LESSON 10: Business Transactions and Their Analysis as Applied to the

Accounting Cycle of a Service Business Part 1

Learning Objectives

At the end of this lesson, the learners should be able to:

1. describe the nature of a service business and give examples

2. identify the different types of business documents
3. Prepare journal entries of business transactions in a service business.
4. Solve problems and exercises in the analysis of business transactions.

Nature of a Service Business

A service business provides a needed service for a fee. In general, service businesses
actually have no physical product sold to clients. Their services are designed to
facilitate the work of clients and in return are paid. Service businesses include salons
or barbershops, laundry services, car repairs, medical centers and services of
professionals like lawyers and doctors. The revenue of a service business is usually
realized once the service has been substantially completed. Aside from the minor
supplies, the service business does not maintain a high level of inventory as compared
to merchandising and manufacturing businesses. In relatively small service
businesses, all transactions are on cash payments.

This means sales are collected immediately while most expenses are paid outright in
the form of cash or checks. The typical financial transactions recorded for a service
company include collecting a deposit from the customer, providing the service and
receiving payment.

The Accounting Cycle

1. Analyzing and Classify Data about an Economic Event.

2. Journalizing the transaction.
3. Posting from the Journals to General Ledger.
4. Preparing the Unadjusted Trial Balance.
5. Recording Adjusting Entries.
6. Preparing the Adjusted Trial Balance.
7. Preparing Financial Statements.
8. Recording Closing Entries.
9. Preparing a Closing Trial Balance.
10. Recording Reversing Entries.

The accounting cycle is a continuous process of accumulating, summarizing and

reporting financial information. The steps include:

Step 1 - Transactions and/or Events

Identification and measurement of external transactions and internal events. At this

stage, the documents used by the business are analyzed whether it has financial
impact or effect. Recall the rule that only financial transactions are recorded and that
the amount can be measured. These two conditions must exist in order that a
particular transaction is recognized or recorded. As defined, financial transactions are
those activities that change the value of an asset, liability or an equity.

Examples of financial transactions:

• Receipt of cash from a client as advance payment to repair a computer. In this

case (asset) will increase. At the same time, the advances from client (liability)
will also increase. The advances from client is a liability because the business
has the obligation to render future service to the client.
• Payment of electric bill is a financial transaction. This will decrease the cash
(asset) and reduce the income of the business at the same time.

Examples of non-financial transactions:

• hiring and termination of employees

• recognition from the government as most outstanding business
• death of owner

The information needed when recording transactions are taken from forms used to
document these transactions. In a typical service business, the following are the
business documents used:

1. Official Receipt or Cash Receipt

This document is used when a business receives money or a check. An Official Receipt
or Cash Receipt is a document that acknowledges that money or a check has been
received.
2. Charge Invoice or Sales Invoice

A charge invoice is a document used when a service has been rendered, but the client
will be billed only after a certain number of days from the date of service. Often, a
company will issue a statement of account to a customer, with the charge or sales
invoice attached. For example: in a laundry business, a customer may avail of the
services of the business. However, that customer and the owner of the business had a
prior agreement that all services availed by the customer will be paid only after 30
days. In this case, a charge invoice is issued on the day the client availed of the
services.

3. Check or Cash Voucher

The check voucher is a document used when a check is issued to pay a certain
supplier or vendor. For example, in a laundry business, for the payment of monthly
electricity bills, the business may pay either in cash or check. But the company must
prepare cash or check voucher to support this payment. This document will serve as a
record of payment and, at the same time, as proof that payment has been made by
the company.
Step 2 - Preparation of Journal Entries (journalization)

Through the use of specialized journals (such as those for sales, purchases, cash
receipts, and cash disbursements) and the general journal, transactions and events
are entered into the accounting records. These are called the books of original entry.

Debits and Credits are an integral part of the journalization process. In accounting,
debits or credits are abbreviated as DR and CR respectively.

When to Debit and when to Credit: An increase in an asset account is called a debit
and an increase in a liability or equity account is called a credit. Likewise, if we
decrease an asset account we credit that account. On the other side of the equation, if
we decrease a liability or equity account we debit those accounts.

Rules on Debits and Credits

• The name of the account to be debited is always listed first. The debited
account is listed on the first line with the amount in the left side of the register.
• The credited account is listed on the second line and is usually indented. The
credited amount is recorded on the right side of the register.
• The total amount of debit should always equal the total amount of credit.

Recall the discussion on the Chart of Accounts

The Chart of Accounts is a listing of all account titles used in the business to record
all the transactions.

It is arranged according to the order of their appearance in the financial statements.

Refer to Table X
Let us take the case of Pedro Matapang, a computer technician. Pedro decided to open
his computer repair shop on February 14, 2016, naming it Matapang Computer
Repairs. Pedro knows that business transactions should be separated from personal
finances. Thus, he decided to invest P200,000 in this business. He deposited the
amount with Nation Bank.

February 15, 2016 - Pedro purchased one computer unit from XY Computer Store to
be used for the business. He issued check number 001 amounting to P25,000.
February 16, 2016 - Pedro hired Juana Magaling, an experienced secretary.

Entry: No entry. This is not a financial transaction.

February 17, 2016 – Repaired the computer of Jean and collected P10,000

February 18, 2016 – Repaired Mike’s computer. However, Mike will pay P15,000 on
March 18, 2016

February 19, 2016 – Pedro purchased Office Supplies from MM Merchandise

amounting to P5,000 on account. Pedro will pay this on March 30, 2016.

February 25, 2016 – Paid the salary of Juana amounting to P4,000

Journal Entries in a Corporate Set-up

The example above assumed that the business is a sole proprietorship. How are
transactions recorded if the owner of the business is a Corporation? Basically, the
same entries are made, except for transactions affecting capital or equity accounts. To
illustrate, let us take the following case:

Sweeper Corporation was established to provide janitorial services to clients for a fee.
The corporation issued 5,000 shares of common stock, at PHP100 par value to
shareholders. The issue price paid by the shareholders on January 3, 2016 equal the
par value. The entry to record this transaction is:
In the above example, if the issue price is P120 per share, what is the entry?

Step 3 – Posting

The summary (in specialized journals) or individual transactions (in the general
journal) are then posted from the journals to the general ledger (and subsidiary
ledgers). Nothing should ever get posted to the ledgers without first being entered in a
journal.

Recall the lesson on the general ledger. We will now post the previous transactions of
Pedro to the general ledger. For purposes of discussion, we will be using the three-
column ledger.
Step 4 - Unadjusted Trial Balance

At the end of an accounting period (for example, one month or one year) the working
trial balance is prepared. This involves copying each account name and account
balance to a worksheet (working trial balance). The resulting first two columns of the
worksheet are called the unadjusted trial balance.

In the preparation of the unadjusted trial balance, the balances in all the general
ledgers at the end of the reporting date are forwarded to the appropriate column. The
unadjusted trial balance for the transactions in our example from Step 3 is the
following:

Notice that all asset accounts are presented first, followed by liabilities, equity (or
capital account), income accounts and lastly, expenses accounts.