction since it affects the accounting equation.

2. The major accounts affected are expenses and assets. More specifically, the account titles affected are Rent Expense
(increase through a debit) and Cash (decrease through a credit).

3. The amount to be debited is P10,000 for Rent Expense (accounts with debit normal balances are increased through a
debit) and the amount to be credited is P10,000 for Cash (accounts with debit normal balance are decreased through a
credit).

Transaction 11

JM Photocopying Center paid rent for two months amounting to P10,000 (with statement of account). Following the
three simple steps, our analysis shall be:

1. The transaction is a business transaction since it affects the accounting equation.

2. The major accounts affected are expenses and assets. More specifically, the account titles affected are Rent Expense
(increase through a debit) and Cash (decrease through a credit).

3. The amount to be debited is P10,000 for Rent Expense (accounts with debit normal balances are increased through a
debit) and the amount to be credited is P10,000 for Cash (accounts with debit normal balance are decreased through a
credit).

JM Photocopying Center received a bill from an electric company, P2,500 (with statement of account). Following the
three simple steps, our analysis shall be:

1. The transaction is a business transaction since it affects the accounting equation.

2. The major accounts affected are expenses and liabilities. More specifically, the account titles affected are Utilities
Expense (increase through a debit) and Accounts Payable (increase through a credit). The receipt of the statement of
account means recognition of an expense and a liability. The business is obliged to pay for this bill.

3. The amount to be debited is P2,500 for Utilities Expense (accounts with debit normal balances are increased through
a debit) and the amount to be credited is $2,500 for Accounts Payable (accounts with credit normal balances are
increased through a credit).

To summarize, the aforementioned 12 transactions have the following effects on the major accounts and account titles:
STEP 2

Journalizing business transactions. A thorough transaction analysis makes journalizing, which is the next step, easier to
do. It is important to take note that journalizing is the first of the two steps in the recording phase of accounting.
Journalizing is the process of entering a business transaction in the form of an accounting entry in the "journal” or the
so-called "book of original entry.” A journal is where business transactions are initially recorded in chronological order.
Moreover, a journal entry can take the form of a simple journal entry or a compound journal entry. A simple journal
entry is a journal entry that has one debit account and one credit account.

Examples of simple journal entries follow:

General Journal page 1

Particulars (Account Title and Explanation)
date F Debit Credit
2015
1-Jul Cash 10,000
Mercado, Capital 10,000
To record Cash investment

1 Photocopying Equipment 30,000

Mercado, Capital 30,000
To record investment of photocopying equipment
On the other and, a compound journal entry is a journal entry with more than one debit account or more than one
credit account, or both. An example of a compound journal entry (which is the journal entry for Transaction 3) follows:

General Journal page 1

Particulars (Account Title and Explanation)
date F Debit Credit
1 Cash 30,000
Photocopying Equipment 30,000
Accounts Payable 50,000
Mercado, Capital 10,000
to record investments of Cash, Photocopying Equipment and accounts payable

Notice that regardless of the forms of the general Journal and the journal entry, a journal entry has the following
important components:
1. The of transaction
2. Particulars (account titles and explanation)
3. Folio (for posting reference)
4. Debit account title/s and debit amount/s
5. Credit account title/s and credit amount/s
6. An explanation

Notice also the indention that separates the debit accounts and amount/s from the credit account/s and amount/s. let
us continue journalizing using the remaining transactions in Step 1 starting with the fourth transaction, but this time, let
us add the date to the transactions. Assume also that transactions dated July 1 to 10 are to be recorded in page 1 of the
journal, transactions dated July 11 to 20 are to be recorded in page 2 of the journal, and transactions dated July 21 to 31
are to be recorded in page 3 of the journal.

Transaction 4: On July 2, JM Photocopying Center paid P 10,000 for the purchase of bond papers (with sales invoice).

General Journal page 1

Particulars (Account Title and
date Explanation) F Debit Credit
2-Jul Unused Supplies 10,000
Cash 10,000
to record purcase of supplies

Transaction 5: Mr. Mercado hired one personnel with a weekly salary of P1,000 to look after the business (with
employment contract).

There is no need to journalize this transaction since this is a nonbusiness transaction which means it does not have any
effect on assets, liabilities, equity, revenues, and expenses.

Transaction 6: JM Photocopying Center paid salary of the personnel for the week, P1,000 (with payroll sheet).

General Journal page 1

Particulars (Account Title and Explanation)
date F Debit Credit
10 Salaries Expense 1,000
Cash 1,000
To record payment of salary

Transaction 7: JM Photocopying Center received P8,000 cash for services rendered (with official receipt).
 General Journal page 2
Particulars (Account Title and Explanation)
date F Debit Credit
16-Jul Cash 8,000
Photocopying Revenue 8,000
to record cash reeived for services rendered

Transaction 8: JM Photocopying Center billed a customer for services rendered during the week, P2,000 (with billing
statement).