Accounting Reviewer

Chapter 5

Books of Accounts
A business maintains two books of accounts, namely:
● Journal
● Ledger

Journal
➢ Also called the “book of original entries”
➢ Accounting record where business transactions are first recorded
➢ Transactions are recorded in the journal through journal entries, this process is called
“journalizing”

Types of Journals

❖ Special Journal
➢ Record transactions of a similar nature.
➢ It simplifies the recording process, thus providing an efficient way
of recording and retrieving information.

examples:
● Sales journal - record sales on account
● Purchases journal - record purchases of inventory on account
● Cash receipts journal - record all transactions involving receipts
of cash
● Cash disbursements journal - record all transactions involving
payments of cash

❖ General Journal
➢ All other transactions that cannot be recorded in the special
journals are recorded in the general journal.

Ledger
➢ Also called the “book of secondary entries” or the “book of final entries”
➢ A systematic compilation of a group of accounts.
 ➢ It is used to classify the effects of business transactions on accounts.
➢ It is used only after business transactions are first recorded in the journals, this process
called “posting”

Kind of Ledgers

❖ General Ledger
➢ Contains all the accounts appearing in the trial balance.

❖ Subsidiary Ledger
➢ Provides a breakdown of the balances of controlling accounts.

Chapter 6

Business Transactions and their Analysis

The Accounting Cycle
➢ It represents the steps or procedures used to record transactions and prepare financial
statements.
➢ It implements the accounting processes of identifying, recording, and communicating
economic information.

Steps in the Accounting Cycle

1. Identifying and analyzing business documents or transactions

➢ The accountant gathers information from source documents and
determines the effect of the transactions on the accounts.

2. Journalizing
➢ The identifies accountable events are recorded in the journals.

3. Posting
➢ Information from the journal is transferred to the ledger.

4. Preparing the unadjusted trial balance

➢ The balances of the general ledger accounts are proved as to the
equality of debits and credits. It serves as a basis for adjusting entries.
 5. Preparing the adjusting entries
➢ The accounts are updated as of the reporting date on an accrual basis
by recording accruals, expiration of deferrals, estimations, and other
events often not signaled by new sources of information.

6. Preparing the adjusted trial balance (worksheet preparation)

➢ The equality of debit and credits are rechecked after adjustments are
made. It serves as a basis for the preparation of financial statements.

7. Preparing the financial statements

➢ These are how information processed is communicated to users.

8. Closing the books

➢ This involves journalizing and posting closing entries and ruling the
ledger. Temporary accounts (nominal accounts) are closed and the
resulting profit or loss is transferred to an equity account.

9. Preparing the post-closing trial balance

➢ The equality of debits and credits are again rechecked after the closing
process.

10. Recording of reversing entries

➢ Reversing entries are usually made at the beginning of the next
accounting period to simplify the recording of certain transactions in that
period.

● A transaction that affects the accounts is an “accountable event” that needs to be

recorded in the books of accounts. While, a transaction that does not affect the
accounts is a “non-accountable event,” which is not recorded in the books of account

Chapter 7

Posting to the Ledger

Posting
➢ The third step in the accounting cycle
➢ The process of transferring data from the journal to the appropriate accounts in the
ledger.
➢ Posting is done by transferring the amounts of debits and credits in a recorded journal
entry to the ledger accounts.
➢ It is to classify the effects of transactions on a specific asset, liability, equity, income,
and expense accounts to provide more meaningful information.

Preparing the Unadjusted Trial Balance

Trial balance
➢ A list of general ledger accounts and their balances.
➢ It is prepared to check the equality of total debits and credits in the ledger.
➢ It creates a starting point for the preparation of the financial statements.

Types of Trial balance

❖ Unadjusted trial balance

➢ It is prepared before adjusting entries are made.
➢ It cannot be prepared unless the total debits and credits in the
unadjusted trial balance are equal

❖ Adjusted trial balance

➢ It is prepared after adjusting entries but before the financial
statements are prepared.

❖ Post-closing trial balance

➢ It is prepared after the closing process.

Chapter 8

Adjusting Entries
Adjusting entries
➢ Entries are made before the preparation of financial statements to update certain
accounts so that they reflect correct balances as of the designated time.
 ➢ It is to take up unrecorded income and expenses of the period
➢ It is to split mixed accounts into their real and nominal elements.

Kinds of adjusting entries

● Prepaid expenses
○ advanced payments for goods or services to be received in the future.
○ Prepaid expenses are initially recorded as assets, because they have future
economic benefits, and are expensed at the time when the benefits are
realized (the matching principle).
○ Prepaid rent, prepaid insurance

● Deferred revenue
○ “Tayo naka receive ng advance payment galing sa mga customers”
○ generated when a company receives payment for goods and/or services that
have not been delivered or completed.
○ Unearned revenue

● Accrued revenue
○ “Yung company yung naunang nagbigay ng goods or services, nakapag render
ka ng goods or services pero di pa bayad ng customer”
○ Revenue that has been earned by providing a good or service, but for which no
cash has been received.
○ Accounts receivable

● Accrued expense
○ “Meron ng expense yung company pero di pa nababayaran, expenses already
incurred pero di pa nababayaran”
○ Those incurred for which there is no invoice or other documentation. They are
classified as current liabilities
○ Payable

● Asset depreciation
○ “Mga assets ng company (i.e., office equipment) through time, naluluma o
nasisira kasi ginagamit”
○ Depreciation expense

● Uncollectable accounts
○ “Mga receivable na baka di na mareceive kaya nagiging expense”
○ Uncollectable expense or bad debts expense
 ● Subsequent measurements
○ Impairment loss or amortization

Accruals of income and expenses

● The term “accrual” (or “to accrue”) means to recognize an:

○ Income that is already earned but not yet collected
○ Expense that is already incurred but not yet paid
● Accruals give rise to both income and receivable (or both expense and payable)

● All adjusting entries involve at least one balance sheet account and one income
statement account (or statement of comprehensive income account)
● All adjusting entries affect the profit or loss for the period (or comprehensive income for
the period)

Expense Recognition Principles

● Matching
➢ Costs that are directly associated with the earning of revenue are
recognized as expenses in the same period in which the related revenue
is recognized.

Application: The cost of inventory is initially recognized as an asset and charged

as expense (i.e., Cost of Goods Sold) when the inventory is sold.

● Systematic & rational allocation

➢ Costs that are not directly associated with the earning of revenue are
recognized as expenses over the periods the economic benefits are
consumed.
Application: The cost of equipment is initially recognized as an asset and
charged as expense (i.e, Depreciation) over the equipment is used.

● Immediate recognition
➢ Costs that do not provide future economic benefits or assets that cease
to provide future economic benefits are recognized immediately as an
expense.

Application: An account receivable that becomes doubtful of the collection is

immediately recognized as expense (i.e., Bad debt expense).
Real, Nominal, and Mixed Accounts

● Real accounts (Permanent accounts)

○ Accounts that are not closed at the end of the reporting period.
○ It includes all balance sheet accounts, except the Owner’s drawings account

● Nominal accounts (Temporary accounts)

○ Accounts that are closed at the end of the accounting period.
○ It includes all income statement accounts, drawings accounts, clearing
accounts, and suspense accounts.

■ Clearing account
➢ Account used temporarily to store amounts that will eventually be
transferred to another account. (i.e,. “Income Summary” account
which stores amounts of income and expenses during the
period). The balance of the “Income Summary” account
represents the profit or loss during the period. The “Income
summary” is closed to the “Owner’s capital” account before the
financial statements are prepared.

■ Suspense account
➢ Account that is used temporarily to store discrepancies in the
accounts pending their analysis and permanent classification.

● Mixed accounts
○ Accounts that have both real and nominal account components.
○ These accounts are subject to adjustment.
○ It includes unadjusted prepayments (prepaid assets) and deferrals (unearned
income” that have both expired and unexpired components.

■ The expired portion is the nominal account while the unexpired portion is
the real account.
■ At the end of the period, adjusting entries are needed to separate these
components because the nominal account is presented in the income
statement while the real account is presented in the balance sheet.
Methods in Initial Recording of Income and Expenses

● Income
Advanced collections of income are initially recorded using either:

❖ Liability method
➢ Advanced collections of income are initially credited to a liability
account. At the end of the period, the earned portion is
recognized as income, while the unearned portion remains a
liability.

❖ Income method
➢ Advanced collections of income are initially credited to an
income account. At the end of the period, the unearned portion
is recognized as liability, while the earned portion remains as
income.

Illustration:

Lipana Tax Consultancy received P150,000 representing advanced payment for six (6)
months tax compliance and consultancy services from one of their clients on November 1,
2020. The accounting period of the entity ends on December 31, 2020.

Date Liability method Income method

2020
Nov 1 Cash 150,000.00 Cash 150,000.00
Unearned revenue 150,000.00 Fees earned 150,000.00\
 Analysis: Analysis:

150,000 x 2 (Nov 1 - Dec 31) /6 150,000 x 4/6 = 100,000.00

= 50,000.00
Adj entry:

Dec 31 Unearned revenue 50,000.00 Fees earned 100,000.00

Fees earned 50,000.00 Unearned revenue 100,000.00

● Liability method - una siyang nirerecord as liability and then sa adjusting entry is
kung magkano yung “earned portion” nung liability.

● Income method - una siyang nirerecord as income and then as adjusting entry is
kung magkanbo yung “unearned portion” nung liability.

● Expenses
Prepayments of expenses are initially recorded using either:

❖ Asset method
➢ Prepayments of expenses are initially debited to an asset
account. At the end of the period, the incurred portion (used up or
expired” is recognized as an expense, while the unused portion
remains as an asset.

❖ Expense method
➢ Prepayments of expense are initially debited to an expense
account. At the end of the period, the unused portion (not yet
incurred or unexpired) is recognized as an asset, while the
incurred portion remains as an expense.

Illustration:

Jimin Company purchased office supplies on August 1, 2020 amounting to P100,000 in

which the company immediately paid in cash. At December 31, 2020 which coincides to be
the end of the accounting period, inventory records show that the amount of remaining office
supplies amount to P40,000.

Date Asset method Expense method

 2020
Aug 1 Office supplies 100,000.00 Office supplies expense 100,000.00
Cash 100,000.00 Cash 100,000.00
Adj entry:

Dec 31 Office supplies expense 60,000.00 Office supplies 40,000.00

Office supplies 60,000.00 Office supplies expense 40,000.00

● Asset method - una siyang nirerecord as an asset and then sa adjusting entry is
yung magkano yung expired or na used portion nung asset.

● Expense method - una siyang nirerecord as an expense and then sa adjusting entry
is yung magkano yung remaining or unused portion nung asset.

Accruals and Deferrals

● The recording of items of income that were collected in advance and items of expense
that were paid in advance is referred to as deferrals. To defer means to postpone the
recognition.

Accrual Deferral

● To recognize income that is already ● To postpone the income recognition

earned but not yet collected. of an advance collection. The
● To recognize expense that is already advance collection is treated as a
incurred but not yet paid. liability until earned.
● To postpone the expense recognition
of prepayment. The prepayment is
treated as an asset until incurred.

Chapter 9
Accounting Cycle of a Service Business
Service Business
➢ Offers services as its main product rather than physical goods

Worksheet
➢ Analytical device used to facilitate the gathering of data for adjustments, the
preparation of financial statements, and closing entries
 ➢ It is optional and not part of the formal accounting records.

Financial statements
➢ The end product of the accounting process.
➢ The journal and ledger entries are summarized and communicated through the financial
statements.

● Statement of financial position (Balance sheet)

➢ Shows information on assets, liabilities, and equity.
➢ It is dated “as of the end of the reporting period”

● Statement of profit or loss (Income statement)

➢ Shows information on income and expenses and the profit or loss for the
period.
➢ It is dated “for the period ended..”

Closing Entries
➢ Entries prepared at the end of the accounting period to “zero out” all nominal accounts
in the ledger.
➢ Special journal entries are used to prepare the temporary accounts for the new fiscal
period.
➢ To close a temporary account, an amount equal to its balance is recorded on the
opposite side of its balance.
➢ It is also referred to as “closing the books,” an application of the time period concept.

Four Closing Entries

● Entry to Close Revenue
● Entry to Close Expenses
● Entry to Close Net Income or Net Loss into
● Capital. This will also close down Income Summary! (Its job is done! ☺)
● Lastly, the entry to close the Drawing Account into Capital.
remember:

● All income accounts are debited and all expense accounts are credited. The
resulting balance is recorded in a clearing account called “Income Summary.”

● The balance of “Income Summary” is closed to the “Owner’s Capital - Credit”

● Any balance in the “Owner’s drawings” account is closed to the “Owner’s Capital -
Debit”

● Any balance in the “Owner’s drawings” account is also closed to the “Owner’s
drawings - Credit”
Income Summary
➢ the temporary account that is used to summarize the closing entries for the revenue and
expense accounts.
➢ Is unique because it does not have a normal balance.
➢ used only at the end of the accounting period to summarize revenue and expense
balances.
➢ has a zero balance before and after the closing.
➢ does not appear on any financial statement.

● If the “Income Summary” account has a credit balance, there is profit.

● If the “Income Summary” account has a debit balance, there is a loss.

Post-closing trial balance

➢ The amounts in the “Adjusted trial balance” (or the income statement and balance
sheet) are cross-footed with the amounts in the “Closing entries” columns.
➢ The amounts in the “Post-closing trial balance” will be the beginning balances of
accounts in the next accounting period.
➢ A list of the permanent general ledger account balances; is prepared to prove the
ledger after the closing entries are posted.
➢

remember:

● After closing entries are posted, the nominal accounts (income, expense, and drawings
accounts) have zero balances. These accounts are referred to as closed accounts.
○ Closed account - an account that has no balance
○ Open account - an account that has balance

● The post-closing trial balance contains only real accounts (assets, liabilities, and equity
accounts). It is similar to the balance sheet. Except for the “Owner’s Capital” account in
the post-closing trial, the balance is the updated amount after closing profit or loss and
damages.
○ (Owner’s Capital Cr sa Balance Sheet) + (Owner’s Capita Cr sa Closing Entries) -
(Owner’s Capita Dr sa Closing Entries) = balance of Owner’s capital

Reversing Entries
➢ Entries usually made on the first day of the next accounting period to reverse certain
adjusting entries in the immediately preceding period.
➢ It is optional, meaning they are not required in the preparation of financial statements.
Adjusting entries that may be reversed
● Not all adjusting entries may be reversed
● Only the adjusting entries made for the following may be reversed:
○ Accruals for income or expense
○ Prepayments initially recorded using the expense method
○ Advanced collection initially recorded using the income method

Chapter 10
Accounting Cycle of a Merchandising Business
Merchandising Business
➢ Business that buys and sells goods without changing their physical form.
➢ Necessarily holds an inventory of physical goods for sale

Inventory
➢ Refers to the goods that a merchandising business has purchased and primarily
intended for resale, normally in their original form.

Inventory Systems
● Perpetual System
● Periodic System

❖ Perpetual Inventory System

➢ “Perpetual” means continuing forever or “tuloy tuloy” in Filipino)
➢ The “inventory” account (or “Merchandise Inventory” account) is updated
each time a purchase or sale is made. Thus, the “inventory” account
shows a continuing or running balance of the goods on hand.
➢ It is commonly used for inventories that are specifically identifiable and
are relatively high valued, such as cars, machinery, furniture, and heavy
equipment.
➢ Records called “stock cards” and “stock ledger cards” are maintained
from which the quantities and balances of goods on hand and goods sold
can be determined at any given point in time without the need of
performing a physical count of inventories.

● All increases and decreases in inventory, such as purchases, freight-in,

purchase returns, purchase discounts, cost of goods sold, and sale
returns are recorded in the “Inventory” (or “Merchandise Inventory)
● Cost of goods sold is also updated each time a sale or sale return is
made.
 ❖ Periodic Inventory System
➢ “Periodic” means occurring or recurring at regular intervals or “pana-
panahon in Filipino”
➢ The “inventory” account (or “Merchandise Inventory “ account) is updated
only when a physical count of inventory is performed. The amounts of
inventory and cost of goods sold are determined only periodically.
➢ The business does not maintain records that show the running balance of
inventory on hand and the cost of goods sold at any given point in time.
To determine this information, a physical count of the quantity of goods
on hand must be performed periodically.

example:

Beginning Inventory xx
Add: Net purchases xx
Total Goods Available for Sale (xx)
Less: Ending inventory (physical count) (xx)
Cost of Goods Sold xx

❖ Purchases
➢ Account used to record purchases of inventory under Periodic System

❖ Freight-in (Transportation-in)
➢ Account used to record the shipping costs incurred on purchases of inventory
under the periodic system
➢ It is an adjunct account (addition)

❖ Purchase returns
➢ Account used to record returns of purchased goods to the supplier
➢ Contra accounts (subtraction)

❖ Purchase discounts
➢ Account used to record cash discounts availed of on the purchased goods.
➢ Contra accounts (subtraction)

● Purchases of inventory are debited to the “Purchases” account

● Shipping costs are debited to the “Freight-in” account
● Purchase returns are credited to the “Purchase returns” account
● Purchase discounts are credited to the “Purchase discounts” account
 remember:

● Under the Perpetual Inventory System, all increases and decreases in the goods on
hand are recorded through the “Inventory” account. Also, “Cost of Goods Sold” is
debited when inventory is sold and credited when there is a sales return.

● Under the Periodic Inventory System, the increases and decreases in the goods on
hand are recorded through the purchases, freight-in, purchase returns, and
purchase discounts accounts. Cost of Goods Sold is not recorded

● Under the Periodic, the balances of inventory on hand and cost of goods sold are not
readily determinable without performing a first a physical count of the number of goods
on hand.

Gross Profit
➢ Also called “Gross Income, Gross Margin or Sales profit”
➢ Represents the profit a business earns after deducting the cost of goods sold or services
rendered, but before deducting other expenses.

● Profit (Net profit) is different from gross profit. Profit is the amount derived after
deducting all other expenses from the gross profit.
❖ Sales
➢ both cash sales and credit sales

❖ Sales returns
➢ account used to record goods returned by customers.
➢ Contra accounts (deductions)

❖ Sales discounts
➢ account used to record cash discounts given to customers
➢ Contra accounts (deductions)

Statement of Cost of Goods Sold and Gross Profit

➢ Is not a formal accounting report that is prepared for external reporting.

Formulas:

● Gross Profit = Net Sales - Cost of goods sold

● Net sales = Total sales - Sales returns & discounts

● Cost of goods sold = Beginning inventory + Net purchases - Ending inventory

● Net purchases = Purchases + Freight-in - Purchase returns - Purchase discounts

● Gross Margin Rate = Gross Profit / Net Sales
 Terms to remember:

● Sales Invoice
➢ A document that the seller gives to the buyer listing the items ordered or sold
together with quality, price, description, value-added tax, terms of the sale and
the total price of all the items sold.

● Delivery receipt
➢ A document issued by the seller and signed by the customer evidencing receipt
of the goods ordered or sold as per sales invoice. In some cases, the sales
invoice also serves as a delivery receipt.

● Credit Memo
➢ A business form used by the seller to notify the buyer that his account is
credited (balance is reduced) for returns made or allowance granted for
defective merchandise

● Sales returns and allowances

➢ Deductions from sales as a result of merchandise returned or allowance
granted damaged or defective merchandise. This is supported by a credit
memo from the seller.

● Sales discount
➢ Discount is given to customers paying earlier than the credit term 2/10, n/30

● Discount period
➢ Period of time in which to pay be entitled to a discount

● Trade discount
➢ A special discount given to customers for buying in large quality. The discount
is automatically deducted from the invoice price.

Credit Terms with discounts

● 2/10, n/30
➢ 2% discount if paid within 10 days. Must be paid not later than 30 days from the
date of the invoice.

● 2/10, 1/15, n/30

➢ 2% if paid within 10 days from the date of invoice, 1% if paid after 10 days but
before the 15th day from the date of invoice, and must be paid within 30 days
from the issue of the invoice.
● 3/EOM, n/60
➢ 3% if paid on or before the end of the month of purchase. Must not be paid later
than 60 days.

● 2/10EOM, n/60
➢ 2% discount on or before the 10th day after the end of the month. Must not be
paid later than 60 days from the invoice date.