Lesson 11:

Business Transactions and Their Analysis

as Applied to the Accounting Cycle of a
Service Business: (Adjusting Entries, Worksheet, Preparation
of Basic Financial Statements)
Learning objectives:
a. Prepare adjusting entries.
b. Prepare Worksheet
c. Prepare financial statements
d. Complete the accounting cycle.

Review of previous topics

Show the accounting cycle and ask learners what they have retained from the previous chapter.
Step 1. Identification of Events to be Recorded
Transaction Analysis. The transactions are analyzed,

Step 2. Transactions are Recorded in the Journal

Aim to record the analyzed transaction on the journal.

Step 3. The Journal Entries are Posted to the Ledger

Aim to transfer the the journalized transactions in the journals to the ledger.

Step 4. Preparation of a Trial Balance

Aim to provide a listing of accounts with balances to verify the eaquality of debit and credit in the ledger.

Step 5. Preparation of Worksheet including Adjusting Entries

This is the preparation of the information to aid in the preparation of the fianancial statements.

Step 6. Preparation of the Financial Statement

This is to provide necessary information to the decision-makers.

Step 7. Adjusting Journal Entries are Joournalized and Posted

This is to record the accruals, exprirations of deferrals, estimations and other events from the worksheets.

Step 8. Closing Journal Entries are Journalized and Posted

This is to close all the temporary and transfer the profit to the owner’s equity.

Step 9. Preparation of a Post-Closing Trial Balance

This is to check the equality of debits and credits after the closing entries.

Step 10. Reversing Journal Entries are Journalized and Posted

This is to simplify the recognition of certain regular transactions in the next accounting period for smoothe and
easy process.

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1. ACCRUAL BASIS, PERIODICITY CONCEPT AND RECOGNITION AND DERECOGNITION

Income Expenses
Accrual Basis (Financial Income when earned Expense when incurred
Accounting) regardless of when regardless of when
payment is received. payment is made.
(receivable) (payable)
Cash Basis (Taxation) Income when cash is Expenses is recognized
received. when payment is made.

Timing difference- timing of recognition of income and expense.

Accrual Basis
The financial statements are prepared on the basis of accrual basis accounting in order to meet their objectives,
except for the cash flow statement. The effect of the transactions and other events are recognized when they
occur and not as the cash is received or paid this means that the income or revenue is recognized when earned
regardless of when it is received and expenses are recognized when incurred regardless of when it is paid.

Cash Basis is the concept of recognizing the transaction at the time when cash is received and paid. Revenues
are recognized when cash is received regardless of when it is earned and expenses are recognized when paid
regardless of when it is incurred.

Example: Jose del Mundo paid Magnaga Waters Beach Resort of P/ 9,000.00 on Jan. 9, 2020 for a 1 day
accommodation on Jan 16, 2020 (actual event).

Under accrual basis of accounting, the revenue is recognized on Jan. 16, 2020 and under cash basis of
accounting, the revenue is recognized on Jan. 9, 2020.

Periodicity Concept
The way to know the success of the business has operated is to close the door, sell all its assets, pay its liabilities
and return any excess cash to the owners. This is known as liquidation. This is not practical way of measuring
business performance.
The indefinite life of the business are subdivided into equal economic artificial business time periods known as
accounting period to provide timely information for decision making purposes. The most basic accounting period
is one year that is either fiscal year, calendar year or natural year. Reports are also prepared in less than one
year known as interim period (monthly, quarterly (4), or semi annual).

Recognition and Derecognition

Recognition is the process of capturing for inclusion in the statement of financial position or performance an
item that meets the definition of an asset, liability, equity, income or expenses. The amount recognized in the
reports is known as “carrying amount”.

The statements are linked with recognition and elements, the recognition of one item requires recognition and
derecognition of one or more other items.

The recognition of income/revenue occurs at the same time as the initial recognition of an assets, or an increase
in the carrying amount of an asset or derecognition of liability or decrease in the carrying amount of a liability.

The recognition of expense occurs at the same time as initial recognition of liability or an increase in the carrying
amount of liability and derecognition of an asset or a decrease in the carrying amount of an asset.

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This will result in both relevant information about the Five (5) elements of FS and faithful representation of this
items as it will provide information to the primary and other users of financial reports

Derecognition is the removal of all or part of a recognized assets or liability from the financial report of the
company.

An asset is derecognized when the entity loses control of part or all of the recognized asset and liability are
derecognized if the entity has no longer present obligation for all or part of the recognized liability.

2. THE NEED FOR ADJUSTMENTS: DEFERRALS AND ACCRUALS

Adjustment are made by accountant to reflect the information from the entity that had occurred but have not yet
been recorded. These are done for revenues that must be recognized as it is earned during the period and the
expenses must be recognized as it is incurred during the period. This is also done to bring the balances of the
accounts to correct one for the financial statements and to properly measure the entity’s profit for the period.

This entries will ensure the recognition and derecognition of the elements of financial statements. This involves
changing the balance of the account at the end of the period from what is the current balances to what is the
correct balance for proper reporting due to unrecorded events or transactions that occurred during the period.
Without this entry, the FS may not be fairly show solvency and profitability of the company.

The procedures are as follows:

The adjusting entries are journalized in the general journal and posted to the ledgers and the amount from the
balances in the ledger this would be transferred to the report called

Adjusted Trial Balance

The transactions that needs adjustments are deferrals and accruals and this is the types of adjustments at the
end of the period.

The adjusting entries always affects a balance sheet account (asset or liability) and an income statement account
(income or expenses)

Deferral – “Advances” – “Advance Payment of an expense” – Prepaid Expense-

“Advance Collection of an income”

Deferrals is the postponement of recognition of an expenses that are already paid but not yet incurred or a
revenue that are already collected but not yet earned. This adjustments considers the amount that are already
recorded in the balance sheet account. The entry of this adjustment decreases the balance sheet account and
increases the income statement account.

Deferral adjusting entries are needed in the following situation:

a. To reflect expenses incurred during the accounting period allocated from assets.
b. To reflect revenues earned during the accounting period allocated from revenues received in advance.

Accruals is the postponement of recognition of an expenses that are already incurred but not yet paid or a
revenue earned but still uncollected. This adjustments considers the amount that are still unrecorded in any
account. The entry of this adjustment includes an increase in both the balance sheet account and income
statement account.

Accrual adjusting entries are needed in the following situation:

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c. To reflect expenses incurred during the accounting period that are unpaid and unrecorded by accruing the
expenses.
d. To reflect revenues earned during the accounting period that are uncollected and unrecorded by accruing
the revenues.

Illustrations:

Prepaid Expenses are assets of the company as it not considered as expenses.

a. Rent
The company paid P/ 24,000.00 / 3 = 8,000 per month rent in advance for the period of January, February and
March on January 2, 2020. What would be the adjusting entry at January 31, 2020?

ASSET METHOD
Original Entry on January 2, 2020:
Prepaid Rent (asset account) 24,000.00
Cash 24,000.00
Payment of two months’ rent in advance.

This journal entry will not affect the assets in total as this is a transaction for exchange of assets but one of the
asset account will increase in the form of prepaid rent and another one will decrease in the form of cash. This
asset will expire each day thus, there is a need for adjusting the account prepaid rent at the end of the accounting
period and transferred the expired portion to the expense account.

Adjusting Entry on January 31, 2020:

Rent Expense 8,000.00
Prepaid Rent 8,000.00
To record the expired portion of the rent (January)

This adjusting entry is done to decrease the asset account in the form of prepaid rent and increase the expense
account in the form or rent expense as the expenses account was not recorded. In this method, the amount to
be recorded in the adjusting entry are the amount expired as asset is recognized in the original entry.

EXPENSE METHOD
Original Entry on January 2, 2020:
Rent Expense (Expense Account) 24,000.00
Cash 24,000.00
Payment of two months’ rent in advance.

This journal entry will increase the expense account in the form of rent expense and decreases the assets in the
form of cash. This account is not expense at the end at the end of January 2020 thus, there is a need for adjusting
the account rent expense at the end of the accounting period and transfer the unexpired amount to the asset
account in the form of prepaid rent.

EXPENSE METHOD
Adjusting Entry on January 31, 2020:
Prepaid Rent 16,000.00
Rent Expense 16,000.00
To record the unexpired portion of the rent

Total 24,000
Expired (January) 8,000
Unexpired (Feb-Mar) 16,000

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This adjusting entry is done to increase the asset account in the form of prepaid rent and decrease the expense
account in the form or rent expense as the expenses account was recorded in the original entry. Thus, in this
method, the amount recognized in the adjusting entry is the amount still unexpired as the expense is recognized
in the original entry.

b. Insurance
The company acquired a 1 year comprehensive insurance coverage for the service vehicle and paid P/ 36,000.00
on January 1, 2020. The manner of recording this transaction is similar to the recognition of rent. What would be
the adjusting entry at January 31, 2020?

ASSET METHOD
Original Entry on January 1, 2020:
Prepaid Insurance 36,000.00
Cash 36,000.00
Payment of one year insurance.

Adjusting Entry on January 31, 2020:

Insurance Expense 3,000.00
Prepaid Insurance 3,000.00
To record the expired portion of the insurance.

EXPENSE METHOD
Original Entry on January 1, 2020:
Insurance Expense 36,000.00
Cash 36,000.00
Payment of one year insurance.

Adjusting Entry on January 31, 2020:

Prepaid Insurance 33,000.00
Insurance Expense 33,000.00
To record the unexpired portion of the insurance.

c. Supplies
The company purchase on January 1, 2020 a total of 22,000.00 worth of supplies for the year and at January
31, 2020 the amount of 12,000.00 is still on hand and unused. What would be the adjusting entry?

ASSET METHOD
Original Entry on January 1, 2020:
Supplies 22,000.00
Cash 22,000.00
To record cash purchase of supplies.

Adjusting Entry on January 31, 2020:

Supplies Expense 10,000.00
Supplies 10,000.00
To record the used portion of supplies.

EXPENSE METHOD
Original Entry on January 1, 2020:
Supplies Expense 22,000.00
Cash 22,000.00
To record cash purchase of supplies.

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Adjusting Entry on January 31, 2020:
Supplies 12,000.00
Supplies Expense 12,000.00
To record the unused portion of supplies.

d. Depreciation of Property, Plant and Equipment

This is when portion of the cost of the long-lived assets that are used by the company in its operation are allocated
based on the life of the assets and recognized the portion used as expense. The proper accounting for this type
of transaction is to compute for the total cost of the asset, get the salvage value and estimate the life of the long-
lived asset. The allocated amount is known as depreciation or depreciation expense.

a. Cost is the total amount paid to purchase or to construct an asset.

b. Salvage Value is the amount that can be recovered from selling the asset after the estimated life of the asset
ends.
c. Estimated Useful life is the number of periods or the number of years that the entity can make use of the
asset.
d. Depreciable Amount is the amount after deducting the salvage value from the cost of the long-lived asset
e. Accumulated Depreciation is the summation of the allocated cost every period that are recognized as
expense. This is also a contra asset account that are deducted from the total cost to know the carrying amount
or the book value of the property, plant and equipment.

The accountants will estimates the periodic depreciation and develop a method of computing depreciation and
the simplest way of allocating the cost over its useful life is the Straight Line Method.

The computations are as follows:

Asset costs XXXXX
Less: Salvage Value (XXXXX)
Depreciable Amount/Cos XXXXX
Divided by: Estimated Useful Life (Years) XXXXX
Depreciation Expense every year XXXXX

Illustration:
The company purchase a Building worth 1,200,000.00 and the estimated useful life is 25 years and it is estimated
that the building can be sold for 200,000.00 after 20 years.

Answer/Solution:
Asset costs 1,200,000.00
Less: Salvage Value (200,000.00)
Depreciable Amount/Cos 1,000,000.00
Divided by: Estimated Useful Life (Years) 20
Depreciation Expense every year 50,000.00

The journal entry to record the depreciation is:

Depreciation Expense – Building 50,000.00
Accumulated Depreciation – Building 50,000.00
To record the allocated depreciation for the year.

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To compute for the Carrying Amount or Book Value
Particulars Depreciation Accumulated Depreciation Carrying Amount
1,200,000.00
Year 1 50,000.00 50,000.00 1,150,000.00
Year 2 50,000.00 100,000.00 1,100,000.00
Year 3 50,000.00 150,000.00 1,050,000.00
And so on and so forth…
Year 19 50,000.00 950,000.00 250,000.00
Year 20 50,000.00 1,000,000.00 200,000.00

e. Revenue Received in Advance

This is the transaction that the company receives payment before the services are rendered and the products
are delivered. Generally, this would be recognized as liability of the company and accounted for as “Unearned
Revenues”.

Illustration:
On January 2, 2020, the company receive P/ 16,000.00 for 4 months subscription of services. What is the
adjusting journal entry should be made at the end of 1/31/2020?

LIABILITY METHOD
Original Entry on January 2, 2020:
Cash 16,000.00
Unearned Service Income 16,000.00
Payment of four months’ service subscription.

Adjusting Entry on January 31, 2020:

Unearned Service Income 4,000.00
Service Income 4,000.00
To record the earned portion of the subscription

INCOME METHOD
Original Entry on January 2, 2020:
Cash 16,000.00
Service Income 16,000.00
Payment of four months’ service subscription.

Adjusting Entry on January 31, 2020:

Service Income 12,000.00
Unearned Service Income 12,000.00
To record the unearned portion of the subscription

ACCRUALS
Accrued Expenses are expenses that are incurred during the period but still unrecorded and unpaid until the
end of the period thus, adjusting entries are needed to recognize this expense the financial statement. These
expenses are salaries, interest, utilities, taxes and others.

Salaries
The company paid salaries every Saturday of the week, the employee is paid at a rate of 350.00 per day and
suppose that January 31, 2020 is Thursday. What is the adjusting entry to be recorded at January 31, 2020?

Adjusting Entry on January 31, 2020:

Salaries Expense (350*4) 1,400.00
Accrued Salaries Expense 1,400.00
Accrual of salaries

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Interest
The company acquire a loan from a bank with 14% interest worth 250,000.00 on January 1, 2020. What is the
adjusting entry to recognize interest expense on January 31, 2020?

Original Entry on January 1, 2020:

Cash 250,000.00
Loan Payable 250,000.00
Loan acquired from a bank.

Adjusting Entry on January 31, 2020:

Interest Expense (250,000*14%*1/12) 2,917.00
Accrued Interest Expense/ Payable 2,917.00
Accrual of interest on loan.

Utilities
The company receives the bill of electricity worth 7,950.00 that are still unpaid and unrecorded on January 31,
2020. Prepare adjusting entry.
Adjusting Entry on January 31, 2020:
Utilities Expense 7,950.00
Accrued Utilities Expense/ Payable 7,950.00
Accrual of unpaid utilities.

Accruals of Revenues
These are income that are earned but still unpaid by the customers and not yet recorded in the books of the
company.

Accrued Service Revenue

The company render service on 3:00 pm of January 31, 2020 worth of 6,000.00 but still unpaid until February 6,
2020. Prepare adjusting entry to record the accrued service revenue.

Adjusting Entry on January 31, 2020:

Accounts Receivable 6,000.00
Service Income 6,000.00
Accrual of service income.

Accrual of Uncollectible Accounts

This is an estimation of the uncollectible amount out from the total credit sales or receivables of the company.
This may be estimated from the percentage of sales and sometimes it is based on the total sales.

Illustration:
The company assumes that the estimated average of 1% of the total sales are uncollectible. The company has
earned a total of 230,000.00 credits sales for the month of January 2020. The adjusting entry to record the
uncollectible accounts.

The Adjusting Entry to Record on January 31, 2020:

Uncollectible Accounts Expense (230,000*1%) 2,300.00
Allowance for Uncollectible Accounts 2,300.00
To record the estimation of uncollectibility of the accounts.

If 500.00 of the recognized allowance are definitely uncollectible then the entry to record are the following:
Allowance for Uncollectible Accounts 500.00
Accounts Receivables 500.00
To record the proven uncollectible accounts.

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