Learning Objectives:

1. Describe accounting cycle.

2. Enumerate the steps in the accounting cycle.
3. Identify the transactions to be recorded in the books of account.
4. Translate into a statement the transactions based on the source documents.
5. Apply the steps in analyzing transaction to given problems
6. Prepare a financial transaction worksheet.

TOPIC: ACCOUNTING CYCLE

Accounting Cycle - is a series of sequential steps performed to accomplish the accounting process.

Steps:
1. Identification of transactions/ events to be recorded in the journal.
2. Journalization of transactions/events in the journal.
3. Posting to the ledger.
4. Preparation of trial balance.
5. Preparation of adjusting journal entries with worksheet.
6. Preparation of financial statements.
7. Adjusting journal entries are journalized and posted to the ledger.
8. Preparation of closing entries.
9. Preparation of post-closing trial balance.
10. Preparation of reversing entries.

The diagram below shows the sequence of the accounting cycle.

Step 1 - Identification of transactions/ events to be recorded in the journal.

Criterion for the recording: If the transaction causes change in the assets, liabilities or owner’s
equity, then that transaction is to be recognized or recorded in the business books of account.
The diagram below shows the criterion for a transaction to be recorded in the journal.

Step 2 - Journalization of transactions/events in the journal.

is the recording to the business transactions.

Journal – is the book of original entries because it is in the journal that we first record the
transactions.

Source Documents - are the physical basis upon which business transactions are recorded.
 are typically retained for use as evidence when auditors later review a company's financial
statements, and need to verify that transactions have, in fact, occurred.
 tell us the nature of the transactions.

Objectivity Principle states that accounting records and statements are based on the most
reliable data available for them to be accurate and useful as possible.

Source documents usually contain the following information:

1. Business name and other information of the seller
2. Kind of source documents used with a serial number (ex. Official Receipt, Cash Sales
Invoice)
4. The date of the transaction
5. Name of the customer
6. Description of a business transaction
7. Specific amount of money
8. Authorized signature of the buyer or of the cashier

Example 1:
 Based on the above source document:
1. Business name and other information of the seller – Manila Car Shop
2. Kind of source documents used with a serial number – Official Receipt #2578
3. Date of the transaction – June 15, 2020
4. Name of the customer – Bee Sembrano
5. Description of a business transaction – received cash for rendering car repair services
6. Specific amount of money - ₱5,000.00
7. Authorized signature of the buyer or of the cashier - Allan Cruz (cashier)

To translate into a statement form the transaction based on the source document:

On the part of Manila Car Shop:

On June 15, 2020, Manila Car Shop received cash in the amount of Five Thousand Pesos
Only (₱5,000.00) from Bee Sembrano for the car repair services rendered as per Official
Receipt #2578.

On the part of the customer (Bee Sembrano):

On June 15, 2020, Bee Sembrano paid cash in the amount of Five Thousand Pesos Only
(₱5,000.00) to Manila Car Shop for the car repair services rendered as per Official Receipt
#2578.

Example 2:

1. Business name and other information of the seller – Local Bookstore

2. Kind of source documents used with a serial number – Cash Sales Invoice #5790
3. Date of the transaction – June 15, 2020
4. Name of the customer – Manila Car Shop
5. Description of a business transaction – sales of office supplies
6. Specific amount of money - ₱690.00
7. Authorized signature of the buyer or of the cashier

On the part of the seller:

On June 15, 2020, Local Bookstore sold on a cash basis office supplies amounting to Six
Hundred Ninety Pesos Only (₱690.00) to Manila Car Shop as per Cash Sales Invoice
#5790.

On the part of the customer:

On June 15, 2020, Manila Car Shop bought on a cash basis office supplies amounting to
Six Hundred Ninety Pesos Only (₱690.00) from Local Bookstore as per Cash Sales Invoice
#5790.
Double-entry accounting is a system where every transaction affects both sides of the accounting
equation. The record the dual effects of a transaction to the accounting equation, analyzing
transactions is needed.
Journalization of business transaction requires analyzation.

Analyzing Business Transactions

Four steps in analyzing business transactions:

1. Determine the specific accounts affected by the business transaction/what are being exchanged?
Ex. On June 15, 2020, Manila Car Shop received cash in the amount of Five Thousand Pesos Only
(₱5,000.00) from Bee Sembrano for the car repair services rendered as per Official Receipt
#2578.
Accounts affected/values exchanged are: Cash and Service Income
2. Determine the element of the accounting equation the specific accounts affected belong.
Cash is Asset; Service Income is Revenue/Income
3. Determine whether the elements affected increased or decreased.
Asset is increased; Income is increased too.
4. Using the rules of debit and credit, determine whether to debit or credit the accounts affected.
What account to debit and credit?

THE ACCOUNT

 is the basic storage of information in accounting.

 it is a record of the increases and decrease in a specific item of asset, liability, equity, income or
expense.
 is the summary device in accounting.
 is used to record business transactions.

Again we will use this example:

On June 15, 2020, Manila Car Shop received cash in the amount of Five Thousand Pesos Only
(₱5,000.00) from Bee Sembrano for the car repair services rendered as per Official Receipt
#2578.
Accounts affected/values exchanged are: Cash and Service Income
We use only these 2 accounts to record the transaction.

An account may be depicted through a “T-account”. It is called a “T-account” because it resembles the
letter “T”.

A “T” has three parts:

Account title – describes the specific item of the element of the financial position.
Debit side – the left side of the account.
Credit side – the right side of the account.
Based on the expanded accounting equation, there are five (5) major accounts:
1. Assets accounts
2. Liabilities accounts
3. Equity accounts
4. Income accounts
5. Expense accounts

THE CHART OF ACCOUNTS

Chart of Accounts – is a list of all accounts used by an entity to record transactions and events in the life of
the business.
- accounts are also arranged and classified as to assets (current and non-current), liabilities
(current and non-current), equity, income and expenses.
- accounts are listed in the order of: ASSETS, LIABILITIES, OWNER’S EQUITY, INCOME and
EXPENSES (ALOEIEx)

Chart of Accounts
Service Business

Statement of Financial Position Accounts

ASSETS

Current Assets – are assets which are:

1. expected to be realized, sold or consumed, in the entity’s normal operating cycle;
2. held primarily for trading;
3. expected to be realized within twelve (12) months after the reporting period; or
4. cash or cash equivalent, unless restricted from being exchanged or used to settle a liability for at
least twelve (12) months after the reporting period.

Cash – is any medium of exchange that a bank will accept for deposit at face value. It includes coins,
currencies, checks, money orders, bank deposits and bank drafts.
Cash Equivalents – are short-term, highly liquid investments that are readily convertible to known amount of
cash and which are subject to an insignificant risk of changes in value.
Notes Receivable – is a written promissory note that the customer will pay the business a fixed amount of
money on a certain date.
Accounts Receivable – are claims against customers arising from the sale of services or goods on credit.
Estimated Uncollectible Accounts – a contra-asset deducted from Accounts Receivable representing the
amount of accounts receivable doubtful of collection.
Prepaid Expenses – are expenses paid for by the business in advance. Ex. Prepaid Insurance, Prepaid Rent,
Prepaid Interest

Non-current Assets - are assets which are not classified as current.

Property and Equipment – are tangible assets that are held by an enterprise for use in the supply of services,
for rentals to others, or for administrative purposes and which are expected to be used during more
than period. (For manufacturing company, we have this as Property, Plant and Equipment)
It is composed of:
Land – where the office building, warehouse or factory plant is constructed.
Building – an office building, warehouse or a factory plant.
Office Equipment (computer sets, airconditioners, fax machines, electrical units
Delivery Equipment (cars, motors, etc.)
Furniture and Fixtures (cabinets, chairs, tables, dividers, etc. )
Accumulate Depreciation – a contra-asset account containing the sum of the periodic depreciation charges.
It is deducted from its related item of property, plant and equipment. Items under Property and
Equipment, except for Land, are subject to depreciation.
Intangible Assets - are assets without physical characteristics that are held by an enterprise for use in the
supply of services, for rentals to others, or for administrative purposes.
Ex. Goodwill, Franchise, Trademarks, Patent
LIABILITIES
Current Liabilities – are liabilities which satisfy any of the following:
a. It is expected to be settled in the entity’s normal operating cycle.
b. It is held primarily for the purpose of being traded.
c. It is due within twelve months after the reporting date.
d. The entity does not have unconditional right to defer settlement of the liability for at
least twelve months after the reporting date.
Accounts Payable – represent obligations of an entity which are on open accounts.
Notes Payable – represents obligations of an entity which are supported with a written promise to pay the
other party a specified amount of money on a specified future date.
Accrued Expenses – are expenses already incurred by the business but not yet paid.
Ex. Rent Payable, Utilities Payable, Interest Payable, Salaries Payable
Unearned Revenues – revenues received in advance before services have been provided.
Ex. Unearned Rent Income, Unearned Interest Income
Current Portion of Long-Term Debt – a portion of a long-term debt which is to be paid within twelve months
after the reporting period.

Non-current Liabilities – these are liabilities other than current.

Mortgage Payable –an obligation of a business which payable beyond one year from the reporting date and
for which the business pledged certain assets as collateral.
Bonds Payable – obligations of a business arising from borrowing money from lenders by issuing bonds. Bond is
a contract of debt.
Long-Term Notes Payable – an obligation of an entity arising from issuing a promissory note to pay the lender
beyond one year from the reporting date.

Owner’s Equity
Capital – represents the original and additional investments of cash or other assets by the owner.
Drawing – represents the withdrawals of cash or other assets by the owner.
Income Summary – is used to close the income and expense accounts at the end of the accounting period.

Income
Service Income – used to record income earned for rendering services for cash and on account.
Other account title may be used depending on the nature of the business. For example: for doctors –
Medical Fees; for lawyers – Legal Fees

Expenses
Salaries Expense –represents remunerations/compensations of employees for their services rendered to the
business.
Supplies Expense – represents the amount of supplies used in the conduct of business.
Utilities Expense – represents the amount of water, electricity, telecommunications consumed during the
accounting period.
Rent Expense –represents the amount of rent for space and other equipment being used.
Uncollectible Accounts –represents the amounts of Accounts Receivable which are doubtful of collection
and recognized as a loss.
Depreciation Expense –represents a portion of tangible assets allocated and charged as expense during the
accounting period.
Miscellaneous Expense – represents expenses which of small amount.

This is just an example of Chart of Accounts.

Each entity has its own Chart of Accounts being used.

Rules of Debit and Credit

One of the steps in analyzing a business transaction is deciding if the accounts involved increase or
decrease. However, we do not use the concept of increase or decrease in accounting. We use the words “debit”
and “credit” instead of increase or decrease. The meaning of debit and credit will change depending on the
account type. Debit simply means left side; credit means right side. The accounting equation must always be in
balance and the rules of debit and credit enforce this balance.
Let’s recall the Accounting Equation:

A = L + OE
Assets are on the left side (debit) of the equation while liabilities and owner’s equity are on
the right (credit) side.

DEBIT CREDIT
Assets Increase Decrease
Liabilities Decrease Increase
Owner’s Equity Decrease Increase
Income Decrease Increase
Expenses Increase Decrease

To increase an Asset or Expense: DR

To increase a Liability, Income, or OE: CR
To decrease an Asset or Expense: CR
To decrease a Liability, Revenue, or OE: DR

What about the Income Statement elements (Revenue and Expense)? They don’t appear in the
fundamental accounting equation, so how does it stay in balance when they are debited or credited?

Let’s recall the expanded accounting equation.

ASSETS = LIABILITIES + (CAPITAL – DRAWINGS + INCOME – EXPENSES)

Let’s have the Rules of Debit and Credit using “T” accounts:

Drawings and expenses decrease Owner’s Equity so their normal balances are Debit (Dr.); while
Revenues/Income increase Owner’s Equity, they have credit as their normal balances.
FINANCIAL TRANSACTION WORKSHEET
- this worksheet helps us determine the total assets, total liabilities and owner’s equity of the business
- facilitates in analyzing business transactions (for beginners in accounting)

Let’s make use of our previous example for Rosanna Bucarin.

1. Rosanna Bucarin starts with a Repair Shop business in Tacurong City. At the beginning of the period, assets
amount to ₱350,000, liabilities, ₱100,000.
a. How much is the owners’ equity at the beginning of the period?
b. For each item below, determine its effects on the accounting values.
1. During the period, the business received cash of ₱50,000 for services rendered.
2. During the period, the business paid expenses (business permit) amounting to ₱20,000.
3. During the period, the business bought repair equipment on account, ₱25,000.
4. At the end of the year, the owner withdrew cash of ₱10,000 from the business for her personal expenses.
5. During the period, the business rendered services on account, ₱20,000.
6. During the period, the business collected the accounts of the customer (refer to #5).
7. During the period, the business acquired land at a cost of ₱200,000, paying ₱50,000 cash and the balance
to be paid the following year.

Illustration:
Assets Liabilities Items affecting
Owner’s Equity owner’s equity
= +
Cash Accounts Repair Accounts Bucarin, Capital Investment by the
Receivable Land Equipment Payable owner

a. ₱ 350,000 ₱100,000 ₱250,000

b.1 50,000 50,000 income (rendered
services)
-------------- ---------------- ------------ --------------- --------------- --------------------
Bal. ₱ 400,000 ₱100,000 ₱300,000
b.2 ( 20,000) (20,000) paid expenses
-------------- ---------------- ------------ --------------- --------------- --------------------
Bal. ₱380,000 ₱100,000 ₱280,000
b.3 25,000 25,000
-------------- ---------------- ------------ --------------- --------------- --------------------
Bal. ₱380,000 ₱25,000 ₱125,000 ₱280,000
b.4 (10,000) (10,000) owner’s drawing
-------------- ---------------- ------------ --------------- --------------- --------------------
Bal. ₱370,000 ₱25,000 ₱125,000 ₱270,000
b.5 20,000 20,000 income (rendered
services)
-------------- ---------------- ------------ --------------- --------------- --------------------
Bal. ₱370,000 ₱20,000 ₱25,000 ₱125,000 ₱290,000
b.6 20,000 (20,000)
-------------- ---------------- ------------ --------------- --------------- --------------------
Bal. ₱390,000 ₱25,000 ₱125,000 ₱290,000
b.7 (50,000) 200,000 150,000
-------------- ---------------- ------------ --------------- --------------- --------------------
Bal. ₱340,000 ₱200,000 ₱25,000 ₱275,000 ₱290,000
======== ======= ======== ======== ============

To summarize: Bucarin Repair Shop has:

Assets: Liabilities:
Cash ₱340,000 Accounts Payable ₱275,000
Land 200,000 Bucarin, Capital 290,000
Office Equipment 25,000 ________
Total Assets ₱565,000 ₱565,000
======== ========
In accounting, the final amount is being double ruled (========)
To apply the steps in analyzing business transactions:

Elements of accounting Effects to elements Debit/Credit the accounts

Accounts Affected equation affected of accounting equation (refer to Col. 1) affected

a. Cash Assets increased debit

Accounts Payable Liabilities increased credit
Bucarin, Capital Owner’s Equity increased credit
b.1 Cash Assets increased debit
Service Income Owner’s Equity increased credit
b.2 Cash Assets decreased credit
Taxes & License s Owner’s Equity decreased debit
b.3 Repair Equipment Assets increased debit
Accounts Payable Liabilities increased credit
b.4 Cash Assets decreased credit
Bucarin, Drawing Owner’s Equity decreased debit
b.5 Accounts Receivable Assets increased debit
Service Income Owner’s Equity increased credit
b.6 Cash Assets increased debit
Accounts Receivable Assets decreased credit
b.7 Land Assets increased debit
Cash Assets decreased credit
Accounts Payable Liabilities increased credit

References: https://courses.lumenlearning.com/sac-finaccounting/chapter/general-rules-for-debits-and-credits/