Module 1: Introduction to Accounting

Learning Objectives:

 To learn the importance, purpose, phases, definitions, basic principles and fundamental
concepts of accounting and its branches
 To learn the businesses and organizations
 To learn the concept of basic financial statements and double-entry bookkeeping

Introduction

Do you know the similarity of "selfie" and accounting?

We take "selfie" to capture the memories on our past events and have it posted in our social media
accounts to be able for us to communicate to our friends and families that we have these moments
in our life. This is basically the same reason why companies need accounting as they need to record
the past events on their economic transactions, post the same in the ledger and communicate the
same to the stakeholders through the financial statements.

Accounting Importance, Purpose and Phases

Accounting has evolved to meet the social and economic needs of society. It provides information
that helps decision-makers make informed choices and allocate resources efficiently. Accounting
measures and communicates business activities and is called the language of business. It is essential
for businesses to know how much they are earning and spending, and accountants provide this
information. Accounting is also important for personal financial planning, education expenses, loans,
taxes, and investments.

The accounting function is an integral part of the broader business system that handles financial
operations and provides information to aid decision-making. It involves recording historical business
transactions, measuring their effects in monetary terms, and classifying and summarizing the
resulting data. The summarized data is presented in financial statements, which are used to evaluate
the liquidity, profitability, and solvency of the business. Ultimately, accounting provides decision-
makers with information to make informed choices about the allocation of scarce resources.

Definitions of Accounting

Accounting is a service activity. Its function is to provide quantitative information primarily financial
in nature, about economic entities that is intended to be useful in making economic decisions.

Accounting is an information system that measures, processes and communicates financial

information about an economic entity.

Accounting is the process of identifying, measuring and communicating economic information to

permit informed judgments and decisions by users of the information.

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 results thereof.
Fundamental Concepts and Basic Principles of Accounting

Several fundamental concepts underlie the accounting process. In recording business

transactions, accountants should consider the following:

Entity Concept. The entity concept in accounting means that a business or organization is treated as
a separate entity from its owners or other businesses

For example, the personal finances of the business owners or the finances of another business that
the company may own are recorded and evaluated separately

Periodicity Concept. Accounting uses a specific time period, usually one year, to report an entity's
financial information.

Stable Monetary Unit Concept. The Philippine peso is a reasonable unit of measure and its
purchasing power is relatively stable, thus, the effects of inflation in the accounting records are
ignored.

Going Concern. Financial statements are normally prepared on the assumption that the reporting
entity is a going concern and will continue in operation for the foreseeable future. Hence, it is
assumed that the entity has neither the intention nor the need to enter liquidation or to cease
trading.

In order to generate information that is useful to the users of financial statements,

accountants rely upon the following general principles:

Objectivity Principle. Accounting records and statements are based on the most reliable data
available so that they will be as accurate and as useful as possible. Reliable data are verifiable when
they can be confirmed by independent observers Ideally, accounting records are based on
information that flows from activities documented by objective evidence. Without this principle,
accounting records would be based on whims and opinions and is therefore subject to disputes.

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

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

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

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

Materiality. Financial reporting is only concerned with information that is significant enough to affect
evaluations and decisions. Materiality depends on the size and nature of the item judged in the
particular circumstances of its omission. In deciding whether an item or an aggregate of items is
material, the nature and size of the item are evaluated together. Depending on the circumstances,
either the nature or the size of the item could be the determining factor.
Consistency Principle. The firms should use the same accounting method from period to period to
achieve comparability over time within a single enterprise However, changes are permitted if
justifiable and disclosed in the financial statements.

Businesses and Organizations

Types of Business

The range of products and services can be summarized in seven broad categories, they are as
follows:

Type

Activity

Structure

Examples

Services

Selling people's time

Hiring skilled staff and selling their time

Software development and Consultancy Firm (Microsoft)

Professional Services Firms (PWC, SGV, Deloitte, KPMG)

Law Firms (ACCRALaw, Romulo Mabanta)

Trader

Buying and Selling products

Buying a range of raw material and manufactured goods and

Wholesaler (Kimberly Clark)

Retailer (7-Eleven)
Type

Activity

Structure

Examples

consolidating them, making them available for sale in locations near to their customers or online for
delivery.

Manufacture

Designing

products, aggregating components and assembling finished products

Taking raw materials and using equipment and staff to convert them into finished goods.

Vehicle Assembly

Construction

Engineering

Electricity, Water, Food and drinks

Chemicals

Media

Pharmaceuticals

Raw Materials

Growing or extracting raw materials

Buying of land and using them to provide raw materials.

Farming

Mining
Oil

Infrastructure

Selling the utilization of infrastructure

Buying and operating assets (typically large assets); selling occupancy often in combination with
services.

Transport (airport, operator, airlines, trains, ferries, buses)

Hotels

Telecoms

Sports facilities

Property management

Financial

Recieving deposits, lending and investing money

Accepting cash from depositors and paying them interest; using the money to provide loans to
borrowers, charging them fees and a higher rate of interest than the depositors receive.

Bank

Investment house

Insurance

Pooling premiums of many to meet claims of a few

Collecting cash from depositors and paying them interest; using the money to provide loans to
borrowers, charging them fees and a higher rate of interest than the depositors receive.

Insurance

Forms of Business Organization

Any of the above types of activities may be performed by a business organization be it a sole
proprietorship, a partnership or a corporation. A business generally assumes one of the three forms
of organization. The accounting procedures depends on which form the organization takes.

Sole Proprietorship. This business organization has a single owner called the proprietor who
generally is also the manager. Sole Proprietorships tend to be small service-type (e.g. physician,
lawyers and accountant) business and retail establishments. The owner receives all profits, absorbs
all losses and is solely responsible for all debts of the business. From the accounting viewpoint, the
sole proprietorship is distinct from its proprietor. Thus, the accounting records of the sole
proprietorship do not include the proprietor's personal financial records.

Partnership. A 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. Each partner is personally liable for any debt incurred by the
partnership. Accounting considers the partnership as a separate organization, distinct from the
personal affairs of each partner.

Corporation. A 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 expressly
authorized by law or incident to its existence. The stockholders are not personally

Activities in Business Organizations

Many types of decisions are made in business organizations. Accounting provides activities as
follows, financing, investing, and operating important information to make these decisions. The three
types of organizational activities are as follows: financing, investing, and operating.

Financing Activities

Organizations require financial resources to obtain other resources used to produce goods and
services. They compete for these resources in financial markets. Financing activities are the methods
an organization uses to obtain financial resources from financial markets and how it manages these
resources. Primary sources of financing for most businesses are owners and creditors, such as banks
and suppliers. Repaying the creditors and paying a return to the owners are also financing activities.

Investing Activities

Managers use capital from financing activities to acquire other resources used in the transformation
process-that is, to transform resources from one form to a different form, which is more valuable, to
meet the needs of the people. Having the right mix of resources is essential to efficient and effective
operations

An efficient business is one that provides goods and services at low costs relative to their selling
prices. An effective business is one that is successful in providing goods and services demanded by
the customers.
Investing activities involve the selection and management including disposal and replacement of
long-term resources that will be used to develop, produce, and sell goods and services Investing
activities include buying land, equipment, buildings and other resources that are needed in the
operation of the business, and selling these resources when they are no longer needed.

Operating Activities

Operating activities involve the use of resources to design, produce, distribute, and market goods
services. Operating activities include research and development, design and engineering purchasing,
human resources, production, distribution, marketing and selling, and servicing Organizations
compete in supplier and labor markets for resources used in these activities. Also, they compete in
product markets to sell the goods and services created by operating activities.

Double-Entry System

Fra Luca Pacioli's book, Summa, outlines the importance of three essential things for a successful
merchant: sufficient cash or credit, a good bookkeeper, and an accounting system to view the
business affairs at a glance. Pacioli introduces the double-entry accounting system, in which every
debit should have a corresponding credit entry.

Pacioli discusses three books in the Summa: the memorandum, the journal, and the ledger. The
memorandum is a chronological record of all transactions in their original currency. The journal is a
private book where entries are made in one currency in chronological order, and the ledger is an
alphabetical listing of all accounts with their running balance. These principles established in the
15th century continue to be the foundation for modern bookkeeping systems.

The Accounting Equation

The most basic tool of accounting is the accounting equation. This equation presents the resources
controlled by the enterprise, the present obligations of the enterprise and the residual interest in the
assets. It states that assets must always equal liabilities and owner's equity. The basic accounting
model is:
Assets = Liabilities + Owner's Equity

To keep the above equation balanced, we use two types of entries called debits and credits. We put
debits on the left side of the equation and credits on the right side. If we increase an asset, we use a
debit entry. If we increase a liability or owner's equity, we use a credit entry.

The logic behind debiting and crediting is that every transaction must keep the accounting equation
balanced. This means that every time we make an entry, we must make sure that the total amount
on the left side of the equation is always equal to the total amount on the right side.

The Basic Financial Statements and Normal Balance of the Accounts

Type

Element

Definition or Description

Balance Sheet or Statement of Financial Position

Asset

A present economic resource controlled by the entity as a result of past events. An economic
resource is a right that has the potential to produce economic benefits.

Liability

A present obligation of the entity to transfer an economic resource as a result of past events.

Equity

The residual interest in the assets of the entity after deducting all its abilities.

Income

Statement or Statements of Financial Performance

Income
Increases in assets, or decreases in liabilities, that result in increases in equity other than those
relating to contributions from holders of equity claims.

Expenses

Decreases in assets, or increases in liabilities, that result in decreases in equity, other than those
relating to distributions to holders of equity claims.

The normal balance of any account refers to the side of the account debit or credit-where Increases
are recorded. Assel, owner's withdrawal and expense accounts normally have debit balances,
liability, owner's equity and income accounts normally have credit balances. This result occurs
because increases in an account are usually greater than or equal to decreases.

Increases Recorded by

Normal Balance

Account Category

Debit

Credit

Debit

Credit

Assets

Liabilities

/
/

Owner's Equity

Owner's Capital

Withdrawals

Income

/
/

Expenses

Debits and Credits

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

An account is debited when an amount is entered on the left side of the account and credited when
an amount is entered on the right side. The abbreviations for debit and credit are Dr. (from the Latin
debere) and Cr. (from the Latin credere), respectively.

The account type determines how increases or decreases in it are recorded. Increases in assets are
recorded as debits (on the left side of the account) while decreases in assets are recorded as credits
(on the right side). Conversely, increases in liabilities and owner's equity are recorded by credits and
decreases are entered as debits.

The rules of debit and credit for income and expense accounts are based on the relationship of these
accounts to owner's equity. Income increases owner's equity and expense decreases owner's equity.
Hence, increases in income are recorded as credits and decreases as debits. Increases in expenses
are recorded as debits and decreases as credits. These are the rules of debit and credit. The following
summarizes the rules:

Balance Sheet Accounts

Assets

Liabilities and Owner's Equity

Debit
(+)

Increases^

Credit

(-)

Decreases_

Debit

(-)

Decreases_

Credit

(+)

Increases^

Normal Balance

Normal Balance

Income Statement Accounts

Debit for decreases in owner's equity

Credit for increases in owner's equity

Expenses

Income

Debit

(+)

Increases^

Credit

(-)

Decreases_

Debit
(-)

Decreases_

Credit

(+)

Increases^

Normal Balance

Normal Balance

Accounts

Debit

Credit

Increases in

Assets

Expenses^

Decreases in

Liabilities

Owner's Capital

Income_

Increases in

Liabilities

Owner's Capital

Income^

Decreases in
Assets

Expenses_

Module 2: Introduction to Financial Statements and Reporting

Learning Objectives:

To learn the elements of financial statements

To leam the usual accounts being used in recording

To learn the types and effects of common transactions

Elements of Financial Statements

The elements of financial statements defined in the March 2018 Conceptual Framework for Financial
Reporting (2018 Conceptual Framework) are:

assets, liabilities and equity-relate to a reporting entity's financial position; and

income and expenses-relate to a reporting entity's financial performance.

Financial Position

Asset

Per March 2018 Conceptual Framework for Financial Reporting (Conceptual Framework), asset is a
present economic resource controlled by the entity as a result of past events. An economic resource
is a right that has the potential to produce economic benefits. There are three aspects to these
definitions: "right", "potential to produce economic benefits"; and "control"

Rights that have the potential to produce economic benefits take many forms, including:

(a) rights that correspond to an obligation of another party, for example:

(i) rights to receive cash

(i) rights to receive goods or services.

(i) rights to exchange economic resources with another party on favorable terms. Such rights include,
for example, a forward contract to buy an economic resource on terms that are currently favorable
or an option to buy an economic resource.

(iv) rights to benefit from an obligation of another party to transfer an economic resource if a
specified uncertain future event occurs.

(b) rights that do not correspond to an obligation of another party, for example:
(i) rights over physical objects, such as property, plant and equipment or inventories. Examples of
such rights are a right to use a physical object or a right to benefit from the residual value of a leased
object.

(ii) rights to use intellectual property.

An economic resource could produce economic benefits for an entity by entitling or enabling it to do,
for example, one or more of the following:

(a) receive contractual cash flows or another economic resource

(b) exchange economic resources with another party on favorable terms:

(c.) produce cash inflows or avoid cash outflows by, for example:

(i) using the economic resource either individually or in combination with other economic resources
to produce goods or provide services

(ii) using the economic resource to enhance the value of other economic resources; or

(iii) leasing the economic resource to another party.

(d) receive cash or other economic resources by selling the economic resource, or

(e) extinguish liabilities by transferring the economic resource.

An entity controls an economic resource if it has the present ability to direct the use of the economic
resource and obtain the economic benefits that may flow from it. Control includes the present ability
to prevent other parties from directing the use of the economic resource and from obtaining the
economic benefits that may flow from it. It follows that, if one party controls an economic resource,
no other party controls that resource.
Liability

A liability is a present obligation of the entity to transfer an economic resource as a result of past
events. For a liability to exist, three criteria must all be satisfied:

(a) the entity has an obligation

(b) the obligation is to transfer an economic resource, and

(c) the obligation is present obligation that exists as a result of past events

An obligation is a duty or responsibility that an entity has no practical ability to avoid. An obligation is
always owed to another party (or parties) The other party (or parties) could be a person or another
entity, a group of people or other entities, or society at large. It is not necessary to know the identity
of the party (or parties) to whom the obligation is owed. If one party has an obligation to transfer an
economic resource, it follows that another party (or parties) has a right to receive that economic
resource.

Obligations to transfer an economic resource include, for example:

(a) obligations to pay cash

(b) obligations to deliver goods or provide services

(c) obligations to exchange economic resources with another party on unfavorable terms. Such
obligations include, for example, a forward contract to sell an economic resource

Typical Account Titles Used

Statement of Financial Position

• Assets
 Assets should be classified only into two current assets and noncurrent assets. Per revised
Philippine Accounting Standards (PAS) No. 1. an entity shall classify assets as current when:

it expects to realize the asset, or intends to sell or consume it, in its normal operating cycle

it holds the asset primarily for the purpose of trading

it expects to realize the asset within twelve months after the reporting period; or

the asset is cash or a cash equivalent (as defined in PAS No. 7) unless the asset is restricted from
being exchanged or used to settle a liability for at least twelve months after the reporting period.

All other assets should be classified as non-current assets. Operating cycle is the time between
the acquisition of assets for processing and their realization in cash or cash equivalents. When the
entity's normal operating cycle is not clearly identifiable, it is assumed to be twelve months.

• Current Assets

Cash. Cash is any medium of exchange that a bank will accept for deposit at face value, it includes
coins, currency, checks, money orders, bank deposits and drafts.

Cash Equivalents. Per PAS No. 7, these are short-term, highly liquid investments that are readily
convertible to known amounts of cash and which are subject to an insignificant risk of changes in
value.

Notes Receivable. A note receivable is a written pledge that the customer will pay the business a
fixed amount of money on a certain date.

Accounts Receivable. These are claims against customers arising from sale of services or goods on
credit. This type of receivable offers less security than a promissory note.

Inventories. Per PAS No. 2, these are assets which are (a) held for sale in the ordinary course of
business; (b) in the process of production for such sale, or (c) in the form of materials or supplies to
be consumed in the production process or in the rendering of services.

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 represent future economic benefits-assets-until the time these start to
contribute to the earning process; these, then, become expenses.

• Non-current Assets

Property, Plant and Equipment. Per PAS No. 16, these are tangible assets that are held by an
enterprise for use in the production or supply of goods or services, or for rental to others, or for
administrative purposes and which are expected to be used during more than one period Included
are such items as land building, machinery and equipment. furniture and fixtures, motor vehicles and
equipment.

Accumulated Depreciation. It is a contra account that contains the sum of the periodic depreciation
charges. The balance in this account is deducted from the cost of the related asset-equipment or
buildings-to obtain book value.

Intangible Assets. Per PAS No. 38, these are identifiable, nonmonetary assets without physical
substance held for use in the production or supply of goods or services, for rental to others, or for
administrative purposes. These include goodwill. patents, copyrights, licenses, franchises,
trademarks, brand names, secret processes, subscription lists and non-competition agreements

• Liabilities

Per revised Philippine Accounting Standards (PAS) No. 1, an entity shall classify a liability as current
when

a. it expects to settle the liability in its normal operating cycle

b. it holds the liability primarily for the purpose of trading

c. the liability is due to be settled within twelve months after the reporting period; or

d. the entity does not have an unconditional right to defer settlement of the liability for
at least twelve months after the reporting period.

All other liabilities should be classified as non-current liabilities.

• Current Liabilities

Accounts Payable. This account represents the reverse relationship of the accounts receivable. By
accepting the goods or services, the buyer agrees to pay for them in the near future.

Notes Payable. A note payable is like a note receivable but in a reverse sense. In the case of a note
payable, the 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.

Accrued Liabilities. Amounts owed to others for unpaid expenses. This includes salaries payable,
utilities payable, interest payable and taxes payable account

Unearned Revenues. When the business entity receives payment before providing its customers with
goods or services, the amounts received are recorded in the

unearned revenue account (liability method). When the goods or services are provided to the
customer, the unearned revenue is reduced and income is recognized.

Current Portion of Long-Term Debt. These are portions of mortgage notes, bonds and other long-
term indebtedness which are to be paid within one year from the balance sheet date.

• Non-current 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.

Bonds Payable. Business organizations 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 contract between the issuer and the lender specifying the terms of repayment
and the interest to be charged.

• Owner's Equity

Capital (from the Latin capitalis, meaning "property"). 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 profit
earned during the year or is decreased by a loss. Cash or other assets that the owner may withdraw
from the business ultimately reduce it. This account title bears 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 Summary. It is a temporary account used at the end of the accounting period to close income
and expenses. This account shows the profit or loss for the period before closing to the capital
account.

Income Statement/Statement of Financial Performance Accounts

• Income

Service Income. 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. Revenues 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 purchase or to produce the products sold to customers during the
period, also called cost of goods sold.

Salaries or Wages Expense. Includes all payments as a result of an employer- employee relationship
such as salaries or wages, 13th month pay, cost of living allowances and other related 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 of using supplies (eg. office supplies) in the conduct of daily business

Insurance Expense. Portion of premiums paid on insurance coverage (e.g on motor vehicle, health,
life, fire, typhoon or flood) which has expired.

Depreciation Expense. The portion of the cost of a tangible asset (eg. buildings and equipment)
allocated or charged as expense during an accounting period,

Uncollectible Accounts Expense. The amount of 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.
Types and Effects of Transactions

It will be beneficial in the long-term to be able to understand a classification approach that

emphasizes the effects of accounting events rather than the recording procedures involved. This
approach is quite pioneering Although business entities engage in numerous transactions, all
transactions can be classified into one of four types, namely:

Source of Assets (SA). An asset account increases and a corresponding claims (abilities or owner's
equity) account increases. Examples: (1) Purchase of supplies on account; (2) Sold goods on cash on
delivery basis.

Exchange of Assets (EA). One asset account increases and another asset account decreases. Example:
Acquired equipment for cash.

Use of Assets (UA). An asset account decreases and a corresponding claims (liabilities or equity)
account decreases. Example (1) Settled accounts payable: (2) Paid salaries of employees.

Exchange of Claims (EC). One claims (liabilities or owner's equity) account increases and another
claims (liabilities or owner's equity) account decreases. Example: Received utilities bill but did not
pay.

Every accountable event has a dual but self-balancing effect on the accounting equation. Recognizing
these events will not in any manner affect the equality of the basic:

accounting model. The four types of transactions above may be further expanded into nine types of
effects as follows:

Increase in Assets = Increase in Liabilities (SA)

Increase in Assets Increase in Owner's Equity (SA)

Increase in one Asset Decrease in another Asset (EA)

Decrease in Assets Decrease in Liabilities (UA)

Decrease in Assets Decrease in Owner's Equity (UA)

Increase in Liabilities Decrease in Owner's Equity (EC)

Increase in Owner's Equity Decrease in Liabilities (EC)

Increase in one Liability Decrease in another Liability (EC)

Increase in one Owner's Equity = Decrease in another Owner's Equity (EC)

Accounting for Business Transactions

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

Financial Transaction Worksheet

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

Distinction between Revenues and Receipts

At this point, it will be useful to learn the distinction between revenues and receipts as illustrated in
the following table. The table shows various types of sales transactions and classifies the effect of
each on cash receipts and sales revenues for "this year":

This Year

Transaction

Amount

Cash Receipts

Sales Revenue

Cash sales made this year.

P200,000

P200,000

P200,000

Credit sales made last year; cash received this year

300,000
300,000

Credit sales made this year; cash received this year.

400,000

400,000

400,000

Credit sales made this year, cash to be received next year

100,000

100,000

Total

P900,000

P700,000

Illustration. Galicano Del Mundo decided to establish a sole proprietorship business and named it Del
Mundo Graphics Design. Del Mundo is a graphic designer who has extensive experience in drawing
layout, typography, lettering, diagramming and photography. He possesses the talent to visually
communicate to a target audience with the right combination of words, images and ideas.

Del Mundo Graphics Design can do the layout and production design of newspapers, magazines,
corporate reports, journals and other publications. The entity can create promotional displays;
marketing brochures for services and products; packaging design for products; and distinctive logos
for businesses. He also enters into agreements with clients for the progressive development and
maintenance of their web sites. His initial revenue stream comes from web designing

The owner, Galicano Del Mundo, makes the business decisions. The assets of the company belong to
Del Mundo and all obligations of the business are his responsibility. Any income that the entity earns
belongs solely to Del Mundo
When a specific asset, liability or owner's equity item is created by a financial transaction, it is listed
in the financial transaction worksheet using the appropriate accounts. The worksheet that follows
shows the first transaction of the Del Mundo Graphics Design. The dates are enclosed in parentheses

During March 2018, the first month of operations, various financial transactions took place. These
transactions are described and analyzed as follows:

Mar. 1 Del Mundo started his new business by depositing P350,000 in a bank account in the name of
Del Mundo Graphics Design at BPI Poblacion Branch

Del Mundo Graphics Design

Financial Transaction Worksheet

Month of March 2018

Assets = Liabilities + Owner's Equi

Cash = Del Mundo, Capital

(1) P350.000 = P350.000

The financial transaction is analyzed as follows:

An entity separate and distinct from Del Mundo's personal financial affairs is created.

An economic resource-cash of P350,000 is invested in the business entity. The source of this asset is
the contribution made by the owner, which represents owner's equity. The owner's equity account is
Del Mundo, Capital.

The dual nature of the transaction is that cash is invested and owner's equity created. The effects on
the accounting equation are as follows: increase in asset- cash from zero to P350,000 and increase in
owner's equity from zero to P350,000.

At this point, the entity has no liabilities, and assets equal owner's equity.

Mar. 5 Computer equipment costing P145,000 is acquired on a cash basis. The effect of the
transaction on the basic equation is:
Assets = Liabilities + Owner's Equity

Cash + Computer = Del Mundo, Capital

Equipment

Bal. P350,000 = P350,000

Mar. (5) (145,000) 145,000 =

Bal. P205,000 + P145,000 = P350,000

P350,000 = P350,000

This transaction did not change the total assets but it did change the composition of the assets-it
decreased one asset-cash and increased another asset-computer equipment by P145,000. Note that
the sums of the balances on both sides of the equation are equal. This equality must always exist

Mar. 9 Computer supplies in the amount of P25,000 are purchased on account

Assets = Liabilities + Owner's Equity

Cash + Computer + Computer = Accounts + Del Mundo, Capital

Supplies Equipment Payable

Bal. P205,000 145,000 = P350,000

(9) P25,000 = P25,000 _________

Bal. P205,000 P25,000 P145,000 = P25,000 P350,000

P375,000 = P375,000

Assets don't have to be purchased in cash. It can also be purchased on credit. Acquiring the
computer supplies with a promise to pay the amount due later is called buying on account This
transaction increases both the assets and the liabilities of the business. The asset affected is
computer supplies and the liability created is an accounts payable.

Mar. 11 Del Mundo Graphics Design collected P88,000 in cash for designing interactive websites for
two exporters based inside the Ortigas Ecozone.
Assets = Liabilities + Owner's Equity

Cash + Computer + Computer = Accounts + Del Mundo, Capital

Supplies Equipment Payable

Bal. P205,000 P25,000 145,000 = P25,000 P350,000

(11) 88,000 88,000

Bal. P205,000 P25,000 P145,000 = P25,000 P438,000

P463,000 = P463,000

The entity earned service income by designing web sites for clients. Del Mundo rendered his
professional services and collected revenues in cash. The effect on the accounting equation is an
increase in the asset-cash and an increase in owner's equity. Income increases owner's equity. This
transaction caused the business to grow, as shown by the increase in total assets from P375,000 to
P463.000

Mar. 16 Del Mundo paid P18,000 to Ceradoy Bills Express, a one-stop bills payment service company,
for the semi-monthly utilities.

Assets = Liabilities + Owner's Equity

Cash + Computer + Computer = Accounts + Del Mundo, Capital

Supplies Equipment Payable

Bal. P293,000 P25,000 145,000 = P25,000 P438,000

(16) 18,000 (18,000)

Bal. P275,000 P25,000 P145,000 = P25,000 P420,000

P445,000 = P445,000

Expenses are recorded when they are incurred. Expenses can be paid in cash when they occur. or
they can be paid later. The payment for utilities is an expense for the month of March. It represented
an outflow of resources and a reduction of owner's equity. Expenses have the opposite effect of
income; they cause the business to shrink as shown by the smaller amount of total assets of
P445,000.

Mar. 17 The entity has service agreements with several Netpreneurs to maintain and update their
web sites weekly, Del Mundo billed these clients P35,000 for services already rendered during the
month.
 A = L + OE

Cash + Accounts + Computer + Computer = Accounts + Del Mundo,

Receivable Supplies Equipment Payable Capital

Bal. P275,000 P25,000 145,000 = P25,000 P438,000

(17) P35,000 P35,000

Bal. P275,000 P35,000 P25,000 P145,000 = P25,000 P455,000

P480,000 = P480,000

The entity has performed services to clients so income should already be recognized. Del Mundo is
entitled to receive payment for these but the clients did not pay immediately. Performing the
services creates an economic resource, the clients promise to pay the amount which is called
accounts receivable. This transaction resulted to an increase in an asset-accounts receivable and an
increase in owner's equity of P35.000.

Mar. 19 Del Mundo made a partial payment of P17,000 for the Mar. 9 purchase on account.

A = L + OE

Cash + Accounts + Computer + Computer = Accounts + Del Mundo,

Receivable Supplies Equipment Payable Capital

Bal. P275,000 P25,000 145,000 = P25,000 P455,000

(19) (17,000) (17,000) . Bal. P258,000

P35,000 P25,000 P145,000 = 8,000 P455,000

P463,000 = P463,000

This transaction is a payment on account. The effect on the accounting equation is a decrease in the
asset-cash and a decrease in the liability-accounts payable. The payment of cash on account has no
effect on the asset-computer supplies because the payment does not increase or decrease the
supplies available to the business.

Mar. 20 Checks totaling P25,000 were received from clients for billings dated Mar. 17.
 A = L + OE

Cash + Accounts + Computer + Computer = Accounts + Del Mundo,

Receivable Supplies Equipment Payable Capital

Bal. P258,000 P35,000 P25,000 145,000 = 8,000 P455,000 (20) (25,000)

(25,000) . Bal. P283,000 P10,000
P25,000 P145,000 = 8,000 P455,000

P463,000 = P463,000

Last Mar 17, Del Mundo billed clients for services already rendered. On Mar 20, the entity was able
to collect P25,000 from them. The asset-cash is increased by P25,000. The business should not
record service income on Mar 20 since it has already recorded the income last Mar. 17. Total assets
are unchanged. The business merely reduced one asset-accounts receivable and increased another-
cash.

Mar. 21 Del Mundo withdrew P20,000 from the business for his personal use.

A = L + OE

Cash + Accounts + Computer + Computer = Accounts + Del Mundo,

Receivable Supplies Equipment Payable Capital

Bal. P283,000 P10,000 P25,000 145,000 = 8,000 P455,000 (21) (20,000)

(20,000) Bal. P263,000 P10,000 P25,000 P145,000 = 8,000 P435,000

P443,000 = P443,000

Withdrawal of cash or other assets for personal use is the way by which the owner of the entity
receives advance distribution of the profits. On Mar 1, Del Mundo invested P350,000, both cash and
owner's equity increased. The transaction was an investment by the owner and not an income-
generating activity. Del Mundo simply transferred funds from his personal account to the business. A
cash withdrawal is exactly the opposite. The P20,000 cash withdrawal transaction resulted to a
reduction in both cash and owner's equity.

Mar. 27 Warlito Blanche Publishing submitted a bill to Del Mundo for P8,000 worth of newspaper
advertisements for this month. Del Mundo will pay this bill next month.
 A = L + OE

Cash + Accounts + Computer + Computer = Accounts + Del Mundo,

Receivable Supplies Equipment Payable Capital

Bal. P263,000 P10,000 P25,000 145,000 = 8,000 P435,000 (27)

8,000 (8,000) Bal. P263,000 P10,000 P25,000 P145,000 = 16,000
P427,000

P443,000 = P443,000

Warlito Blanche rendered services on account. Del Mundo Graphics Design has incurred an expense
in the amount of P8,000 by availing of Warlito Blanche's services. There was no payment during the
month. This advertising expense resulted to a decrease in owner's equity and an increase in the
liability-accounts payable.

Mar. 31 Del Mundo paid his assistant designer salaries of P15,000 for the month.

A = L + OE

Cash + Accounts + Computer + Computer = Accounts + Del Mundo,

Receivable Supplies Equipment Payable Capital

Bal. P263,000 P10,000 P25,000 145,000 = 16,000 P427,000 (31) (15,000)

(15,000) Bal. P248,000 P10,000 P25,000 P145,000 = 16,000 P412,000

P428,000 = P428,000

This transaction resulted to a reduction in owner's equity as well as a reduction in cash. By providing
his services to Del Mundo for the month, the assistant designer has created for the business an
expense-salaries expense.

Use of T-Accounts

Analyzing and recording transactions using the accounting equation is useful in conveying a basic
understanding of how transactions affect the business. However, it is not an efficient approach once
the number of accounts involved increases Double-entry system provides a formal system of
classification and recording business transactions.

Illustration. The rules of debit and credit will be applied to the Del Mundo Graphics Design
illustration for comparison. Three transactions will be added to the example. Before being recorded,
a transaction must be analyzed to determine which accounts must be increased or decreased. After
this has been determined, the rules of debit and credit are applied to effect the appropriate
increases and decreases to the accounts.

Mar. 1 Del Mundo started his new business by depositing P350,000 in a bank account in the name of
Del Mundo Graphics Design at BPI Poblacion Branch.

Assets (Increase)

Cash

Owner's Equity (Increase)

Del Mundo, Capital

Debit

(+)

3-1 350,000

Credit

(-)

Debit

(-)

Credit

(+)

3-1 350,000
This transaction increased both the asset-cash and owner's equity. According to the rules of debit
and credit, an increase in asset is recorded as debit while an increase in owner's equity is recorded as
credit, thus, the entry is to debit cash and to credit Del Mundo, Capital. The transaction dates are
placed on the left side of the amounts for reference.

Mar. 2 Computer equipment is acquired by issuing a P50,000 note payable to Maribeth Buenviaje
Office Systems. The note is due in six months.

Assets (Increase)

Computer Equipment

Liabilities (Increase)

Notes Payable

Debit

(+)

3-2 50,000

Credit

(-)

Debit

(-)

Credit

(+)

3-2 50,000

The transaction increased by P50,000 the asset-computer equipment and the liability-notes payable.
Computer equipment must be debited and notes payable must be credited.

Mar. 3 Del Mundo paid P15,000 to RF Refozar Suites for rent on the office studio for the months of
March, April and May.
Assets (Decrease)

Cash

Assets (Increase)

Prepaid Rent

Debit

(+)

3-1 350,000

Credit

(-)

3-3 15,000

Debit

(+)

3-3 15,000

Credit

(-)

The entity paid advance rent for three months. A resource having future economic benefit-prepaid
rent, is acquired for a cash payment of P15,000. Increases in assets are recorded by debits and
decreases in assets are recorded by credits. The transaction resulted to a debit to prepaid rent and a
credit to cash for P15,000. The prepaid rent is consumed based on the passage of time so that after
one month, P5,000 of the prepaid rent will be transferred to the rent expense account.
Mar. 4 Received advance payment of P18,000 from Marco Polo Ortigas Hotel for web site

updating for the next three months.

Assets (Increase)

Cash

Liabilities (Increase)

Unearned Revenues

Debit

(+)

3-1 350,000

3-4 18,000

Credit

(-)

3-3 15,000

Debit

(-)

Credit

(+)

3-4 18,000

The entity has an obligation to Marco Polo Ortigas Hotel for the next three months. This liability is
called unearned revenues. The asset-cash is increased by a debit of P18,000 and the liability-
unearned revenues is increased by a credit of P18,000. As it renders service, the entity discharges its
obligation at a rate of P6,000 per month for the next three months.

Mar. 5 Computer equipment costing P145,000 is acquired on cash basis.

Assets (Decrease)

Cash

Assets (Increase)

Computer Equipment

Debit

(+)

3-1 350,000

3-4 18,000

Credit

(-)

3-3 15,000

3-5 145,000

Debit

(+)

3-2 50,000

3-5 145,000

Credit

(-)
This transaction increased the asset-computer equipment and decreased the asset-cash. Assets are
increased by debits and decreased by credits; thus, computer equipment is debited and cash is
credited for P145,000.

Mar. 9 Computer supplies in the amount of P25,000 are purchased on account.

Assets (Increase)

Computer Supplies

Liabilities (Increase)

Accounts Payable

Debit

(+)

3-9 25,000

Credit

(-)

Debit

(-)

Credit

(+)

3-9 25,000
The asset-computer supplies is increased by a debit of P25,000 while the liability account- accounts
payable is increased by a credit for the same amount.

Mar. 11 Del Mundo Graphics Design collected P88,000 in cash for designing web sites.

Assets (Increase)

Cash

Owner's Equity (Increase)

Design Revenues

Debit

(+)

3-1 350,000

3-4 18,000

3-11 88,000

Credit

(-)

3-3 15,000

3-5 145,000

Debit

(-)

Credit

(+)

3-11 88,000
The transaction increased the asset-cash and increased the income account-design revenues. Assets
are increased by debits, income are increased by credits; hence, a debit of P88,000 to cash and a
credit of P88,000 to design revenues is made. Increases in income increase owner's equity.

Mar. 16 Del Mundo paid P18,000 to Ceradoy Bills Express for the semi-monthly utilities.

Assets (Increase)

Cash

Owner's Equity (Decrease)

Utilities Expense

Debit

(+)

3-1 350,000

3-4 18,000

3-11 88,000

Credit

(-)

3-3 15,000

3-5 145,000

3-16 18,000

Debit

(+)

3-16 18,000

Credit

(-)
Expenses are increased by debits and assets are decreased by credits; therefore, utilities expense is
debited and cash credited for P18.000. Increases in expenses decrease owner's equity.

Mar. 17 Del Mundo billed clients P35,000 for services already rendered during the month.

Assets (Increase)

Accounts Receivable

Owner's Equity (Increase)

Design Revenues

Debit

(+)

3-17 35,000

Credit

(-)

Debit

(-)

Credit

(+)

3-11 88,000

3-17 35,000

Assets are increased by debits, income are increased by credits. Increases in income increase owner's
equity. A debit of P35,000 to accounts receivable and a credit of P35,000 to the income account-
design revenues is needed.
Mar. 19 Del Mundo partially paid P17,000 for the Mar. 9 purchase of computer supplies.

Assets (Decrease)

Cash

Liabilities (Decrease)

Accounts Payable

Debit

(+)

3-1 350,000

3-4 18,000

3-11 88,000

Credit

(-)

3-3 15,000

3-5 145,000

3-16 18,000

3-19 17,000

Debit

(-)

3-19 17,000

Credit

(+)

3-9 25,000
Assets are decreased by credits while liabilities are decreased by debits. The transaction is recorded
by debiting accounts payable and crediting cash for P17,000 each.

Mar. 20 Received checks totaling P25,000 from clients for billings dated Mar. 17.

Assets (Decrease)

Cash

Liabilities (Decrease)

Accounts Payable

Debit

(+)

3-1 350,000

3-4 18,000

3-11 88,000

3-20 25,000

Credit

(-)

3-3 15,000

3-5 145,000

3-16 18,000

3-19 17,000

Debit

(+)

3-17 35,000

Credit

(-)
3-20 25,000

Collections on account reduced the asset-accounts receivable but increased the asset-cash. Assets
are increased by debits and decreased by credits; thus, a debit to cash for P25,000 and a credit to
accounts receivable for P25,000 is made.

Mar. 21 Del Mundo withdrew P20,000 from the business for his personal use.

Assets (Decrease)

Cash

Owner's Equity (Decrease)

Del Mundo, Withdrawals

Debit

(+)

3-1 350,000

3-4 18,000

3-11 88,000

3-20 25,000

Credit

(-)

3-3 15,000

3-5 145,000

3-16 18,000

3-19 17,000

3-21 20,000

Debit

(+)
3-21 20,000

Credit

(-)

Withdrawals are reductions of owner's equity but are not expenses of the business entity. A
withdrawal is a personal transaction of the owner that is exactly the opposite of an investment.

This transaction increased the withdrawals account but reduced cash. Debits record increases in the
withdrawals account and credits record decreases in asset accounts; thus, a debit to withdrawals and
a credit to cash for P20,000 each is necessary.

Mar. 27 Warlito Blanche billed Del Mundo for P8,000 ads. Del Mundo will pay next month.

Liabilities (Increase)

Accounts Payable

Owner's Equity (Decrease)

Advertising Expense

Debit

(-)

3-19 17,000

Credit

(+)
3-9 25,000

3-27 8,000

Debit

(+)

3-27 8,000

Credit

(-)

This transaction increased the expense-advertising expense and increased the liability-accounts
payable by P8,000. Expenses are increased by debits while liabilities are increased by credits, hence,
an entry to debit advertising expense and to credit accounts payable for P8,000 is needed.

Mar. 31 Del Mundo paid his assistant designer salaries of P15,000 for the month.

Assets (Decrease)

Cash

Owner's Equity (Decrease)

Salaries Expense

Debit

(+)

3-1 350,000

3-4 18,000

3-11 88,000
3-20 25,000

Credit

(-)

3-3 15,000

3-5 145,000

3-16 18,000

3-19 17,000

3-21 20,000

3-31 15,000

Debit

(+)

3-31 15,000

Credit

(-)

Expenses are increased by debits and assets are decreased by credits. Hence, salaries expense is
debited for P15,000 and cash credited for the same amount. Increases in salaries expense decrease
owner's equity.
Module 3: Accounting Process

Learning Objectives:

To learn the whole accounting process

Weather or not! The moral of the following story is to look for a potentially prosperous technology
gathering dust and exploit it in a good way. That's what Frederic Fox, 34, did when he bought a
business that supplied advisory services to large corporations.

After renaming the acquired company as Strategic Weather Services (SWS) Inc., Fox expanded his
core business-patented technology that forecasts weather 12 months advance in North America and
Europe, and analyzes business techniques to predict a company's success. Today, his 90-employee
firm projects 1999 sales of US$13.0 million from its three divisions. One division helps retailers and
manufacturers plan sales based on long-range weather data: Another division helps utility companies
plan operations. Launched late last year, the third division offers consumers the popular
WeatherPlanner, the long-range weather forecasting via a web site.

Fox did not know if the Weather Planner concept would prosper. He seriously considered starting the
business only after consulting SWS meteorologists in 1993 to plan his wedding. His fiancée's
requirement was for Fox to ensure that their wedding would be free from rain. It was rain-free. In
1994, WeatherPlanner hit the drawing board. Adapted from: Business Start-Ups, April 1999,

Fox provides people with valuable information-weather forecasts twelve months in advance in North
America and Europe. His weather services help businesses plan their operations. Fox is using data to
study the weather cycle in that part of the world. In parallelism, entities also have their own
"weather" cycle-the accounting cycle.

Source Documents

Transactions and events are the starting points in the accounting cycle. By relying on source
documents, transactions and events can be analyzed as to how they will affect performance and
financial position. Source documents identify and describe transactions and events entering the
accounting process. These original written evidences contain information about the nature and the
amounts of the transactions These are the bases for the journal entries; some of the more common
source documents are sales invoices, cash register tapes, official receipts, bank deposit slips, bank
statements, checks, purchase orders, time cards and statements of account.
Accounting Cycle

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

Step 1. Identification of Events to be Recorded

Aim: To gather information about transactions or events generally through the source documents,

During the accounting

Step 2 Transactions are Recorded in the Journal

Aim: To record the economic impact of transactions on the firm in a journal, which is a form that
facilitates transfer to the accounts.

Step 3 Journal Entries are Posted to the Ledger

Aim: To transfer the information from the journal to the ledger for classification

Step 4 Preparation of a Trial Balance

Aim: To provide a listing to verify the equality of debits and credits in the ledger.

Step 5 Preparation of the Worksheet including Adjusting Entries

Aim: To aid in the preparation of financial statements.

Step 6 Preparation of the Financial Statements

Aim: To provide useful information to decision-makers.

At the end of the accounting period

Step 7 Adjusting Journal Entries are Journalized and Posted

Aim: To record the accruals, expiration of deferrals, estimations and other events from the
worksheet.

Step 8 Closing Journal Entries are Journalized and Posted

Aim: To close temporary accounts and transfer profit to owner's equity.

Step 9 Preparation of a Post-Closing Trial Balance

Aim: To check the equality of debits and credits after the closing entries.

At the start of the next period

Step 10 Reversing Journal Entries are Journalized and Posted

Aim: To simplify the recording of certain regular transactions in the next accounting period.

This cycle is repeated each accounting period. The first three steps in the accounting cycle are
accomplished during the period. The fourth to the ninth steps generally occur at the end of the
period. The last step is optional and occurs at the beginning of the next period.
The Journal

The journal is a chronological record of the entity's transactions. A journal entry shows all the effects
of a business transaction in terms of debits and credits. Each transaction is initially recorded in a
journal rather than directly in the ledger. A journal is called the book of original entry. The nature and
volume of transactions of the business determine the number and type of journals needed. The
general journal is the simplest journal.

Format

The standard contents of the general journal are as follows

Date. The year and month are not rewritten for every entry unless the month changes or a new page
is needed.

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, skip a line after each entry.

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.

Debit. The debit amount for each account is entered in this column.

Credit. The credit amount for each account is entered in this column.

Assume that Maria Concepcion Jennifer Perez-Manalo established her own wedding consultancy
with an initial investment of P250,000 on May 1.

The journal entry is shown below:

Journal

page 1
Date

Account Titles and Explanation.

P. R.

Debit

Credit

2018

May 1

Cash

250,000

Perez-Manalo, Capital
250,000

Initial Investment.

Simple and Compound Entry

In a simple entry, only two accounts are affected-one account is debited and the other account
credited. An example of this is the entry to record the initial investment of Perez-Manalo. However,
some transactions require the use of more than two accounts.
When three or more accounts are required in a journal entry, the entry is referred to as a compound
entry.

Transaction Analysis (Step 1).

The analysis of transactions should follow these four basic steps:

Identify the transaction from source documents.

Indicate the accounts-either assets, liabilities, equity, income or expenses- affected by the
transaction.

Ascertain whether each account is increased or decreased by the transaction.

Using the rules of debit and credit, determine whether to debit or credit the account to record its
increase or decrease.

Transactions are Journalized (Step 2)

After the transaction or event has been identified and measured, it is recorded in the journal. The
process of recording a transaction is called journalizing. The following are the transactions for
Weddings "R" Us during the month of May. The double-entry system will be used.

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

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

Two or more accounts are affected by each transaction.

The sum of the debits for every transaction equals the sum of the credits.

The equality of the accounting equation is always maintained.

Initial Investment (Source of Assets)

May 1

Dr. Rose Besaro is a social entrepreneur from the South. She is into a lot of interesting causes. Her
fine taste is preeminent such that she is considered an authority in planning weddings. She does not
intend to "charge much". Upon the advice and prodding of an esteemed colleague. Dr. Yolanda
Sayson, Besano decided to organize her wedding consultancy. She invested P250,000 into this entity.

Analysis

Assets increased. Owner's equity increased

Rules

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

Entry

Increase in assets is recorded by a debit to cash. Increase in owner's equity is recorded by a credit to
Besano Capital What is the journal entry?

Dr Cr

Rent Paid in Advance (Exchange of Assets)

May 1

Rented office space and paid two months rent in advance, P8,000

Analysis

Assets increased. Assets decreased.

Rules

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

Entry

Increase in assets is recorded by a debit to prepaid rent. Decrease in assets is recorded by a credit to
cash. What is the journal entry?

Dr Cr

Note Issued for Cash (Source of Assets)

May 2

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

Analysis

Assets increased. Liabilities increased.

Rules

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

Entry

Increase in assets is recorded by a debit to cash. Increase in liabilities is recorded by a credit to notes
payable. What is the journal entry?

Dr Cr

May 2

Hired an office assistant and an account executive each with a P7.800 monthly salary Or, each is to
receive P300 per day for the 26-day work month. What is the journal entry?

Service Vehicle Acquired for Cash (Exchange of Assets)

May 4

Acquired service vehicle for 20,000

Analysis

Assets increased. Assets decreased.

Rules

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

Entry

Increase in assets is recorded by a debit to service vehicle. Decrease in assets is recorded by a credit
to cash. What is the journal entry?

Dr Cr

Insurance Premium Paid (Exchange of Assets)

May 4

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

Analysis

An asset increased. Another asset decreased.

Rules

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

Entry

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

credit to cash. What is the journal entry?

Dr Cr

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

May 5

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

Analysis

Assets increased. Assets decreased. Liabilities increased.

Rules

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

Entry

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

credit to cash. Increase in liabilities is recorded by a credit to accounts payable. What is the journal
entry?

Dr Cr

Supplies Purchased on Account (Source of Assets)

May 8

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

Analysis

Assets increased. Assets decreased. Liabilities increased.

Rules

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

Entry

Increase in assets is recorded by a debit to supplies. Increase in liabilities is recorded by a credit to

accounts payable.

Dr Cr

Accounts Payable Partially Settled (Use of Assets)

May 9

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

Analysis

Assets decreased. Liabilities decreased

Rules

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

Entry
Decrease in abilities is recorded by a debit to accounts payable. Decrease in assets is recorded by a
credit to cash. What is the journal entry?

Dr Cr

Revenues Earned and Cash Collected (Source of Assets).

May 10

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

Analysis

Assets increased. Owner's equity increased.

Rules

Increases in assets are recorded by debits.

Entry

Increases in owner's equity are recorded by credits Increase in assets is recorded by a debit to cash
increase in owner's equity in recorded by a credit to consulting revenues What is the journal entry?

Dr Cr

Salaries Paid (Use of Assets)

May 13

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

Analysis

Assets decreased. Owner's equity decreased.

Rules

Decreases in assets are recorded by credits. Decreases in owner's equity are recorded by debts.

Entry

Decrease in owner's equity is recorded by a debit to salaries expense Decrease in assets is recorded
by a credit to cash. What is the journal entry?

Dr Cr

Unearned Revenues Collected (Source of Assets)

May 15

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

Analysis

Assets increased. Liabilities increased.

Rules

Increases in assets are recorded by debits. Increases in abilities are recorded by credits.

Entry

Increase in assets is recorded by a debit to cash. Increase in liabilities is recorded by a credit to

unnamed referral revenues. What is the journal entry?

Dr Cr

Revenue Earned on Account (Source of Assets)

May 19

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

Analysis

Assets increased. Owner's equity increased.

Rules

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

Entry

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

recorded by a credit to consulting revenues. What in the journal entry?

Dr Cr

Withdrawal of Cash by Owner (Use of Assets)

May 25

Besario withdrew P14,000 for personal expenses.

Analysis

Assets decreased. Owner's equity decreased.

Rules

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

Entry

Decrease in owner's equity is recorded by a debit to Besario, Withdrawals. Decrease in assets is

recorded by a credit to cash. What is the journal entry?

Dr Cr

Salaries Paid (Use of Assets)

May 27
Paid salaries P7,200

Analysis

Assets decreased. Owner's equity decreased.

Rules

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

Entry

Decrease in owner's equity is recorted by a debit to salaries expense. Decrease in annets in recorded
by a credit to cash What is the journal entry?

Dr Cr

Expenses Incurred but Unpaid (Exchange of Claims)

May 30

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

Analysis

Liabilities increased. Owner's equity decreased.

Rules

Increases in liabilities are recorded by credits. Decreases in owners equity are recorded by debits.

Entry

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

recorded by a credit to utilities payable. What is the journal entry?

Dr Cr

Accounts Receivable Partially Collected (Exchange of Assets)

May 30

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

Analysis

An asset increased. Another asset decreased.

Rules

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

Entry

Increase in assets is recorded by a debit to cash. Decrease in assets is recorded by a credit to

accounts receivable. What is the journal entry?

Dr Cr
WEDDING "R" Us

Chart of Accounts

Balance Sheet Accounts Income Statement Accounts

Assets Income

110 Cash 410 Consulting Revenues

120 Accounts Receivable 420 Referral Revenues

130 Supplies

140 Prepaid Rent Expenses

150 Prepaid Insurance 510 Salaries Expense

160 Service Vehicle 520 Supplies Expense

165 Accumulated Depreciation 530 Rent Expense

170 Office Equipment 540 Insurance Expense

175 Accumulated Depreciation 550 Utilities Expense

Liabilities 560 Depreciation Expense-Service Vehicle

210 Notes Payable 570 Depreciation Expense - Office Equipment

220 Accounts Payable 580 Miscellaneous Expense

230 Salaries Payable 590 Interest Expense

260 Unearned Referral Revenues

Owner's Equity

310 Besario, Capital

320 Besario, Withdrawals

330 Income Summary

Posting (Step 3)
 Posting means transferring the amounts from the journal to the appropriate accounts in the
ledger. Debits in the journal are posted as debits in the ledger, and credits in the journal as credits in
the ledger. The steps are illustrated as follows:

Transfer the date of the transaction from the journal to the ledger.

Transfer the page number from the journal to the journal reference (J.R.) column of the ledger.

Post the debit figure from the journal as a debit figure in the ledger and the credit figure from the
journal as a credit figure in the ledger.

Enter the account number in the posting reference column of the journal once the figure has been
posted to the ledger.

The Journal

Date

Account Titles and Explanation.

P. R.

Debit

Credit

2020
2

May 1

Cash

110

250,000

Besario, Capital

310

250,000

Initial Investment.

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

The accounts in the general ledger are classified into two general groups:

balance sheet or permanent accounts (assets, liabilities and owner's equity).

income statement or temporary accounts (income and expenses). Temporary or nominal accounts
are used to gather information for a particular accounting period. At the end of the period, the
balances of these accounts are transferred to a permanent owner's equity account.

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

Chart of Accounts

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

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

The Ledger

Account: Cash
Date

Account Titles and Explanation.

P. R.

Debit

Credit

Credit

2020

May 1

Cash

J-1

250,000

250,000

Account: Besario, Capital

Date

Account Titles and Explanation.

P. R.

Debit

Credit

Credit

2020

May 1

Cash

J-1

250,000

250,000

Ledger Accounts After Posting

At the end of an accounting period, the debit or credit balance of each account must be determined
to enable us to come up with a trial balance.

Each, account balance is determined by footing (adding) all the debits and credits.

If the sum of an account's debits is greater than the sum of its credits, that account has a debit
balance.

If the sum of its credits is greater, that account has a credit balance.

Illustration. The ledger accounts of Weddings "p" Us after posting are shown below. The account
numbers and journal reference columns are purposely omitted. The balance of each account has
been determined.

Cash

Notes Payable

May 1

250,000

May 1

8,000

May 2

210,000

210,000

420,000
Balance

210,000

10

26,400

14,400

15

10,000

15,000

Accounts Payable

30

24,000

10,000

May 9

10,000

May 5

45,000

13

6,600
8

18,000

25

14,000

10,000

63,000

27

7,200

Balance

53,000
31

3,000

Utilities Payable

520,400

498,200

May 30

1,400

Balance

22,200

Balance

1,400
Unearned Referral Revenues

May 15

10,000

Accounts Receivable

Balance

10,000

May 19

36,000

May 31

24,000

Balance

12,000
Besario, Capital

Supplies

May 1

250,000

May 8

18,000

Balance

250,000

Balance

18,000
Prepaid Rent

Besario, Withdrawals

May 1

8,000

May 25

14,000

Balance

8,000

Balance

14,000
Prepaid Insurance

Consulting Services

May 4

14,000

May 10

26,400

Balance

14,000

19

36,000
62,400

Balance

53,000

Service Vehicle

Salaries Expense

May 4

420,000

May 13

6,600

Balance

420,000
7,200

13,800

Office Equipment

Balance

13,800

May 5

14,000
Balance

14,000

Utilities Expense

May 30

1,400

31

3,000

Balance

4,400
3.4 Trial Balance (Step 4)

Trial Balance - is a list of all accounts with their respective debit or credit balances. It is prepared to
verify the equality of debits and credits in the ledger at the end of each accounting period or at any
time the postings are updated

The procedures in the preparation of a trial balance follow:

List the account titles in numerical order.

Obtain the account balance of each account from the ledger and enter the debit balances in the
debit column and the credit balances in the credit column.

Add the debit and credit columns.

Compare the table.

The trial balance is a control device that helps minimize accounting errors. When the totals are
equal, the trial balance is in balance. This equality provides an interim proof of the accuracy of the
records but it does not signify the absence of errors For example, if the bookkeeper failed to record
payment of rent expense is understated and cash is overstated.

The trial balance for the illustration follows:

Weddings "R" Us

Trial Balance

May 31, 2020

Cash

P 22,200
Accounts Receivable

12,000

Supplies

18,000

Prepaid Rent

8,000

Prepaid Insurance

14,400

Service Vehicle

420,000

Office Equipment

60,000

Notes Payable

P 210,000

Accounts Payable
53,000

Utilities Payable

1,400

Unearned Referral Revenue

10,000

Besario, Capital

250,000

Besario, Withdrawals

14,000

Consulting Revenues

62,400

Salaries Expense

13,800

Utilities Expense

4,400
586,800

586,800

Locating Errors

An inequality in the totals of the debits and credits would automatically signal the presence of an
error. These errors include:

Error in posting a transaction to the ledger.

an erroneous amount was posted to the account

a debit entry was posted as a credit or vice versa.

a debit or credit posting was omitted.

Error in determining the account balances.

a balance was incorrectly computed.

a balance was entered in the wrong balance column.

Error in preparing the trial balance:

one of the columns of the trial balance was incorrectly added.

the amount of an account balance was incorrectly recorded on the trial balance.

a debit balance was recorded on the trial balance as a credit or vice versa, or a balance was omitted
entirely.

What is the most efficient approach in locating an error? The following procedures when done in
sequence may save considerable time and effort in locating errors:

Prove the addition of the trial balance columns by adding these columns in the opposite direction.

If the error does not lie in addition, determine the exact amount by which the trial balance is out of
balance. The amount of the discrepancy is often a clue to the source of the error If the discrepancy is
divisible by 9, this suggests either a transposition (reversing the order of numbers)

error or a slide (moving of the decimal point). For example, assume that the cash account balance is
P21,750, but in copying the balance into the trial balance the figures are transposed and written as
P21,570. The resulting error amounted to P180 and is divisible by 9. Another common error is the
slide, or incorrect placement of the decimal point, as when P21,750.00 is copied as P2, 175.00. The
resulting discrepancy in the trial balance will also be an amount divisible by 9.

Assume that the office equipment account has a debit balance of P42,000 but it is erroneously listed
in the credit column of the trial balance. This will cause a discrepancy of two times P42,000 or
P84,000 in the trial balance totals. Since such errors as recording a debit in a credit column are
common, it is advisable, after determining the discrepancy in the trial balance totals, to scan the
columns for an amount equal to exactly one-half of the discrepancy.

It is also advisable to look over the transactions for an item of the exact amount of the discrepancy.
An error may have been made by recording the debit side of the transaction and forgetting to enter
the credit side.

Compare the accounts and amounts in the trial balance with that in the ledger. Be certain that no
account is omitted.

Recompute the balance of each ledger account.

Trace all postings from the journal to the ledger accounts. As this is done, place a check mark in the
journal and in the ledger after each figure is verified. When the operation is completed, look through
the journal and the ledger for unchecked amounts. In tracing postings, be alert not only for errors in
amount but also for debits entered as credits, or vice versa

Note that even when a trial balance is in balance, the accounting records may still contain errors A
balanced trial balance simply proves that, as recorded, debits equal credits. The following errors are
not detected by a trial balance:

Failure to record or post a transaction.

Recording the same transaction more than once.

Recording an entry but with the same erroneous debit and credit amounts.

Posting a part of a transaction correctly as a debit or credit but to the wrong account.

ADJUSTING THE ACCOUNTS

ACCRUAL BASIS
The financial statements, except for the cash flow statement, are prepared on the accrual basis of
accounting in order to meet their objectives. Under the accrual basis, the effects of transactions and
other events are recognized when they occur and not as cash is received or paid. This means that the
accountant records revenues as they are earned and expenses as they are incurred. The timing of
cash flows is relatively immaterial for determining when to recognize revenues and expenses.

Financial statements prepared on the accrual basis inform users not only of past transactions
involving the payment and receipt of cash, but also of obligations to pay cash in the future, and of

resources that represent cash to be received in the future. Generally accepted accounting principles
require that a business use the accrual basis.

In cash basis accounting, however, the accountant does not record a transaction until cash is received
or paid. Generally, cash receipts are treated as revenues and cash payments as expenses Cash basis
income is the difference between operating cash receipts and disbursements. These cash flows
necessarily exclude investments by and distributions to the owner in the computation of income.

Illustration. A client paid the Sea Wind Resort in Boracay Island P7,000 on April 8, 2020 for a one- day
super deluxe accommodation on May 13, 2020. Under accrual basis of accounting, the receipt of
P7,000 will be considered as revenues when the business has rendered its services on May 13.

In contrast, if cash basis is used, the hotel will recognize revenues on April 8: Expenses related to this
revenue transaction will be incurred on May 13. Suppose a financial report is prepared at the end of
April, under accrual basis, no revenue or expense will be reported, under cash basis, revenues of
P7,000 will be reported but the related expenses will be recognized when incurred on May 13.
Observe that the accrual basis provided a better measure of the results of transactions.

PERIODICITY CONCEPT

The only way to know how successfully a business has operated is to close its doors, sell all its assets,
pay the liabilities and return any excess cash to the owners. This process of going out of business is
called liquidation This, however, is not a practical way of measuring business performance.

Accounting information is valued when it is communicated early enough to be used for economic
decision-making. To provide timely information, accountants have divided the economic life of a
business into artificial time periods. This assumption is referred to as the periodicity concept
Accounting periods are generally a month, a quarter or a year. The most basic accounting period is
one year. Entities differ in their choice of the accounting year-fiscal, calendar or natural. A fiscal year
is a period of any twelve consecutive months. A calendar year is an annual period ending on
December 31. A natural business year is a twelve-month period that ends when business activities
are at their lowest level of the annual cycle. A period of less than a year is an interim period. Some
even adopt an annual reporting period of 52 weeks.

Businesses need periodic reports to assess their financial condition and performance. The periodicity
concept ensures that accounting information is reported at regular intervals. It interacts with the
recognition and derecognition principles to underlie the use of accruals. To measure profit in a fair
manner, entities update the income and expense accounts immediately before the end of the period.

RECOGNITION AND DERECOGNITION

Per 2018 Conceptual Framework, recognition is the process of capturing for inclusion in the
statement of financial position or the statement(s) of financial performance an item that meets the
definition of an asset, a liability, equity, income or expenses. The amount at which an asset, a

liability or equity is recognized in the statement of financial position is referred to as its "carrying
amount".

The statement of financial position and statement(s) of financial performance depict an entity's
recognized assets, liabilities, equity, income and expenses in structured summaries that are designed
to make financial information comparable and understandable.

Recognition links the elements, the statement of financial position and the statement(s) of financial
performance. The statements are linked because the recognition of one item (or a change in its
carrying amount) requires the recognition or derecognition of one or more other items (or changes
in the carrying amount of one or more other items). For example:

(a) the recognition of income occurs at the same time as:

(i) the initial recognition of an asset, or an increase in the carrying amount of an asset, or (ii) the
derecognition of a liability, or a decrease in the carrying amount of a liability.

(b) the recognition of expenses occurs at the same time as:

(i) the initial recognition of a liability, or an increase in the carrying amount of a liability; or (ii) the
derecognition of an asset, or a decrease in the carrying amount of an asset.

The initial recognition of assets or liabilities arising from transactions or other events may result in
the simultaneous recognition of both income and related expenses. For example, the sale of goods
for cash results in the recognition of both income (from the recognition of one asset-the cash) and an
expense (from the derecognition of another asset-the goods sold). The simultaneous recognition of
income and related expenses is sometimes referred to as the matching of costs with income.
Recognition is appropriate if it results in both relevant information about assets, liabilities, equity,
income and expenses and a faithful representation of those items, because the aim is to provide
information that is useful to investors, lenders and other creditors.

Derecognition is the removal of all or part of a recognized asset or liability from an entity's statement
of financial position. Derecognition normally occurs when that item no longer meets the definition of
an asset or of a liability:

(a) for an asset, derecognition normally occurs when the entity loses control of all or part of the
recognized asset; and

(b) for a liability, derecognition normally occurs when the entity no longer has a present obligation
for all or part of the recognized liability.

DEFERRALS AND ACCRUALS

Accountants use adjusting entries to apply accrual accounting to transactions that cover more than
one accounting period. There are two general types of adjustments made at the end of the
accounting period-deferrals and accruals.

Each adjusting entry affects a balance sheet account (an asset or a liability account) and an income
statement account (income or expense account).

Deferral is the postponement of the recognition of "an expense already paid but not yet incurred," or
of "revenue already collected but not yet earned". This adjustment deals with an amount already
recorded in a balance sheet account, the entry, in effect, decreases the balance sheet account and
increases an income statement account. Deferrals would be needed in two cases:

1. Allocating assets to expense to reflect expenses incurred during the accounting period (e.g.
prepaid insurance, supplies and depreciation).

2. Allocating revenues received in advance to revenue to reflect revenues earned during the
accounting period (e.g. subscriptions).

Accrual is the recognition of "an expense already incurred but unpaid", or "revenue earned but
uncollected". This adjustment deals with an amount unrecorded in any account, the entry, in effect,
increases both a balance sheet and an income statement account. Accruals would be required in two
cases:

1. Accruing expenses to reflect expenses incurred during the accounting period that are unpaid and
unrecorded.

2. Accruing revenues to reflect revenues earned during the accounting period that are uncollected
and unrecorded.
THE NEED FOR ADJUSTMENTS

Accountants make adjusting entries to reflect in the accounts information on economic activities that
have occurred but have not yet been recorded. Adjusting entries assign revenues to the period in
which they are earned, and expenses to the period in which they are incurred. These entries are
needed to measure properly the profit for the period, and to bring related asset and liability
accounts to correct balances for the financial statements.

In short, adjustments are needed to ensure that the recognition and derecognition principles are
followed thus resulting to financial statements reporting the effects of all transactions at the end of
the period.

Adjusting entries involve changing account balances at the end of the period from what is the
current balance of the account to what is the correct balance for proper financial reporting. Without
adjusting entries, financial statements may not fairly show the solvency of the entity in the balance
sheet and the profitability in the income statement.

ADJUSTMENTS FOR DEFERRALS

Allocating Assets to Expenses Entities often make expenditures that benefit more than one period.
These expenditures are generally debited to an asset account. At the end of each accounting period,
the estimated amount that has expired during the period or that has benefited the period is
transferred from the asset account to an expense account. Two of the more important kinds of
adjustments are prepaid expenses, and depreciation of property and equipment.

Prepaid Expenses

Some expenses are customarily paid in advance. These expenditures (e.g. supplies, rent and
insurance) are called prepaid expenses. Prepaid expenses are assets, not expenses. At the end of an
accounting period, a portion or all of these prepayments may have expired. The portion of an asset
that has expired becomes an expense. Prepaid expenses expire either with the passage of time or
through use and consumption. The flow of costs from the balance sheet to the income statement is
illustrated below:
Cost of insurance policies and supplies ==> that will benefit future periods

Balance Sheet

As insurance policies expire and supplies used

Income Statement

Assets

Prepaid

Insurance

Supplies

==============>

Revenues

Expenses

Insurance Expense Supplies Expense

If adjustments for prepaid expenses are not made at the end of the period, both the balance sheet
and the income statement will be misstated. First, the assets of the entity will be overstated; second,
the expenses of the company will be understated. For this reason, owner's equity in the balance
sheet and profit in the income statement will both be overstated. Besides prepaid rent, Weddings.
"R" Us has prepaid expenses for supplies and insurance, both accounts need adjusting entries

The Weddings "R" Us case is continued to illustrate the adjustment process. The letters A, L, OE, OE:l
and OE E are still used to ensure a better understanding of the nature of the accounts affected.
Prepaid Rent (Adjustment a). On May 1, Weddings "R" Us paid P3,000 for two months' rent in Pent
advance. This expenditure resulted to an asset consisting of the right to occupy the office for two
months. A portion of the asset expires and becomes an expense each day. By May 31, one-half of the
asset had expired, and should be treated as an expense. The analysis of this economic event is shown
below:

Transaction

Expiration of one month's rent.

Analysis

Assets decreased. Owner's equity decreased.

Rules

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

Entries

Decrease in owner's equity is recorded by a debit to rent expense. Decrease in assets is recorded by
a credit to prepaid rent.

Dr.

Cr.

Rent Expense (OE:E)

4,000

Prepaid Rent (A)

4,000

After adjustments, the prepaid rent account has a balance of P4,000 (May 1 prepayment of P8,000
less the P4,000 expired portion); the rent expense account reflects the P4,000 expense for the
month.
Prepaid Insurance (Adj. b) Weddings "R" Us acquired a one-year comprehensive insurance coverage
on the service vehicle and paid P14,400 premiums. In a manner similar to prepaid rent, prepaid
insurance offers protection that expires daily. The adjustment is analyzed and recorded as shown
below:

Transaction

Expiration of one month's insurance.

Analysis

Assets decreased. Owner's equity decreased.

Rules

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

Entries

Decrease in owner's equity is recorded by a debit to insurance expense; decrease in assets as a credit
to prepaid insurance.

Dr.

Cr.

Insurance Expense (OE:E)

1,200

Prepaid Insurance (A)

1,200

The prepaid insurance account has a balance of P13,200 (May 4 prepayment of P14,400 less P1,200)
and insurance expense reflects the expired cost of P1,200 for the month. As a matter of company
policy, the period May 4 to 31 is considered a month.
Supplies (Adjustment c). On May 8, Weddings "R" Us purchased supplies, P18,000, During the
month, the entity used supplies in the process of performing services for clients. There is no need to
account for these supplies every day since the financial statements will not be prepared until the end
of the month. At the end of the accounting period, Besario makes a careful physical inventory of the
supplies. The inventory count showed that supplies costing P15,000 are still on hand. This transaction
is analyzed and recorded as follows:

Transaction

Consumption of supplies.

Analysis

Assets decreased. Owner's equity decreased.

Rules

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

Entries

Decrease in owner's equity is recorded by a debit to supplies expense Decrease in assets is recorded
by a credit to supplies.

Dr.

Cr.

Supplies Expense (OE:E)

3,000

Supplies (A)

3,000

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

When an entity acquires long-lived assets such as buildings, service vehicles, computers or office
furniture, it is basically buying or prepaying for the usefulness of that asset. These assets help
generate income for the entity. Therefore, a portion of the cost of the assets should be reported as
expense in each accounting period. Proper accounting requires the allocation of the cost of the asset
over its estimated useful life. The estimated amount allocated to any one accounting period is called
depreciation or depreciation expense. Three factors are involved in computing depreciation expense:

1. Asset cost is the amount an entity paid to acquire the depreciable asset.

2. Estimated salvage value is the amount that the asset can probably be sold for at the end of its
estimated useful life.

3. Estimated useful life is the estimated number of periods that an entity can make use of the asset.
Useful life is an estimate, not an exact measurement.

Cost of a depreciable asset ===>

Balance Sheet

As insurance policies expire and supplies used

Income Statement

Assets

Service Vehicle

Office Equipment

===============>

Revenues

Expenses
Depreciation

Accountants estimate periodic depreciation. They have developed a number of methods for
estimating depreciation. The simplest procedure is called the straight-line method. The formula for
determining the amount of depreciation expense for each period using this method is:

Asset cost xx

Less: Estimated salvage value xx

Depreciable cost xx

Divided by: Estimated useful life xx

Depreciation Expense for each time period xx

The asset account is not directly reduced when recording depreciation expense. 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.

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

Transaction

Recording depreciation expense.

Analysis
Assets decreased. Owner's equity decreased.

Rules

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

Entries

Owner's equity is decreased by debits to depreciation expense-service vehicle and depreciation

expense-office equipment. Assets are decreased by credits to contra-asset accounts accumulated
depreciation-service vehicle and accumulated depreciation-office equipment.

Dr.

Cr.

Depreciation Expense-Service Vehicle (OE:E)

4,000

Accumulated Depreciation-Serv. Vehicle (A)

4,000

Depreciation Expense-Office Equipt. (OE:E)

1,000

Accumulated Depreciation-Office Equipt. (A)

1,000
After adjustments, the property and equipment section of the balance sheet for Weddings "R" Us
will be:

Weddings "R" Us

Partial Balance Sheet

May 31, 2020

Property and Equipment (Net):

Service Vehicle

P420,000

Less: Accumulated Depraciation

4,000

416,000

Office Equipment

P60,000

Less: Accumulated Depraciation

1,000

59,000

P 475,000

Allocating Revenues Received in Advance to Revenues

There are times when an entity receives cash for services or goods even before service is rendered or
goods are delivered. When such is received in advance, the entity has an obligation to perform
services or deliver goods. The liability referred to is unearned revenues.

For example, publishing companies usually receive payments for magazine subscriptions in advance.
These payments must be recorded in a liability account. If the company fails to deliver the magazines
for the subscription period, subscribers are entitled to a refund. As the company delivers each issue
of the magazine, it earns a part of the advance payments. This earned portion must be transferred
from the unearned subscription revenues account to the subscription revenues account.

Cost of a depreciable asset ===>

Balance Sheet

As insurance policies expire and supplies used

Income Statement

Assets

Service Vehicle

Office Equipment

===============>

Revenues

Expenses

Depreciation

Value of

Balance Sheet
goods or services

to be

As the goods or services are provided

Income Statement

Liabilities Unearned Revenues

Revenues Revenues from

provided in future periods

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

Transaction

Recognition of income where cash is received in advance. Analysis Liabilities decreased. Owner's
equity increased.

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

Analysis Rules

recorded by credits. Decrease in liabilities, is recorded by a debit to unearned referral revenues.

Increase in owner's equity is recorded by a credit to referral revenues.

Entries
Dr. 4,000

Cr

Unearned Referral Revenues (L) Referral Revenues (OE:1)

£4,000

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

ADJUSTMENTS FOR ACCRUALS

Accrued Expenses

An entity often incurs expenses before paying for them. Cash payments are usually made at regular
intervals of time such as weekly, monthly, quarterly or annually. If the accounting period ends on a
date that does not coincide with the scheduled cash payment date, an adjusting entry is needed to
reflect the expense incurred since the last payment. This adjustment helps the entity avoid the
impractical preparation of hourly or daily journal entries just to accrue expenses.