Acc 101 Financial Accounting and Reporting PDF

ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1
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Module 1
ACCOUNTING AND ITS ENVIRONMENT
Week 1
Introduction
Accounting has evolved, as in the case of medicine and law, in response to the social and
economic needs of society. As business and society become more complex, accounting develops
new concepts and techniques to meet the ever-increasing needs for financial information. Without
such information, many complex economic developments and social programs may never have
been undertaken.
In a market economy, information helps decision-makers make informed choices regarding the
allocation of scarce resources under their control. When decision-makers are able to make well-
informed decisions, resources are allocated in a way that better meets the needs and goals of
those within the market.
Accounting is relevant in all walks of life, and it is absolutely essential in the world of business.
Accounting is the system that measures business activities, processes that information into
reports and communicates the results to decision-makers. Accounting quantifies business
communication. For this reason, accounting is called the language of business. The task of
learning accounting is very similar to the task of learning a new language; thus, the need for this
book which teachers the Basics of Accounting in a very conceptual manner.
No business could operate very long without knowing how much it was earning and how much it
was spending. Accounting provides the business with this information and more. So, accountants
can be called the scorekeepers of business. Without accounting, a business couldn’t function
optimally; it wouldn’t know where it stands financially, whether it’s making a profit or not, and it
wouldn’t know its financial situation. Also, a sound understanding of this language will bring about
a better management of the financial aspects of living. Personal financial planning, education
expenses, car amortization, business loans, income taxes and investments are based on the
information system that we call accounting.
INTENDED LEARNING OUTCOMES

After studying this module, students should be able to:
1. Define accounting and explain its role in business.
2. Explain the fundamental business model and determine how it is applied to the various
types of businesses.
3. Differentiate the forms and activities of business organizations.
4. Determine the importance of the purpose and phases of accounting.
5. Explain the fundamental accounting concepts and principle.
6. Identify the career opportunities open to accountants.
DEFINITIONS OF ACCOUNTING
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Table 1 presents the definitions of accounting and their respective references.
Table 1 - Definitions of Accounting
Definition Reference
Accounting is a service activity. Its Statement of Financial Accounting Standards No.

function is to provide quantitative 1, “Basic Concepts and Accounting Principles
information primarily financial in Underlying Financial Statements of Business
nature, about economic entities that Enterprises” (Manila: Accounting Standards
is intended to be useful in making Council, 1983), par. 1
economic decisions
Accounting is an information Statement of Financial Accounting Concepts No. 1,

system that measures, processes “Objectives of Financial Reporting by Business
and communicates financial Enterprises” (Norwalk, Conn.: Financial Accounting
information about an economic entity Standards Board, 1978), par. 9
Accounting is the process of American Accounting Association, “A Statement of

identifying, measuring and Basic Accounting Theory” (Evanston, III.: American
communicating economic information Accounting Association, 1966), par. 1;
to permit informed judgments and
decisions by users of the information Accounting Principles Board, Statement No. 4,
“Basic Concepts and Accounting Principles
Underlying Financial Statements of Business
Enterprises”(New York: AICPA, 1970), par. 40
Accounting is the art of recording, American Institute of Certified Public Accountants,

classifying and summarizing in a “Review and Resume”, Accounting Terminology
significant manner and in terms of Bulletin No. 1 (New York: AICPA, 1953), par.9
money, transactions and events
which are, in part at least, of a
financial character, and interpreting
the results thereof
FUNDAMENTAL BUSINESS MODEL
● Developing a product or service that customers will pay and thus, will create a revenue
stream is necessary for a business to be successful.
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○ Such can be
■ a new product or service that meets specific needs.
■ a better product or service.
■ a product or service that offers a better value proposition.
● A business requires investments to enable it to pay for the infrastructure, equipment and
personnel. A skillful combination of these elements are necessary for a business to
generate a revenue stream.
Figure 1 illustrates how a business is structured to provide a customer proposition.
Figure 1 - Fundamental Business Model
Five activities on the Fundamental Business Model:

1. Investors provide the required capital for the business. The cash investment will then be
held in a bank account.
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2. The cash invested in the business can be:

● Converted into other type of assets that will be used in the business (e.g.
equipment) or sold (e.g. inventory); or
● Spent on operating costs such as salaries, supplies, rentals and utilities.
3. Combining the business resources provides the basis for producing the products or
services.
4. The sale of a product or service generates an asset called a receivable. Once collected this
asset will produce a cash inflow for the business.
5. If there’s an existing debt from banks, the cash inflow from collections will be used to pay the
debt providers with interest on their loans to the company. Remaining cash can be sent back to
the cycle by being converted into other assets or spent on operating costs (back to stage 2). In
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the normal course of business, this whole process will earn profits on which tax will have to be
paid. Any profit after tax can continue to be reinvested in the cycle or paid out to the owners as a
“return” on their investments (withdrawals or dividends).
The model outlines the way money flows around a business and provides the basis of accounting.
To manage a business effectively it is necessary to know how the cash has been spent and how
profitable the products or services have been to the business. The availability of this historical
information helps management to make informed judgments on how to improve the performance
of business.
TYPES OF BUSINESS
Despite the absence of variation in the fundamental business model, there are numerous ways
of applying this in providing the scope of products and services that comprise the business world.
However, the range of products and services can be synthesized into seven (7) types which are
listed below;
Table 1
Summary of Types of Business
Type Activity Structure Examples
Services Selling people’s Hiring skilled workers and selling Banking,

time their time Education
Accounting
Legal
Salon services
Trader Buying and Purchasing a range of raw Wholesaler

selling materials and finished goods, Retailer
commodities or consolidating them, enabling
products them to sell in locations within
the proximity of their customers
or for online delivery
Manufacture Designing Buying raw materials and Vehicle Assembly

products, combining equipments and labor Construction
combining parts to convert them into finished Engineering
and components products Electricity, Water,
and assembling Food and Drink
finished goods Chemicals
Media
Pharmaceuticals
Raw Growing or Commonly purchasing blocks of Farming

materials extracting raw land and using them to create or Mining
materials produce the raw materials Oil
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Infrastructure Selling the Purchasing and operating assets Transport (airport

utilization of (typically large assets); selling operator, airlines,
infrastructure occupancy or utilization often in trains, ferries, buses)
combination with services Hotels
Telecoms
Sports facilities
Property
management
Financial Receiving Accepting cash from depositors Banks

deposits, lending and paying them interest; using Microfinance
and investing the money to provide loans to institutions
money borrowers, charging them fees Investment house
and a higher rate of interest than
the depositors receive
Insurance Pooling Collecting cash from many Insurance companies

premiums of customers; investing the money
many to meet to pay the losses experienced by
claims of a few a few customers. By
understanding the risk accepted
and the likelihood of a claim,
more premium income can be
earned than claims paid.
FORMS OF BUSINESS ORGANIZATIONS
The types of businesses mentioned above may be performed by any of the forms of organization,
be it a single or sole proprietorship, a partnership or a corporation. The accounting procedures to
be followed will depend on the form of organization.
Sole Proprietorship
● It has a single owner known as the proprietor who usually is also the manager.
● This form tends to be small-service-type like those of physicians, lawyers and accountants
forming their own business and retail establishments.
● All profits go to the owner. However, the owner also absorbs all losses and the only one
responsible for all liabilities of the organization.
● This form of organization is distinct from its owner or proprietor in terms of accounting
viewpoint. In relation to this, their accounting records do not include the owner or
proprietor’s personal financial records.
Partnership
● As defined in Philippine Civil Code, Article 1767, it is a contract whereby two or more
persons bind themselves to contribute money, property, or industry to a common fund,
with the intention of dividing the profits among themselves.”
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● Partners in this form of organization are personally liable for any obligations incurred by
the partnership.
● Partnership is considered as a separate organization which is distinct from the personal
affairs of each partner in accounting point of view.
Corporation
● As defined in the Revised Corporation Code of the Philippines (RA 11232), 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.”
● A form of business organization owned by its shareholders.
Since the corporation is a separate legal entity, the stockholders are not personally liable for the
corporation’s obligations.
ACTIVITIES IN BUSINESS ORGANIZATIONS
The discussion that will follow focuses on the three types of organizational activities:
Financing Activities
● These are the methods an organization uses to obtain financial resources from financial
markets and how it manages these resources. These resources are needed to acquire
other resources used in producing goods and services.
● Primary sources of financing
○ Owners
○ Creditors like banks and suppliers
● The following are some of the financing activities:
○ Initial and additional investments
○ Repaying the creditors
○ Paying a return to the owners
● Financial resources derived from financing activities are utilized by the organization to
acquire other resources necessary in the transformation process, that is from one form to
a different form. It can serve the needs and demands of the customers. Having the right
mix of resources is essential to efficient and effective operations.
Investing Activities
● These 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.
● Some of the activities involve are the following:
○ 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.
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Operating Activities
● These activities involve the use of resources to design, produce, distribute, and market
goods and services.
● Specifically, the following are the common activities in this area:
○ research and development,
○ design and engineering,
○ purchasing,
○ human resources,
○ production,
○ distribution,
○ marketing and selling, and
○ servicing.
● Business organizations compete both in searching for the best suppliers and labor
providers as well as meeting the demand of their target markets.
PURPOSE AND PHASES OF ACCOUNTING
Accounting function handles not only the financial operations but also provides information and
advice to other departments of the organization. It does not operate in isolation. In fact, the
accounting function is just a part of the broader business system.
A significant function of accounting is to record historical events that affect the resources of the
organization. These historical events are the business transactions that represent the economic
activities of a business. Accounts are produced to aid management in planning, control and
decision-making and to comply with regulations.
● Recording is not the first step in accounting. Before recording the effects of transactions,
it must first be measured. Accounting information will be useful if such will be expressed
in terms of a common financial denominator - money. Money serves as both a measure
of value and a medium of exchange.
○ Several considerations need to be decided before measuring a business transaction
■ Recognition Issue - when the transaction occurred
■ Valuation Issue - what value to place on the transaction
■ Classification issue - how the components of the transaction should be classified
● To maximize the benefit out of the financial information, it is not enough to just simply
measure and record the transactions. It must be classified and summarized for such to be
useful in making decisions. The effects of numerous transactions are categorized into
useful groups or categories. This phase is known as classification.
● Summarization of financial data is achieved through financial statements preparation.

This phase summarizes the effects of all business transactions that occurred during a
particular period.
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● The last phase in accounting which is interpretation or analysis of financial information
will be performed after going through the summarization phases. The results are
interpreted or analyzed to evaluate the financial position and performance of the
organization through financial ratios such as liquidity, profitability and solvency. .
Accounting provides the decision-makers with information to make reasoned choices
among alternative uses of scarce resources in the conduct of business and economic
activities.
FUNDAMENTAL CONCEPTS
In recording business transactions, accountants should consider the following fundamental
concepts that underlie the accounting process.
Fundamental Explanation
Concept
Entity Concept ● An accounting entity is an organization or a section of an organization

that stands apart from other organizations and individuals as a
separate economic unit.
● This concept states that the transactions of different businesses or
entities should not be accounted for together. Even businesses of
one single proprietor need to be accounted for separately.
● Each entity should be evaluated separately.
Periodicity Concept ● This concept allows users to acquire timely information that will
serve as a basis on arriving at economic decisions about future
activities.
● An entity’s life can be meaningfully subdivident into equal time
intervals for reporting purposes. Waiting for the actual last day of
operations will not be necessary to perfectly measure the entity’s
profit.
● The common accounting period for the purpose of reporting
externally is one year.
Stable Monetary ● This concept is the basis for ignoring the effects of inflation in the
Unit Concept accounting records of the organization.
● A reasonable unit of measure that is considered in accounting is the
Philippine Peso. Its purchasing power is assumed to be relatively
stable meaning it allows accountants to add and subtract peso
amounts as though each peso has the same purchasing power as
any other peso at any time.
Going Concern ● This concept pertains to the preparation of financial statements

considering the assumption that the reporting entity is a going
concern and will continue in operation for the foreseeable future.
● With this concept, it is assumed that the entity has neither the
intention nor the need to enter liquidation or to cease operations.
● This concept underlies the depreciation of assets over their useful
lives.
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CRITERIA FOR GENERAL ACCEPTANCE OF AN ACCOUNTING PRINCIPLE
Certain guidelines need to be followed in accounting practice. Generally accepted accounting

principles (GAAP).encompass the conventions, rules and procedures necessary to define
accepted accounting practice at a particular time.
Accounting principles
● Established by humans
●
● Evolving, not eternal truths
● General acceptance usually depends on how well it meets three criteria
○ Relevance- extent to which the resulting information is meaningful and useful to
those who need to know something about a certain business.
○ Objectivity - extent to which the resulting information is not influenced by the
personal bias or judgment of those who furnish it. It connotes reliability and
trustworthiness. It also connotes verifiability, which pertains to determining
whether the information provided is correct.
○ Feasibility - extent to which it can be implemented without undue complexity or
cost. These criteria often conflict with one another. In some cases, the most
relevant solution may be the least objective and the least feasible.
BASIC PRINCIPLES
In order to generate information that is useful to the users of financial statements, accountants
rely upon the following 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
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● Under this principle, revenue is to be recognized in the accounting period when goods are
delivered or services are rendered or performed. This is regardless of whether there is an
actual collection on the date of sale.
Expense Recognition Principle.
● Expenses should be recognized in the accounting period in which goods and services are
used up or incurred to produce revenue and not when the entity pays for those goods and
services.
Adequate Disclosure
● Under this principle, it requires all relevant information that would affect the user’s
understanding and assessment of the accounting entity to be disclosed in the financial
statement.
Materiality
● Under this principle, 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.
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.
THE ACCOUNTANCY PROFESSION
Characteristics
Accountancy qualifies as a profession because it possesses the following attributes:

● All members of the accountancy profession are Certified Public Accountants, which means
that they have earned a Bachelor of Science in Accountancy degree and have passed the
CPA Licensure Examinations.
● CPAs have their own body of language. They use terminology peculiar to the profession
(e.g. debits and credits).
● CPAs adhere to a Code of Ethics. This code upholds the CPA’s responsibility to serve the
public with competence and integrity. The public, in return, expresses its confidence to
CPAs by relying on the financial statements they audit.
● Like other professions, CPAs are members of a national organization, the PICPA, whose
role is to ensure the continued improvement of the accountancy profession to meet the
demands of the times.
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Career Opportunities
The professional accountant is presented with diverse opportunities. The demand for accounting
services has increased with the increase in number, size, and complexity of business. The
accountant may be engaged in any of the following areas of competence:
Public Practice
● This pertains to those accountants who render services on a fee basis and staff
accountants employed by them.
● Public accountants, who practice individually or as members of public accounting firms,
should be certified public accountants (CPAs).
● Their work includes auditing, taxation and management advisory services.
● Firms vary greatly in size. Some are small proprietorship and others are large
partnerships. There are large global CPA firms with more than 1,000 partners.
● Largest accounting firms (in alphabetical order) in the United States:
○ Deloitte & Touche,
○ Ernst & Young,
○ KPMG, and
○ PriceWaterhouseCoopers.
○ Arthur Andersen & Co. is now history;
■ The firm used to be the biggest but succumbed to pressures brought about
by a lot of financial fiascos including that of Enron, Sunbeam, Waste
management and WorldCom.
■ These firms employ only about 12 percent of the CPAs in the United States
but they audit the financial statements of approximately 85 percent of the
top corporations.
● Biggest firms In the Philippines,
○ Sycip Gorres Velayo & Co. (SGV & Co. )
■ with over 1,800 professionals from various disciplines.
■ SGV & Co. is a member practice of Ernst & Young Global.
○ Punongbayan & Araullo,
○ Laya Mananghaya & Co.,
○ C.L. Manabat & Co.,
○ Isla, Lipana & Co. (Joaquin Cunanan & Co.),
○ Constantino, Guadalquiver & Co.,
○ Carlos J. Valdez & Co.,
○ Alba Romeo & Co.,
○ Diaz Murillo Dalupan & Co. and
○ Reyes Tacandong & Co. among others.
● The top partners in these large accounting firms earn about the same amount as the top
executives of other large businesses. Public accounting is the frequently traveled career
path because it offers excellent opportunities to gain multi-faceted business experience.
● Sample Entry level jobs:
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○ Audit staff
○ Tax Staff
○ Management Services/Consulting Manager
● Advanced positions:
○ Partner
○ Senior Partner
○ Senior Consultant/Financial Advisor.
Commerce and Industry

● Accountants employed in this area vary widely in their scope of activities and
responsibilities.
● Sample Entry-level jobs:
○ Financial Accounting and ○ Financial Analyst,
Reporting Staff, ○ Budget Analyst,
○ Management Accounting Staff, ○ Credit Analyst,
○ Tax Accounting Staff, ○ Cost Accountant;
○ Internal Audit Staff,
● Middle-level positions:
○ Comptroller, ○ Senior Fraud Examiner,
○ Senior Information Systems ○ Senior Forensic Auditor
Auditor,
● Advanced positions:
○ Chief Financial Officer ○ Chief Information Officer.
Government Service
● Accountants may be hired by the following:
○ Congress of the Philippines,
○ Commission on Audit (COA),
○ Bureau of Internal Revenue (BIR),
○ Department of Finance,
○ Department of Budget and Management,
○ Bangko Sentral ng Pilipinas (BSP) and
○ the local government units (e.g. provincial, city or municipal governments).
● Sample Entry-level jobs
○ State Accounting Examiner ○ Audit Examiner
○ State Accountant ○ Budget Analyst
○ LGU Accountant ○ Financial Services Specialist
○ Revenue Officer
● Middle-level positions
○ State Accountant V
○ Director III and Director IV, Government Accountancy and Audit
○ Financial Services Manager
○ Audit Services Manager
○ Senior Auditor
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● Advanced positions
○ National Treasurer
○ Vice President for Finance/ CFO (for GOCC’s)
○ Commissioner
○ Associate Commissioner
○ Assistant Commissioner, (COA/ BIR, BOC).
Education/ Academe
● This area guarantees the continued development of the profession by endeavoring to
clarify and address emerging issues through research and sharing the results obtained
with their colleagues.
● Considered as modern day heroes, they make others understand the body of accounting
knowledge.
● In addition, they painstakingly prepare candidates for the tough CPA exams. With the
advent of information technology, this sector is being challenged to focus accounting
education from the “transfer of knowledge” approach to the more-effective “learning to
learn” approach.
● Sample Entry-level jobs
○ Junior Accounting Instructor
● Middle-level positions
○ Senior Faculty
○ Accounting Department Chair
● Advanced positions
○ Vice President for Academic Affairs
○ Dean.
BRANCHES OF ACCOUNTING
The main branches of accounting and their brief description are discussed as follows:
Auditing
● accountancy profession’s most significant service to the public.

○ An external audit
■ the independent examination that ensures the fairness and reliability of the
reports that management submits to users outside the business entity.
■ The result of the examinations is embodied in the independent auditor’s report.
■ Once the required financial statements have been prepared by management,
they have to be evaluated in order to ensure that they do not present a distorted
picture.
■ External auditors
● appointed from outside the organization.
● job is to protect the interests of the users of the financial statements.
○ Internal auditors
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■ By contrast to external auditors, they are employees of the company.
■ They are appointed by, and answer to the companies management though
they work independently of the accounting and other departments.
■ They ensure the accuracy of business records, uncover internal control
problems and identify operational difficulties.
○ To differentiate further, internal auditors perform routine tasks and undertake detailed
checking of the company’s accounting procedures, whereas external auditors are
likely to go in for much more selective testing.
○ Nonetheless, they usually work very closely together, although the distinction made
between them still remains important.
Bookkeeping
● a mechanical task involving the collection of basic financial data.

● The data are first entered in the accounting records of the books of accounts, and then
extracted, classified and summarized in the form of income statement, balance sheet and
cash flow statement.
○ An income statement shows whether the business has made a profit or loss
during the period, i.e. it measures how well the business has done.
○ A balance sheet lists what the entity owns (its assets), and what it owes (its
liabilities) as at the end of the period.
○ The cash flows statement presents the cash inflows and outflows of the business
during the period.
○ The bookkeeping procedures usually end when the basic data have been entered
in the books of accounts and the accuracy of each entry has been tested. At the
stage, the accounting function takes over.
● Accounting tends to be used as a generic term covering almost anything to do with the
collection and use of basic financial data.
● Bookkeeping is a routine operation, while accounting requires the ability to examine a
problem using both financial and non-financial data.
Cost Bookkeeping, Costing and Cost Accounting
Cost bookkeeping
● the process that involves the recording of cost data in books of accounts.
● similar to bookkeeping except that data are recorded in very much greater detail.
● Cost accounting makes use of those data once they have been extracted from the cost
books in providing information for managerial planning and control.
The difference between bookkeeping per se and cost bookkeeping is largely one of degree of
detail.
Cost accounting
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● cost accounting system contains a great deal more data, and thus once the data are
summarized there is much more information available to the management of the company.
● deals with the collection, allocation, and control of the cost of producing specific goods
and services. This accumulation and explanation of actual and prospective cost data is
important to control current operations and to plan for the future.
● one of the main sub-branches of management accounting.
Financial Accounting
● Focused on the recording of business transactions and the periodic preparation of reports
on financial position and results of operations.
● Financial accountants accord importance to generally accepted accounting principles.
● More specific term applied to the preparation and subsequent publication of highly
summarized financial information.
● The information supplied is usually for the benefit of the owners of an entity, but it can also
be used by management for planning and control purposes. It will also be of interest to
other parties, e.g., employees and creditors.
Financial Management
● a relatively new branch of accounting that has grown rapidly over the last 30 years.
● Financial managers
○ responsible for setting financial objectives, making plans based on those
objectives, obtaining the finance needed to achieve the plans, and generally
safeguarding all the financial resources of the entity.
○ much more heavily involved in the management of the entity than is generally the
case with either financial or management accountants
○ draws on a much wider range of disciplines and relies more extensively on non-
financial data than does the more traditional accountant.
Management Accounting
● Incorporates cost accounting data and adapts them for specific decisions which
management may be called upon to make
● A management accounting system incorporates all types of financial and non-financial
information from a wide range of sources.
Taxation
● includes the preparation of tax returns and the consideration of the tax consequences of
proposed business transactions or alternative courses of action.
● Accountants with this specialization aim to comply with existing tax statutes but are also
in constant legal search for ways to minimize tax payments.
● If tax experts attempt to reduce their clients’ tax liabilities strictly in accordance with the
law, this is known as “tax avoidance”.
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○ Tax avoidance is a perfectly legitimate exercise,
○ Tax evasion (the non-declaration of sources of income on which tax might be due)
is a very serious offense.
Government Accounting
● It is concerned with the identification of the sources and uses of resources consistent with
the provisions of city, municipal, provincial and national laws.
● The government collects and spends a huge amount of public funds annually so it is
necessary that there is proper custody and disposition of these funds.
Exercises and Activities
True or False
1. An audit is the independent examination that ensures the fairness and reliability of the
reports that management submits to users outside the business entity.
2. A business transaction is the occurrence of an event or of a condition that must be
recorded.
3. One characteristic of a corporation is that its owners are personally liable for any losses
incurred by the business.
4. The set of guidelines and procedures that constitute acceptable accounting practice at a
given time is GAAP, which stands for generally accepted accounting process.
5. Classification reduces the effects of numerous transactions into useful groups or
categories.
6. The liability of corporate stockholders is limited to the amount of their investment.
7. The terms bookkeeping and accounting are synonymous.
8. Most members of the accountancy profession are Certified Public Accountants.
9. A corporation is an economic unit that is legally separate from its owners.
10. The personal liability of a partner is limited to the amount of his investment.
11. Manufacturing companies buy raw materials, convert them into products and then sell
the products to other companies or to final consumers.
12. The entity concept states that the transactions of different entities should not be
accounted for together.
13. Accounting is often characterized as the “language of business”.
14. 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.
15. The Philippine accountant considers peso as the common unit of measure for all
business transactions.
16. For accounting purposes, a business and its owner are considered one and the same.
17. Summarization reduces the effects of numerous transactions into useful groups or
categories.
18. A partnership is always owned by two individuals.
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19. For reporting purposes, the personal assets and debts of a business owner should be
combined with the assets and debts of the business.
20. Government accounting deals solely with the identification of the sources of resources
consistent with laws.
21. All members of the accountancy profession are Certified Public Accountants.
22. Accounting is a service activity whose function is to provide quantitative information
about economic activities that is intended to be useful in making economic decisions.
23. A corporation is a business owned by its stockholders.
24. A separate legal entity organized in accordance with codes and laws and in which
ownership is divided into shares of stock is referred to as a corporation.
Multiple Choice
1. Which of the following are true of partnerships?

1. The partners’ individual exposure to debt is limited.
2. Financial statements for the partnership by law must be produced and made
public.
3. A partnership is not a separate legal entity from the partners themselves.
a. 1 and 2 only
b. 2 only
c. 3 only
d. 1 and 3 only
2. Which accounting concept should be considered if the owner of a business takes goods
from inventory for his personal use?
a. The substance over form concept
b. The accrual concept
c. The going concern concept
d. The business entity concept
3. Which accounting concept states that omitting or misstating this information could
influence users of the financial statements?
a. The consistency concept
b. The accrual concept
c. The materiality concept
d. The going concern concept
4. Which of the following accounting concepts means that similar items should receive a
similar accounting treatment.
a. Going concern
b. Accrual
c. Substance over form
d. Consistency
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5. Assets are usually valued under which basis?
a. Replacement cost
b. Historical cost
c. Net realizable value
6. Which of the following best explain the feature of consistency of presentation?

a. When preparing the accounts of a firm, one should normally account for similar
items in the same way from one accounting period to the next.
b. Firms in the same industry must account for similar items in the same way.
c. Firms must comply with accounting standards and regulations.
d. None of the above
.
7. Which of the following statements about accounting concepts and the characteristics of
financial reporting information is not correct?
(i) Entities may exclude information that is relevant in financial statements
because it is too difficult for the users to understand.
(ii) The historical cost concept means that only items capable of being measured
in monetary terms can be recognized in the financial statements.
(iii) Consistency in use of the same accounting policies for the same or similar
items from one period to the next is essential to enhance comparability among the
entities.
a. (i) and (ii)

b. (i) and (iii)
c. (ii) and (iii)
d. All of the above
8. Which type of business organization is owned by its stockholders?

a. Corporation
b. Partnership
c. Proprietorship
d. All the above are owned by stockholders
Multiple Choice
1. Which of the following is an appropriate definition of accounting?

a. The measurement, processing, and communication of financial information about
an identifiable economic entity.
b. A means of recording transactions and keeping records.
c. The interconnected network of subsystems necessary to operate a business
d. Electronic collection, organization, and communication of vast amount of
information
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2. Accountants employed by a particular business firm or not-for-profit organization,
perhaps as chief accountant, controller, or financial vice president, are said to be
engaged in
a. General accounting.
b. Public accounting.
c. Practice in commerce and industry
d. Independent accounting
3. The entity concept means that

a. Because a firm is separate and distinct from its owner, those owners cannot have
access to its assets unless the firm ceases to trade.
b. Accounts must be prepared for every firm.
c. The financial affairs of a firm and its owner are always kept separate for the
purpose of preparing accounts.
d. None of the above.
4. The financial accounting process provides information about economic activities of an

enterprise for a specified accounting period that is shorter than the life of the enterprise.
a. Time period
b. Going concern
c. Measurement of economic resources and obligations
d. Measurement in terms of money
5. The consistency concept means that

a. When preparing the accounts of a firm, one should normally account for similar
items in the same way form one accounting period to the next.
b. Firms in the same industry must account for similar items in the same way.
c. Firms may never change the way in which they prepare their accounts.
d. None of the above.
6. The consistency standard of reporting required that

a. expenses be reported as charges against the period in which they are incurred.
b. the effect of changes in accounting upon income be propertly disclosed.
c. extraordinary gains and losses should not appear on the income statement.
d. accounting procedures be adopted which give a consistent rate of return
7. Which accounting process is the recognition or non-recognition of business activities as

accountable events?
a. Identifying
b. Communicating
c. Recording
d. Measuring
8. The basic purpose of accounting is
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a. To provide the information that the managers of an economic entity need to
control its operations.
b. To provide information that the creditors of an economic entity can use deciding
whether to make additional loans to the entity
c. To measure the periodic income of the economic entity.
d. To provide quantitative financial information about a business enterprise that is
useful in making rational economic decision
.
9. During the lifetime of an entity, accountants produce financial statements at arbitrary
points in time in accordance with which basic accounting concept?
a. Objectivity
b. Periodicity
c. Conservatism
d. Matching
10. The skills needed to be developed by Filipino accountants include the following
a. Intellectual skills
b. Interpersonal skills
c. Communication skills
d. “a”and “c” only
e. “a”, “b” and “c”
11. Which of the following accounting concepts states that an accounting transaction should
be supported by sufficient evidence to allow two or more qualified individuals to arrive at
essentially similar conclusion?
a. Matching
b. Objectivity
c. Periodicity
d. Stable monetary unit
12. The financial statements should be stated in terms of a common financial denominator.
a. Accrual
b. Going concern
c. Time period
d. Stable monetary unit
13. Stating assets and liabilities and changes in them in terms of a common financial
denominator is a prerequisite in measuring financial position and periodic net income.
a. Unit of measure
b. Measurement of economic resources and obligations
c. Exchange price
d. Accrual
14. Carrying out professional responsibilities diligently and in accordance with applicable
technical and professional standards is descriptive of the principle of
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a. Professional competence and due care
b. Objectivity
c. Independence
d. Integrity
15. A professional accountant should be straightforward and honest in all professional and
business relationships. This is in consonance with the fundamental principles of
a. Integrity
b. Objectivity
c. Confidentiality
d. Professional competence and due care
16. Proponents of historical costs maintain that in comparison with all other valuation
alternatives for general purpose financial reporting, statements prepared using historical
costs are more
a. Objective
b. Relevant
c. Indicative of the entity’s purchasing power
d. Conservative
17. The records of properties acquired and services availed of by a business are maintained
in accordance with the
a. Business entity concept
b. Cost principle
c. Proprietorship principle
d. Matching principle
18. This principle requires relevant information to form part of financial statements for
decision-making purposes
a. Objectivity
b. Materiality
c. Adequate disclosure
d. Accounting entity
19. The principle of objectivity includes the concept of

a. Summarization
b. Verifiability
c. Classification
d. Conservatism
20. The concept of matching is best demonstrated by

a. Not recognizing any expense unless some revenue is realized.
b. Recognizing prepaid rent received as revenue
c. Associating effort with accomplishment
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d. Establishing an allowance for possible market decline in inventory account.
21. Accounting changes are often made and the monetary impact is reflected in the financial
statements of an entity even though, in theory, this may be a violation of the accounting
concept of
a. Materiality
b. Objectivity
c. Conservatism
d. Consistency
22. The measurement phase of accounting is accomplished by

a. Storing data
b. Reporting to decision makers
c. Recording data
d. Processing data
23. Which area of public accounting means the examination of financial statements by a
CPA for the purpose of expressing an opinion as to the fairness of the statements?
a. Management advisory services
b. Taxation
c. Internal auditing
d. External auditing
24. A person applying for examination shall establish the following requisites to the
satisfaction of the Board that he:
a. Is a Filipino citizen
b. Is of good moral character
c. Is a holder of degree of Bachelor of Science in Accountancy conferred by a
school, college, academy or institute duly recognized and/or accredited by the
Commission on Higher Education (CHED) or other authorized government
offices
d. Has not been convicted of any criminal offense involving moral turpitude
e. “A” and “c” only
f. “A”, “b” and “c”
g. All of the above
25. The main function is to establish and improve accounting standards that will be generally
accepted in the Philippines.
a. Financial Reporting Standards Council
b. Professional Regulation Commission
c. Philippine Institute of CPAs
d. Board of Accountancy
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26. Which area of public accounting means the examination of financial statements by a
CPA for the purpose of expressing an opinion as to the fairness of the statements?
a. Management advisory services
b. Taxation
c. Internal audit
d. External audit
27. Accountants do not recognize that the value of the peso changes over time. This
concept is called the
a. Stable monetary unit concept
b. Going concern concept
c. Cost principle
d. Entity concept
28. The periodicity concept

a. Requires that all companies prepare monthly, quarterly and annual financial
statements.
b. Results from the Bureau of Internal Revenue requirement that taxable income be
reported on an annual basis
c. Requires all companies to use a fiscal year ending December 31
d. Involves dividing the life of a business entity into accounting periods of equal
length thus enabling the financial users to periodically evaluate the results of
business operations
29. They encompass the conventions,rules,and procedures necessary to define what is

accepted accounting practice
a. Accounting assumptions
b. Accounting concepts
c. Conceptual frameworks
d. Generally accepted accounting principles
30. The Filipino accountants should possess knowledge to enable them to compete
internationally, they are:
a. General knowledge
b. Organizational and Business Knowledge
c. Information Technology Knowledge
d. Accounting Knowledge
e. All of the above
31. Which of the following best describes the attributes of a partnership?

a. Limited ability to raise capital; unlimited personal liability of owners
b. Limited ability to raise capital; limited personal liability of owners
c. Ability raise large capital; unlimited personal liability of owners
d. Ability to raise large amounts of capital; limited personal liability of owners.
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32. The concept of the accounting entity is applicable
a. Only to the legal aspects of business organizations
b. Only to the economic aspects of business organizations
c. Only to business organizations
d. Whenever accounting is involved.
Reference:
Ballada, Win and Ballada, Susan (2020). Basic Accounting Financial Accounting and Reporting.
Domdane Publishers & Made Easy Books. Sampaloc, Manila.
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Module 2
THE ACCOUNTING INFORMATION SYSTEM, ACCOUNTING EQUATION AND
DOUBLE-ENTRY BOOKKEEPING SYSTEM
Week 2 to 4
Introduction
The practice of accounting entails following accounting concepts, principles,
procedures and standards applied uniformly in the preparation of financial reports of all
types of businesses. In Module I, students were introduced to Accounting and its
environment. This module will expose students to the broader aspect of the accounting
information system, identify various accounting elements and how to analyze business
transactions using the accounting equation and acquire basic knowledge of the double-
entry system of bookkeeping.
Learning Objectives:
After studying this chapter, students should be able to:

1. describe the accounting information system in a broader perspective.
2. differentiate the types of accounting information system: manual system,
computer-based system and data-based system.
3. explain how the accounting information system generates timely and accurate
financial information through various stages, which helps the stakeholders in
making important decisions.
4. identify and understand the nature of the accounting elements and its uses.
5. recognize how the elements affect the accounting equation as applied to all types
of businesses.
6. analyze business transactions from source documents using the accounting
equation and financial transaction worksheet.
7. apply knowledge of the accounting equation to better understand the rules of
debits and credits for recording purposes.
ACCOUNTING INFORMATION SYSTEMS

• With the employment of technology brought about by business
globalization, providing and processing of financia⁰l information becomes a
“click of a finger”. Though the effectiveness of the system largely depends
on the nature, size of the business and volume of data to process, yet
accounting information systems made businesses cope up with the fast
demands of accounting information and transactions. While accounting
information involves planning, recording, analyzing and interpreting data, it
needs to gather and process it and then distributes this information to
interested end-users.
• Accounting information system is the planned process for the collection, storage and
processing of financial accounting data to provide reliable information that can be
used by the management and other stakeholders (Valencia 2016).
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• It refers to a whole range of records and special accounting procedures use by the
business in achieving the objectives of financial accounting, preparation and
communication of financial reports (Valencia, 2016).
• A collection of people, procedures, software, hardware and data which work together
to provide information necessary to running an organization (Ballada, 2018)
• It is a device or an organization of planned procedures designed to transform
economic information and other data into meaningful reports (Valencia, 2016)
Figure 1.1 Accounting information Cycle
Importance of accounting information system
1. Business record-keeping is required by law.

For how long does a company have to store its accounting books and records?
Under RR 17-2013 and RR05-2014, all books, registers, records, vouchers and
other supporting papers and documents prescribed by the BIR must be kept by a
business for a period of 10 years, a sufficient time to maintain records for audit
examination and income tax purposes.
2. It helps prevent unnecessary cost.

A good accounting information in place means a company maintains proper
business records while a weak or poor accounting information system poses greater
risk to business.
3. It facilitates decision-making.
Accounting information system generally guides managers to facilitate in
providing financial information and reports in order to make sound economic
decisions.
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Figure 1. 2 Stages of Accounting Information System
The accounting information system comprises of three (3) stages as follows:
Stage 1 – Inputs
The collection of raw data, acquired from internal and external sources,
evidenced by source documents such as invoices, receipts, contracts,
etc.
Stage 2 – Process
Refers to data processing which includes sorting , classifying and
summarizing function into their respective files and
categories, storing them in their respective records.
Stage 3 - Outputs
The generation of financial reports and communication of the needed
information to the decision makers or end-users.
Types of accounting information system
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1. Manual accounting system – utilize paper-based journals and ledgers, the whole
process is done manually. This is labor intensive and dependent on human
processing.
2. Computer-based system – uses modern information technology resources and

transactions are coded and can be quickly posted bypassing the journalizing
process. It replaced paper records with computer records.
3. Database system – it embeds accounting data within the business event data on
which they are based. It reduces inefficiencies and redundancies that often exist
in a transaction -based systems. The computer, with the use of accounting
software processes the inputs. This system recognizes and capture both financial
and non-financial data and store it in a data warehouse.
In many situations, manual systems are inferior to computerized systems in

terms of productivity, speed, accessibility, quality of output, incidence of errors and
volume of data.
ELEMENTS OF FINANCIAL STATEMENTS
There are hundreds or even thousands of transactions that a business undertakes

during the accounting period. These transactions and events are grouped into broad
classes according to economic characteristics or attributes in the financial statements.
The broad classification of business transactions in the financial statements are called
accounting elements.
As defined in March 2018 Conceptual Framework for Financial Reporting, these elements
of financial statements are:
1. Assets
2. Liabilities
3. Equity
4. Income
5. Expenses
Assets
• The term “assets” refers to the resources controlled by the entity as a result of past
events and from which future economic benefits are expected to flow to the entity.
• In simple terms, assets are properties owned and controlled by the business.
• An economic resource is a right that has potential to produce economic benefits
for the entity which has the sole control or ability to prevent other parties to direct
the use of that economic resource.
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Examples: right to own land, building, equipment, machinery, furniture and fixtures,
etc., right to receive cash, right to receive goods or services
Liabilities
• The term “liabilities” refers to the present obligations of an entity arising from past
events, the settlement of which is expected to result in an outflow from the entity
of resources embodying economic benefits.
• Simply stated, liabilities are the debts incurred by the business for the transfer of
an economic resource as a result of past events.
• An obligation of the entity, owed to another party
Examples: unpaid expenses, unpaid salaries, purchases made on account, etc.
Equity
• The term “equity” refers to the residual interest in the assets of the entity after
deducting all its liabilities.
• Equity represents owner’s capital and what is left to the owner after deducting the
entity’s debts or obligation.
• It represents claim of the owner/s over the assets of the business in the form of
capital.
Examples: R & B Service Business has total assets of P1,000,000 and total
liabilities of P450,000, therefore, the equity of the owner is P550,000.
NOTE: Assets, liabilities and equity – relate to a reporting entity’s financial position
(shown in the Statement of Financial Position or Balance Sheet)
Income
• The term “income” refers to the increase in economic benefits during the
accounting period in the form of inflow or enhancement of assets or decrease of
liabilities resulting in an increase in equity other than those relating to equity claims
from equity participants or equity contributors.
• The basic accounting principle is that income increases the equity of the owners
while loss decreases the owner’s equity.
Examples: R & B Service Business profited from its business as a result of its
operating activities in the amount of P50,000. From the previous example, its equity
amount is P550,000 , but due to income generated, the equity amount of R & B will
now be P600,000. However, if it incurs a loss of P50,000, R & B’s owners’ equity
will decrease to P500,000.
Expenses
• The term “expenses” refers to decreases in economic benefits during the
accounting period in the form of outflow or depletion of assets or incurrence of
liabilities that result in decreases in equity other than those relating to equity
claims from equity participants or equity contributors.
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• The basic accounting principle is that expenses decrease the equity of the owners.
Examples: rent expense, salaries expense, supplies expense, etc.
NOTE: Income and expenses – relate to a reporting entity’s financial performance (shown
in the Statement of Comprehensive Income or Income Statement).
ACCOUNTING EQUATION
The most basic tool of accounting is the accounting equation. This equation
presents the resources controlled by the enterprise, the present obligation of the
enterprise, and the residual interest in the assets as shown in this model.
Figure 1.3 Basic Accounting Model
Account
• The basic summary device of accounting is the account.
• It is an accounting record in which the effects of similar business
transactions are grouped or classified.
• It records the increases or decreases of specific asset, liability, owner’s
equity, revenue and expense.
• The account is separately labeled with a specific name to identify one
element from the other.
• The name designated to the account is called account title. Ex. Cash,
Accounts Receivable, Office Supplies, Land, Accounts Payable, Notes
Payable, Service Income, Salaries Expense, Rent Expense, etc.
• The account titles used to record accounting transactions for a particular
business should be uniformly listed and arranged chronologically in a
chart called Chart of Accounts.
• Each accounting element is composed of several accounts which describe
the related transactions and events as provided by the source
documents.
Books of Accounts
The books of accounts commonly used in recording economic transactions and
events are as follows:
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General Journal – called as the “book of original entry”, is an accounting record

that is used to initially record business transactions known as journal entry.
General Ledger – called as the “book ⁰of final entry” where the accounts and their
related amounts previously recorded in the journal are posted and summarized
periodically.
DOUBLE-ENTRY SYSTEM
The double-entry system of accounting is based on the dual aspect concept

that for every transaction, there would always be a two-sided effect to the extent of the
same amount as recorded in the accounting books. It shows that for every “value
received”, there is a corresponding “value parted with”. In accounting, value received
is the debit and value parted with is the credit.
This system is the basis of modern accounting theory. It is known as the most
acceptable accounting system in recording accountable transactions due to the
following reasons:
1. It results in more accurate accounting records and financial reports.
2. It allows a more convenient means of recording business transactions and events.
3. It provides numerous ways to safeguard and check errors and misstatements
committed.
In analyzing transactions, the accounting equation is used where the rules of

debits and credits apply. Business transactions are recorded with a debit entry (value
received) and a credit entry (value parted with), to show the dual effects of each event.
The recording process requires that the value of debits must equal the value of credits
for each transaction entry or simply put, both debits and credits are in balance.
Debit (Dr.) The place of debit is the left-hand side of the accounting equation therefore an
account is debited when it is entered in the left side of the T-Account.
Credit (Cr.) The place of credit is on the right-hand side of the accounting equation
therefore the account is credited when it is entered on the right side.
To better understand the debits and credits, a T-Account is used. It is called such
because it resembles a big letter T, used to summarize and determine account
balances without the need for the formal ledger. The T-Account has three (3) parts: the
account title, the debit and the credit side.
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Figure 1.4 The T-Account
Rules of Debits and Credits
The rules of debits and credits depend on the account type and how increases or
decreases in it are recorded. This increase-decrease effect should be expressed in
the technical parlance of accounting which is to debit and to credit as it affects all
the accounting elements.
A. For the elements of financial position (Assets, Liabilities, Owner’s Equity), the
following rules apply:
• Increases in assets are recorded as debits (left side), while decreases in
assets are recorded as credits (right side).
• Increases in liabilities and owner’s equity are recorded as credits (right
side) decreases are entered as debits (left side)
B. For the elements of financial performance (Income and Expenses), the rules of debits
and credits 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 (right side) and
decreases are recorded as debits (left side).
• Increases in expenses are recorded as debits (left side) and decreases
are recorded as credits (right side)
Figure 1.5 summarizes the rules of debits and credits. It shows the effects of
transactions to the elements of financial statements in terms of increases and
decreases.
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Figure 1.5 Rules of Debits and Credits

Statement of Financial Position or Balance Sheet Accounts
The Normal Balance of an Account

The normal balance of an account refers to the side of the account, debit or credit, where
increases are recorded.
• Assets, Owner’s withdrawals and Expenses increases on the debit side
therefore the normal balance of these accounts is a debit.
• Liability, Owner’s Capital and Income accounts increases on the credit side
therefore the normal balance of these accounts is a credit.
Accounting Events and Transactions
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An accounting event is an economic occurrence that causes changes in an

entity’s assets, liabilities, and/or equity. It can be an internal event such as the use of
equipment for the production of goods or services or an external event such as the
purchase of raw materials from a supplier. A business transaction is a particular kind of
event that involves the transfer of something of value between two parties such as
purchasing and selling of goods or services and borrowing funds from creditors and that
it can be reliably recorded.
It is beneficial in the recording process that transactions are analyzed relative to
their effects to the different accounting elements rather than the recording involved. We
call this classification approach. All business transactions can be classified into one of
four types namely:
1. Source of Assets (SA). An asset account increases and a corresponding claim

(liabilities or owner’s equity) account increases.
• Examples: Purchase supplies on account.
Sold goods on cash on delivery basis.
2. Exchange of Assets (EA). One asset account increase and another asset
account decrease.
Example: Acquired equipment for cash.
3. Use of Assets (UA). An asset account decreases and corresponding claims

(liabilities or equity) account decreases.
Examples: Settled accounts payable.
Paid salaries of employees.
4. Exchange of Claims (EC). One claim (liabilities or owner’s equity) account

increases and another claims (liabilities or owner’s equity) account decreases.
Examples: Received utilities bill but did not pay.
Financial Transaction Worksheet
It is a form used to analyze increases and decreases in the assets, liabilities and
owner’s equity. A financial transaction is listed in the worksheet using the appropriate
accounts.
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Table 1 Sample Financial Transaction Worksheet

ASSETS LIABILITIES OWNER’S EQUITY
TRANSACTION Cash Accts. Accounts Notes Owner’s Owner’s
Receivable Payable Payable Withdrawal Capital
(Dr) (Dr) (Cr) (Cr) (Dr) (Cr)
1. Owner invested P50,000 P50,000
P50,000 to the
business
2. Rendered P15,000 15,000
services on credit,
15,000
3.Received P3,000 (3,000)
Meralco bill,
P3,000
4. Borrowed money
from P50,000 P50,000
ACR Bank and
issued promissory
note P50,000
5. Withdrew cash
for personal use, (30,000) P30,000
P30,000
P70,000 P15,000 P3,000 50,000 P30,000 P62,000
TOTAL P85,000 P53,000 P32,000
Assets P85,000 = Liabilities P53,000 + Owner’s Equity P32,000
Analysis:
Transaction No. 1. The owner invested cash to the business, Cash increases an asset
account and the equity of the business also increases.
Transaction No.2. When the entity renders services on credit, it creates an account
receivable which is an asset account and a revenue account which increases owner’s
equity.
Transaction No. 3. When an electric bill is received, an expense account is created, but
it was not paid, therefore, the incurrence of an expense decreases the owner’s equity
account and increases the liability account due to non – payment.
Transaction No. 4. Borrowings increase the asset account Cash and the Notes Payable
due to issuance of promissory note which is a liability account.
Transaction No.5. The owner withdraws cash for personal use, therefore asset cash
decreases and a withdrawal account is created which is a contra-equity account. Owner’s
equity account has a normal balance of “credit”, the withdrawal account is a contra
account and has a normal balance of “debit”.
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TYPICAL ACCOUNT TITLES USED
Statement of Financial Position (briefly discuss)
Assets. As per revised Philippine Accounting Standards (PAS) No. 1, assets should be
classified only in two (2): Current and Non-Current Assets. Assets are considered current
when:
a. it expects to realize, consumes or intends to sell it within the normal operating cycle
of the business
b. it holds the asset primarily for the purpose of trading
c. it expects to realize the asset within twelve (12) months after the reporting period
d. the asset is cash or 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.
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 (12) months. The entity uses an
accounting period that covers certain accounting functions which can be either a
calendar or fiscal year.
Calendar year means the accounting operations of the business covers one year from
January and ends in December.
Fiscal year or period means any 12-month period covering the accounting operations
of the business.
Example: May 2019 to May 2020 is one fiscal period.
Current Assets
Cash. It refers to any medium of exchange that a bank will accept for deposit at face
value including 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 amount of cash and which are subject to
insignificant risk of changes in value
Notes Receivable. 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.
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Allowance for Uncollectible accounts /Bad debts. A contra-asst account which

provides for possible losses from uncollected accounts receivable. The amount
provided for this is only an estimate.
Inventories. Per PAS No. 2, these are assets (a) which are 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
classified as an asset because the business avoids having to pay cash in the
future for a specific expense.
Noncurrent Assets
Property, Plant & 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.
Examples: Land, Machinery, Equipment, furniture and fixtures.
Accumulated Depreciation. It is a contra-account that contains the sum of the periodic

depreciation charges. The balance from this account is deducted from th cost of
the related asset – equipment or building – to obtain book value.
Intangible Assets: Per PAS No. 38, these are identifiable non-monetary assets without
physical substance held for use in the production or supply of goods or services,
for rental to others, or for administrative purposes.
Examples: Goodwill, patents, copyrights, licenses, franchises, trademarks,
brand names, secret processes, subscription lists and on-competitive
agreements.
Liabilities
Current Liabilities. As per revised PAS No 1, an entity shall classify 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 (12) months after the reporting period.
d. the entity does not have an unconditional right to defer settlement of the liability for
at least twelve months after the reporting period.
Accounts Payable. It denotes obligations or debts of the business arising from services
received, merchandise, supplies or property, plant and equipment acquired on
account. It is an “open account” obligation because it is not supported by a
promissory note.
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Notes Payable. The treatment is similar to accounts payable however, this account is
supported with a promissory note executed by the debtor in favor of the creditor.
Accrued liabilities. Amounts owed to others for unpaid expenses. This account
includes salaries payable, utilities payable, interest payable and taxes payable.
Unearned Revenues. The business entity receives payment before providing the
customers with goods or services, the amount received is reorder to unearned
revenue account. When the goods or services are provided to the customer, the
unearned revenue account is reduced and income is recognized.
Current Portion of Long-term Debt. These are portion of mortgage notes, bonds and
other long-term indebtedness which are to be paid within one year from the
balance sheet date.
Noncurrent liabilities
Mortgage Payable. This account is used to record long-term debt that is supported or
backed up by a collateral or has pledged certain assets as security to the
creditor.
Bonds Payable. Is a contract between the issuer and the lender specifying the terms
and conditions of repayment and the amount of interest to be charged. It is a
long-term obligation evidenced by certificate of indebtedness. Business obtain
funds to finance acquisition of equipment and other needed assets by issuing
bonds.
Equity. The equity represents what is left to the business after the liabilities are fully
paid.
Capital. This account is used to record the original and additional investments of the
owner of the business. It is increased by the amount of profit earned during the
year or decreased by a loss or by cash or other assets that the owner may
withdraw from the business. This account bears the name of the owner.
Example: if the owner of the business is Mr. Landicho, therefore, the
capital account of the business will be Landicho, Capital.
Withdrawals. When the owner of a business entity withdraws cash or other assets for
personal use, such is recorded in the withdrawal account rather than directly
reducing the owner’s equity account.
Income Summary. Is a temporary account used at the end of accounting period to

close income and expenses.This account shows the profit or loss for the period
before closing to the capital account.
Statement of Comprehensive Income
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Income. Increases in economic benefits during the accounting period in the form of
inflows and enhancement of assets. The definition of income encompasses both
revenue and gains. Though these terms are almost similar,, however, there is a distinct
technical difference between them.
Service Income. Revenues earned by performing services for a customer or client.

Example: accounting services by a CPA, laundry services by a laundry shop.
Sales. Revenues earned as a result of sale of merchandise.

Example: sale of hardware materials by a hardware company
sale of medicines by a pharmaceutical company
Expenses. A decrease in economic benefits during the accounting period as a result of

outflows or depletion of assets.
Cost of Sales. The cost incurred to purchase or produce the products sold to the
customers during the period. It is also known as the cost of goods sold.
Salaries and Wages Expense. All payments that arise from services from workers/
employees in an employee-employer relationship. It includes salaries and wages,
13 month pay, cost of living allowances and other related benefits.
th
Rent Expense. Expense for renting a space, equipment or other asset rental.
Supplies expense. Expense of using supplies like office supplies, in the conduct of
daily business.
Insurance Expense. Portion of premium paid on insurance coverage which has

expired.
Depreciation Expense. That portion of the cost of tangible asset (e.g. buildings and
equipment) allotted or charged to expense during the accounting period. All
tangible assets depreciate except Land.
Uncollectible Accounts or Bad Debts Expense. It is the amount of receivables

estimated to be doubtful of collection and charged to expense during the
accounting period.
The list of accounts mentioned and discussed are typical accounts used in introductory
accounting. As you move to higher accounting subjects, new account titles will be
introduced.
ASSESSMENTS
Exercise No.1
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Understanding the Accounting Equation
Case Assets Liabilities Owner’s Equity

1 P ? P 990,000 P500,000
2 110,000 60,000 ?
3 5,180,000 ? 2,180,000
4 ? 225,000 (25%) ?
5 ? ? 560,000 (2/3)
6 671,200 ? 246,000
7 784,000 ? (1/2) ?
Required: Fill-in the amount of the missing element of the Statement of Financial Position
Exercise No. 2
Transaction Analysis
TRANSACTION ASSETS LIABILITIES OWNER’S CLASSIFICATION

EQUITY Of TRANSACTION
1. Purchased equipment on
account.
2. Received water bill from
Prime water
3. Owner invested cash to the
business
4. Purchased supplies for
cash
5. Paid rent for the month
6. Received payment for
services rendered on
account
7. Paid advertising expense
8. Borrowed money from the
bank
9. Settled account in No. 1
10.Rendered services for

Cash.
Required: Indicate whether the transaction signifies increase (+), decrease (-) or no
effect (0) to the accounting elements and its classification as to source of asset (SA),
exchange of asset (EA), use of asset (UA) or exchange of claims (EC).
Exercise No. 3
Understanding the accounting elements and normal balance of an account
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ACCOUNT TITLE ELEMENT NORMAL BALANCE

1. Prepaid rent expense
2. Service revenue
3. Accrued Income
4. Signage
5. Tuition fee
6. Accrued expense
7. Notes Receivable
8. Unearned Income
9. Machinery
10. Accumulated Depreciation
11. X, Withdrawal
12. Allowance for bad debts
Required: Classify the account titles according to the elements of a financial statement
and indicate whether its normal balance is a debit or a credit.
2. ONLINE QUIZZES (after discussion of the topics)

3. MAJOR EXAMINATION USING GOOGLE CLASSROOM (short answered questions ,
multiple choice, true or false)
REFERENCES
Ballada, W.L. (2018). Basic accounting: Made easy. Manila. Domdane Publishers
Aduana, N.L. (2015). Fundamentals of Accounting. Quezon City. C&E Publishing, Inc.
Valencia, E. G. et al (2016). Basic accounting: Concepts, principles, procedures and

applications. Baguio City. Valencia Educational Supply
Module 3
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THE ACCOUNTING CYCLE FOR A SERVICE BUSINESS

Week 5 to 8
Introduction
In the preceding module, we studied deeply and gained better understanding of the nature
of the different accounting elements that composed the financial statements. The five (5)
accounting elements where various account titles had been categorized are: assets, liabilities,
equity, income and expense. These accounting elements have relationship in the recording
process and in the preparation of financial statements. Better understanding of their basic
relationship and the underlying premise is a requirement for those who have great desire in
studying the field of accounting.
Basic rule to remember: Every business transaction affects two or more accounting elements.
This basic principle serves as the bedrock of the recording process. Studying Module 3, which is
the Accounting Cycle of a service type of business, we have to emphasize that in understanding
the relationship of the accounting elements, it is better to express it in the form of accounting
equation. The analysis should be made from the point of view of the business and not from the
point of view of the owner.
Learning Objectives:
After studying this module the students should be able to:

1. List and explain in brief the sequential steps in the accounting cycle.
2. Describe the use of the two books of accounts-General Journal and General Ledger and
what purposes it serve.
3. Outline the steps in analyzing transactions and the important role of the source
documents.
4. Develop chart of Accounts and distinguish between permanent or temporary accounts.
5. Analyze the impact of transactions on the accounting elements and specific accounts by
applying the rules of debits and credits.
6. Journalize transactions in proper form using the general journal.
7. Post entries from the general journal to the general ledger.
8. Prepare and explain the worksheet and the various financial reports derived from it.
9. Explain the importance of adjusting entries.
10. Perform the proper procedures in closing of the books.
THE ACCOUNTING CYCLE – SERVICE BUSINESS
Businesses handle voluminous transactions during the year. Some of the transactions are
simple while others appear complicated. In the recording process, transactions are analyzed and
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recorded, regardless of their complexity, in accordance with the prescribed rules and guidelines,
the GAAP.
Generally Accepted Accounting Principles (GAAP). It refers to a common set of accounting

principles, standards, and procedures which aims to improve the clarity, consistency and
comparability of the communication of financial information. The accounting profession has
developed standards that are generally accepted and universally practiced. These standards
indicate how to report economic events.
Standard Setting Bodies:

Financial Accounting Standards Board (FASB)
Securities and Exchange Commission (SEC)
International Accounting Standards Board (IASB)
Selection of which principles to follow generally relates to trade-offs between relevance

and faithful representation. These are two primary qualities that make accounting information
useful for decision-making. This was clearly discussed in Module 1. The accounting process will
be discussed step by step in this module using accrual accounting.
ACCRUAL ACCOUNTING VERSUS CASH BASIS ACCOUNTING
Accrual Accounting.
• Means revenue and expenses are recognized and recorded when they occur, paid or
unpaid.
• It focuses on anticipated revenue and expenses.
• Revenue is accounted for when it is earned such that when a product or service is
delivered to a customer with future expectation that it will be paid.
• Expenses are recorded despite no cash is being paid out yet for those expenses.
• The accrual method is the most commonly used method of recognizing revenue and
expenses as it portrays a more accurate picture of a company’s health, particularly in the
long term by including accounts payable and accounts receivable.
Cash Basis Accounting.

• Revenue is reported on the income statement only when cash is received, and expenses
are only recorded when cash is paid out.
• Cash method is a more immediate recognition of revenue and expenses and is mostly
used by small businesses or for personal finances for its simplicity.
• Tracking the cash flow of a company is also easier, however it might overstate the health
of the company that is cash-rich but has large sums of accounts payable that could exceed
the cash on the books and the company’s current revenue stream.
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• An investor might think that the company is making profit but in reality, the company is
losing money.
STEP 1. IDENTIFICATION OF EVENTS TO BE RECORDED

Aim: To analyze information from the source documents for proper recording and
transfer to their respective accounts.
The analyzing stage follows these four basic steps:
1. identify transactions from source documents
2. indicate the accounts affected by the transaction, either assets, liabilities, equity, income
or expenses.
3. ascertain whether each account is increased or decreased by the transaction.
4. using your knowledge of the rules of debits and credits, determine whether to debit or
credit the account to record the increase or decrease
It is also important to note that companies require that accounting records include only
transactions that can be expressed in terms of money and that activities of the entity be kept
separate and distinct from that of its owners and all other economic entities.
Source documents identify and describe transactions and events entering the accounting
process. It is the starting point in the accounting cycle. These original written evidences contain
information about the nature and the amounts of transactions. Common source documents are
sales invoices, cash register tapes, official receipts, bank deposit slips, bank statements, checks,
purchase orders, timecards and statements of account.
Illustration: Both documents were received by Accounting Department from Human Resource
Department.
Which of the two (2) documents is a valid accountable transaction that will merit a journal entry?
Analysis:
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Source document A is not yet a recordable event since the basis is just a memo from HRD
informing the accounting department that three (3) new sales clerks will be working for the
store. There is no proof that the three newly hired people have actually rendered their services
even if their salary amount is clearly stated.
Source document B is a valid transaction evidenced by the payroll form with names, rate and
period covered of their actual services rendered.
Value received in this transaction is the creation of an expense account, Salaries
Expense; and Value parted with is the obligation of the company to pay the salary, Salaries
Payable.
EXPENSE = LIABILITY
The expense account is increased by P7,500 which is a debit and a corresponding increase of
P7,500 also in the liability account which is a credit.
STEP 2. TRANSACTIONS ARE RECORDED IN THE JOURNAL

Aim: To record the economic events that took place within the firm in a journal known as
“general journal” using the rules of debits and credits.
The General Journal. The journal is the simplest form of journal which reflects the
chronological record of the entity’s transaction in terms of debits and credits. Each transaction is
initially recorded in the journal rather than the ledger. The journal is considered the book of
original entry.
Format. The standard contents of the general journal are as follows:

1. Date. The year and month are not rewritten for every entry unless the year or month
changes or a new page of the book is needed.
2. 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 or explanation is usually made on the line below the credit
entry. Generally, SKIP a line after each entry.
3. P.R. (posting reference) The column for P.R. will be used when the entries are posted,
that is, until the amounts are transferred to the related leger accounts. The posting process will be
described later.
4. Debit. The debit amount for each account is entered into this column.
5. Credit. The credit amount for each account is entered into this column.
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For our illustration in Step 1, the transaction is “to record payroll covering the period July 1-15
for Salesclerks A, B and C in the amount of P7,500.
Simple and Compound Entry

The example given above is a simple entry because only two accounts are affected-one account
is debited and one account is credited. However, there are transactions that will require the use of
more than two accounts. This is known as compound entry wherein one or more debit account or
one or more credit account is required.
Example of Compound Entry Transaction

On July 30, 2019, MJ Car Rental Agency, purchased a Machine from Hade Trading for
P150,000 on terms: 25% down payment and the balance payable after 30 days,
It is clearly stated in the example above that the transaction requires more than one
credits, therefore it is a compound entry. The entries follow the basic rule that total Debits =
total Credits. No matter how
many debits or how many credits a transaction has the amount of total debits must always equal
to the amount of total credits.
STEP 3. JOURNAL ENTRIES ARE POSTED TO THE LEDGER

Aim: To transfer the information from the journal to the ledger for classification.
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The General Ledger. A grouping of accounts with corresponding account codes. It is the
reference book of the accounting system and is used to classify and summarize transactions, and
to prepare data for basic financial statements. All firms have general ledger as shown in the
sample below:
The accounts in the general ledger are classified into two general groups:
1. Balance Sheet accounts (assets, liabilities and owner’s equity) are classified as
permanent or real accounts.
2. Income Statement accounts (income and expenses) are classified as temporary or
nominal accounts and is used to gather information for a particular accounting
period. At the end of the period, the balances of these accounts are closed to Income Summary
account whose balance is transferred to a permanent owner’s equity, the capital account. Each
account has its own record in the ledger. Compared to a journal, a ledger organizes information
by the account.
Posting. The process of transferring the amounts from the general 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 as shown in this figure:
Figure 2.2 Posting Process
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CHART OF ACCOUNTS
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An entity has its own listing of accounts, follows its own format or coding,
however they are the same in respect to the organization of the elements of the financial
statements.
• It is an index of all financial accounts in the general ledger of a company.
• It is an organizational tool that provides a listing of the accounts used in business to
define each class of items for which money or its equivalent is spent or received.
• The caption or header are coded by an account type to permit indexing and cross-
referencing.
• The list is typically arranged in the order of the appearance of accounts in the financial
statements: assets, liabilities’ owner’s equity, income and expenses.
Figure 2.3
The chart of accounts depends on the nature or type of one’s business. It can differ and be
tailored to reflect a company’s operations however, it must always respect the guidelines set out
by FASB and GAAP. It is of crucial importance that the same chart of accounts are kept year to
year to ensure accurate comparison of the company’s finances.
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STEP 4. PREPARATION OF THE TRIAL BALANCE

Aim: To prove the arithmetical accuracy of bookkeeping and the ledgers.
Trial Balance. Is a type of financial report that is generated at the end of an accounting period
prior to the creation of the company’s financial statements. It shows that the total balances of the
debit column is equal to the total balances of the credit column. It provides a good check on the
accuracy of the work done in preparing the ledger accounts but equality of both debits and
credits is not a guarantee of the absence of errors.
Example: A receipt of P5,000 Cash was erroneously recorded by the bookkeeper as a

debit to Accounts Receivable instead of using Cash account. To this effect, the Trial Balance
would still be equal because both have debit normal balances. This should be corrected since the
Cash account will be understated by such amount and Accounts Receivable will be overstated.
Below is a proper presentation of a Trial Balance done after accomplishing Step 1 to 3.
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CONTRA-ACCOUNTS
An account with a balance that is the opposite of the normal balance for that account
classification. The use of contra account allows an entity to report the original amount and the
reduction to the account to arrive at the carrying value or net realizable value.
Examples of Common Contra Accounts:

1. Allowance for Uncollectible/Bad Debts/Doubtful Accounts- is a contra asset account related to
Accounts Receivable. The receivable is an asset with a debit normal balance, therefore the
contra-asset Allowance has
a credit normal balance.
2. Accumulated Depreciation- is a contra account related to any asset under property, plant and
equipment. All assets under this category are subject to depreciation except Land. Since the
normal balance of the related asset is debit, the normal balance of Accumulated Depreciation is
credit.
Depreciation. A reduction in value of an asset with the passage of time, due in particular
to wear and tear.
3. Withdrawal/ or Drawing Account-is a contra-equity account, a reduction in the capital

account. Equity has a normal balance of credit and Withdrawal’s normal balance is the opposite
which is debit.
Other contra-accounts not discussed here are merchandising business accounts.
STEP 5. PREPARATION OF THE WORKSHEET including ADJUSTING ENTRIES

Aim: To verify accuracy of the accounting information and adjust necessary accounts to
provide an up-to-date financial reports.
What is a Worksheet?
It is a multiple-column device or a computer spreadsheet, used for easy preparation of the
financial statements done in a systematic process. All necessary accounting information are
properly presented and structured in the worksheet. Preparation is being done at the end of
accounting period prior to preparation of financial statements. Necessary adjusting entries are
also reflected in the worksheet.
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Figure 2.5 The Worksheet
MJ Car Rental Agency

Worksheet
December 31, 2018
Figure 2.5 is a sample worksheet prepared from the sample Trial Balance of MJ Car Rental
Agency. The columns for Adjustments and Adjusted Trial Balance is not yet filled-up. After
discussion of the topic Adjusting Entries, then students will be familiar with the format and the
extension of the accounts to their respective financial statements. The use of the worksheet
makes the preparation of financial reports easy for
accountants as it is prepared in a manner that all accounts are properly classified.
ADJUSTING ENTRIES
In adjusting the accounts, there are important dates to take into consideration, the date of
the transaction or the journal entry date and the end of accounting period of the business for
accurate computation of the amount to be adjusted.
Why is there a need for adjustments?

• Adjusting entries are adjustments used to bring the assets, liabilities, revenue and
expenses up-to date at the end of accounting period.
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• Adjusting entry can never be equated with correcting entry because the journal entry
made before adjustment is correct, only at end of accounting period the balances may
have been affected because of the happening of some events thus the need for
adjustments. In correcting entry, there is a presumption that error has already been
committed at the time of journalizing.
• The need to provide timely and accurate information, the economic life of the business
are subdivided into artificial time periods known as periodicity concept. Business need
periodic reports to assess the financial condition of the entity and this is the best way to
achieve that without going through the process of liquidation. It interacts with recognition
and derecognition principles to underlie the use of accrual accounting.
• Adjusting entries assigned revenues to the period in which they are earned, and expenses
are assigned to the period in which they are incurred.
• Adjusting entries are needed to measure properly the profit for the period and to bring
related asset and liability accounts to correct balances for an accurate financial reporting
purpose.
• Without adjusting entries, the financial statements may not fairly show the liquidity and
solvency of the business in the statement of financial position, same with its profitability
as reflected in the statement of income.
What are the accounts for adjustments?
DEFERRALS AND ACCRUALS

Adjusting entry is the answer to those transactions that covers more than one accounting
period as a result of the use of accrual accounting. Each adjusting entry either affects a balance
sheet account and an income statement 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. Deferrals are needed in two
cases:
1. Allocating assets to expense to reflect expenses incurred during
the accounting period.
Example: prepaid insurance expense, rent expense, supplies and depreciation.
2. Allocating revenues received in advance to revenue to reflect revenues earned during

the accounting period.
Example: subscription, unearned revenue
Accrual. Is the recognition of an expense already incurred but not yet paid, or revenue earned
but not yet collected. Accrual will be required in two cases:
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1. Expenses to be accrued 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.
I. ADJUSTMENTS FOR DEFERRALS:
A. PREPAID EXPENSES
This includes expenses that are paid in advance of its use such in the case of prepaid
insurance prepaid supplies, prepaid rent, prepaid advertising, prepaid interest expense. In
adjusting this account two methods can be used, asset method or the expense method.
Illustration: On September 1, 2018, MJ Car Rental Agency paid office rent for one year
amounting to P120,000. The business follows the calendar year as the end of the accounting
period.
Analysis:
The payment of rent will take effect from Sept. 1, 2018 until Sept. 1, 2019 (one year) as
shown in this timeline:
Therefore, the portion of expense that has expired is only for four months (Sept 1 to Dec 1) or a
total amount of P40,000 ( P120,000/12 = 10,000 per mo. x 4 months)
Using Asset Method the adjustments would be:
Dec. 31, 2018 Rent Expense......................................................P40,000

Prepaid Rent Expense............................................P40,000
Using Expense Method, the adjustments would be:

Dec. 31, 2018 Prepaid Rent Expense...........................................80,000
Rent Expense ..........................................................80,000
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At the end of accounting period, the Prepaid Rent account balance have been adjusted to an
amount of P80,000 which represents the unused portion, which is the remaining 8 months (Jan 1
to Aug. 1) and Rent Expense of P40,000 was recognized, representing the used portion of 4
months (Sept 1 to Dec 1).
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To be able to adjust, it is very important to know the original entry of the transaction. Same
adjusting process applies to Prepaid Insurance Expense.
B. SUPPLIES ADJUSTMENT
Analyzing transaction for supplies requires adjustments pertaining to consumption.
Illustration: On July 1, 2018, MJ Car Rental Agency purchased supplies amounting to P5,000
on credit. As of December 31, 2018, the end of accounting period, after actual inventory count of
supplies, it revealed a balance of P2,000.
Analysis:
The book balance of Supplies account decreased by P3,000. The original entry, when the
supplies were purchased was posted to the ledger as follows:
It means there is unrecorded consumption as the physical inventory count done at the
end of accounting period resulted to only P2,000.
Adjusting Entry
12/31/18 Supplies expense P3,000

Supplies P3,000
After posting the adjustment, ledger would now appear like this:
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The asset account Supplies now reflect the adjusted amount of P2,000 which is the amount
derived from the actual count and the amount of supplies consumed during the accounting period
is reflected as P3,000 in the Supplies Expense account..
C. UNEARNED REVENUES
• Unearned revenues are advances made by the customers awaiting future services as in the
case of customers making advance payment for services.
• As of the date of receipt, the amount still remains unearned because the performance of
services have not been rendered yet.
• It is treated as liability account for the reason that the entity still owes from the customer
the services covered by the payment.
• Accounting principles dictates that only income realized during the period shall be
recognized hence unearned revenues is a pre-collected payment subject to realization of
services in the future.
• Two methods can be used to record unearned revenue transactions: Liability method and
Income method
Examples of Unearned Revenues:

Commission income collected in advance
Interest income collected in advance
Rent income collected in advance
Advertising income collected in advance
Illustration: On Oct. 15, 2018 MJ Car Rental Agency received P150,000 from Customer A as
rental payment for five (5) vans to be used by his foreign guests for five months starting next
month. The company uses a calendar period.
Analysis:
The transaction implies that the amount of P150,000 is an advance payment by Customer
A for the use of the MJ vans for a period of five months. This transaction gives rise to a liability
to provide Customer “A” with the needed vans which will take effect on November 1, 2018 and
ends on March 2019.
Nov Dec 2018 Jan 2019 Feb Mar

P30,000 P30,000 P30,000 P30,000 P30,000
Looking at the table, the amount of the contract or agreement is P150,000 for five months so
that means P30,000 per month (150,000/5mos =P30,000 per month). At the end of accounting
period December 31, two months income must already been realized.
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For adjustment purposes, a comparative original entry is created:
Date Liability Method Income Method

2018 Cash P150,000 Cash P150,000
Oct. 15 Unearned Rent Revenue 150,000 Rent Income 150,000
Adjusting Entry using both methods would be:
Date Liability Method Income Method

2018 Unearned Rent Income 60,000 Rent Income 90,000
Dec. 31 Rent Income 60,000 Unearned Rent 90,000
From the ledger, this is how we derived our balance:
After posting the adjusting entries, Rent Income account has a balance of P60,000 and the
Unearned rent Income account has an adjusted balance of P90,000.
D. PROVISION FOR DEPRECIATION

The concept of depreciation applies to assets or resources of the business that are tangible
and its useful life extends beyond one year. Most assets subject to depreciation are those
classified under property, plant and equipment whose value continuously decreases as they are
used in the day-to-day operation of the business. Depreciation does not apply to Land which in
most cases, the value increases as time passed by.
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Depreciation. Is a reduction in value of the asset because of the passage of time or due to wear
and tear. It is classified as Expense.
Example of common depreciable assets: Building, Machinery, Furniture and Fixtures,

Office Equipment and Store Equipment
THREE IMPORTANT ELEMENTS
Acquisition Cost. Refers to the purchase price of the asset or the cash paid to acquire it. It
includes all incidental expenses necessary for the acquisition and in making the asset ready for
use such as cost of test and trial run test, carrying costs, etc. added to the purchase price.
Salvage Value. Refers to the value of the asset at the point of disposal. It is the estimated amount
that the business will receive upon the disposal of the asset. Depreciable assets do not stay in
business forever, so when they are no longer productive, they are usually disposed. It is the
product of estimates based on professional judgement. Other terms used are trade-in value,
residual value, scrap value.
Estimated Useful Life. Refers to the period wherein depreciable assets are productive. The
useful life of depreciable assets is influenced by some factors such as technology, advancement,
obsolescence, number of units produced or number of service hours.
METHODS OF COMPUTING DEPRECIATION

There are various methods to compute depreciation such as:
• Straight-line
• Sum-of-year’s digit
• Declining balance
• Double declining balance
• Output method
• Retirement method
• Replacement method
For this module, we will only consider using the straight-line method. Other methods
will be discussed lengthily in higher accounting. The formula for straight-line is:
Cost – Salvage Value

Annual Depreciation =
Estimated Useful Life
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The pro-forma entry to record depreciation is
Depreciation Expense – fixed assets xxxx

Accumulated Depreciation – fixed assets xxxx
OTHER TERMS RELATED TO DEPRECIATION
Depreciable Cost. Is equal to the difference between cost and salvage value.
Accumulated depreciation.is the sum of depreciation in direct relation with the expired life of
the asset.
Book Value. The difference between cost and accumulated depreciation. It is sometimes called
the carrying value of the asset.
Illustration: Assuming MJ Car Rental Agency purchased set of computers for P95,000 on
terms, with salvage value of P5,000 on November 1, 2018. It is estimated to have a useful life of
6 years. Compute for the depreciation cost of the asset at the end of accounting period and
prepare the entry to adjust the books.
GIVEN: Cost P95,000

Salvage Value 5,000
Estimated useful life 6 years
Annual Depreciation = Cost – Salvage Value

Estimated Useful Life
= P95,000 – 5000
6 years
= P 90,000
6
= P15,000
Analysis
The amount of P15,000 is the annual depreciation rate which will remain the same every
year but the accumulated depreciation increases every time the life of the asset expires. From the
time the computers were purchased in November to the end of accounting period, the asset
already depreciates for two months. This amount will be charged to depreciation expense
computed as :
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Annual Depreciation = P15,000/12 months = P1250 per month
Depreciation Expense = P1,250 x 2 months =P2,500
Adjusting Entry
12/31/18 Depreciation Expense-Computers P2,500

Accumulated Depreciation-Computers P2,500
II. ADJUSTMENTS FOR ACCRUALS
Accruals
Adjustments help the entity avoid the impractical preparation of hourly or daily journal
entries just to accrue expenses. It updates the accounting values by recognizing expired
transactions that remained unrecorded.
A. ACCRUED EXPENSES
Accrued expenses are expenses already incurred before payment is made as of cut-off
date such as salaries, interest, utilities (electricity, water and telecommunications) and taxes.
According to expense recognition principle, expenses must be recognized in the books of
accounts at the time of its incurrence and not at the time of payment.
Pro-forma adjusting entry is
Expenses xxxx
Accrued Expense or Expense Payable xxxx
Illustration: On December 30, 2018, MJ Car Rental Agency hired a daily wage worker for the
maintenance of the office. MJ follows the calendar year as the accounting period. The daily wage
of the worker is P350 or a weekly salary of P2,100 for six days except Sunday. MJ salary scheme
is weekly and pays every Saturday. Assume that December 30, 2018 falls on Monday. This
would imply that December 31, 2018 falls on Tuesday which is the end of accounting period.
Analysis:
Starting December 30, 2018 salaries expense are incurred daily and the cut-off date of
accounting records is December 31, 2018 while payment of salary on a weekly basis is on
January 4, 2019. The unpaid salary expense is for two days as of end of accounting period
equivalent to P700. Though the scheduled payment is on January 4, 2019, the two days salary
expense should be recognized because it has been incurred already.
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Adjusting entry
12/31/2018 Salaries Expense P 700

Salaries Payable or Accrued Salaries P700
B. ACCRUED INCOME
Accrual of income is income already earned but not yet collected or received. The
business already done with services but payment of revenue is received in future date. Similar to
the recognition principle of expenses, income must also be recognized in the period earned and
not at the time of collection.
Pro-forma adjusting entry

Accrued Receivable or Accrued Income xxxx
Service Revenue xxxx
NOTE: The account titles for accrual and income should be clearly identified in the adjusting
entry.
Illustration:
On December 20, 2018 MJ Car Rental Agency received a contract for the exclusive use
of its two drivers to assist the foreign guests of a well-respected client for three months. MJ will
be paid P24,000 per month for a period of three months. The payment will be made every 20 th of
the month.
Analysis:
The collection of rental payment of P24,000 will be every 20th of the month, it means the
first collection will be on January 20, 2019. As of Dec. 31, 2018, the cut-off date, MJ already
realized an income for 10 days. Income must be recognized at the time the income is earned paid
or unpaid, so an adjusting entry is needed to reflect this.
Adjusting entry:
12/31/2018 Accrued Rental Income P8,000

Rental Income P8,000
(P24,000/30 days x 10 days)
C. ACCRUAL FOR UNCOLLECTIBLES ACCOUNTS
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Businesses normally have credit policy in order to generate more revenues. This
policy allows customers to purchase goods or services on terms agreed upon. However, not all
of the credit sales are 100% collectibles within the reasonable period. Experience dictates that
credits are not totally collected due to the following reasons:
• Debtor losses his capacity to pay
• Customer is not willing to pay
• Customer cannot be located anymore
• Customer dies
In this case, the revenue that has been recognized earlier was already lost because of non-
payment. The service revenue should be adjusted by charging a small portion to doubtful
accounts or uncollectible accounts. Mostly the amount charged against doubtful or uncollectible
account is estimated based on the professional judgement of the management and business
experience.
Pro-forma entry
Doubtful Accounts or Uncollectible accounts xxxx

Allowance for Doubtful or Uncollectible accounts xxxx
Basis of Estimating Doubtful Accounts

Doubtful accounts are computed based on the following:
• Percent of credit sales
• Percent of receivable balance
• Based on aging of receivables
Illustration: Percent of Credit Sales or service income
MJ Car Rental Agency provided the following ledger accounts as of December 31, 2018:
Total Credit Sales or Service Income P3,500,000
Accounts Receivable 2,100,000
Allowance for uncollectible accounts per ledger 50,000
The business estimated that uncollectible accounts at the end of the current year are 5% of
credit service income.
Required: 1. Compute the doubtful account expense

2. Prepare the adjusting entry.
Credit service income P3,500,000
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Multiplied by uncollectible accounts rate 5%

Uncollectible account expense 175,000
Adjusting Entry
12/31/2018 Uncollectible Accounts Expense P175,000

Allowance for Uncollectible Accounts P175,000
Illustration: Percent of Accounts Receivable
The same information will be used to illustrate this concept:
MJ Car Rental Agency revealed the following information from its ledger accounts as at
December 31, 2018
as follows:
Credit sales or Service income P3,500,000

Accounts Receivable 2,100,000
Allowance for Uncollectible Accounts 50,000
The business estimated that uncollectible accounts at the end of the current year are 5% of
credit service income.
Required: 1. Compute the uncollectible accounts expense.

2. Prepare the adjusting entry.
Accounts Receivable P 2,100,000

Multiplied by Uncollectible accounts rate 5%
Required Allowance Uncollectible Account Expense 105,000
Less: Allowance per ledger 50,000
Uncollectible account expense 55,000
Adjusting Entry
12/31/2018 Uncollectible Accounts Expense P 55,000

Allowance for Uncollectible Accounts P55,000
Net Realizable Value. Refers to the value of receivable after deducting the allowance for
uncollectible accounts shown as:
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Accounts Receivable P2,100,000

Less: Allowance for doubtful accounts 105,000
Net Realizable value P1,995,000
The most common method to compute for allowance for uncollectible accounts are percent of
credit sales or percent of receivables, aging of receivables will be discussed in higher
accounting.
STEP 6. POSTING OF THE ADJUSTING ENTRIES TO THE LEDGER AND TO THE

WORKSHEET
Aim: To communicate to interested parties accounting information for decision-making.
Financial statements are the final product of the accounting process. It usually follows
after the worksheet process is complete. It is the very purpose of the accounting system.
The complete set of Financial Statements are:

1. Statement of Comprehensive Income
2. Statement of Financial Position
3. Statement of Changes in Equity
4. Statement of Cash Flows
In the preparation of the financial statements, the ultimate guide is the Worksheet. All the
accounting information from the worksheet are merely transferred to the Statement of
Comprehensive Income and Statement of Financial Position. The first three financial reports will
be discussed in this module while the Statement of Cash flows in Module 4.
The same worksheet of MJ Car Rental Agency will be used to produce a complete set of
financial statements. Additional data for adjustments will be provided for presentation purposes
and to complete the columns.
Figure 2.6 Worksheet with Adjustments

Worksheet
December 31, 2018
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As of December 31, 2018, assume the following data for adjustments :

1. The actual count of Supplies on hand is P2,000 only.
2. Additional five (2) months of insurance has already expired.
3. Rent expense will be adjusted to P15,000.
4. Additional 2% will be charged as depreciation expense to Vehicles and Equipment
5. The estimated allowance for uncollectible accounts will be adjusted to 2% of accounts
receivable
Adjusting Entries as of December 31, 2018
1. Supplies Expense P 3,000

Supplies P3,000
To adjust supplies account to correct balance.
2. Insurance Expense 8,000

Prepaid Insurance 8,000
To adjust the insurance expense acct.
(P48,000/12= 4,000 per month)
3. Rent Expense 5,000
Prepaid rent 5,000
To adjust rent expense to P15,000
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4. Depreciation Expense-Vehicles 36,000

Accumulated depreciation-Vehicles 36,000
To adjust depreciation expense by 2%
Depreciation Expense -Equipment 1,600

Accumulated depreciation- Equipment 1,600
5. Uncollectible Accounts 1,000

Allowance for uncollectible accounts 1,000
(A/R = 225,000 x 2% = 4,500-3,500)
To adjust allowance for uncollectible
Accounts to 2% of A/R)
After posting the adjusting entries to the Worksheet, the next step is the preparation of Financial
Statements.
STEP 7. PREPARATION OF THE FINANCIAL STATEMENTS
A. THE STATEMENT OF COMPREHENSIVE INCOME

It is a statement showing the performance of the business for a given period of time. It
summarizes the revenues earned and expenses incurred for that period and communicates to the
users its profitability status for a one-year operation. If the revenue exceeds the expenses of the
business, then it is a Profit, vice-versa, then the result is a Loss for the business. A
comprehensive income statement includes other line items discussed only in higher accounting
subjects. For this module, our discussion will focus mainly on the results of operation of MJ Car
Rental Agency, whose data were taken from the accompanying worksheet.
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Figure 2.7 Statement of Comprehensive Income

Income Statement
For the year ended December 31, 2018
Revenues
Rental Revenue P360,000
Less: Operating Expenses P 12,000

Insurance 15,000
Expense 15,000
Gasoline & oil 3,000
Rent Expense 30,000
Repairs & maintenance 2,000
Salaries Expense 96,000
Miscellaneous Expense 11,600
Depreciation Exp- 4,500
Vehicles 18,000
Depreciation Exp-Equipment 3,000
Uncollectible Accounts 210,100
Utilities Expense
Supplies Expense P 149,900
Total Operating Expenses
Net Operating Income
The net operating income of MJ Car Rental Agency of P149,900 is tax inclusive. If the
applicable income tax (NIRC) rate will be deducted, then the next amount derived is the Net
Income.
B. THE STATEMENT OF FINANCIAL POSITION

It is a statement that measures the financial position of the business in terms of Assets,
Liabilities and Owner’s Equity. It shows the resources(Assets) employed by the business first,
followed by the claim of the creditors (Liabilities) against the assets, and then the claim of the
owner called Capital. The Statement of Financial Position otherwise known as “Balance Sheet”
indicates liquidity and solvency status of the business. The items in this statement are measured
and presented in conformity with the requirements of PAS and PFRS. It is also presented in two
formats: Report Form (vertical) or Account Form (horizontal). For our example we follow the
most commonly used format, the account format.
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Liquidity. Refers to the ability of the business to settle its currently maturing obligations.
Solvency. Refers to the ability of the business to pay its non-current liabilities and still remain
stable.
Figure 2.8 The Statement of Financial Position
C. THE STATEMENT OF CHANGES IN EQUITY

It presents the different elements that affect the equity of the owners during a particular
period. It also shows the changes in the equity structure of the entity as it increases when at a
profit and decreases when the business posted a loss, or when additional investments and
temporary withdrawals are made by the owners.
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Figure 2.9 Statement of Changes in Owner’s Equity

Statement of Changes in Owner’s Equity
For the Year Ended December 31, 2018
MJ, Capital Beginning P 1,000,000

Add: Additional Investment 300,000
Net Income 149,900
Total 1,449,900
Less: Withdrawal 30,000
MJ, Capital Ending P 1,419,900
STEP 8. CLOSING JOURNAL ENTRIES

Aim: To describe all the procedures in closing the books, close all temporary accounts
and transfer profit or loss to owner’s capital account.
Closing Entries. Are journal entries that close balances of nominal or temporary accounts using
Income Summary account. The income summary account is ultimately closed to a real account
which is the Capital. Closing entries make the balances of all temporary accounts equal to zero
in preparation for the next accounting period. To close means to debit all credits and credit all
debits. As we go on with the closing procedures, we will be closing the books of MJ Car Rental
Agency.
STEPS TO FOLLOW:
Step 1. Close the revenue or income
Rental Revenue P360,000

Income Summary P360,000
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Step 2. Close the cost and expense accounts
Income Summary 210,100

Insurance expense 12,000
Gasoline and Oil 15,000
Rent Expense 15,000
Repairs and Maintenance 3,000
Depreciation Expense-Vehicles 96,000
Depreciation Expense-Equipment 11,600
Uncollectible Accounts 4,500
Utilities Expense 18,000
Supplies Expense 3,000
Step 3. Close the Income Summary to Capital Account

MJ, Capital 149,900
Step 4. Close the Drawing account to Capital account
MJ, Capital 30,000

MJ, Withdrawal 30,000
After the closing entries are correctly posted to their respective accounts in the ledger,
these accounts will have zero balances. Before moving on to the next step of the accounting
cycle, important guidelines must be remembered:
• Only temporary or nominal accounts are closed ; permanent or real
accounts are not.
• Closing entries are recorded in the general journal.
• Closing entries are posted to the general ledger.
• Closing entries are made at the end of accounting period only.
STEP 9. PREPARATION OF POST-CLOSING TRIAL BALANCE

Aim: To determine the accuracy of the adjusting and closing entries and to ensure that
the ledger balances for the next accounting period are equal.
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Post-closing Trial Balance. Is a trial balance after the preparation of the closing entries. It
contains the ending balances of all real or permanent accounts as reflected in the Statement of
Financial Position. It is also called a balance sheet in a trial balance form.
These balances will be the beginning balances of the ledger next accounting period.
STEP 10. REVERSING ENTRIES (OPTIONAL)

Aim: To facilitate the normal recording of transactions in the succeeding accounting
period.
Reversing Entries: are entries that reversed the adjusting entries. They are prepared at the
beginning of the next accounting period, the reason why reversing entries sometimes called the
first step in the next accounting cycle. They are the first entries recorded in the general journal of
the next accounting period. Although, reversing entries affect only adjusting entries, but not all
adjusting entries are reversed.
What adjusting entries are reversed?
1. Accrual of income
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2. Accrual of expenses
3. prepayment using expense method
4. unearned income using income method.
All remaining adjusting entries need not be reversed such as: prepayment using asset
method, unearned revenue using liability method, depreciation and uncollectible accounts.
Figure 2.11 Relationship of Adjusting and Reversing Entries
Nature of Adjustment Adjusting Entries Reversing Entries

Accrued Income Accrued Receivable xx Income account xx
Income account xx Accrued
Receivable xx
Accrued Expense Expense account xx Accrued exp./payable xx
Accrued exp or payable xx Expense
account xx
Prepayment-expense Prepaid expense xx Expense account xx
method Expense account xx Prepaid
expense xx
Unearned income-income Income account xx Unearned income xx
method Unearned income xx Income
account xx
All remaining adjusting entries need not be reversed such as: prepayment using asset
method, unearned revenue using liability method, depreciation and uncollectible accounts.
ASSESSMENTS:
I. Exercises
Exercise 1 . ANALYZING AND JOURNALIZING TRANSACTIONS:
Car Splash N’ Wash is a high-end car wash business owned by Jung Suk, a Filipino-Korean.
During the one month-period of its operation, the following transactions took place:
1. Jung Suk withdrew from his personal bank account P400,000 and deposited the money to
the account of Car Splash N’ Wash as initial investment.
2. Purchased spray equipment on account, P60,000.
3. Paid 5 months rent for the site of his business at P10,000 per month.
4. Bought one TV monitor worth P30,000 for the reception and waiting area of customers.
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5. Rendered full service for the luxury vehicles of three(3) celebrities and received
P12,000.
6. Partially settled account in No. 2, P30,000.
7. Received P75,000 and signed a contract agreement for a bus company for services to be
rendered in the future.
8. Paid half month salaries of his shop personnel at P20,000 per month.
9. Rendered services to a friend’s vehicles on account P6,000.
10. Brought to the business his personal furniture for use in the waiting area valued at
P35,000.
11. Received bill for utilities P5,000.
12. Cash collected from walk-in customers P15,000.
13. Purchased supplies for the shop, P10,000.
14. Received and paid advertising bill to advertise the opening of the business,P8,000.
15. Purchased one-year insurance for the business P24,000.
Required: 1. Prepare chart of accounts for Car Splash N’ Wash.

2. Prepare proper journal entry for each transaction.
Exercise 2. TRUE OR FALSE QUESTIONS

1. A cash acquisition of a computer for the business will cause total assets to increase and
should be recorded as a debit.
2. A debit entry always increases the balance of an account.
3. Cost is the exchange price associated with a business transaction at the time the
transaction is recognized.
4. Accounts that appear on the left side of the accounting equation usually have credit
balances.
5. Payment of a liability will not affect total assets but will cause total liabilities to
decrease.
6. Expenses cause a decrease in owner’s equity and are recorded as debits.
7. A debit entry has an unfavorable effect on an account.
8. A credit means an account has been increased.
9. When a company receives a product previously ordered, a recordable event has
occurred.
10. When revenue has been earned, no entry is recorded until the related cash has been
recorded.
11. Owner’s withdrawal is classified as a reduction of assets and therefore considered as
expense.
12. Depreciation is an expense account that involves cash.
13. Losses decreases the Capital account and are recorded as debits.
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14. All expenses represent cash paid for goods sold or services rendered in the process of
generating revenue.
15. The double-entry system is possible because all business transactions have two equal and
opposite aspects.
Exercise 3. MULTIPLE CHOICE QUESTIONS (ADJUSTMENTS)

1. Marie issued a P280,000 ,180-day note bearing an interest of 24% A on Oct. 1,
2007. Payment of the principal plus interest will be on maturity date. For the fiscal year
ending February, 2008, what will be the adjusting entry on the books of Marie?
a. Dr. Interest Receivable P28,000 Cr. Interest Income P 28,000
b. Dr. Interest Expense 28,000 Cr. Interest Payable 28,000
c. Dr. Interest Receivable 67,200 Cr. Interest Income 67,200
d. Dr. Interest Expense 67,200 Cr. Interest Payable 67,200
2. Kraft Co. paid a three-year insurance premium for 46,800 on February 15, 2002. The
bookkeeper uses an expense method to record this transaction. What will be the adjusting entry if
accounting period ends Sept. 30, 2002.
a. Dr. Insurance Expense 9,750 Cr. Prepaid Insurance 9,750
b. Dr. Prepaid Insurance 37,050 Cr. Insurance Exp 37,050
c. Dr. Insurance Expense 29,250 Cr. Prepaid Ins. 29,250
d. Dr. Prepaid Expense 46,800 Cr.Insurance Exp 46,800
3. Cinderella pays its weekly salary of P50,400 for a 6-day work-week ending on Saturday. The
company follows the calendar year ending on December 31. Assuming that December 31 falls
on a Thursday, how much is accrued salaries at the end of accounting period?
a. P33,600 c. P16,800
b. 8,400 d. 50,400
4. Unearned rent has a credit balance of P240,000 composed of the following:

**January 1 balance of P45,000 representing rent prepaid for 3 months, that is,
January-March
**A credit of P195,000 representing advance rental payment for 12 months
beginning April 1
The December 31 adjusting entry will require a debit to unearned rent and a credit to
revenue account of how much?
a. P195,000 c. P191,250
b. 240,000 d. 45,000
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5. Which of the following is not a closing entry?

a. Income Summary P5,000
Rent expense 5,000
b. Owner, Capital 50,000

Owner, Withdrawal 50,000
c. Accrued Utilities 10,000

d. Service Revenues 200,000

6. A one-year insurance policy was purchased in October 1, 2010 for 36,000. At the end of
accounting period December 31, 2010, how much insurance had expired?
a. P3,000 c. P 9,000
b. 36,000 d. 33,000
7. ABC Co. acquired a truck from TRI-STAR Trading in the amount of

P350,000 “on account” on June 21, 2016. The estimated useful life of the asset is 6
years with a salvage value of P50,000. The fiscal year ends October 31, 2016. The annual
depreciation of the truck would be
a. P25,000 c. P50,000
b. 60,000 d. 72,000
8. Same data in No.7,how much is the amount of depreciation expense for the period?
a. P18,082 c. P25,000
b. 16,667 d. 31,918
9. An accounting firm started the business in November with office supplies of P16,000. During
the month the entity purchased supplies of P29,000. On November 30, supplies on hand totaled
P21,000. Supplies expense for the period is
a. P24,000 c. P45,000
b. 29,000 d. 21,000
10. On September 31, 2018, the business purchased a delivery van for P350,000 with a trade-in
value of P70,000 and estimated useful life of 8 years. The enterprise follows a fiscal
accounting period which ends on February 28, 2019. At the end of accounting period,
how much is the depreciation expense to be recognized for the van?
a. P35,000 c. P14,583
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b. 8,750 d. 18,229
Exercise 4. COMPREHENSIVE ACCOUNTING PROBLEM
Hyun Bin opened his computer repair services shop on November 30, 2018. The following
transactions happened during the operations of the business since the opening of the shop. The
business uses a calendar accounting period.
Dec.
1 Hyun Bin deposited P500,000 to the account of the business as initial investment
2 Purchased various computer repair equipment for P250,000, with down payment of
P150,000 and the balance to be paid on terms.
3 Bought office supplies for P25,000. Expense method is used.
5 Billed various customers for services rendered, P80,000.
8 Paid rent for three months at P15,000 per month. Asset method is used.
10 Paid taxes and licenses, P8,000.
14 Received partial payment of billing on December 5, P50,000.
15 Paid half month salary of the staff receiving P36,000 on a monthly basis.
18 Rendered services to various customers: Cash basis P90,000 and On
20 account P70,000.
22 Paid advertising expenses for 6 months, P42,000. Expense method is used.
25 Withdrew P50,000 for personal use.
Received a 12%, 30-day note from customers as payment of the account on December
26 5, P30,000.
Received P25,000 for repair of 20 units of computer. Services will be provided on
28 December 30, 2018. Income method is used.
31 Paid the transportation of the staff, P4,000.
Purchased office furniture on account, P120,000.
Additional information:
1. The computer repair equipment and office furniture has estimated useful life of 5
years with out residual value.
2. Office supplies on hand per physical count, P3,000
3. Salaries of staff for the remaining half – month of December still unpaid.
4. Doubtful accounts is 5% of outstanding accounts receivable.
5. Unearned service income balance is 12,000.
Required:
1. Prepare Chart of Accounts with account codes.
2. Record the transactions in a two-column journal.
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3. Post the journal entries to the T-Accounts.

4. Prepare unadjusted Trial Balance.
5. Prepare adjusting entries in to-column journal
6. Prepare a 10-column worksheet.
7. Prepare closing entries in two-column journal.
8. Prepare Post-closing Trial Balance.
9. Prepare Statement of Comprehensive Income in good form.
10.Statement of Financial Position
11. Statement of Changes in Owner’s Equity.
II. Quizzes
III. Major exams
REFERENCES
Text books-
Ballada, W.L. (2018). Basic accounting: Made easy. Manila. Domdane Publishers
Aduana, N.L. (2015). Fundamentals of Accounting. Quezon City. C &E Publishing, Inc.
Valencia, E. G. et al (2016). Basic accounting: Concepts, principles, procedures and
applications. Baguio City. Valencia Educational Supply
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Module 4
THE ESSENCE OF FINANCIAL STATEMENTS
(Week number)
Introduction
There are questions that the owner of a business periodically asks - How much did the business
entity earn? What is the financial condition of the business? How much is the owner's interest
in the entity today? What happened to the cash receipts? Where did cash go? Investorsm,
creditors, taxing arthritis and other users have their own questions about the business.These
questions can be answered through the financial statements of the business. In this module, the
set of financial statements as well as their uses will be discussed. It also presents how to
prepare these financial statements and how they are interrelated.
Learning Objectives

1. Explain the usefulness of financial statements
2. Demonstrate skills in the preparation of financial statements
3. Explain how the financial statements are interrelated.
Essence of Financial Statements

The financial statements are the end product of the accounting process. Information from the
journal and the ledger are meaningless to most users unless they are summarized and
communicated through the financial statements. The financial statements are the means by
which the information accumulated and processed in financial accounting is periodically
communicated to the users. Without accounting information embodied in the financial
statements, users may not be able to arrive at sound economic decisions. The objective of
financial statements is to provide information about the financial position, financial performance,
and cash flows of an entity that is useful to a wide range of users in making economic decisions.
Complete Set of Financial Statements

An entity shall present with equal prominence all the financial statements in a complete
set of financial statements. Per revised Philippine Accounting Standards (PAS) No.1, a
complete set of financial statements comprises:
1. a statement of financial position (balance sheet) at the end of the period;
2. a statement of profit or loss and other comprehensive income for the period (presented
as a single statement, or by presenting the profit or loss section in a separate statement
of profit or loss, immediately followed by a statement presenting comprehensive income
beginning with profit or loss);
3. a statement of changes in equity for the period;
4. a statement of cash flows for the period;
5. notes, comprising a summary of significant accounting policies and other explanatory
notes comparative information prescribed by the standard.
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6. An entity may use titles for the statements other than those stated above. All financial
statements are required to be presented with equal prominence.
7. When an entity applies an accounting policy retrospectively or makes a retrospective
restatement of items in its financial statements, or when it reclassifies items in its
financial statements, it must also present a statement of financial position (balance
sheet) as at the beginning of the earliest comparative period.
In a nutshell, the statement of financial position or balance sheet lists all the assets, liabilities
and equity of an entity as at a specific date. The statement of profit or loss or income statement
presents a summary of the revenues and expenses of an entity for a specific period. The
statement of changes inequity presents a summary of the changes in capital such as
investments, profit or loss, and withdrawals during a specific period. The statement of cash
flows reports the amount of cash received and disbursed during the period. Accounting policies
are the specific principles, bases, conventions, rules and practices adopted by an enterprise in
preparing and presenting financial statements. Notes to financial statements provide narrative
descriptions of disaggregation of items presented in the statements and information about items
that do not qualify for recognition in the statements.
Preparing the Financial Statements

Preparation of the financial statement is an easy step after the worksheet is completed.
Most of the information needed can be derived from this worksheet.
Statement of Profit or Loss (Income Statement)

The statement of profit or loss or income statement shows the results of operations for a
given period of time. The result of operations are basically measured in terms of the income
earned through the utilization of its sources. It is prepared for a given period of time which
means a certain length of time is covered for example, a month, quarter or semi-annual or
annual.
Monstera Landscaping Services

Income Statement
For the month ended May 31, 2020
Revenues
Landscaping Revenues P 422,500
Expenses
Salaries Expense P 56.000
Supplies Expense 5,000
Rent Expense 70,000
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Insurance Expense 20,000
Gas Expense 15,000
Advertising Expense 17,500
Depreciation Expense -Vehicles 45,000
Depreciation Expense - Equipment 10,000
Interest Expense 14,000
Total 252,500
Profit P 170,000
Information about the performance of an enterprise is required in order to assess the potential
changes in the economic resources that are likely to control in the future. It is also useful in
predicting the capacity of the business to generate cash flows from its existing resources.
An entity shall present all items of income and expense recognized in a period.:
a. In a single statement of comprehensive income, or
b. In two statements: a statement displaying components of profit or loss (separate income
statement) and a second statement beginning with profit or loss and displaying components of
other comprehensive income (statement of comprehensive income).
Statement of Changes in Equity

The statement of changes in equity summarizes the changes that occurred in owner’s
equity. The is statement is now a required statement. Changes in an entity’s equity between two
balance sheet dates reflect the increase or decrease in its net assets during the period.
In the case of sole proprietorships, increases in owner's equity arise from additional
investments by the owner and profit during the period. Decreases result from withdrawals by the
owner and from loss for the period. The beginning balance and additional investments are taken
from the owner’s capital account in the general ledger. The profit or loss amount comes from the
income statement while the withdrawals front the balance sheet column in the worksheet.
Monstera Landscaping Services

Statement of Changes in Equity
For the month ended May 31, 2020
Monstera,Capital, May 1, 2020 P 450,000

Add: Additional investment P -0-
Profit 170,000 170,000
Total P 620,000
Less: Withdrawals 50,000
Monstera, Capital, May 31, 2020 P 570,000
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Statement of Financial Position (Balance Sheet)
A Statement of Financial Position (Balance Sheet) is a formal statement showing the
financial position of an enterprise as of a particular date. The balance sheet represents the three
elements of financial position namely: assets; liabilities, and equity or proprietorship.
Users of financial statements analyze the balance sheet to evaluate an entity’s liquidity,
its financial flexibility, and its ability to generate profits, and its solvency. Liquidity refers to the
availability of cash in the near future after taking account of the financial obligations over this
period. Financial flexibility is the ability to take effective actions to change the amounts and
timings of cash flows so that it can respond to unexpected needs and opportunities. This
includes the ability to raise new capital. Solvency refers to the availability of cash over the
longer term to meet financial commitments as they fall due.
In practice there are two customary forms of balance sheet namely:

a. The Report form - this form sets forth the three major sections in a downward sequence
of assets, liabilities and proprietorship.
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Report Form
b. The Account form - this form lists the assets on the left and the liabilities and owner’s
equity on the right.
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Account Form
It is proper to present a classified balance sheet. Assets are classified as current assets and
noncurrent assets; while liabilities as current liabilities and noncurrent liabilities. Classifying
balance sheet aids in the analysis of financial statement data. Assets are classified and
presented in decreasing order of liquidity. Cash is the most liquid. Liabilities are generally
classified and presented baked on time of maturity, so obligations which are currently due are
listed first.
Statement of Cash Flows

The statement of cash flows provides information about the cash receipts and cash
payments of an entity during a period. It is a formal; statement that classifies cash receipts
(inflows) and cash payments (outflows) into operating, investing and financing activities. This
statement shows the net increase or decrease in cash during the period and the cash balance
at the end of the period; it also helps project the future net cash flows of the entity. The
discussion below gives an overview of some important concepts involved in the preparation of
a cash flow statement.
The cash flow statement explains the change during the period in cash and cash equivalents.
Cash includes currency on hand and demand deposits. Cash equivalents are short-term, highly
liquid investments that are readily convertible to cash.
Components of a cash flow statement

The statement provides information about the cash generated from a company’s daily
operating activities. Operating activities are those which produce either revenue or are the direct
cost of producing a product or service. Operating activities which generate cash inflows include
customer collections from sales of their primary products or services, receipts of interest and
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dividends, and other operating cash receipts. Operating activities which create cash outflows
include payments to suppliers, payments to employees, interest payments, payment of income
taxes and other operating cash payments.
Investing activities include buying and selling noncurrent assets which will be used to
generate revenues over a long period of time; or buying and selling securities not classified as
cash equivalents. Cash inflows generated by investing activities include sales of noncurrent
assets such as property, plant, and equipment. Investing activities can also include the
purchase or sale of stock and securities. Lending money and receiving loan payments would
also be considered investing activities.
Financing activities include borrowing and repaying money, issuing stock (equity) and paying
dividends. For example, if you borrow funds to purchase equipment or pay off a loan, the cash
flow statement will enable you to determine how much cash was either generated or used as a
result of those transactions.
Income Flows and Cash Flows
The income statement and balance sheet are based on accrual accounting which was
developed nbased on the principle of matching. The matching principle states that revenues
generated and the expenses incurred to generate those revenues should be reported in the
same income statement. This emphasizes the cause-and-effect association between revenue
and expense. Many revenues and expenses result from accruals and allocations that do not
affect cash. A company can operate at a profit and continually be short of cash. It can also
generate huge inflows of cash from operations and still report a loss. The statement of cash
flows can explain how these situations might occur. Answers to these questions cannot be
found in the other financial statements. There are two types of items that cause differences
between income flows and outflows: non cash income or expense and nonoperating income or
expense. An example of a noncash item on the income statement would be depreciation or
amortization. An example of a non operating item on the income statement would be a gain on
the sale of an asset. These transactions must be reported on a cash flow statement in order to
properly determine the true effect of conducting business on cash.
Information used to prepare a cash flow statement is taken from the income statement for the
current year and balance sheets for the past two years. Net income is adjusted for deferrals and
accruals. The purpose of these adjustments is to convert the accrual basis income statement to
a cash flow statement. The cash flow statement follows an activity format and is divided into
three sections: operating, investing and financing activities. Generally, the operating activities
are reported first, followed by the investing and finally, the financing activities. Additionally, there
are two methods of calculating and reporting the net cash flow from operating activities. Both
methods result in identical figures for net cash flow from operating activities because the
underlying accounting concepts are the same.
• The direct method reports gross cash inflows and gross outflows from operating
activities.
• The indirect method reconciles net income with net cash flow from operating activities by
adjusting net income
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The first step in preparing the cash flow statement is to determine the net increase in cash and
cash equivalents for the period. This amount will be a control figure and the cash flow statement
will reconcile the inflows and outflows (sources and uses) to this figure.
Cash Effects of Balance Sheet Account Changes
Cash Inflow Cash Outflow
A Decrease in an Asset Account An Increase in an Asset Account
An Increase in a Liability Account A Decrease in a Liability Account
An Increase in an Equity Account A Decrease in an Equity Account
The Direct Method
The first method performed will be the direct method of calculating cash flow. This method
combines information from both the Income Statement and the Cash Flow worksheet we
created using the Balance Sheet. The result is an accurate indication of exactly what funds were
collected in the form of cash, paid in the form of cash, and if the company actually generated
cash.
The Indirect Method

The second method used to calculate the Cash Flows from Operating Activities is referred to as
the Indirect Method. Using the Indirect Method, cash flows from Operating Activities are
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reported by adjusting net income for revenues, expenses, gains, and losses that appear on the
income statement but do not have an effect on cash.
Cash flow from investing activities is the second part of both types of cash flow statements.
Investing activities are the changes to the cash position created by the buying or selling of non-
current assets. This includes selling and replacing equipment that wears out or acquiring a new
building or land to facilitate growth in a company. Investing activities can also include the
purchase or sale of stocks, bonds and securities. Lending money and receiving loan payments
are also considered investing activities. For a small business, the investing activities section of a
cash flow statement usually reports the following information:
For a given period, there may not be much in the way of investing activities. But over
time, it is an important consideration for assessing how to choose to use the cash generated by
your business.
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Financing activities on a cash flow statement reflect borrowing money and repaying money,
issuing stock, and paying dividends. The financing activities section of the cash flow statement
can be reduced to the following formula:
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Accounting Errors
Accounting errors are unintentional mistakes in book-keeping of transactions. Accounting errors
are different from accounting fraud because in fraud an intentional mistake is made to
misrepresent financial information or to conceal misappropriation of assets.
Accounting errors are easier to identify when they cause a difference between debit and credit
totals of a trial balance. However accounting errors may not always cause a trial balance to
imbalance, in which case they are relatively difficult to identify. Where a trial balance is
imbalanced by accounting errors, the difference between the debit and credit totals of the trial
balance is temporarily kept in suspense account until the errors are corrected.
Types
Accounting errors can be broadly classified into the following types. Please note that different
types of errors may have overlapping characteristics.
1. Errors of Principle. Errors that involve violation of accounting principles, misinterpretation
of facts, unintentional unrealistic estimates or incorrect method of calculation. These
errors are usually caused due to insufficient accounting knowledge.
Example: Recognizing expense in wrong accounting period, recognizing unearned revenue as
income instead of a liability, inconsistent application of accounting principles, etc.
2. Clerical Errors. It is in human nature to make mistakes. For example, an accountant
may inadvertently enter an incorrect figure in accounts. Such errors are known as clerical errors.
Clerical errors may be minimized with experience. Clerical errors have following sub-types:
• Arithmetic: Errors in calculations other than incorrect method of calculation.
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Example: Calculations such as 3+2×6 may be incorrectly done by performing addition before
multiplication, thus arriving at 30 as the answer. However the correct answer is 15 because we
have to perform multiplication before addition.
• Input Errors: Incorrect figures input into accounting records. Most common input error is
a transposition error in which a number is input with incorrect order of digits.
Example: Entering 120000 as 12000 or 2389 as 3289. These errors may be minimized by using
comma as a separator i.e. formatting 120000 as 120,000.
• Omissions: Forgetting to enter a transaction in accounting records.
Example: Forgetting to record a purchase transaction.
• Misplacement: Entering a transaction in wrong account.
Example: Recording amount receivable from Customer A in Customer B’s account.
Assessments
Review Questions
1. Enumerate the components of a complete set of financial statements and briefly
describe each.
2. How are the accounts in the statement of financial position presented?
3. Describe the components of a statement of cash flows.
4. What is the importance of a financial statement?
Exercise
Jasmine is the owner of the Jasmine Laundry Shop. During January 202, the following income
statement accounts reflected balances:
Cash P 53,200
Washing Machine 124,000
Furniture and Fixtures 95,400
Laundry Supplies 17,500
Other Supplies 1,500
Accounts Payable 22,000
Advertising Expense 7,500
Revenue from laundry services 216,750
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Maintenance expense 5,200
Rent Expense 11,000
Utilities expense 67,250
Jasmine, Capital January 1 250,000
Jasmine, Withdrawal 12,000
Depreciation- Washing Machine 8,000
Depreciation expense - Furniture and Fixtures 2,000
Required: Prepare the income statement, statement of changes in equity and and balance
sheet.
References
Ballada, W.L. (2018). Basic accounting: Made Easy. Manila. Domdane Publishers.
Reyno Jr., F and Reyno D.W. (2019). Fundamentals of Accounting and Reporting Part One.
Dagupan City. Reyno Publishing House.
https://www.zionsbank.com/pdfs/biz_resources_book-4.pdf
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Module 5
ACCOUNTING FOR MERCHANDISING BUSINESS
Week 12 to 15
Introduction
This module deals with the accounting procedures for a merchandising type of business.
It first distinguishes merchandising from service type. Then this proceeds with the account
titles used for merchandising particularly the merchandise inventory. It presents the
periodic and perpetual inventory systems. Lastly, it presents the accounting for sales and
purchases transactions and the effect of value-added tax (VAT).
Learning Objectives

1. Describe merchandising activities and identify the income components for a
merchandising entity.
2. Distinguish between income statements of service and merchandising entities.
3. Illustrate the operating cycle of a merchandising entity.
4. Identify the different source documents being used by merchandising entities.
5. Apply the accounting for treatment for cash discounts and trade discounts, and
transportation costs.
6. Analyze and record transactions for merchandise sales and purchases under
periodic and perpetual systems.
7. Prepare entries showing the effects of value-added tax on merchandising
transactions.
8. Demonstrate the complete accounting cycle for merchandising business.
Merchandising Business
A merchandising business is an entity engaged in the activities of buying and
selling of products. Sometimes, the business is called trading business or buy and sell
business. The difference between a merchandising and a service business is the
existence of physical products sold to customers. Merchandising businesses sell products
in order to generate revenue while service oriented businesses render service. The major
activities of a merchandising business consist of buying and selling of products called
merchandise. Normally, the entity buys goods or merchandise on a wholesale basis,
either from a manufacturer or a wholesaler, and sells the same for profit. The revenue of
a merchandising business is called sales.
The goods that are bought for sale are reported as merchandise inventory and are
classified as current assets. However when the merchandise is sold, their cost is
transferred to an expense account called cost of sales or cost of goods sold.
A merchandising business is also different from a manufacturing business. The
latter purchases materials and transforms them into products before they are sold. While
a merchandising business purchases goods and sells them without changing their form.
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Comparison of Income Statements
Operating Cycle of a Merchandising Business

The major business activities of a merchandising business are:
a. Purchasing Activities. These activities refer to the buying or acquisition of
merchandise that is intended for sale. Merchandise can be purchased either for cash or
on account. The cost of merchandise purchased should include the purchase price plus
all other incidental costs related to the acquisition.
b. Selling Activities. These activities refer to the transfer of the title of ownership
over the merchandise from the seller to the buyer for a consideration either in money or
in other things of value.
The merchandising entity purchases inventory, sells the inventory and uses the
cash to purchase more inventory- and the cycle continues. For cash sales, the cycle is
from cash to inventory and back to cash. For sales on account, the cycle is from cash to
inventory to accounts receivable and back to cash. The goal of many business
owner/manager is to shorten this cycle. The faster the sale of inventory and the collection
of cash, the higher the profits and better liquidity position. The following illustrates the
operating cycle.
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Source Documents
1. Sales invoice is prepared by the seller of goods and sent to the buyer. It contains
the name and address of the buyer, the date of sale and information - quantity,
description and price- about the goods sold. It also specifies the amount of sales,
and the transportation and payment terms.
2. The bill of lading is a document issued by the carrier - a trucking, shipping or
airline - that specifies contractual conditions and terms of delivery such as freight
terms, time, place, and the person named to receive the goods.
3. The statement of account is a formal notice to the debtor detailing the accounts
already due.
4. The official receipt evidences the receipt or cash by the seller or the authorized
representative. It notes the invoices paid and other details of payment.
5. Deposit slips are printed forms with the depositor's name, account number and
space for details of the deposit. A validated deposit slip indicates that cash and
checks with the supplied details were actually deposited or credited to the
account holder.
6. A check is a written order to a bank by a depositor to pay the amount specified in
the check from his checking account to the person named in the check. The
entity issuing the check is the payor while the receiver is the payee.
7. The purchase requisition is a written request to the purchases of an entity from
an employee or user department of the same entity that goods be purchased.
8. The purchase order is an authorization made by the buyer to the seller to deliver
the merchandise as detailed in the form.
9. Receiving report is a document containing information about goods received from
a vendor. It formally records the quantities and description of the goods
delivered.
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10. A credit memorandum is a form used by the seller to notify the buyer that this
account is being decreased due to errors or other factors requiring adjustments.
Sales
The Sales account is a revenue account used to record sales of merchandise.
Sales are initially recorded via one of the following entries, depending on whether the
sale is for cash or is a sale on account:
Cash xxx
Sales xxx
Sold merchandise for cash.
Accounts Receivable xxx

Sales xxx
Sold merchandise on account.
Sales Returns and Allowances

Occasionally, a customer returns merchandise. When that occurs, the following
entry should be made:
Notice that the above entry included a debit to Sales Returns and Allowances (rather than
canceling the sale). The Sales Returns and Allowances account is a contra-revenue
account that is deducted from sales. The calculation of sales less sales returns and
allowances is sometimes called “net sales.” This approach allows interested parties to
easily track the level of sales returns in relation to overall sales. Important information is
revealed about the relative level of returns, thereby providing a measure of customer
satisfaction or dissatisfaction. Sales returns (on account) are typically documented by the
creation of an instrument known as a credit memorandum. The credit memorandum
indicates that a customer’s Account Receivable balance has been credited (reduced) and
that payment for the returned goods is not expected. If the transaction involved a cash
refund, the only difference in the entry would involve a credit to Cash instead of Accounts
Receivable. The calculation of net sales would be unaffected.
The following income statement provides an example showing the presentation of net
sales:
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Note the use of the word “allowances” in the account title “Sales Returns and Allowances.”
What is the difference between a return and an allowance? Perhaps a customer’s reason
for wishing to return an item is because of a minor defect; the customer may be willing to
keep the item if the price is reduced. The merchant may give an allowance to induce the
customer not to return the item. The entry to record the allowance would ordinarily involve
the same accounts as those previously illustrated for the return. However, one could use
a separate account for returns and another for allowances.
Trade Discounts
Product catalogs often provide a list price for an item. Those list prices may bear little
relation to the ultimate selling price. A merchant may offer customers a trade discount
that involves a reduction from list price. Ultimately, the purchaser is responsible for the
invoice price, that is, the list price less the negotiated trade discount. Trade discounts
are not entered in the accounting records. They are not considered to be a part of the
sale because the exchange agreement was based on the reduced price.
Remember the general rule that sales are recorded when an exchange takes place.
Because the measurement of the sale is based on the exchange price, the amount
recorded as a sale is the invoice price. The entries previously shown for a P40,000 sale
would also be appropriate if the list price was P50,000, subject to a 20% trade discount.
Cash Discounts/Purchase Discounts
Recall the previous discussion of cash discounts (sometimes called purchase discounts
from the purchaser’s perspective). Discounts are typically very favorable to the purchaser,
as they are designed to encourage early payment.Discount terms vary considerably. Here
are some examples:
· 1/15, n/30 — 1% if paid within 15 days, net due in 30 days

· 1/10, n/eom — 1% if paid within 10 days, net due end of month
· .5/10, n/60 — ½% if paid within 10 days, net due in 60 days
While discounts may seem slight, they can represent substantial savings and should
usually be taken. Consider the following calendar, assuming a purchase was made on
May 31, terms 2/10, n/30. The discount can be taken if payment is made within the “blue
shaded” days. The discount cannot be taken during the “yellow shaded” days (of which
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there are twenty). The bill becomes past due during the “purple shaded” days. What is
important to note here is that skipping past the discount period will only achieve a twenty-
day deferral of the payment. Consider that a 2% return is “earned” by paying 20 days
early. This is indeed a large savings. There are approximately 18 twenty-day periods in a
year (365/20), and, at 2% per twenty-day period, this equates to over a 36% annual
interest rate equivalent.
Freight Charges
When merchandise is shipped by a common carrier - a trucking entity or an airline
- the carrier prepares a freight bill in accordance with the instructions of the party making
the shipping arrangements. The freight bill designates which party shoulder the costs,
and whether the shipment is freight prepaid or freight collect.
Freight bills usually show whether the shipping terms are FOB shipping point or
FOB destination. When the freight terms are FOB shipping point , the buyer shoulders
the shipping costs; ownership over the goods passes from seller to buyer when the
inventory leaves the seller’s place of business - the shipping point. The buyer already
owns the goods while still in transit and therefore, shoulders the transportation costs. If
the terms are FOB destination, the seller bears the shipping costs. Title passes only when
the goods are received by the buyer at the point of destination; while in transit, the seller
is still the owner of the goods so the seller is still the owner of the goods so the seller
shoulders the transportation costs.
In freight prepaid, the seller pays the transportation costs before shipping the
goods sold; while in freight collect when the terms are FOB shipping point; and freight
prepaid when the terms are FOB destination.
Freight terms Who shoulders the Who Pays the

Transportation Costs Shipper?
FOB destination, Freight Seller Seller

prepaid
FOB shipping point, Freight Buyer Buyer

collect
FOB destination, Freight Seller Buyer

collect
FOB shipping, Freight Buyer Seller

prepaid
The shipping costs borne by the buyer using the periodic inventory system are debited to
transportation in account. In accounting, the cost of an asset - the merchandise
inventory includes all costs incurred to bring the asset to its intended use. In the cost of
sales section of the income statement, the balance in this account is added to purchases
in computing for the net purchases for the period.
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Shipping costs borne by the seller are debited to transportation out account. This account
which is also called delivery expense, is an operating expense in the income statement.
If goods are sold F.O.B. destination, the seller is responsible for costs incurred in moving
the goods to their destination. Freight cost incurred by the seller is called freight-out and
is reported as a selling expense that is subtracted from gross profit in calculating net
income.
Seller’s entry Purchaser’s entry
Accounts REceivable 7,000 Purchases 7,000

Freight out 400 Accounts
Cash 400 Payable 7,000
Sales 7,000 Purchased P7,000 of inventory,
Sold merchandise on account for P7,000 terms terms FOB destination.
FOB destination, and paid the freight bill of
P400.
If goods are sold F.O.B. shipping point, the purchaser is responsible for paying freight
costs incurred in transporting the merchandise from the point of shipment to its
destination. Freight cost incurred by a purchaser is called freight-in, and is added to
purchases in calculating net purchases:

Sales 7,000 Freight in 400
Sold merchandise on account for P7,000 Accounts Payable 7,000
terms FOB shipping point. Cash 400
Purchased P7,000 of inventory, terms
FOB shipping point and paid the shipping
freight bill of P400.
If goods are sold F.O.B. shipping point, freight prepaid, the seller prepays the trucking
company as an accommodation to the purchaser. This prepaid freight increases the
accounts receivable of the seller. That is, the seller expects payment for the merchandise
and a reimbursement for the freight. The purchaser would record this transaction by
debiting Purchases for the amount of the purchase, debiting Freight-In for the amount of
the freight, and crediting Accounts Payable for the combined amount due to the seller.
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Cash 400 Freight in 400
Sales 7,000 Accounts
Sold merchandise on account for P7,000 Payable 7,40000
terms FOB shipping point, P400 freight Purchased P7,000 of inventory,
prepaid. terms FOB shipping point, P400
freight prepaid.
Inventory Systems
The first phase of the merchandising cycle occurs when the merchant acquires goods to
be stocked for resale to customers. The appropriate accounting for this action requires
the recording of the purchase. There are two different techniques for recording the
purchase; a periodic system or a perpetual system. Generally, the periodic inventory
system is easier to implement but is less robust than the “real-time” tracking available
under a perpetual system. Conversely, the perpetual inventory system involves more
constant data update and is a far superior business management tool.
Perpetual Inventory System

Under the perpetual inventory system, the inventory is continuously updated.
Perpetually updating the inventory account requires that at the time of purchase,
merchandise acquisitions be recorded as debits to the inventory account. At the time , the
cost of sales is determined and recorded by a debit to the cost of sales account and a
credit to the inventory account. With a perpetual inventory system both the inventory and
cost of sales accounts receive entries throughout the accounting period.When an entity
uses the perpetual inventory system, the ending inventory should reconcile with the
actual physical count at the end of the period.
Periodic Inventory System

In the periodic inventory system, no entries are made to the inventory account as
the merchandise is bought and sold. When goods are purchased a separate set of
accounts - purchases, purchase discounts , purchase returns and allowances, abgd
transportation in - is used to accumulate information on the net cost of the purchases.
Only at the end of the period, when the inventory is counted, will entries be made to the
inventory account to establish its proper balance.
The following section focuses on the use of periodic inventory system.
Gross Method
A fundamental accounting issue is how to account for purchase transactions when
discounts are offered. One technique is the gross method of recording purchases. This
technique records purchases at their total gross or full invoice amount:
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Accounts Receivable 5,000 Purchases 5,000

Sales 5,000 Accounts Payable 5,000
Sold merchandise on account terms 2/10, Purchased inventory on account, terms
n/30. 2/10 n/30
If payment is made within the discount period, the purchase discount is recognized in a
separate account. The Purchase Discounts account is similar to Purchases Returns &
Allowances, as it is deducted from total purchases to calculate the net purchases for the
period:
Cash 4,900 Accounts Payable 5,000

Sales discount 100 Purchase discount 100
Accounts Receivable 5,000 Cash 4,900
Collected outstanding receivable within Paid outstanding payable within discount
discount period. period.
If payment is made outside the discount period, the purchaser loses the right to take a
discount. Therefore, the full amount of the invoice becomes due and payable. The
following entry would be needed to reflect this payment:
Cash 5,000 Accounts Payable 5,000

Accounts Receivable 5,000 Cash 5,000
Collected outstanding receivable beyond Paid outstanding payable within discount
discount period period.
Net Method
Rather than recording purchases under the gross method, a company may elect
to record the purchase and payment under a net method. With this technique, the initial
purchase is again recorded by debiting Purchases and crediting Accounts Payable.
However, the amount of the entry is for the invoice amount of the purchase, less the
anticipated discount. Assuming the company intends to take the discount, this entry
results in recording the net anticipated payment into the accounts.
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Purchases 4,900
Purchased inventory on account,
terms 2/10 n/30
If payment is made within the discount period, the entry is quite straightforward because
the payable was initially established at the net of discount amount:
Cash 4,900
Paid outstanding payable within the discount period.
If payment is made outside the discount period, the lost discounts are recorded in a
separate account. The Purchase Discounts Lost account is debited to reflect the added
cost associated with missing out on the available discount amount:
Cash 100
Paid outstanding payable within 4,900
In evaluating the gross and net methods, notice that the Purchase Discounts Lost account
(used only with the net method) indicates the total amount of discounts missed during a
particular period. The presence of this account draws attention to the fact that discounts
are not being taken, frequently an unfavorable situation. The Purchase Discounts account
(used only with the gross method) identifies the amount of discounts taken, but does not
indicate discounts missed, if any. For reporting purposes, purchases discounts are
subtracted from purchases to arrive at net purchases, while purchases discounts lost are
recorded as an expense following the gross profit number for a particular period.
The following illustration contrasts the gross and net methods for a case where the
discount is taken. Notice that P4,900 is accounted for under each method. The gross
method reports the $P5,000 gross purchase, less the applicable discount. In contrast, the
net method only shows the P4,900 purchase amount.
The next illustration contrasts the gross and net methods for the case where the discount
is lost. Notice that $5,000 is accounted for under each method. The gross method simply
reports the $5,000 gross purchase, without any discount. In contrast, the net method
shows purchases of $4,900 and an additional $100 expense pertaining to lost discounts.
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Cost of Goods Sold

A number of new accounts have been introduced in this chapter. Purchases, Purchase
Returns and Allowances, Purchase Discounts, and Freight-in have all been illustrated.
Each of these accounts is necessary to calculate the “net purchases” during a period.
Note that storage costs, insurance, interest and other similar costs are considered to be
period costs that are not attached to the product. Instead, those ongoing costs are simply
expensed in the period incurred as operating expenses of the business.
The cost of all purchases must ultimately be allocated between cost of goods sold and
inventory, depending on the portion of the purchased goods that have been resold to end
customers. This allocation must also give consideration to any beginning inventory that
was carried over from prior periods.
Goods that remain unsold at the end of an accounting period should not be “expensed”
as cost of goods sold. Therefore, the calculation of cost of goods sold requires an
assessment of total goods available for sale, from which ending inventory is subtracted.
With a periodic system, the ending inventory is determined by a physical count. In that
process, the goods held are actually counted and assigned cost based on a consistent
method. The actual methods for assigning cost to ending inventory is the subject of
considerable discussion in the inventory chapter. Understanding the allocation of costs to
ending inventory and cost of goods sold is very important and is worthy of additional
emphasis.
The beginning inventory is equal to the prior year’s ending inventory, as determined by
reference to the prior year’s ending balance sheet. The net purchases is extracted from
this year’s ledger (i.e., the balances of Purchases, Freight-in, Purchase Discounts, and
Purchase Returns & Allowances). Goods available for sale is the sum of beginning
inventory and net purchases. Goods available for sale is not an account, per se; it is
merely a defined result from adding two amounts together. The total cost incurred (i.e.,
cost of goods available for sale) must be “allocated” according to its nature at the end of
the year. The cost of goods still held are assigned to inventory (an asset), and the
remainder is attributed to cost of goods sold (an expense).
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Periodic and Perpetual Inventory Systems Compared

Periodic Perpetual
Periodic inventory system records inventory Perpetual inventory system updates
purchase or sale in "Purchases" account. inventory accounts after each purchase or
"Purchases" account is updated continuously, sale.
however, "Inventory" account is updated on a
periodic basis, at the end of each accounting Inventory subsidiary ledger is updated after
period (e.g., monthly, quarterly) each transaction.
Inventory subsidiary ledger is not updated after Inventory quantities are updated
each purchase or sale of inventory. continuously.
Inventory quantities are not updated
continuously.
Inventory quantities are updated on a periodic
basis.
Purchased 1,000 units of merchandise at P30 per unit
Purchases 30,000 Merchandise Inventory 30,000

Accounts payable 30,000 Accounts payable 30,000
Paid freight on the P30,000 purchase; terms FOB shipping point, freight collect.
Freight in 200 Merchandise Inventory 200

Cash 200 Cash 200
Sold 200 units of merchandise at P50 per unit on credit.
Accounts Receivable 10,000 Accounts Receivable 10,000

Sales 10,000 Sales 10,000
Cost of Goods Sold 6,000

Inventory 6,000
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Customer returned merchandise costing P400 that had been sold on account for P500.
Sales Returns and Allowances 500 Sales Returns and Allowances 500
Accounts Receivable 500 Accounts Receivable 500
Merchandise Inventory 400

Cost of Goods Sold 400
Returned merchandise costing P300.
Accounts Payable 300 Accounts Payable 300

Purchase returns and allowances 300 Merchandise Inventory 300
To transfer the beginning inventory balance to the Income Summary account (part of
closing entries)
Income Summary XXX No entry

Merchandise Inventory XXX
To record the ending inventory balance (part of closing entries)
Merchandise Inventory XXX No entry

Income Summary XXX
To adjust the ending perpetual inventory balance for the shrinkage during the year.
No entry (shrinkage is already effected) Cost of Sales XXX

Merchandise Inventory XXX
Value-Added Tax Entries

Value Added TAx (VAT) is imposed upon any person who in the ordinary course of trade
or business, sells, barters, exchanges, leases goods or properties, renders services and
any person who imports goods. It is an indirect tax and the amount of VAT maybe shifted
or passed on to the buyer, transferee or lessee of the goods, properties or services.
The VAT on purchases is normally called input VAT while the VAT added on sales is
called output VAT. In computing the VAT due and payable to BIR creditable input taxes
are deducted from output VAT (output tax from sales).
For example, Company Seller (VAT-registered) sold to Company Buyer for P200,000,
exclusive of 12% VAT or a total of P224,000. Company Seller’s purchases amounted to
P100,000 exclusive of 12% VAT or a total of P112,000.
Cash/Accounts Receivable P 224,000

Sales P200,000
Output Tax 24,000
To record sales.
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Purchases 100,000
Input Tax 12,000
Cash/Accounts Payable 112,000
To record purchases.
Output Tax 24,000

Input Tax 12,000
VAT Payable 12,000
To set up VAT Payable.
Assessments
Exercise 1
1. Which of the following journal entry is correct for the transactions of goods returned
by a customer?
Account to be debited Account to be credited
a. Sales returns Trade payables
b. Sales returns Trade receivables
c. Purchases returns Trade payables
d. Purchases returns Trade receivables
2. Which of the following is a correct definition of gross profit?

a. Gross profit = Profit – Other Expenses
b. Gross profit = Net Sales – Net Purchases
c. Gross Profit = Net Sales – Cost of Goods Sold
d. Gross Profit = Net Purchases + Cost of Goods Sold
3. ABC Company sold 10 units of goods with a unit list price of P 2,000 on Jan. 1,
2018. Given that the trade discount is 5% and the cash discount is 10%, and that the
cash discount period is 10 days and the credit period is 30 days, if the customer settles
the debt on Jan. 28, 2018, what is the actual amount he needs to pay?
a. P 17,100
b. P 18,050
c. P 19,000
d. P 20,000
4. What is the meaning of transportation in?

a. The expenses spent on carrying the returned goods from customers
b. The expenses spent on carrying the goods returned to suppliers
c. The expenses spent on carrying the goods sold to customers
d. The expenses spent on carrying the goods purchased from suppliers to the entity
Use the following information to answer questions below:
Account Name Debit Credit
Sales P750,000
Sales returns and allowances P 15,000
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Sales discounts 10,000

Purchases 170,000
Purchases Returns and Allowances 20,000
Transportation In 30,000
Selling Expenses 75,000
General and Administrative Expenses 275,000
In addition, beginning merchandise inventory was P 55,000 and ending merchandise

inventory was P 35,000.
5. Net sales for the period were

a. P 755,000
b. P 725,000
c. P 735,000
d. P 775,000
6. Net purchases for the period were
a. P 150,000
b. P 180,000
c. P 210,000
d. P 430,000
7. Cost of goods sold for the period was

a. P 235,000
b. P 160,000
c. P 200,000
d. P 170,000
8. Profit for the period was

a. P 525,000
b. P 450,000
c. P 250,000
d. P 175,000
9. Which of the following equations correctly shows the meaning of net sales?
a. Net Sales = Gross Sales – Purchases
b. Net Sales = Gross Sales – Sales returns
c. Net Sales = Gross Sales – Purchase Returns
d. Net Sales = Gross sales – Sales returns – Transportation in
10. The collection of P 5,000account beyond the 2% discount period would result in
a
a. Credit to Accounts Receivable for P 5,000.
b. Credit to Cash for P 5,000
c. Debit to Cash for P 4,900
d. Debit to Sales Discounts for P 100.
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11. Assuming that net purchase was P 900,000 during the year and that ending
merchandise inventory was P 20,000 less than the beginning merchandise inventory of
P 250,000, how much was cost of goods sold?
a. P 1,130,000
b. P 670,000
c. P 920,000
d. P 1,170,000
12. Goods totaling P 50,000 were purchased February 2 with terms of 2/10, n/30.
Returns of P 10,000 were made on February 10. What discounts, if any can be availed
of if the invoice was paid on February 12?
a. None
b. P 1,000
c. P 800
d. P 200
13. The December 31, 2018 trial balance for Aileen Maglana Company included the
following: purchases, P 40,000; purchases returns and allowances, P 2,000;
transportation in, P 3,000; ending inventory was P 8,000. What was the cost of goods
sold for 2018?
a. P 39,000
b. P 33,000
c. P 38,000
d. None of the above
14. The two main inventory accounting systems are the following
a. Purchase and sale
b. Returns and allowances
c. Cash and accrual
d. Perpetual and periodic
15. A merchandiser will earn an operating income of exactly zero when

a. Cost of goods sold equals gross margin
b. Gross margin equals operating expenses
c. Net sales equals cost of goods sold
d. Operating expenses equal net sales
16. A sale on March 21 with terms of n/10 eom is due to be collected by

a. March 31
b. April 1
c. April 10
d. April 30
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17. Under the perpetual inventory system, which of the following accounts would not
be used?
a. Cost of goods sold
b. Merchandise Inventory
c. Purchases
d. Sales
18. The entry to record the return of goods from a customer would include a
a. Credit to Sales
b. Credit to Sales Returns and Allowances
c. Debit to Sales
d. Debit to Sales Returns and Allowances
19. Under the perpetual inventory system, in addition to making the entry to record a
sales return, an entity would
a. Debit Cost of Goods Sold and credit Merchandise Inventory.
b. Debit Cost of Goods Sold and credit Purchases.
c. Debit Merchandise Inventory and credit Cost of Goods Sold.
d. Make no additional entry until the end of the period.
20. The amount of cost of goods available for sale during the year depends on the
amounts of
a. Beginning merchandise inventory and cost of goods sold.
b. Beginning merchandise inventory and net purchases.
c. Beginning merchandise inventory, cost of goods sold, and ending merchandise
inventory.
d. Beginning merchandise inventory, net purchases, and ending merchandise
inventory.
Exercise 2
Below are important information from Zeline Merchandise:
Cost of Good Sold P836,000
Transportation In 20,000
Merchandise inventory, 1/31/2020 180,000
Purchase discounts 18,000
Purchase returns and allowances 9,000
Purchases 900,00
Required: Compute the merchandise inventory as at January 1, 2020
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Exercise 3
Boy Barios established the BARIOS TRADING. The following is the chart of accounts
for the business transactions.
Chart of Accounts
101 401
Cash Sales
102 401.1
Accounts Receivable Sales Discounts
102.1 501
Allowance for Bad debts Purchases
103 501.1
Notes Receivable Freight in
104 501.2
Purchase Returns and
Interest receivable Allowances
105 501.3
Office Supplies Purchase discounts
106 502
Merchandise Inventory Rent Expense
107 503
Prepaid rent Utilities expense
108 504
Furniture and Fixtures Salaries Expense
108.1 505
Accum. Depreciation - Furniture and
Fixtures Freight out
201 506
Accounts Payable Depreciation expense
202 507
Salaries Payable Office Supplies Expense
203 508
Utilities Payable Interest expense
204 509
Interest Payable Interest income
205 510 Bad Debts
Notes Payavle
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301
Barios, Capital
302
Barrios, Drawing
The transactions of Boy Barios for the month of December, 2018 are summarized
below:
December
1 Started his business named BARIOS TRADING with investments of cash
P640,000, furniture and fixtures, P50,000.
2 Bought merchandise for cash amounting to P40,000.
3 Bought merchandise from FAR Company on credit, P67,200 FOB destination

terms n/30.
3 Paid rent for three months, P16,800.
4 Bought supplies for office use, by paying P11,200 cash.
4 Purchased merchandise for cash, P224,000 and paid freight P5,000.
5 Purchase merchandise on account from Ronnie Black, P112,000, FOB destination

terms 2/10, n/20.
6 Purchase merchandise from MM Mfg. and issued promissory note for P44,800.
7 Sold to Dagupan Trading merchandise for P336,000 FOB destination and received
a promissory note for this amount.
7 Sold merchandise on account to Juan Carlos, P145,600, FOB destination Terms:

1/10, n/20.
8 Returned merchandise purchased in December 4, and received a cash refund

amounting to P22,000.
9 Sold to Joy Poe merchandise for cash, P56,000.
11 Sold to Western Trading on account merchandise for P134,400. FOB destination

Freight paid by Barios P2,000.. terms: 2/10, 1/20, n/30.
12 Returned P11,200 merchandise purchased from Ronnie Black in December 5.
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13 Paid Ronnie Black the total amount due to him.
15 Collected full payment from Juan Carlos on the sale in December 6.
15 Paid half month salaries of employees, P8,000.
17 Purchased merchandise on account from Central Trading, P280,000 FOB

destination, terms 2/10, n/30.
19 Sold to Art Cruz merchandise for P201, 600 on account, FOB destination terms
2/5, n/30 and paid P2,000 for delivery charge.
22 Paid telephone bill for the month P770.
23 Collected in full the account of Western Trading.
23 Paid half of the account of Central Trading.
28 Boy Barios withdrew P10,000 cash for personal use.
Data for adjustments:
a. The estimated life of the furniture and fixture is four years with scrap value of
P2,000.
b. Expense method was used in recording the rental payment.
c. Asset method was used in recording the office supplies, P2,000 worth is unused
as of December 31, 2019.
d. Accrued interest on notes payable at December 31 is P1,000.
e. Accrued interest on notes receivable at December 31 is P3,000.
f. Accrued salaries as of December 31, is P12,000.
g. Accrued electric bill as of December 31, is P10,000.
h. Bad debts is estimated to be 1% of the accounts receivable ending balance.
i. Unsold merchandise as of December 31 is P200,000.
Requirements:
1. Journalize the transactions.
2. Post the entries to the T-accounts.
3. Prepare the adjusting entries.
4. Prepare the worksheet for the month ended, December 31, 2019.
5. Prepare the closing entries.
6. Prepare the reversing entries.
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References
Reyno Jr., F and Reyno D.W. (2019). Fundamentals of Accounting and Reporting Part
One. Dagupan City. Reyno Publishing House.
https://www.principlesofaccounting.com/chapter-5/the-merchandising-operation-sales/
https://www.principlesofaccounting.com/chapter-5/purchase-considerations/
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Module 6
SPECIAL JOURNALS AND THE VOUCHER SYSTEM
Week 16
Introduction
The small organizations with only a limited number of transactions usually use a single journal
known as general journal or journal proper. In large organizations where hundreds or even
thousands of transactions occur each month, the use of a single journal is not adequate. Such
organizations usually maintain many journals in addition to general journal. These journals are
collectively known as special journals. Other names used for special journals are books of
original entry.
The special journals are used to journalize and make the process of recording transactions
easier in an accounting system. In the daily course of any large business organization, a great
number of transactions occurs in a single day. It becomes difficult to record every single
transaction in the related t-accounts and sub-ledgers. Special Journals are therefore used to
record these transactions from the source documents on a daily basis as they occur and then
these transactions are transferred to the general ledger as if it was a single transaction in a day.
In this way special journals make the recording and maintaining of accounting records easier
and less complex.
Nowadays, the importance of ‘special journals’ has decreased for larger companies. In large
businesses use of modern accounting software is more preferred which bifurcate transactions
on their own and update all the sections of the accounting system with only a single entry of
transaction. However, accounting software programs are expensive and most of the smaller and
medium-sized organizations cannot afford to buy and maintain them. Such small and medium
entities make use of special journals to organize their business transactions.
Learning Objectives

1. Describe the use of controlling accounts and subsidiary ledgers.
2. Explain the goals and uses of special journals.
3. Record transactions using special journals.
4. Post transactions to the general and subsidiary ledgers.
5. Prepare and prove the accuracy of subsidiary ledgers.
6. Prepare schedules of accounts receivables and accounts payable.
7. Explain the features of the voucher system.
Special Journals
Special journals are all accounting journals except for the general journal. These journals are
used to record specific types of high-volume information that would otherwise be recorded in
and overwhelm the general ledger. The total amounts in these journals are periodically
transferred to the general ledger in summary form.
Transactions are recorded in these journals in chronological order, making it easier to research
transactions. Examples of special journals are:
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• Sales journal
• Purchases journal
• Cash receipts journal
• Cash disbursements journal
journal
_____ used to store detailed sales transactions.
Sales Journal. A sales journal is a subsidiary ledger
Its main purpose is to remove a source of high-volume transactions from the general ledger,
thereby streamlining the general ledger. The following information is typically stored in the sales
journal for each sale transaction:
• Transaction date
• Account number
• Customer name
• Invoice number
• Sale amount (debit the accounts receivable account and credit the sale account)
The journal only stores receivables; this means that sales made in cash are not recorded in the
sales journal. A sale made in cash would instead be recorded in the cash receipts journal.
In short, the information stored in this journal is a summary of the invoices issued to customers.
At the end of each reporting period, the sum total of the debits and credits is posted to the
general ledger. If anyone wants to research these posted balances listed in the general ledger,
they refer back to the sales journal, and may use the invoice number listed in the
The sales journal lists all credit sales made to customers. Sales returns and cash sales are not
recorded in this journal. Entries in the sales journal typically include the date, invoice number,
customer name, and amount. Invoices are the source documents that provide this information.
In its most basic form, a sales journal has only one column for recording transaction amounts.
Each entry increases (debits) accounts receivable and increases (credits) sales.
Notice the dates and posting references applied to each entry in the illustration to the right.
Each day, individual sales journal entries are posted to the accounts receivable subsidiary
ledger accounts so that customer balances remain current. Customer account numbers (or
check marks if customer accounts are simply kept in alphabetical order) are placed in the sales
journal's reference column to indicate that the entries have been posted. At the end of the
accounting period, the column total is posted to the accounts receivable and sales accounts in
the general ledger. Account numbers are placed in parentheses below the column to indicate
that the total has been posted.
Many companies use a multi‐column (columnar) sales journal that provides separate columns
for specific sales accounts and for sales tax payable. Each line in a multi‐column journal must
contain equal debits and credits. For example, the entries in the sales journal to the right appear
below in a multi‐column sales journal that tracks hardware sales, plumbing sales, wire sales,
and sales tax payable. Individual entries are still posted daily to the accounts receivable
subsidiary ledger accounts, and each column total is posted at the end of the accounting period
to the appropriate general ledger account.
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Purchase Journal. A purchases journal is a subsidiary-level journal in which is stored

information about purchasing transactions. This journal is most commonly found in a manual
accounting system, where it is necessary to keep high-volume purchasing transactions from
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overwhelming the general ledger. All types of purchases made on credit are recorded in the
purchases journal, including the following:
• Office supplies
• Services
• Goods acquired for resale
Any transaction entered into the purchases journal involves a credit to the accounts payable
account and a debit to the expense or asset account to which a purchase relates. For example,
the debit relating to a purchase of office supplies would be to the supplies expense account.
The journal also includes the recordation date, the name of the supplier being paid, a source
document reference, and the invoice number. Optional additions to this basic set of information
are the payment due date and authorizing purchase order number.
Periodically, and no later than the end of each reporting period, the information in the purchases
journal is summarized and posted to the general ledger. This means that the purchases stated
in the general ledger are only at the most aggregated level. If a person were researching the
details of a purchase, it would be necessary to go back to the purchases journal to locate a
reference to the source document.
The purchases journal lists all credit purchases of merchandise. Entries in this journal usually
include the date of the entry, the name of the supplier, and the amount of the transaction. Some
companies include columns to identify the invoice date and credit terms, thereby making the
purchases journal a tool that helps the companies take advantage of discounts just before they
expire. The purchases journal to the right has only one column for recording transaction
amounts. Each entry increases (debits) purchases and increases (credits) accounts payable.
Each day, individual entries are posted to the accounts payable subsidiary ledger accounts.
Creditor account numbers (or check marks if the creditor accounts are not numbered) are
placed in the purchases journal's reference column to indicate that the entries have been
posted. At the end of the accounting period, the column total is posted to purchases and
accounts payable in the general ledger. Account numbers are placed in parentheses below the
column to indicate that the total has been posted.
Companies that frequently make credit purchases of items other than merchandise use a multi‐
column purchases journal. For example, the purchases journal below includes columns for
supplies and equipment. Of course, every purchase in the journal below must credit accounts
payable; equipment purchased with a note payable or supplies purchased with cash would not
be recorded in this journal. Individual entries are still posted daily to the accounts payable
subsidiary ledger accounts, and each column total is posted at the end of the accounting period
to the appropriate general ledger account.
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Cash Receipts Journal. A cash receipts journal is a subsidiary ledger in which cash sales are
recorded. This journal is used to offload transaction volume from the general ledger, where it
might otherwise clutter up the general ledger. The journal contains the following fields:
• Date
• Customer name
• Identification of cash receipt, which may be any of the following:
o Check number paid
o Customer name
o Invoice paid
Debit and credit columns to record both sides of each entry; the normal entry is a debit to cash
and a credit to sales
There may be a large number of entries into this journal, depending on the frequency of cash
receipts from customers.
The balance in the journal is regularly summarized into an aggregate amount and posted to the
general ledger. If someone needs to investigate a specific cash receipt, they might begin at the
general ledger and then move down to the cash receipts journal, from which they might obtain a
reference to the specific receipt.
Transactions that increase cash are recorded in a multi‐column cash receipts journal. If sales
discounts are offered to customers, the journal includes a separate debit column for sales
discounts. Credit columns for accounts receivable and for sales are normally present, but
companies that frequently receive cash from other, specific sources use additional columns to
record those types of cash receipts. In addition, the cash receipts journal includes a column
named Other, which is used to record various types of cash receipts that occur infrequently and
therefore do not warrant a separate column. For example, cash receipts from capital
investments, bank loans, and interest revenues are generally recorded in the Other column.
However, a company that provides consumer loans and receives interest payments from many
customers would probably include a separate column for interest revenue. Whenever a credit
entry affects accounts receivable or appears in the Other column, the specific account is
identified in the column named Account.
Accounts receivable payments are posted daily to the individual subsidiary ledger accounts, and
customer account numbers (or check marks if the customer accounts are not numbered) are
placed in the cash receipts journal's reference column. At the end of the accounting period,
each column total is posted to the general ledger account listed at the top of the column, and
the account number is placed in parentheses below the total. Entries in the Other column are
posted individually to the general ledger accounts affected, and the account numbers are placed
in the cash receipts journal's reference column. A capital X is placed below the Other column to
indicate that the column total cannot be posted to a general ledger account.
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Cash Disbursement Journal. The cash disbursement journal is a detailed record of the cash
payments made by a business. The journal itemizes when checks and other types of payments
are made, as well as the amounts paid, the names of the recipients, and the accounts charged.
This journal is a good source document for tracking down the specifics regarding individual
payments. The information in the cash disbursement journal is periodically summarized and
forwarded to the general ledger.
Transactions that decrease cash are recorded in the cash disbursements journal. The cash
disbursements journal to the right has one debit column for accounts payable and another debit
column for all other types of cash payment transactions. It has credit columns for purchase
discounts and for cash. Since each entry debits a control account (accounts payable) or an
account listed in the column named Other, the specific account being debited must be identified
on every line.
The nature of each company's transactions determines which columns this journal includes. For
example, companies sometimes choose to include separate debit columns for regularly used
accounts such as salaries expense, sales commissions expense, or other specific accounts
affected by cash disbursements.
Entries that affect accounts payable are posted daily to the individual subsidiary ledger
accounts, and creditor account numbers (or check marks if the creditor accounts are not
numbered) are placed in the cash disbursements journal's reference column. At the end of the
accounting period, each column total is posted to the general ledger account listed at the top of
the column, and the account number is placed in parentheses below the total. Entries in the
Other column are posted individually to the general ledger accounts affected, and the account
numbers are placed in the cash disbursements journal's reference column. A capital X is placed
below the Other column to indicate that the column total cannot be posted to a general ledger
account.
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General journal entries. The general journal is used for adjusting entries, closing entries,
correcting entries, and all transactions that do not belong in one of the special journals. If a
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general journal entry involves an account in a subsidiary ledger, the transaction must be posted
to both the general ledger control account and the subsidiary ledger account. Both account
numbers are placed in the general journal's reference column to indicate that the entry has been
posted correctly.
Subsidiary Ledgers
A subsidiary ledger is a group of similar accounts whose combined balances equal the
balance in a specific general ledger account. The general ledger account that summarizes a
subsidiary ledger's account balances is called a control account or master account. For
example, an accounts receivable subsidiary ledger (customers' subsidiary ledger) includes a
separate account for each customer who makes credit purchases. The combined balance of
every account in this subsidiary ledger equals the balance of accounts receivable in the general
ledger. Posting a debit or credit to a subsidiary ledger account and also to a general ledger
control account does not violate the rule that total debit and credit entries must balance because
subsidiary ledger accounts are not part of the general ledger; they are supplemental accounts
that provide the detail to support the balance in a control account.
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The accounts receivable subsidiary ledger is essential to most businesses. Companies may
have hundreds or even thousands of customers who purchase items on credit, who make one
or more payments for those items, and who sometimes return items or purchase additional
items before they finish paying for prior purchases. Recording all credit purchases, returns, and
subsequent payments in a single account would make an individual customer's balance virtually
impossible to calculate because the customer's transactions would be interspersed among
thousands of other transactions. But the accounts receivable subsidiary ledger provides quick
access to each customer's balance and account activity.
Companies create subsidiary ledgers whenever they need to monitor the individual components
of a controlling general ledger account. In addition to the accounts receivable subsidiary ledger,
companies often use an accounts payable subsidiary ledger (creditors' subsidiary ledger), which
has separate accounts for each creditor, an inventory subsidiary ledger, which has separate
accounts for each product, and a property, plant, and equipment subsidiary ledger, which has
separate accounts for each long‐lived asset.
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Assessments
Review Questions
1. What are special journals? Describe the four special journals and the specific
transactions recorded in each journal.
2. What is a subsidiary ledger?
3. Cite the advantages and in using the special journals.
Exercise 1
Place a check mark in the column that indicates the journal in which each of the following
transactions should be recorded.
Item Sales Purchases General

Journal Journal Journal
1. Sold refrigerator on account.
2. Bought office supplies for cash.
3. Sold merchandise for cash.
4. Bought office furniture on account.
5. Received credit memo for merchandise

returned.
6. Issued credit memo for merchandise

returned by customer.
7. Recorded and paid month’s payroll.
8. Paid freight on office furniture.
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Exercise 2
The following transactions of Eisear Corporation must be recorded and posted in special
journals.
Dec. Jan Eisear invested P250,000 cash, merchandise of P25,000 and furniture and
equipment for P25,000
1
1 Paid December rent P10,000 (use expense method)
3 Bought merchandise on account form D. Doctolero, P50,000 terms 2/10 n/30
4 Sold merchandise to CJ Udarbe for cash P10,000, invoice no. 1001
4 Paid cash P5,000 to Dagupan News for advertising
5 Opened a checking account with Export back making an initial deposit of P75,000
5 Cash sales per invoice no. 1002 P20,000
7 Sold on account to R. Basuit , P4,500 invoice no. 1003 Terms 2/10, n/30
7 Deposited at the Export Bank P15,000
7 Paid P250cash to R.A. Ramos for office supplies bought
8 Cash sales per invoice no. 1004, P7,500
8 Bought merchandise on account from A. Castillo, P50,000 terms: down payment of

P10,000 and the balance, a 20-day 20% note.
8 Received a credit memo of P1,000 from D. Doctolero for merchandise returned to

him.
10 Sold on account to J.P De Sola as per invoice no. 1005, P20,000 terms: 1/10, n/60
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10 Issued check no. 001 for merchandise bought from ABC Company, P10,000.
13 Cash sales per invoice number 1006, P9500
13 Deposited cash at the Export Bank, P7500
15 Issued check no. 002 for wages and salaries of employees P25,000
15 Sold on account to M.J. Eslava as per invoice no. 1007, P12,000. Terms:
Downpayment of P2,000 and the balance, a 10-day note dated today.
15 Deposited at the bank P30,000
17 Bought merchaidse on account from R. Lopez, P30,000 Terms 2/15 n/60
17 Issued check no. 003 in payment of fright for the above merchandise P150
17 Issued credit memo of P750 to J.P De Sola for merchandise returned.
17 Issued check no. 004 in full payment of account to D. Doctolero
20 Cash sales per invoice no. 1008, P16,000. This amountwas deposited immediately at
the Export Bank.
20 Received a check from JP De Sola in full settlement of his account on December 10.
21 Bought merchandise from the following:

D. Doctolero, P25,000 terms: 2/10, n/30
A. Castillo, P15,000 terms 1/10, n/60
J. Loresco, P5,000. Terms: Cash
23 Sold merchandise to the following

KL Solano invoice no. 1009, P19,000 terms 3/10, 2/20, n/60
JP De Sola invoice no. 1010 P22,500 Terms: n/60
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23 Issued check no. 005 in payment in payment of delivery expense of the above
merchandise sold, P300
24 Cash sales per invoice no. 1011, P15,000
25 Received a check fro MJ Eslava in payment of her note dated December 15.
28 Deposited at the Export Bank, P41,000
28 Issued check no. 006 to A. Castillo in full payment of the note dated December 8.
28 Deposited at the Export Bank, P41,000.
28 Issued check no. 006 to A. Castillo in full payment of the note dated December 8.
31 Issued check no. 7 to A. Castillo in full payment of account on December 21.
31 Paid in cash the following:

Light and water P5,000
Wages and salaries P25,000
Advertising expense P7,500
Repairs P4,500
Telephone bill P10,000
31 Withdrew P500 cash for personal use
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128
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General Journal
Date Particulars P.R. Debit Credit
References
Reyno Jr., F and Reyno D.W. (2019). Fundamentals of Accounting and Reporting Part One.
Dagupan City. Reyno Publishing House.
https://www.accountingformanagement.org/what-are-special-journals/
https://www.accountingtools.com/articles/2017/5/16/special-journals
https://www.cliffsnotes.com/study-guides/accounting/accounting-principles-i/subsidiary-ledgers-
and-special-journals/special-journals
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Module 7
MANUFACTURING BUSINESS
Week 17
Introduction
Both merchandising and manufacturing types of business earn revenues by selling goods. A
merchandiser normally buys a product that is ready for resale when it is received. Profit was
earned for every unit sold at a mark-up to customers. A manufacturer buys raw materials and
processes them into finished goods that it sells to customers. Therefore, the main difference
between the two is the way they acquire inventory for resale.
Illustration:
Merchandiser - athletic shoes section of PureGold Duty Free Inc. in Clark Field, Pampanga.
Cost is the price that the merchandiser paid for the shoes plus incidental costs.
Manufacturer - entities that manufacture athletic shoes such as Nike, Reebok, Adidas, K-
Swiss, Puma, Converse and Tretorn. Entities that supply athletic shoes to merchandisers utilize
their laborers and factory assets to convert raw materials into finished goods. Their
manufacturing processes begin with materials such as cloth, rubber and plastics. These
materials are cut, glued, stitched and formed into athletic shoes. The process of converting
materials into finished products makes it more difficult to measure the inventory cost of a
manufacturer.
Note: Merchandising type of business buys ready for sale goods to which mark-up was added
to arrive at the selling price. On the other hand, manufacturing businesses purchases raw
materials, converts them into finished goods to which mark-up was added in computing the
selling price.
In your 2nd year in the program, these topic will be discussed in detail. This is considered as one
subject in our program.
Learning Objectives

1. Compare the activities prevalent to merchandising and manufacturing entities.
2. Identify the elements of manufacturing costs.
3. List the manufacturing inventory accounts.
4. Show the pro-forma entries of the common transactions for a manufacturing entity.
5. Prepare a statement of cost of goods manufactured.
6. Prepare a statement of cost of goods sold.
7. Pinpoint the differences in the worksheet of a manufacturing entity as compared to a
merchandising entity.
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Elements of Manufacturing Costs
Manufacturing costs include all costs related to the production process. They are classified into
three categories:
Direct Materials
• become a physical part of a finished product.
• costs can be conveniently and economically traceable to the finished product.
• Example: For a pair of Nike basketball shoes as the finished product,
o its leather uppers,
o the rubber and plastic soles, and
o the laces
Direct labor. I
• It is the compensation of employees or workers who physically convert raw materials
into finished goods.The efforts of these persons are directly traceable to the finished
product.
• Example: For Nike, direct labor includes
o the wages of the machine operators and
o the persons who assemble the shoes.
Manufacturing Overhead. This includes all manufacturing costs that cannot be classified as
direct materials or direct labor. Major classifications of this cost follow:
• Indirect materials and supplies. Glue, thread, nails, rivets, lubricants and small tools.
• Indirect labor costs. Salaries of plant managers and engineers, wages of forklift
operators, maintenance and inspection labor, and machine helpers.
• Other indirect manufacturing costs. Includes building, machinery and tool maintenance,
real property taxes, property insurance, rent expense, utilities expense and depreciation
on property and equipment.
• These major cost elements are at times combined into prime costs or conversion costs.
o Prime costs consist of direct materials and direct labor.
o Conversion costs consist of direct labor and manufacturing overhead.
Manufacturing Inventory Accounts
Accounting for inventory differs between merchandisers and manufacturers. Merchandisers

need only one category of inventory for the finished goods they buy and sell. In contrast,
manufacturers have various inventory accounts, as follows:
Finished goods Inventory. It is the cost of completed goods that have remained unsold at the
end of the accounting period. This inventory is what the manufacturers sell to the
merchandisers.
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Work in Process Inventory. This account gives the cost of the goods that are in the
manufacturing process but are not yet complete at the end of the accounting period.
Raw Materials Inventory. This account holds the cost of direct materials on hand that is
intended for use in the manufacturing process.
Factory Supplies Inventory. It is the cost of unused indirect materials at period end.
Finished goods inventory, work in process inventory, raw materials inventory and factory
supplies inventory are assets to the manufacturers and are reported as current assets in the
statement of financial posi tion.
ACCOUNTING FOR MANUFACTURING ACTIVITIES

Two accounting systems may be used in accounting for manufacturing activities – cost and non-
cost.
Cost system
• keeps perpetual records of the costs of raw material, work in process and finished goods
inventories
• provides more timely information about those inventories and changes in their levels
• produces timely information about manufacturing costs per unit of product which
managers use in their efforts to control costs
• It is the subject of courses in higher accounting.Note: This will be used in your next
accounting subject in 2nd year.
Non-cost system
• produces a manufacturing accounting system based on the periodic inventory system.
• The costs of raw materials, work in process and finished goods inventories are based on
physical counts of the quantities on hand at the end of each period. This information is
then used to compute the amounts consumed, finished and sold during the period.
• This system does not provide for a detailed flow of costs in the manufacturing process.
• In the discussions to follow, the non-cost system will be used. It is also assumed that the
entity uses the voucher system. The following are the pro-forma journal entries of the
more common transactions for a manufacturing entity.
1. To record purchase of raw materials and indirect materials on account:

Purchases - Raw Materials xx
Indirect Materials xx
Vouchers Payable xx
2. To record cost of defective raw materials returned to vendor:

Vouchers Payable xx
Purchase Returns and Allowances xx
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3. To record payment of account within the discount period:
Vouchers Payable xx
Purchases Discounts xx
Cash in Bank xx
4. To record freight and handling of raw materials

Transportation In xx
Vouchers Payable xx
5. To record payroll for factory employees:

Direct Labor xx
Indirect Labor xx
SSS Contributions Payable xx
MEdicare Contributions Payable xx
Pag-IBIG Contributions Payable xx
Withholding Taxes Payable xx
Vouchers Payable xx
6. To record employer’s payroll expenses:

Employer’s Payroll Contributions - Factory xx
SSS Contributions Payable xx
MEdicare Contributions Payable xx
EC Contributions Payable xx
Pag-IBIG Contributions Payable xx
7. To record distribution of payroll:

Vouchers Payable xx
Cash in Bank xx
8. To record accrual of factory payroll

Direct Labor xx
Indirect Labor xx
Accrued Payroll xx
9. To record depreciation of factory building

Depreciation Expense- Factory Bldg xx
Accumulated depreciation - Factory Bldg. xx
10. To record repairs on factory building:

Repairs and Maintenance - Factory Building xx
Voucher Payable xx
11. To record amortization of patents

Amortization of Patents xx
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Patent xx
12. To record real property taxes on factory site

Real Property Taxes xx
Vouchers Payable xx
13. To record factory utilities incurred:

Factory Utilities xx
Vouchers Payable xx
14. To record cost of tools used:

Tools Used xx
Tools xx
15. To record sales of finished goods:

Accounts Receivable xx
Sales xx
16. To record sales returns of customers:
Sales Returns and Allowances xx
Accounts Receivable xx
17. Closing entries peculiar to manufacturing concerns:

In order for a manufacturer to summarize all the transactions that affect the computation of the
cost of goods manufactured, a manufacturing summary account is maintained. It is credited
for the results of the physical count of raw materials inventory and work in process inventory at
the end of the accounting period. The contra-purchases accounts are also credited to this
account. This account is debited for the beginning balances of raw materials and work in
process inventory, and the manufacturing accounts with debit balances. The balance of the
manufacturing summary account is then closed to the income summary account
a. To close manufacturing accounts with credit balances, and to record ending inventory for
materials and work in process:
Raw Materials Inventory, end xx

Work in Process Inventory, end xx
Purchases Returns and Allowances xx
Purchases Discounts xx
Manufacturing Summary xx
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b. To close manufacturing accounts with debit balances
Raw Materials Inventory, beginning xx
Work in Process, Inventory, beginning xx
Purchases - Raw Materials xx
Transportation In xx
Direct Labor xx
Indirect Labor xx
Indirect Materials xx
Depreciation Expense - FactoryBldg. xx
Repairs and Maintenance - Factory Bldg. xx
Amortization of Patents xx
Real Property Taxes xx
Factory Utilities xx
Tools Used xx
Employer’s Payroll Contribution - Factory xx
Factory Supplies Expense xx
Miscellaneous Factory Expense xx
c. To close manufacturing summary and beginning finished goods inventory to income

summary:
Income Summary xx
Finished Good Inventory, beginning xx
The debit balance in the manufacturing summary represents the cost of goods manufactured.
d. To establish the ending finished goods inventory:

Finished Goods Inventory, beginning xx
Income Summary xx
The other closing entries after this procedure are the same as those for a merchandising entity.
Note:
By preparing the closing entries, beginning inventory balances were removed as assets of the
company. Such was the reason why we prepare closing entry letter b wherein we credited the
beginning inventory balances of raw materials and work in process. It was replaced with the
balances from the ending inventories. Entry letter a and letter d increased the current assetswhen
we debited raw materials and work in process inventory in entry letter a and finished goods
inventory in entry letter d.
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STATEMENT OF COST OF GOODS MANUFACTURED
Renante Balocating Manufacturers

Statement of Cost of Goods Manufactured
For the Year Ended Dec. 31, 2015
Direct Materials Used:

Raw Materials Inventory, beginning P xxx
Add: Net Cost of Purchases:
Purchases - Raw Materials P xx
Less: Purchases Returns and Allowances P xx
Purchases Discounts xx xx
Net Purchases P xx
Add: Transportation In xx xxx
Raw Materials Available for Use P xxx
Less: Raw materials Inventory, end xxx
P xxx
Direct Labor xxx
Manufacturing Overhead
Indirect Labor xxx
Indirect Materials xxx
Depreciation Expense - Factory Bldg. xxx
Repairs and Maintenance - Factory Bldg. xxx
Amortization of Patents xxx
Real Property taxes xxx
Factory Utilities xxx
Tools Used xxx
Employer’s Payroll Contributions - Factory xxx
Factory Supplies Expense xxx
Miscellaneous Factory Expense xxx xxx
Total Manufacturing Costs P xxx
Add: Work in Process, beginning xxx
Total Cost of Goods Placed in Process P xxx
Less: Work in Process, End xxx
Cost of Goods Manufactured P xxx
Total manufacturing costs should not be confused with the cost of goods manufactured.
Total manufacturing costs

• the costs of direct materials used, direct labor and manufacturing overhead incurred and
charged to production during an accounting period.
Cost of goods manufactured
• consists of the total manufacturing costs related to the products completed during an
accounting period. This statement is also called the manufacturing statement.
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• Note: Meaning, not all of the manufacturing cost will become part of the cost of goods
manufactured. It is possible that the company will have work-in process inventories
which decreases the units completed/ manufactured for the period.
STATEMENT OF COST OF GOODS SOLD
The difference in the income statement of a merchandising and a manufacturing entity lies in
the cost of goods sold section. As illustrated, observe that the merchandiser used the term
merchandise inventory while the manufacturer used the term finished goods inventory. A
merchandiser’s entire inventory is finished goods; a merchandiser has no materials inventory
and work in process inventory.
A manufacturer produces its own finished goods inventory. Cost of goods manufactured is the
manufacturer’s counterpart to the merchandiser’s purchases. Net cost of purchases is the cost
of all the goods a merchandiser bought for resale during the period. Cost of goods
manufactured is the manufacturing cost of the goods completed during a production period.
Merchandising Entity Manufacturing Entity
Merchandise Inventory, Beg. P xx Finished Goods Inventory, Beg. P xx

Add: Net Cost of Purchases xx Add: Cost of Goods Manufactured xx
Goods Available for Sale P xx Goods Available for Sale P xx
Less: Merchandise Inventory, End xx Less: Finished Goods Inventory, End xx
Cost of Goods Sold P xx Cost of Goods Sold P xx
Note: In a manufacturing entities’ cost of goods sold computation, notice that cost of goods
manufactured (which was presented in the previous page) was added to finished goods
inventory, beg. This cost of goods manufactured are the completed/finished units during the
period. Adding with the Finished Goods Inventory, Beg., we will arrive at the total goods which
will become available for sale to the consumers.
WORKSHEET FOR A MANUFACTURING ENTITY
The worksheet for a manufacturing entity is basically the same as that for a merchandising
entity except that it includes a pair of columns for cost of goods manufactured. All the accounts
that comprise the statement of cost of goods manufactured are extended to these columns.
Beginning raw materials inventory and work in process are debited in the manufacturing
columns while the related ending inventories are credited.
The other manufacturing accounts are either debited or credited as necessary. The difference
between the total debits and total credits of these two columns is then extended to the debit
column of the income statement. Beginning finished goods inventory being a component in the
computation of cost of goods sold is extended to the debit side of the income statement
columns while the ending finished goods inventory to the credit column.
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Assessments
Exercises
True or False
1. Product costs are the costs of purchasing or manufacturing inventory and considered as
assets until the goods are sold.
2. All costs and expenses incurred by a manufacturing corporation are considered product
costs rather than period costs.
3. Manufacturing costs are regarded as expenses of the current period and are expensed
when incurred.
4. A manufacturing corporation usually has three separate inventories: raw materials, work
in process and finished goods.
5. Manufacturing overhead includes all manufacturing costs except direct labor and direct
materials.
6. Prime costs consist of direct materials and direct labor. Conversion cost is essentially
direct labor.
7. Finished goods inventory is an asset, but inventories of raw materials and work in
process are not considered assets until production is completed.
8. Product costs are all deducted from revenue in the period in which they are incurred.
9. The wages paid to supervisors are an example of indirect labor.
10. Raw materials inventory refers to the direct materials on hand and available for use in
the manufacturing process.
Multiple Choice
1. Which of the following costs may be included when arriving at the cost of finished goods
inventory for inclusion in the financial statements of a manufacturing corporation?
1. Transportation in
2. Transportation out
3. Depreciation of factory building
4. Finished goods storage costs
5. Factory supervisors’ salaries
a. 1 and 5 only
b. 2, 4 and 5 only
c. 1, 3 and 5 only
d. 1, 2, 3 and 4 only
2. According to IAS 2 Inventories, which of the following costs should be included in valuing
the inventories of a manufacturing corporation?
1. Transportation in
2. Transportation out
3. Depreciation of factory building
4. General administrative expenses
a. 1, 2 and 4 only
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b. 2 and 3 only
c. 1 and 3 only
3. Which of the following is not likely to be treated as a product cost?

a. Deprecation on the factory.
b. Interest paid on notes payable.
c. Wages paid to factory workers.
d. Portion of the cost of running the quality control department.
4. The direct labor account is debited

a. When a new factory employee begins work
b. When the goods manufactured are completed.
c. At the end of the payroll period, when employees are paid.
d. When related labor costs are transferred into the Work in Process Inventory account
5. Manufacturing costs would not include

a. Deprecation on factory equipment
b. Indirect materials used.
c. Sales salaries expense.
d. Indirect labor costs.
6. The purchases – raw materials account is debited when
. Indirect materials are placed into production.
a. Direct materials are placed into production.
b. Indirect materials are purchased.
c. Direct materials are purchased.
7. Each of the following is true with respect to product costs, except

a. Product costs are deducted from revenue when the manufacturing process is completed.
b. Product costs are not regarded as expenses of the current period.
c. Product costs represent inventoriable costs.
d. Direct labor is an example of a product cost.
Problem 1
Cost of Goods Manufactured
In addition to the year-end statement of financial position and statement of comprehensive

income, the management of Del Mundo Corporation required the controller to prepare the
statement of cost of goods manufactured. During 2019, P 361,920 of raw materials were
Direct Labor (10,430 hours at P 9.50 per hour) P 99,085
Plant Supervision 42,500
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Indirect Labor (20,280 hours at P 6.25 per hour) 126,750
Factory Insurance 8,100
Factory Utilities 29,220
Depreciation – Factory Building 46,200
Depreciation – Factory Equipment 62,800
Manufacturing Supplies 9,460
Repairs and Maintenance 14,980
Selling and Administrative Expenses 76,480
Raw Materials Inventory, Jan. 1, 2019 26,490
Work in Process Inventory, Jan. 1, 2019 101,640
Finished Goods Inventory, Jan. 1, 2019 148,290
Raw Materials Inventory, Dec. 31, 2019 24,910
Work in Process Inventory, Dec. 31, 2019 100,400
Finished Goods Inventory, Dec. 1, 2019 141,100
purchased. Operating cost data and inventory account balances for 2019 follow:
Required:
1. Compute the cost of direct materials used during the year.
2. Compute the total manufacturing costs for the year.
3. Compute the cost of goods manufactured during the year.
Problem 2
Manufacturing Overhead, Statement of Cost of Goods Manufactured and Statement of
Comprehensive Income
The following account balances and other information were taken from the accounting records
of Langga Corporation for the year ended, Dec. 31, 2019. Use the information to prepare a
schedule of manufacturing overhead costs, a manufacturing statement (show only the total
overhead cost), and a statement of comprehensive income.
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Advertising Expense P 85,000
Amortization of Patents 16,000
Uncollectible Accounts Expense 28,000
Depreciation Expense – Office Equipment 37,000
Depreciation Expense – Factory Building 133,000
Depreciation Expense – Factory Equipment 78,000
Direct Labor 250,000
Factory Insurance Expense 62,000
Factory Supervision 74,000
Factory Supplies Expense 21,000
Factory Utilities 115,000
Indirect Labor 26,000
Interest Expense 25,000
Miscellaneous Expenses 55,000
Property Taxes – Factory Site 14,000
Raw Materials Inventory – Dec. 31, 2018 60,000
Raw Materials Inventory – Dec. 31, 2019 78,000
Purchases – Raw Materials 313,000
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Repairs and Maintenance – Factory Equipment 31,000

Sales 1,630,000
Required:
1. Analyze the list of the costs and select those items that are manufacturing overhead.
2. Arrange these costs in a schedule of manufacturing overhead costs for 2019.
3. Prepare the cost of goods manufactured statement for 2019.
4. Prepare the statement of comprehensive income for 2019.
Reference:
Ballada, Win and Ballada, Susan (2020). Basic Accounting Financial Accounting and Reporting.
Domdane Publishers & Made Easy Books. Sampaloc, Manila.
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ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1

INTENDED LEARNING OUTCOMES

Table 1 - Definitions of Accounting

Accounting is a service activity. Its Statement of Financial Accounting Standards No.

Accounting is an information Statement of Financial Accounting Concepts No. 1,

Accounting is the process of American Accounting Association, “A Statement of

Accounting is the art of recording, American Institute of Certified Public Accountants,

FUNDAMENTAL BUSINESS MODEL

Figure 1 illustrates how a business is structured to provide a customer proposition.

Figure 1 - Fundamental Business Model

Five activities on the Fundamental Business Model:

2. The cash invested in the business can be:

Services Selling people’s Hiring skilled workers and selling Banking,

Trader Buying and Purchasing a range of raw Wholesaler

Manufacture Designing Buying raw materials and Vehicle Assembly

Raw Growing or Commonly purchasing blocks of Farming

Infrastructure Selling the Purchasing and operating assets Transport (airport

Financial Receiving Accepting cash from depositors Banks

Insurance Pooling Collecting cash from many Insurance companies

FORMS OF BUSINESS ORGANIZATIONS

ACTIVITIES IN BUSINESS ORGANIZATIONS

PURPOSE AND PHASES OF ACCOUNTING

● Summarization of financial data is achieved through financial statements preparation.

Entity Concept ● An accounting entity is an organization or a section of an organization

Going Concern ● This concept pertains to the preparation of financial statements

Certain guidelines need to be followed in accounting practice. Generally accepted accounting

Revenue Recognition Principle

Expense Recognition Principle.

THE ACCOUNTANCY PROFESSION

Accountancy qualifies as a profession because it possesses the following attributes:

Commerce and Industry

● accountancy profession’s most significant service to the public.

● a mechanical task involving the collection of basic financial data.

Cost Bookkeeping, Costing and Cost Accounting

Exercises and Activities

1. Which of the following are true of partnerships?

6. Which of the following best explain the feature of consistency of presentation?

a. (i) and (ii)

8. Which type of business organization is owned by its stockholders?

1. Which of the following is an appropriate definition of accounting?

3. The entity concept means that

4. The financial accounting process provides information about economic activities of an

5. The consistency concept means that

6. The consistency standard of reporting required that

7. Which accounting process is the recognition or non-recognition of business activities as

8. The basic purpose of accounting is

19. The principle of objectivity includes the concept of

20. The concept of matching is best demonstrated by

22. The measurement phase of accounting is accomplished by

28. The periodicity concept

29. They encompass the conventions,rules,and procedures necessary to define what is

31. Which of the following best describes the attributes of a partnership?

After studying this chapter, students should be able to:

ACCOUNTING INFORMATION SYSTEMS

Figure 1.1 Accounting information Cycle

Importance of accounting information system

1. Business record-keeping is required by law.

2. It helps prevent unnecessary cost.

Figure 1. 2 Stages of Accounting Information System

The accounting information system comprises of three (3) stages as follows:

Types of accounting information system

2. Computer-based system – uses modern information technology resources and

In many situations, manual systems are inferior to computerized systems in