FABM

Week 4: Accounting Cycle of a Service Business (Part I)

THE ACCOUNTING BIG FOUR

Do you want to be an accountant? If you do, chances are you will end up being part pf a global network of
accounting professionals. These are huge organizations of professionals and experts from different fields,
including operations management, cybersecurity, strategic management, and international taxation. These groups
are called professional service firms, and one of their primary revenue streams is their audit arms. External
auditors lend credibility to the financial statements produced by businesses to give users of financial statements a
reasonable degree of assurance that companies make no unfair claims made on the face of the statements.
Currently, there are four dominant firms in global audit practice, as enumerated:

Firm 2014 Revenues Headquarters Philippine Member Firm

Deloitte $ 34.2 billion United States Navarro Amper & Co

PwC $ 34.0 billion United Kingdom Isla Lipana & Co

EY $ 27.4 billion United Kingdom Sycip Gorres Velayo & Co

KPMG $ 24.8 billion Netherlands R. G. Manabat & Co

But no matter how complex their practice is and how expansive their area of expertise may be, one thing remains
true. The member firms of these professional service networks can be reduced to fit the basic business model of a
service organization. Their main revenue source is the rendition of services, and not the sale of goods bought
from somewhere else or manufactured in the company plant. In a service firm, the “good” being sold is the
professional conduct of, for example, audit services, be very qualified auditors.
Auditors are expected to know a great deal of accounting, and in the Philippines, to be able to audit the financial
statements of publicly traded companies, one of the requirements is a Certified Public Accountant license, the
examination for which requires a degree in accountancy. The practice of accountancy starts in the recording of
business transactions. In this chapter, we will learn how various economic events are translated into words and
numbers, which travel the whole length of the accounting cycle, and eventually end up as numbers on the
financial statements.
💎As you go through the lesson, try to reflect on the following essential questions:
 What are the rules of debits and credits?
 How do you determine whether to record or not a transaction in the books of accounts?
 What is a trial balance?
 BUSINESS TRANSACTIONS AND THEIR ANALYSIS AS APPLIED
TO THE ACCOUNTING CYCLE OF A SERVICE BUSINESS (PART I)
The accounting process begins with the identification of an event, the analysis of that event, and the
measurement of the impact of that event to the business’s financial statements. We are talking about events, but
later in this chapter, you will learn that not all events are actually recorded in the financial statements. The
following is a list of events. Some of which will be recorded in the company’s books, and some will not be
recorded. Which of these events do you think needs to be recorded? How do you know if an event is to be
recorded in the books or not?

LIST OF EVENTS:
1. Firm buys a printer for the office for ₱5,500.
2. Firm hires two employees which will be paid ₱15,000 monthly.
3. Firm pays rent on the land where its building stands for ₱12,300.
4. Firm signs a subscription contract for an internet plan at ₱999 per month which will be due at the end of each
month.
5. Firm orders 20 packs of brown envelopes from the bookstore at ₱20 per pack.

Of the five events listed, only events 1 and 3 will be recorded. There is really no hard-and-fast rule to determine
which events need to be recorded in a business’s books of accounts. Generally, though, accountants record an
event if it affects any of the elements of the financial statements, and if there is a monetary amount that can be
assigned to it.

➤How do you determine whether to record or not a transaction in the books of

accounts?

Here is a summary of our decision-making framework:

Does it affect the composition of either

    assets, liabilities, equity, revenues, or
expenses?

  YES NO
Is there a monetary amount
that can be assigned to the YES Record in the books. Do not record.
event?
NO Do not record. Do not record.

In the previous chapter (Chapter 9), we discussed the uses and various types and formats of the journals. After
analyzing the transactions, these are recorded to the appropriate journals in a process aptly named journalizing.
Following the format, we recall that each journal entry will require a date, one or more debit account titles, one or
more credit account titles, amounts, and an explanatory note to express in words what the transaction was made
for. A final step is made when the journal entries are posted to the ledgers.
Now that we know how to use debit (Dr.) and credit (Cr.), we can start journalizing the entries. To understand how
to record a variety of transactions, we will illustrate and analyze the business of Del Mundo Landscape Specialist.
Some transactions contain notes (in italics) for clarification and guidance.
For better appreciation of the nature of the affected accounts, the letter A (for asset), L (liability) or OE (owner’s
equity) is inserted after each entry. In addition, owner’s equity is further classified into OE:I (income) and OE:E
(expenses).
Note that the rules of double-entry system are observed in each transaction:
1. Two or more accounts are affected by each transaction.
2. The sum of the debits for every transaction equals the sum of the credits.
3. The equality of the accounting equation is always maintained.

➤What are the rules of debits and credits?

1. Increases in assets are recorded by debits.
2. Decreases in assets are recorded by credits.
3. Increases in liabilities are recorded by credits.
4. Decreases in liabilities are recorded by debits.
5. Increases in owner’s equity are recorded by credits.
6. Decreases in owner’s equity are recorded by debits.

Note that in this lesson, we focus on the accounting cycle of a service

type of business. A service business generally uses their employees
to provide intangible products or services to customers that includes
professional skills, advice, expertise, and other related products.

Illustration of using the accounting cycle in a service business:

Initial Investment
November 1 The owner of the Del Mundo Landscape Specialist, Galicano Del Mundo, invests ₱450,000
to open the business in the year 2020.
Analysis Assets increased. Owner’s equity increased.

Date Account Titles and Explanation P.R. Debit Credit

2020

November 1 Cash (A) ₱450,000

Del Mundo, Capital (OE) ₱450,000
To record initial investment.

Rent Paid in Advance

November 1 Rented office space and paid three months’ rent in advance, ₱21,000. Given the length of
time, i.e., more than a month, that this contract is in effect, the matching principle requires that the
contract’s cost initially be recorded as an asset since it provides a future benefit.
Analysis Assets increased. Assets decreased.

Date Account Titles and Explanation P.R. Debit Credit

November 1 Prepaid Rent (A) ₱21,000
Cash (A) ₱21,000
To record advance payments in rent.

Vehicle Acquired by Issuing a Note

November 2 Del Mundo purchases a ₱300,000 used truck by paying ₱200,000 in cash and signing a
₱100,000 note payable which is due in eighteen months.
Analysis Assets increased. Assets decreased. Liabilities increased.

Date Account Titles and Explanation P.R. Debit Credit

November 2 Vehicles (A) ₱300,000

Cash (A)
₱200,000
Notes Payable (L)
₱100,000
To record the purchased of vehicle in
cash and on account signed into notes.

Equipment Acquired for Cash

November 3 Del Mundo purchases mechanical lawn mowers for ₱54,000 in cash.
Analysis Assets increased. Assets decreased.

Date Account Titles and Explanation P.R. Debit Credit

Equipment (A)
November 3 ₱54,000
Cash (A)
₱54,000
To record the purchase of mechanical
lawn mowers.

Expenses incurred and Paid

November 4 Del Mundo purchases ₱1,500 worth of gasoline
Analysis Assets decreased. Owner’s equity decreased.

Date Account Titles and Explanation P.R. Debit Credit

November 4 Utilities Expense (OE:E) ₱1,500

Cash (A) ₱1,500
To record payment for gasoline.

Insurance Premiums Paid

November 5 Del Mundo pays ₱24,000 for a one-year insurance contract that protects his business from
November 1 – October 31 of the following year.
Analysis An asset increased. Another asset decreased.

Date Account Titles and Explanation P.R. Debit Credit

Prepaid Insurance (A)
November 5 ₱24,000
Cash (A)
₱24,000
To record payment for insurance
premiums.

Supplies Purchased on Account

November 8 Del Mundo purchases ₱1,000 worth of office supplies, placing the purchase on his account
with the store rather than paying cash. Supplies are a prepaid expense (an asset) until they are
used and thereby become a cost of doing business (an expense). Accounts payable differ from
notes payable. Accounts payable are amounts the entity owes based on the good credit of the
entity or the owner, whereas notes payable are amounts the entity owes under formal obligations.
Analysis Assets increased. Liabilities increased.

Date Account Titles and Explanation P.R. Debit Credit

Supplies (A)
November 8 ₱1,000
Accounts Payable (L)
₱1,000
To record the purchased of supplies on
account.

Revenues Earned and Cash Collected

November 14 The Del Mundo Landscape Specialist cuts grass for seven customers, receiving ₱2,500
from each.
Analysis Assets increased. Owner’s equity increased.

Date Account Titles and Explanation P.R. Debit Credit

November 14 Cash (A)

₱17,500
Service Income (OE:I)
₱17,500
To record the receipt of cash from service
rendered to customers.

Unearned Revenues Collected

November 20 Del Mundo receives ₱13,500 from a customer for six future maintenance visits. An advance
deposit from a customer is an obligation to perform work in the future. It is a liability until the work is
performed, at which time it becomes revenue. Therefore, the advance deposit is call unearned
revenues.
Analysis Assets increased. Liabilities increased.

Date Account Titles and Explanation P.R. Debit Credit

 Cash (A)
November 20 ₱13,500
Unearned Revenues (L)
₱13,500
To record the receipt of advance payment
of cash customer.

Revenues Earned on Account

November 22 Del Mundo Landscape Specialist cut grass for eight customers, billing each one ₱2,500 but
receiving no cash. In accordance with the revenue recognition principle, revenue is recognized
upon the completion of a service or the delivery of a product, even if no cash changes hands at
that time.
Analysis Assets increased. Owner’s equity increased.

Date Account Titles and Explanation P.R. Debit Credit

November 22 Accounts Receivable (A) ₱20,000

Service Income (OE:I) ₱20,000
To record the service rendered to eight
customers on account.

Salaries Paid
November 26 Del Mundo pays ₱4,000 in salaries to a part-time employee.
Analysis Assets decreased. Owner’s equity decreased.

Date Account Titles and Explanation P.R. Debit Credit

November 26 Salaries Expense (OE:E) ₱4,000

Cash (A) ₱4,000
To record the payment of salaries.

Advertising Paid
November 28 Del Mundo pays ₱1,750 to print advertising fliers.
Analysis Assets decreased. Owner’s equity decreased.

Date Account Titles and Explanation P.R. Debit Credit

Advertising Expense (OE:E)
November 28 ₱1,750
Cash (A)
₱1,750
To record the payment of advertising
fliers.
Withdrawal of Cash by Owner
November 29 Del Mundo withdraws ₱5,000 for personal use.
Analysis Assets decreased. Owner’s equity decreased.

Date Account Titles and Explanation P.R. Debit Credit

Del Mundo, Withdrawals (OE)
November 29 ₱5,000
Cash (A)
₱5,000
To record the cash withdrawal of the
owner.

Accounts Receivable Partially Collected

November 30 Five of the eight customers billed last November 22 each pay ₱2,500.
Analysis An asset increased. Another asset decreased.

Date Account Titles and Explanation P.R. Debit Credit

Cash (A)
November 30 ₱12,500
Accounts Receivable (A)
₱12,500
To record the partial cash receipt from
customers on account.

To have a clearer view and understanding of the journal entries made, let us take a look on the general journal of
Del Mundo Landscape Specialist:

Del Mundo Landscape Specialist

GENERAL JOURNAL
Date Account Titles and Explanation P.R. Debit Credit

November
2020

Cash ₱450,000
Del Mundo, Capital ₱450,000
To record initial investment.
1
Prepaid Rent ₱21,000
Cash ₱21,000
To record advance payments in rent.
 Vehicles
₱300,000
Cash
₱200,000
2 Notes Payable
₱100,000
To record the purchased of vehicle in cash
and on account signed into notes.
Equipment
₱54,000
Cash
3 ₱54,000
To record the purchase of mechanical lawn
mowers.
Utilities Expense ₱1,500
4 Cash ₱1,500
To record payment for gasoline.

5 Prepaid Insurance ₱24,000

Cash ₱24,000
To record payment for insurance premiums.
Supplies
₱1,000
Accounts Payable
8 ₱1,000
To record the purchased of supplies on
account.
Cash
₱17,500
Service Income
14 ₱17,500
To record the receipt of cash from service
rendered to customers.
Cash
₱13,500
Unearned Revenues
20 ₱13,500
To record the receipt of advance payment of
cash customer.
Accounts Receivable
₱20,000
Service Income
22 ₱20,000
To record the service rendered to eight
customers on account.

Salaries Expense ₱4,000

26 Cash ₱4,000
To record the payment of salaries.

Advertising Expense ₱1,750

28 Cash ₱1,750
To record the payment of advertising fliers.
 Del Mundo, Withdrawals ₱5,000
29 Cash ₱5,000
To record the cash withdrawal of the owner.

Cash
₱12,500
Accounts Receivable
30 ₱12,500
To record the partial cash receipt from
customers on account.

When analyzing transactions, the accountant refers to the chart of accounts to identify the pertinent accounts to
be increased or decreased. If an appropriate account title is not listed in the chart, an additional account may be
added. Presented below is the chart of accounts for the illustration:

Del Mundo Landscape Specialist

Chart of Accounts
---------------------------------------------------------------------------------------------------------------------

Balance Sheet Accounts Income Statement Accounts

Assets Income
110 Cash 410 Service Income
120 Accounts Receivable
130 Supplies Expenses
140 Prepaid Rent 510 Salaries Expense
150 Prepaid Insurance 520 Supplies Expense
160 Vehicles 530 Rent Expense
165 Accumulated Depreciation – Vehicles 540 Insurance Expense
170 Equipment 550 Utilities Expense
175 Accumulated Depreciation – Equipment 560 Advertising Expense
570 Interest Expense
Liabilities 580 Depreciation Expense – Vehicles
210 Accounts Payable 590 Depreciation Expense – Equipment
220 Notes Payable
230 Salaries Payable
240 Interest Payable
250 Unearned Revenues

Owner’s Equity
310 Del Mundo, Capital
320 Del Mundo, Withdrawals
330 Income Summary
Now that we’re done journalizing and we have the chart of accounts of Del Mundo Landscape Specialist, let us
now post the entries in the ledger accounts:

Account: Cash Account No. 110

Date Explanation J.R. Debit Credit Balance

2020

November 1 Investment of capital by owner. J1 ₱450,000 ₱450,000

1 Rent paid in advance. J1 ₱21,000 429,000

2 Partial payment for the vehicle acquired. J1 200,000 229,000

3 Purchased of equipment. J1 54,000 175,000

4 Payment for the gasoline. J1 1,500 173,500

5 Payment for the insurance premiums. J1 24,000 149,500

14 Receipt of cash from service rendered. J1 17,500 167,000

20 Receipt of advance payment from customer. J1 13,500 180,500

26 Payment of salaries to part-time employee. J1 4,000 176,500

28 Payment of print advertising fliers. J1 1,750 174,750

29 Personal withdrawal of the owner. J1 5,000 169,750

Partial cash receipt from customers on
30 J1 12,500 182,250
account.
30 Balance ₱182,250

Account: Accounts Receivable Account No. 120

Date Explanation J.R. Debit Credit Balance

2020

November 22 Rendered service to customers on account. J1 ₱20,000 ₱20,000

Partial cash receipt from customers on
30 J1 ₱12,500 7,500
account.
30 Balance ₱7,500

Account: Supplies Account No. 130

 Date Explanation J.R. Debit Credit Balance

2020

November 8 Purchased of supplies on account. J1 ₱1,000 ₱1,000

30 Balance ₱1,000

Account: Prepaid Rent Account No. 140

Date Explanation J.R. Debit Credit Balance

2020

November 1 Advance payment of rent. J1 ₱21,000 ₱21,000

30 Balance ₱21,000

Account: Prepaid Insurance Account No. 150

Date Explanation J.R. Debit Credit Balance

2020
Payment of insurance premiums for
November 5 J1 ₱24,000 ₱24,000
one year.
30 Balance ₱24,000

Account: Vehicles Account No. 160

Date Explanation J.R. Debit Credit Balance

2020

November 2 Acquisition of vehicle. J1 ₱300,000 ₱300,000

30 Balance ₱300,000

Account: Equipment Account No. 170

Date Explanation J.R. Debit Credit Balance

2020

November 3 Purchased of mechanical lawn mowers. J1 ₱54,000 ₱54,000

30 Balance ₱54,000

Account: Accounts Payable Account No. 210

 Date Explanation J.R. Debit Credit Balance

2020

November 8 Purchased of supplies on account. J1 ₱1,000 ₱1,000

30 Balance ₱1,000

Account: Notes Payable Account No. 220

Date Explanation J.R. Debit Credit Balance

2020

Purchased of vehicle, balance on account

November 2 J1 ₱100,000 ₱100,000
and signed a note.

30 Balance ₱100,000

Account: Unearned Revenues

Account No. 250

Date Explanation J.R. Debit Credit Balance

2020
Payment received for service to be rendered
November 20 J1 ₱13,500 ₱13,500
in the future.
30 Balance ₱13,500

Account: Del Mundo, Capital Account No. 310

Date Explanation J.R. Debit Credit Balance

2020

November 1 Initial investment made by the owner J1 ₱450,000 ₱450,000

30 Balance ₱450,000

Account: Del Mundo, Withdrawal Account No. 320

Date Explanation J.R. Debit Credit Balance

2020

November 29 Withdrawal of cash for personal use. J1 ₱5,000 ₱5,000

30 Balance ₱5,000
 Account: Service Income Account No. 410

Date Explanation J.R. Debit Credit Balance

2020
Service rendered to seven customers,
November 14 J1 ₱17,500 ₱17,500
receiving cash.
22 Service rendered on account. J1 20,000 37,500

30 Balance ₱37,500

Account: Salaries Expense Account No. 510

Date Explanation J.R. Debit Credit Balance

2020

November 26 Payment of salaries to part-time employee. J1 ₱4,000 ₱4,000

30 Balance ₱4,000

Account: Utilities Expense Account No. 550

Date Explanation J.R. Debit Credit Balance

2020

November 4 Payment for gasoline used. J1 ₱1,500 ₱1,500

30 Balance ₱1,500

Account: Advertising Expense Account No. 560

Date Explanation J.R. Debit Credit Balance

2020

November 28 Payment for print advertising fliers. J1 ₱1,750 ₱1,750

30 Balance ₱1,750

Now that we’re done posting the entries to the ledger, let us now prepare a trial balance of Del Mundo Landscape
Specialist for the month of November to review and verify if our entries in the debits and credits are balance.

➤What is a trial balance?

 The trial balance is a list of all accounts with their respective debit or credit balances. It is prepared to
verify the equality of debits and credits in the ledger at the end of each accounting period or at any time the
postings are updated.
➤What are the procedures in the preparation of a trial balance?

1. List the account titles in numerical order.

2. Obtain the account balance of each account from the ledger and enter the debit balances in the debit column
and the credit balances in the credit column.
3. Add the debit and credits columns.
4. Compare the totals.

The trial balance is a control device that helps minimize accounting errors. When the totals are equal, the trial
balance is in balance. This equality provides an interim proof of the accuracy of the records but it does not signify
the absence of errors. For example, the bookkeeper failed to record payment, the trial balance columns are equal
but in reality, the accounts are incorrect since rent expense is understated and cash overstated. The trial balance
for the illustration follows:

Del Mundo Landscape Specialist

Trial Balance
November 2020

Cash ₱182,250  

Accounts Receivable 7,500  

Supplies 1,000  

Prepaid Rent 21,000  

Prepaid Insurance 24,000  

Vehicles 300,000  

Equipment 54,000  

Accounts Payable   ₱    1,000

Notes Payable   100,000

Unearned Revenues   13,500

Del Mundo, Capital   450,000

Del Mundo, Withdrawals 5,000  

Service Income   37,500

Salaries Expense 4,000  

Utilities Expense 1,500  

Advertising Expense 1,750  

  ₱602,000 ₱602,000
📌SAMPLE EXERCISE:
Jackielyn Matagumpay organized Eternal Images, a photography and portrait studio, on October 1, 2020. The
studio completed the following transactions during the month of October:
1 Deposited ₱350,0000 in a bank account in the name of the business.
3 Paid two month’s rent deposit and one-month advance, ₱40,500.
5 Transferred to the business personal photography equipment valued at ₱129,000.
7 Ordered additional photography equipment, ₱75,000.
8 Purchased office equipment for cash, ₱54,000.
10 Received and paid for the photography equipment ordered on October 7.
12 Purchased photography supplies on credit, ₱21,000.
13 Received cash for previously unbilled portraits, ₱11,400.
17 Billed customers for portraits, ₱22,500.
19 Paid fifty percent of the supplies ordered on October 12.
25 Paid the electricity bill for October, ₱3,600.
26 Paid the telephone bill for October, ₱2,100.
28 Received payments from the customers billed on October 17, ₱7,500.
29 Paid salaries to personnel, ₱12,000.
30 Received an advance payment from a customer, ₱1,500.
31 Withdrew ₱16,000 from the business for personal emergency.

Required: Determine the balance of each account and prepare a trial balance of Eternal Images for the month of
October.

G E NE RAL I Z AT I O N:
The accounting process begins with the identification of an event, the analysis of that event, and the
measurement of the impact of that event to the business’s financial statements. The rules of debits and credits
are: increases in assets are recorded as debits; decreases in assets are recorded as credits; increases in
liabilities are recorded as credits; decreases in liabilities are recorded as debits; increases in owner’s equity are
recorded as credits; and, decreases in owner’s equity are recorded as debits. The trial balance shows all accounts
with their corresponding balances, segregated into debit and credit columns. The trial balance is prepared to
prove the equality of the debits and the credits in the journal entries.

“If you allow people to make more withdrawals than deposits in your life, you will be out of balance. And in
the negative, know when to close the account.”
--Jessica Weber