CHAPTER 8 ACCOUNTING PROCESS QUESTION 8-1 What are the steps in the accounting cycle? ANSWER 8-1 1. Analyzing the business docu .—nts or transactions. This means that the accountant determines the impact of the transactions on the financial position as represented by the basic equation “assets equal liabilities plus equity.” 2. Journalizing — This is the process of recording the transactions in a journal. Posting — Transactions as classified and recorded in the journal are transferred to the appropriate accounts in the general ledger and subsidiary ledger, if appropriate. Preparing the unadjusted trial balance Preparing the adjusting entries Preparing the financial statements Preparing the closing entries Preparing a postclosing trial balance Preparing the reversing entries o SHAD AS Actually, the accounting process can be classified into two parts, namely recording phase and summarizing phase. The recording phase includes analyzing the transaction, journalizing and posting. The summarizing phase includes the unadjusted trial balance, «ljusting entries, financial statements, closing entries, postclosing trial balance and reversing entries. The postclosing trial balance, reversing entries and worksheet are optional. -106QUESTION 8-2 What is a journal? ANSWER 8-2 The most fundamental journal is the general journal, often called simply as journal. A journal is a chronological record of transactions. A general journal entry consists of the transaction date, the accounts and amounts to be debited, the accounts and amounts to be credited, and a brief explanation of the transaction. A simple journal entry consists of one debit and one credit. A compound journal entry consists of two or more debits or two or more credits. QUESTION 8-3 What is a ledger? ANSWER 8-3 The general ledger, often called simply as the ledger, is a group of accounts. An account is the accounting device used in summarizing the effects of transactions on each asset, liability, equity, revenue and expense. The accounts used by a particular entity are usually expressed in the form of chart of accounts. A chart of accounts is a listing of all the entity's general ledger accounts in a systematic form. 107 eeQUESTION 8-4 What is a trial balance? ANSWER 8-4 A trial balance is a list of general ledger accounts with their respective debit or credit balance. The trial balance prepared at this time is often called the unadjusted trial balance because account balances do not yet reflect adjustments. A trial balance is prepared at the end of every accounting period after all transactions for the period have been recorded and posted to the general ledger. The trial balance is a control device that helps eliminate accounting errors. When total debits do not equal total credits, the trial balance is out of balance. This condition alerts the accountant that errors have been made. On the other hand, if the total debits equal total credits, the trial balance is said to be in balance. However, this condition does not necessarily signify the absence of errors. For example, the trial balance does not indicate the failure to record a transaction or the recording of a transaction in the wrong accounts. QUESTION 8-5 What are the purposes of a trial balance? ANSWER 8-5 1. The trial balance provides evidence that the total debits in the general ledger equal credits. 2. The trial balance provides information that helps thé _ accountant to formulate adjustments. 108QUESTION 8-6 Describe transposition, transplacement and error of omission. ANSWER 8-6 1. Transposition — The fi i Ei ee ag oy a 2. Transplacement ~ Error in placing the decimal example, P12,000 is written as P1,200. 3. Error of omission — A transaction is not recorded. For example, a sale of P10,000 is not journalized. xample, point. For QUESTION 8-7 What are the two methods of recording expenses? ANSWER 8-7 1. Expense method — The original payment is debited to an expense account. For example, the payment for a one-year insurance premium is debited to insurance expense account. 2. Asset method —The original payment is debited to an asset account. For example, the payment for a one-year insurance premium is debited to prepaid insurance account. QUESTION 8-8 What are the two methods ANSWER 8-8 1. Income method — An income receipt of the income. the receipt of a one-year rental is credited to of recording income? account is credited for the For example, rertal income account. Liability method — A liability account is credited for the receipt of the income. For example, the receipt of a one-year rental is credited to unearned rental income account. 109QUESTION 8-9 What are adjusting entries? ANSWER 8-9 Adjusting entries are made at the end of every accountin, orod in order to split mixed accounts or to bring the accounts up to date. Adjusting entries allocate revenue and expenses between current and future periods. Moreover, every adjusting entry affects both a real account and a nominal account. Under the cash basis of accounting, revenue is recorded only when cash is received, and expenses are recorded when paid in cash. In contrast, the accrual basis of accounting requires recognition of revenue when earned and recognition of expenses when incurred. Generally accepted accounting principles require the use of accruai accounting. Accordingly, adjusting entries are necessary for a fair and accurate measurement of performance and financial position on the accrual basis. QUESTION 8-10 What are the items that normally require adjusting entries? Indicate the proforma adjustment. ANSWER 8-10 1. Ending inventory Inventory — end Income summary or cost of sales xx 2. Doubtful accounts Doubtful accounts xx Allowance for doubtful accounts xx 3. Depreciation Depreciation xx Accumulated depreciation xx 110- Prepaid expenses are already paid but not yet incurred and therefore an asset. If the asset method is used or if the account appearing on the trial balance is an asset account, the adjusting entry is: Expense xx Prepaid expense xX If the expense method is used or if the account appearing on. the trial balance is an expense account, the adjusting entry is: Prepaid expense xX xx Expense Accrued expenses are expenses already incurred but not yet paid and therefore a liability. Expenses Accrued expenses XX Deferred income is income already received but not yet earned and therefore a liability. od is used or if the account appearing If the liability meth e adjusting entry on the trial balance is a liability account, thi is: Deferred income XX Income Xx me method is used or if the account appearing If the inco: s alance is an income account, the adjusting entry on the trial b is: Income Deferred income = Accrued income is income already earned but not yet received and therefore an asset. Accrued income XxX Income Xx 530QUESTION 8-11 What is a worksheet? ANSWER 8-11 A worksheet is multicolumn sheet of paper that an accountant uses in compiling and summarizing the information necessary for the preparation of the financial statements. A worksheet is not a formal statement. A worksheet is only a tool of an accountant in the preparation of financial statements. The accountant prepares a worksheet at that stage of the accounting cycle when it is time to make adjustments and prepare financial statements. A worksheet facilitates the preparation of financial statements by: : a. Providing a place where adjusting entries can be made informally before they are journalized and posted. b. Providing an orderly means whereby each account can be classified according to the financial statement in which it will appear. c. Providing a balancing mechanism that helps to uncover accounting errors. Actually, the balancing figure in the worksheet is the net income or net loss. If the total of the debits exceeds the total of the credits in the income statement columns, there is a net loss. Accordingly, in the statement of financial position columns, if the total of the credits exceeds the total of the debits, there also a net loss. If the total of the credits exceeds the total of the debits in the income statement columns, there is a net income. Accordingly, in the statement of financial position columss, # the total of the debits exceeds the total of the credits, there * also a net income. 12QUESTION 8-12 What are closing entries? ANSWER 8-12 Closing entries are made at the end of an accounting period after adjusting entries and financial statements have been prepared for the purpose of closing all nominal or temporary accounts. To close an account means to reduce its balance to zero. Closing nominal accounts is logical because they measure activities that have occurred during a given period of time. At the end of an accounting period, nominal accounts have served their purpose. Thus, their balances must be reduced to zero so that the new nominal accounts can be used to measure activities in the next accounting period. Actually, nominal accounts are temporary equity accounts. Accordingly, their balances may be transferred directly to an equity account during closing. However, most accountants transfer nominal accounts to a clearing account known as income summary. The income summary account summarizes the net income or net loss for the period and its balance is ultimately closed to capital in the case of a proprietorship or retained earnings in the case of a corporation. QUESTION 8-13 What is a postclosing trial balance? ANSWER 8-13 A postclosing trial balance is simply a listing of general ledger accounts and their balances after the closing entries have been made. Accordingly, the postclosing trial balance consists entirely of real or permanent accounts. 113QUESTION 8-14 What are reversing entries? ANSWER 8-14 Reversing entries are made at the beginning of the new accounting period in order to transfer all accrued and prepaid items established by adjusting entries to the nominal accounts that are to be used in recording transactions during the new period, These are called reversing entries because they are the exact opposite of certain adjusting entries made at the end of the preceding period. Reversing entries do not mean that the adjusting entries reversed are unnecessary or inaccurate. The sole purpose of reversing entries is to simplify the recording of certain kinds of recurring transactions. The adjustments normally requiring reversal at the beginning of the new period are: a. Accrued expenses b. Prepaid expenses, if the expense method is used in recording expense ce. Accrued income d. Deferred income, if the income method is used in recording income 14> QUESTION 8-15 Explain the principle of debit and credit. ANSWER 8-15 The term “debit” refers to the left side of an account and credit” refers to the right side of an account. When both sides of an account are each totaled, and the smaller sum is deducted from the larger sum, the difference is called the balance of the account. Every account has a normal balance, which is simply the balance ordinarily found in an account. The normal balance may be either a debit or credit, depending on the type of account. If an account has a normal debit balance, it is increased when debited and decreased when credited. If an account has a normal credit balance, it is increased when credited and decreased when debited. Thus, a debit does not necessarily mean an increase and a credit does not necessarily mean a decrease. of transactions requires understanding of the Proper analysis s with their normal balances. types of account: These accounts are summarized below. Normal Balance Balance Account balance increasedby decreased by Asset Debit Debit Credit Liability Credit, Credit Debit. Equity Credit. Credit Debit Revenue Credit Credit Debit Expense Debit Debit Credit 15