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Lesson 8

Completing the Accounting Process

for a Service Business
Lesson Objectives:

At the end of the lesson, students are expected to:

1. Learn how to prepare at the end of the accounting period the preparation of worksheet, the financial
statements, adjusting entries, closing entries and post-closing trial balance.
2. Review the adjusting entries and the steps in the accounting cycle.

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DISCUSSION OF CONTENT

WORKSHEET

A Worksheet is needed to gather and “workout” the adjustments at the reporting date. A worksheet is a columnar
paper where the first two columns are provided for the trial balance, which is the starting point for the preparation of the
financial statements. The next two columns are for the adjustments and from which adjusted balances are determined. A
ten-column worksheet has the following money columns:

Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit

ILLUSTRATION – WORKSHEET

A trial balance and additional information for adjustments appear below for Carla Auto Repair Shop after one
year of operation:

CARLA AUTO REPAIR SHOP

TRIAL BALANCE
December 31, 2020

Debit Credit
Cash On Hand P 25,000
Cash In Bank 45,000
Accounts Receivable 49,000
12% Notes Receivable 30,000
Prepaid Insurance 15,000
Prepaid Supplies 600
Machinery & Equipment 150,000
Furniture & Fixtures 25,000
Accounts Payable P 26,000
18% Notes Payable 50,000
Bella, Capital 132,850
Bella, Personal 5,000
Repair Income 275,000
Referral Income 15,000
Salaries Expense 45,000
Rent Expense 55,000
Taxes & Licenses Expense 7,250
Utilities Expense 46,750
Interest Expense 250
TOTALS P 498, 850 P 498, 850

1. 10% of the accounts receivable should be recognized as doubtful of collection.

2. Insurance Premium recorded as Prepaid Insurance was for six months starting September 1, 2020
3. Supplies amounting to P200 are still on hand.

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4. The notes receivable represents a 60-day note received from the customer on Nov. 16, 2020.
5. Machinery and equipment were acquired April 1, 2020 with an estimated useful life of 10 years and a scrap
value of P50,000.
6. The furniture and fixtures were acquired January 1, 2020 with an estimated useful life of 10 years and a scrap
value of P2,500
7. The notes payable dated December 1 is for 60 days due to Republic Finance.
8. December gross receipts is P50,000 subject to 3% Percentage tax.

Computations/ Explanations:

1. The amount estimated as doubtful of collection should be treated as uncollectible, hence, deduction to the amount
of account receivable. 10% x P49,000 = P4,900. This will be discussed in detail in Intermediate Accounting
subject.

2. As of December 31, 2020, the expired portion of the Prepaid Insurance acquired for six months recorded
on September 1, 2020 was four months. P15,000 x 4/6 = P10,000. “4” represents the months expired while “6”
represents the full term of the insurance. P10,000 is the expired portion to be recognized as “Insurance Expense”
and will be deducted to the P15,000 amount recorded as Prepaid Insurance.

3. The unadjusted balance of Prepaid Supplies presented was P600. The amount of unused Supplies amounts to
P200 and it follows that the difference of P400 should be recognized as “Supplies Expense” as it was used
during the year. The amount of Prepaid Supplies that should be recognized is P200.

4. The Note Receivable was acquired from customers on November 16, 2020 and the interest from that date up to
the balance sheet date (December 31, 2020) should be recognized. The computation of the ‘Interest Income’
for this note should be computed as: P30,000 x 12% x 45/360 = P450. ‘45’ represents the number of days from
November 16 – December 31, 2020 while ‘360’ represents the number of days in the whole year. (Applying the
banker’s rule in computing interest, 360 should be used instead of 365 unless stated that 365 days will be used)

5. Depreciation is a reduction in the value of an asset with the passage of time, due in particular to wear and
tear.The machinery and equipment were acquired on April 1, 2020 and as of December 31, 2020; these were
already used for 9 months. The statement above provided that the machinery and equipment have a useful life of
10 years and salvage value at the end of its useful life of P50,000. In computing the depreciation:
P150,000 – P50,000 = P10,000 x 9/12 = P7,500 (Depreciation Expense)
10 years
 P10,000 – annual depreciation of the equipment
 9 – number of months that the machinery and equipment have been used
 12 – number of months in a year
 9/12 – proration of the annual depreciation if in case the asset is not used for the whole year.

6. Depreciate the furniture and fixtures for one year since it was acquired on January 1,2020:
P25,000 – P 2,500 = P2,250 (Depreciation Expense)
10 years

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 P2,250 – the annual depreciation of P2,250 will be recognized in its totality since the asset was used for the
whole year. No proration of this amount since the date of acquisition and presumed use of the asset is January
1 of this year.

7. The 18% Notes Payable dated December 1, 2020 will have an accrued interest from December 1 to 31 and will be
recognized as “Interest Payable” because it is from a liability. The computation is as follows: P50,000 x 18% x
30/360 = P750 (Interest Payable). ‘30/360’ is the proration because the note was not contracted at the beginning
of the year and ‘30’ represents the number of days the loan was outstanding.

8. The Percentage Tax is a business tax recognized as “Taxes Expense” in the books of the taxpayer and the amount
that should be recognized as expense is computed: P50,000 x 3% = P1,500. This amount should be recognized as
“Taxes Payable” assuming no payment was made to the taxing agency.

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Carla Auto Repair and Paint Shop

Worksheet
For the year ended December 31, 2020
Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit
Cash in Hand 25,000 25,000 25,000
Cash in Bank 45,000 45,000 45,000
Accounts Receivable 49,000 49,000 49,000
Notes Receivable 30,000 30,000 30,000
Prepaid Insurance 15,000 2) 10000 5,000 5,000
Prepaid Supplies 600 3) 400 200 200
Machinery & Equipment 150,000 150,000 150,000
Furniture & Fixtures 25,000 25,000 25,000
Accounts Payable 26,000 26,000 26,000
Notes Payable 50,000 50,000 50,000
Carla, Capital 132,850 132,850 132,850
Carla, Personal 5,000 5,000 5,000
Repair Income 275,000 275,000 275,000
Referral Income 15,000 15,000 15,000
Salaries Expense 45,000 45,000 45,000
Taxes & Licenses Expense 7,250 8) 1500 8,750 8,750
Rent Expense 55,000 55,000 55,000
Utilities Expense 46,750 46,750 46,750
Interest Expense 250 7) 750 1,000 1,000
498,850 498,850
Doubful Accounts Expense 1) 4900 4,900 4,900
Allow for Doubtful Accounts 1) 4900 4,900 4,900
Insurance Expense 2) 10000 10,000 10,000
Supplies Expense 3) 400 400 400
Interest Receivable 4) 450 450 450
Interest Income 4) 450 450 450
Depreciation Exp.-Mach&Eq 5) 7500 7,500 7,500
Accumulated Depr.-Mach&Eq 5) 7500 7,500 7,500
Depreciation Exp.-Fur&Fix 6) 2250 2,250 2,250
Accumulated Depr.-Fur&Fix 6) 2250 2,250 2,250
Interest Payable 7) 750 750 750
Taxes Payable 8) 1500 1,500 1,500
Totals 27,750 27,750 516,200 516,200 181,550 290,450 334,650 225,750
Net Income 108,900 108,900
Totals 290,450 290,450 334,650 334,650

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Steps in preparing the worksheet:

1. Enter the worksheet heading which consists of three lines shown above: (Name of company, Title ‘Worksheet’
and the period covered)

2. Enter the column headings, providing the first two money columns for the trial balance, and the next eight money
columns two for each of the following: Adjustments, Adjusted Trial Balance, Income Statement and Balance
Sheet.
3. Copy the trial balance in the first two money columns. Do not copy the totals. Prove the trial balance by footing
again. Rule and double rule the totals.

4. Enter the adjustments in the next two money columns. If the account to be adjusted exists in the trial balance, just
write the figure alongside the account. If no account exists in the trial balance, then create an account below it.
Identify each adjustment by using key letters or numbers for easy reference. Prove the equality of what you did by
footing the debit and credit columns, then rule and double rule.

5. Take the adjusted balances of all accounts and extend to the Adjusted Trial Balance column. Accounts with no
adjustments are extended in their original amounts.
A debit account in the trial balance with a debit adjustment is added (refer to interest expense) while a
credit adjustment is deducted to arrive at the adjusted balance (refer to prepaid insurance). If the result is a debit,
extend to the debit column of the adjusted trial balance, if a credit, extend to the credit column of the adjusted trial
balance. A credit account in the trial balance with a credit adjustment is added while a debit adjustment is
deducted to arrive at the adjusted balance. Again extend the balance to the debit or credit side of the adjusted trial
balance. All new accounts below the trial balance are extended directly to the appropriatecolumn of the adjusted
trial balance column.

6. From the adjusted balances, extend all income and expense accounts to the income statement column. Total the
debit column and credit column. The debit total represents the expenses and the credit total represents the income.
If the credit total is more than the debit total, the difference represents a net income from operation and should be
placed on the debit side of the income statement and extended to the credit side of the statement of financial
position. Using the illustrated worksheet, it will appear as follows:

Income Statement
Debit Credit
Subtotal P181,550 P290,450
Net Income 108, 900
Totals P290,450 P290,450

7. Extend all assets, liabilities, capital and drawing account to the statement of financial position column. Sub-total
the debit and the credit columns. Enter the net income on the credit side and present the totals. Using the
illustrated worksheet, it will appear thus:

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Statement of Financial Position

Subtotal P334,650 P225,750
Net Income 108, 900
Totals P334,650 P 334,650

If the debit total in the income statement column is more than the credit total, the result is a net loss figure
which should be entered on the credit column. This in turn is extended to the debit column of the statement of
financial position. Care should be taken in preparing the worksheet. If the difference (net income or net loss) in
the income statement column and in the statement of financial position column are not the same, errors may have
been committed either in copying amounts or in the extension process. Balancing the last four money columns,
however, is not an assurance that your work is correct since errors in computations and in analyzing the data for
adjustments will not be reflected in a balanced worksheet. The completed worksheet will assist the accountant in
preparing the financial statements and in recording the adjusting and closing entries.

ADJUSTING ENTRIES RECORDED AND POSTED TO THE LEDGER

Based on the adjustment column of the worksheet we prepared above, the adjusting entries will now be formally
recorded in the general journal. Take note of the ledger page numbers in the F column.

GENERAL JOURNAL
Date Particulars F Debit Credit
2020
Dec. 31 Adjusting Entries:
1) Doubtful Accounts 607 4,900
Allowance for Doubtful Accounts 103 4,900
To provide for uncollectible accounts.

2) Insurance Expense 608 10,000

Prepaid Insurance 107 10,000
To adjust for the expired insurance.

3) Supplies Expense 602 400

Prepaid Supplies 108 400
To adjust for the supplies used up.

4) Interest Receivable 106 450

Interest Income 503 450
To accrue interest on notes.

5) Depreciation Expense - Machinery & Equipment 609 7,500

Accumulated Depreciation - Machinery & Equipment 202 7,500
To take up depreciation on machinery and equipment.

6) Depreciation Expense - Furnitures & Fixtures 610 2,250

Accumulated Depreciation - Furniture & Fixtures 204 2,250
To take up depreciation on furnitures and fixtures.

7) Interest Expense 606 750

Interest Payable 303 750
To accrue for interest on note due to Republic Finance.

8) Taxes and Licenses Expense 603 1,500

Taxes Payable 304 1,500
To record accrued taxes.

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Note that the date is the end of the accounting period. The entries should next be posted to the general ledger to arrive at
the adjusted balances. Postings for the first two entries will appear thus:

Allowance for Doubtful Accounts Acct. No. 103

Date Explanation Ref Debit Credit Balance
2020 Debit Credit
Dec. 31 AE1 4,900 4,900

Doubtful Accounts Expense Acct. No. 607

Date Explanation Ref Debit Credit Balance
2020 Debit Credit
Dec. 31 AE1 4,900 4,900

Prepaid Insurance Acct. No. 107

Date Explanation Ref Debit Credit Balance
2020 Debit Credit
Sept. 1 CPJ 9 15,000 15,000
Dec. 31 AE2 10,000 5,000

Insurance Expense Acct. No. 608

Date Explanation Ref Debit Credit Balance
2020 Debit Credit
Dec. 31 AE2 10,000 10,000

Note that the Reference (Ref) Column identifies the adjusting entries (AE) with reference numbers copied from
the entry number. After all the postings, the ledger balances will reflect the same amounts as shown in the Adjusted Trial
Balance column of the worksheet. Shown below is the Adjusted Trial Balance after taking into consideration the year-end
adjustments of Carla:

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CARLA AUTO REPAIR SHOP

ADJUSTED TRIAL BALANCE
December 31, 2020

Debit Credit
Cash On Hand P 25,000
Cash In Bank 45,000
Accounts Receivable 49,000
Allowance for Doubtful Accounts P 4,900
Notes Receivable 30,000
Interest Receivable 450
Prepaid Insurance 5,000
Prepaid Supplies 200
Machinery & Equipment 150,000
Accumulated Depreciation – Machinery & Equipment 7,500
Furniture & Fixtures 25,000
Accumulated Depreciation – Furniture & Fixtures 2,250
Accounts Payable 26,000
Notes Payable 50,000
Interest Payable 750
Taxes Payable 1,500
Carla, Capital 132,850
Carla, Personal 5,000
Repair Income 275,000
Referral Income 15,000
Interest Income 450
Depreciation Expense – Machinery & Equipment 7,500
Depreciation Expense – Furniture & Fixtures 2,250
Doubtful Accounts Expense 4,900
Insurance Expense 10,000
Salaries Expense 45,000
Supplies Expense 400
Rent Expense 55,000
Taxes & Licenses Expense 8,750
Utilities Expense 46,750
Interest Expense 1,000
TOTALS P 516,200 P 516,200

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PREPARING THE FINANCIAL STATEMENTS

INCOME STATEMENT – An income statement is a summary of revenues earned and expenses incurred for a certain
period of time. This is usually presented first because you need to determine the profit which has to be shown in the
capital statement then the balance of the capital account is transferred in the statement of financial position.

Rules in preparing the Income Statement:

1. The statement consists of four parts: heading, body of the statement for revenues earned and for expenses
incurred and net income or profit.
2. Heading consist of three lines: Name of Business, title of report, time period.
3. There are two margins in the body – the extreme margin on the left side is used to describe the accounts
contained in the major section.
4. There are two money columns in the body – the extreme margin on the left side is for the major amounts and
the inner money column contains the details of the major amounts.
5. Peso signs in the final money column (extreme right) are placed on the first and last amounts.
6. A single line is placed under the last figure to be added or subtracted and a double line is placed under the
final figure.
7. The principal income is always presented first. Expenses may be presented from the highest amount to the
lowest amount (descending order), in which case other operating expenses may be presented first in the
expense section. Or expenses may be arranged alphabetically. Interest expense being a financial cost is always
presented last. The rule is also the same in the arrangement of the expenses in the supporting notes.

Applying the aforementioned rules in preparing an income statement, refer to the adjusted trial balance in the worksheet
of Carla Auto Repair Shop. Presented below is the nature of expense form of income statement of the said auto repair
shop. The two presentation forms of income statement will be tackled in detail in higher accounting subjects so for the
meantime, an income statement based on the nature of expenses is presented:

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CARLA AUTO REPAIR SHOP

INCOME STATEMENT
For the year ended December 31, 2020

Revenue:
Repair Income ₱ 275,000
Other Income (Note 1) 15,450
Expenses:
Salaries Expense ₱ 45,000
Depreciation Expense (Note 2) 9,750
Other Operating Expense (Note 3) 125,800 - 180,550
Interest Expense - 1,000
PROFIT/(LOSS) ₱ 108,900

Note 1: Other Income

Referral Income ₱ 15,000
Interest Income 450
Total ₱ 15,450

Note 2: Depreciation Expense

Depreciation: Machinery & Equipment ₱ 7,500
Depreciation: Furnitures & Fixtures 2,250
Total ₱ 9,750

Note 2: Other Operating Expense

Rent Expense ₱ 55,000
Utilities Expense 46,750
Insurance Expense 10,000
Taxes & Licenses 8,750
Bad Debts Expense 4,900
Supplies Expense 400
Total ₱ 125,800

STATEMENT OF CHANGES IN EQUITY – Changes in the owner’s capital or owner’s equity are summarized in the
statement also known as the capital statement. This statement is presented for a period of one year and give the owner a
satisfactory explanation of how his/her capital changes throughout the year. The changes that may affect the equity of an
owner are the initial and additional investments made during the year, withdrawal of assets, and net income/net loss
sustained by the entity.

In the example below, take note that in the unadjusted trial balance of Carla, she had P132,850 in her capital account. Her
initial investment in her business was P100,000 and she made an additional investment amounting to P32,850.

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CARLA AUTO REPAIR SHOP

STATEMENT OF CHANGES IN OWNER'S EQUITY
For the year ended December 31, 2020
Carla, Capital, January 1 ₱ 100,000
Additional Investment 32,850
Add: Net Income 108,900
Total ₱ 241,750
Less: Withdrawals 5,000
Carla, Capital, December 31 ₱ 236,750

STATEMENT OF FINANCIAL POSITION – This statement lists in detail the assets and liabilities of the business and
shows the residual interest of the owner as of a specific date.

The Statement of Financial Position may be presented in two ways, account form and report form, depending on the
preference of users of the financial statements. Note that both ways are accepted by the standarads.

1. The account form balance sheet is presented in a horizontal format, with information in two columns beside
each other. The left column of the account form balance sheet lists assets, while the right column lists liabilities
and equity. Naturally, the last line in each column lists the total value of all assets and liabilities and equity,
respectively. The account form balance sheet can be easier to use when information is being presented for
multiple periods, and it allows the reader to verify that the ledger is in balance at a glance.
2. The report form balance sheet is presented in a vertical orientation, and is essentially one column that spans
the entire width of a page. Starting with assets, the report form balance sheet provides a total value at the end of
the assets section, followed by liabilities and equity, with the final line of the report form balance sheet providing
the total combined value of liabilities and equity.

Rules in presenting the Statement of Financial Position:

1. The heading consists of three lines:

a. Name of the Business
b. Title of the Report
c. Date
2. Margin on the left side for the major classifications: The extreme left margin is used for describing the major
classifications like current assets or current liabilities and the inner margin is used for describing the accounts
herein like cash, accounts receivable and supplies.
3. Money column on the right side: The placement of the amounts usually follows the margin on the left side;
extreme right money column for the major amounts following the major classifications like total current assets
P149,750, total current liabilities P78,250, and inner money columns for the amounts of the described accounts
like Cash P70,000, Trade and Other Receivables P74,550, and Prepaid Expenses P5,200.
4. In the final money column, the peso sign is placed on the first and last amounts per accounting value; while in the
inner money column, the peso sign is placed on the first amount of every column.
5. A single line is placed under the last figure to be added or subtracted and a double line is placed under the final
figure.

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The rules are to be followed whether the format used is a report format or account format.

Shown below is an example of a Statement of Financial Position for Carla’s Auto Repair Shop in an Report
Form with disclosures (in the previous part of this module, the account form of Statement of Financial Position was
shown for Mr. N Travel and Tours):

CARLA AUTO REPAIR SHOP

STATEMENT OF FINANCIAL POSITION
December 31, 2020
ASSETS
Current Assets:
Cash (Note 1) ₱ 70,000
Trade and Other Receivables (Note 2) 74,550
Prepaid Expenses (Note 3) 5,200
Total ₱ 149,750
Non-Current Assets:
Property & Equipment (Note 4) 165,250
Total Assets ₱ 315,000

LIABILITIES AND OWNER'S EQUITY

Current Liabilities:
Trade & Other Payables (Note 5) ₱ 78,250
Owner's Equity:
Carla, Capital 236,750
Total Liabilities & Owner's Equity ₱ 315,000

Note 1: Cash on Hand ₱ 25,000

Referral Income 45,000
Total ₱ 70,000

Note 2: Accounts Receivable ₱ 49,000

Less: Allowance for Bad Debts 4,900
Net Realizable Value ₱ 44,100
Notes Receivable 30,000
Interest Receivable 450
Total ₱ 74,550

Note 3: Prepaid Insurance ₱ 5,000

Prepaid Supplies 200
Total ₱ 5,200

Note 4: Machinery & Equipment ₱ 150,000

Less: Accumulated Depreciation 7,500 ₱ 142,500

Furnitures & Fixtures ₱ 25,000

Less: Accumulated Depreciation 2,250 22,750
Total ₱ 165,250

Note 5: Accounts Payable ₱ 26,000

Notes Payable 50,000
Interest Payable 750
Taxes Payable 1,500
Total ₱ 78,250

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Current and Non-Current Classification

Current Assets – include cash and cash equivalents which are not restricted in use, as well as other assets expected to be
realized into cash, or sold or consumed within the normal operating cycle of the business or one year, whichever is longer.
The following are examples of current assets: Cash, Marketable Securities, Receivables that are collectible within one
year or the normal operating cycle of the business, Merchandise Inventory, Prepaid Expenses and Contra-Asset Accounts
such as Allowance for Bad Debts that are treated as deduction to another current asset account.

Non-Current Assets – those assets that are not included in the current assets such as the property, plant and equipment or
fixed assets which are needed to support the operation of the business over a long period of time and are not intended for
sale. Examples are Land, Building, Equipment, Furniture & Fixtures, Leasehold or Lease Right and Contra-Asset Account
such as Accumulated Depreciation which are treated as deduction to another non-current asset account.

Current Liabilities – those debts or obligations reasonably expected to be liquidated in the normal course of the entity’s
operating cycle or paid within a period of one year by the use of current assets or the creation of other current liabilities.
Examples are Accounts Payable, Loan Payable (payable within one year), Utilities Payable, Interest Payable and Taxes
Payable.

Non-Current Liabilities – long term liabilities or obligations which are payable longer than one year such as Note
Payable, Mortgage Payable and Bond Payable.

These will be discussed thoroughly in Intermediate Accounting subjects. I included this for you to have an idea of the
basic classification of accounts and to know the basics as early as now. 

Adequate Disclosures – require the inclusion of significant information that will help enhance the entity’s financial
statements. Also helps users be informed of additional facts and other information such as major liabilities and their due
dates, contingent assets and liabilities, subsequent events that may affect the resources that were presented in the
Statement of Financial Position that will aid them in properly interpreting the financial statements. Notes supporting line
items shown in the Income Statement and Statement of Financial Position are included to adequately inform the users of
the contents and relevant information that will help them make their decision based on the financial statement presented to
them.

STATEMENT OF CASH FLOWS – The definition and function of this statement has been given in the previous part of
this module. Relevance of this statement are: a) it will enlighten the owner/entity on how the cash is being managed, b)
being able to monitor the cash flows in the business as it is vital to the financial health of the business and c) some
businesses fail because of its inability to maintain a proper balance between receipts and disbursements.

A summary of cash flows is given below:

Activities Inflows Outflows

Operating Revenue collections Payment of expenses
Investing Sale of securities, plant, property Acquisition of securities, plant,
and equipment property and equipment
Financing Loans extended by creditors or Cash paid to creditors or
contributors of investors withdrawn by investors

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Shown below is the Statement of Cash Flows for the Auto Repair Shop of Carla. Take note of the following additional
information: Cash on January 1, 2020 was P100,000 with an additional investment of P32,850 in cash during the year.
Accounts Payable came from purchase of machinery.
CARLA AUTO REPAIR SHOP
STATEMENT OF CASH FLOWS
For the year ended December 31, 2020
Cash flows from operating activities:
Cash received from customers (schedule 1) ₱196,000
Collections for referrals made 15,000
Payment of rent - 55,000
Payment of utilities - 46,750
Payment of salaries - 45,000
Payment of insurance (schedule 2) - 15,000
Payment of taxes (schedule 3) - 7,250
Payment of supplies (schedule 4) - 600
Payment for interest expense (schedule 5) - 250
Net cash provided by operating activities ₱ 41,150
Cash flows from investing activities:
Acquisition of machinery & equipment (schedule 6) -₱124,000
Acquisition of furniture - 25,000
Net cash used by investing activities - 149,000
Cash flows from financing activities:
Cash Investment of Carla ₱ 32,850
Cash Withdrawals made by Carla - 5,000
Loan from Republic Finance 50,000
Net cash provided by financing activities 77,850
Increase in cash -₱ 30,000
Cash, January 1 100,000
Cash, December 31 ₱ 70,000

Schedule 1: Repair Income ₱ 275,000

Accounts Receivable, Dec. 31 - 49,000
Notes Receivable, Dec. 31 - 30,000
Collection from customers ₱ 196,000

Schedule 2: Insurance Expense ₱ 10,000

Prepaid Insurance, Dec. 31 5,000
Insurance paid ₱ 15,000

Schedule 3: Taxes and Licenses Expense ₱ 8,750

Prepaid Insurance, Dec. 31 - 1,500
Insurance paid ₱ 7,250

Schedule 4: Supplies Expense ₱ 400

Prepaid Supplies, Dec. 31 200
Insurance paid ₱ 600

Schedule 5: Interest Expense ₱ 1,000

Interest Payable, December 31 - 250
Payment for interest ₱ 750

Schedule 6: Machinery & Equipment ₱ 150,000

Accounts Payable - 26,000
Payment for machinery ₱ 124,000
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Note that the Statement of Cash Flows tell the users that the cash flows from operation and financing activities are
inadequate to meet the investing activities of the business such as acquisition of needed property and equipment. A more
detailed discussion about this financial statement will be tackled more and elaborated in higher accounting subjects.

CLOSING ENTRIES

After all the adjustments have been journalized and posted, and the financial statements prepared, and income and
expense accounts and owner’s drawing account have to be closed. Income, expense and drawing accounts accumulate
information only for a specific accounting period and must be closed at the end of the calendar or fiscal period.

Closing the book means bringing the nominal and drawing accounts to zero balances by transferring them to the
owner’s equity (capital account of the owner). Remember profit or loss goes to the owner and this is done by adding profit
to or subtracting loss from the owner’s capital account to arrive at ending capital. After the closing entries, the books are
“cleared” of the temporary or nominal accounts, so that in the following accounting period a new set of temporary or
nominal accounts will again be opened and used for recording the revenue and expense transactions for that year. This is
the reason why the heading of the income statement is only for one accounting period.

On the other hand, assets, liabilities, and the capital accounts do not need closing entries since these are real or
permanent accounts whose balances are brought forward to the next accounting period. These accounts are brought to a
zero balance only when the assets are disposed, the liabilities are paid and the capital is recovered by the owner.

In making the closing entries, use the income statement column of the worksheet as a guide. The title Income
Summaryis an account used to close the nominal values and bring them to the capital account. These are the steps in
making the closing entries:

1. Close the revenue accounts such as Repair Income and Interest Income which normally are credit balances by
a debit entry and credit the title ‘Income Summary”.
2. Close the expense accounts such as Salaries Expense and Taxes Expense which normally are debit balances by a
credit entry and debit the title ‘Income Summary”
3. Determine the balance of the Income Summary account. A credit balance, representing a net income, should be
closed by debiting “Income Summary” and crediting to increase the Owner’s capital account. A debit balance,
representing a net loss, should be closed by crediting the Income Summary account and debiting to decrease the
Owner’s Capital Account.
4. The drawing account which normally is a debit balance should be closed by crediting this account and debiting to
decrease the capital account.

The diagram shown below shows the flow of the nominal accounts to the capital account of the owner. This
diagram portrays the steps in making the closing entries we have discussed above. The ledger or T-accounts are used to
explain how we will make the balances of the nominal accounts (revenue and expense accounts) be closed to the “Income
Summary” account and the drawing account be closed ultimately to the capital account of the owner. The ending balance
of the capital account, representing a “catch all” of the nominal accounts as well as the owner’s investment and personal
drawing, is presented in the Statement of Financial Position.

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Each Expense accounts Each Revenue accounts

Normal debit Normal credit
Credit to close Debit to close
balance 1) balance
2)
Income Summary account
Total Expense Total Income

If a credit balance,
close on the debit
side
Carla, Drawing 3) Carla, Capital
Normal debit Normal credit
Credit to close Withdrawals
balance balance
4)
Net Income

The closing entries for Carla Auto Repair Shop will be recorded as follows:

Date Particulars F Debit Credit

2020
Dec. 31 Closing Entries:
1) Repair Income 275,000
Referral Income 15,000
Interest Income 450
Income & Expense Summary 290,450
To close the credit accounts.

2) Income & Expense Summary 181,550

Salaries Expense 45,000
Supplies Expense 400
Taxes & Licenses 8,750
Rent Expense 55,000
Utilities Expense 46,750
Interest Expense 1,000
Bad Debts Expense 4,900
Insurance Expense 10,000
Depreciation Expense - Machinery 7,500
Depreciation Expense - Furniture 2,250
To close the debit accounts.

3) Income & Expense Summary 108,900

Carla, Capital 108,900
To close profit to capital.

4) Carla, Capital 5,000

Carla, Drawing 5,000
To close drawing to capital.

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On December 31, 2020, the capital account will show an ending balance of P236,750, the same amount shown
in the statement of financial position. (Kindly get this amount by taking into account all entries that involved the capital
account. You will arrive at this amount by using the T-Accounts or in any other way that is convenient for all of you.
Familiarize yourselves on how every account moves and how a transaction affects that particular account.) Also, take
note that all of the nominal accounts (such as Repair Income, Supplies Expense, Carla, Drawing) are all zero or
cleared accounts.

After the closing entries have been recorded and posted, all accounts in the general ledger whether real or
nominal, have to be double-ruledto show the end of the accounting period. All the real accounts with balances will be
brought forward next accounting period unlike the nominal accounts which will start from the scratch.

PREPARING THE POST-CLOSING TRIAL BALANCE

After accomplishing so many accounting steps, there is a need again to prepare a trial balance to prove the
equality of the debits and credits. This time, the trial balance is called a Post Closing Trial Balance since it is prepared
after closing the books and contains only real accounts. Post Closing Trial Balance has the same accounts and amounts as
those found in the statement of financial position.

Shown below is the Post-Closing Trial Balance of Carla Auto Repair Shop:

CARLA AUTO REPAIR SHOP

POST CLOSING TRIAL BALANCE
December 31, 2020

Debit Credit
Cash On Hand P 25,000
Cash In Bank 45,000
Accounts Receivable 49,000
Allowance for Doubtful Accounts P 4,900
Notes Receivable 30,000
Interest Receivable 450
Prepaid Insurance 5,000
Prepaid Supplies 200
Machinery & Equipment 150,000
Accumulated Depreciation – Machinery & Equipment 7,500
Furniture & Fixtures 25,000
Accumulated Depreciation – Furniture & Fixtures 2,250
Accounts Payable 26,000
Notes Payable 50,000
Interest Payable 750
Taxes Payable 1,500
Carla, Capital 236,750
TOTALS P 329,650 P 329,650

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REVERSING ENTRIES

Reversing entries are journal entries that are made by an accountant at the beginning of the accounting cycle. This
is an optional step in the accounting cycle and if the bookkeeper wishes can skip it entirely. The purpose of these entries is
to reverse the adjusting entries that were made in the previous financial reporting period. It is commonly used for revenue
and expense account which had accruals or prepayment in the preceding accounting cycle and the accountant prefers not
to keep these in the accounting system.

There are two key benefits to making a reversal entry:

 It significantly reduces the chances of making an error of double counting certain expenses or revenues.
 It will allow efficient processing of actual invoices during the current accounting period.

Why are Reversal Entries needed?

Reversal entries will significantly make life of a bookkeeper easier, since he won’t have to remember which
expenses and revenues were accrued and prepaid. He can record the reversing entries to negate the effect of the adjusting
entries that were passed in the preceding year and essentially start anew. For the current period, he would just have to
record the expenses and revenue as they come in and not worry about the accrued and prepayments of the last period.

If the bookkeeper does not record these reversal entries, then he would have to remember which portion of the
current expenses, for example, has already been paid out in the previous period. Therefore, there is a high chance of
double-counting certain revenues and expenses. The practice of making reversal entries at the beginning of the accounting
cycle will ensure that this error of double counting is avoided.

It should be emphasized that reversing entries are OPTIONAL. Generally, a reversing entry should be made
for any adjusting entry that increased an asset or liability account. Therefore, all accruals are reversed but only
deferrals initially recorded in income statement – income or expense – accounts are reversed.

Illustration: A certain company has accrued the salaries of their employees on the balance sheet date:

2020 Salaries Expense 18,000

Dec. 31 Salaries Payable 18,000
To record accrued salaries.

When the employees are paid on the next regular payday, the entry would be:

2021 Salaries Payable 18,000

Jan. 10 Salaries Expense 54,000
Cash 72,000
To record accrued salaries.

Note that when the payment is made, without a prior reversing entry, the accountant must look into the records to
find out how much of the P72,000 applies to the current accounting period and how much was accrued at the beginning of
the period.

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This step may appear easy in this simple case, but think of the problems that may arise if the company has many
employees, especially if some of them are paid on different time schedules such as weekly or monthly. A reversing entry
is an accounting procedure that helps solve this difficult problem. As noted above, a reversing entry is exactly what its
name implies. It is a reversal of the adjusting entry made. For example, observe the following sequence of transactions
and their effects on the ledger account – salaries expense:

1. Adjusting entry
2020 Salaries Expense 18,000
Dec. 31 Salaries Payable 18,000
To record accrued salaries.

2. Closing entry

2020 Income & Expense Summary 18,000

Dec. 31 Salaries Expense 18,000
To record closing of salaries expense account.

3. Reversing entry

2021 Salaries Payable 18,000

Jan. 1 Salaries Expense 18,000
To record reversal of salaries expense account.

4. Payment entry

2021 Salaries Expense 72,000

Jan. 10 Cash 72,000
To record payment of salaries.

These transactions had the following effects on salaries expense:

a. Adjusted salaries expense to accrue P18,000 in the proper accounting period(which is 2020).
b. Closed the amount of Salaries Expense accrued to Income & Expense Summary account (assume that the amount
accrued is the only Salaries Expense to be recognized for 2020).
c. Established a credit balance of P18,000 on January 1, 2021 in salaries expense equal to the expense recognized
through the adjusting entry on December 31, 2020. The liability account Salaries Payable was reduced to a zero
balance. (Effect of reversing entry in #3)
d. Recorded the P72,000 payment of salaries in the usual manner. The reversing entry has the effect of leaving a
balance of P54,000 (P72,000 – P18,000) in the Salaries Expense account. This P54,000 balance represented the
salaries expense which pertains to 2021 expense already.

Making the payment entry was simplified by the reversing entry. Reversing entries apply to all accrued expenses
or revenues.

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SUMMARY OF THE LESSON

 The Income Statement contains the following information: a. Revenue; b. Itemized list of expenses; c. Net
Income or Net Loss
 The Statement of Financial Position contains the following information: a. Assets of the business; b. Liabilities
or the amount of the assets funded by the creditors; c. Residual interest of the owner(s)
 The Statement of Changes in Owner’s Equity gives details on: a. Capital Balances; b. Drawings; c. Additional
Investments; d. Net Income or Net Loss
 A Cash Flow Statement is prepared to show the effect on cash of the following business activities: a. Financing;
b. Operating; c. Investing
 The closing process is the method of giving zero balances to the temporary accounts so that these accounts will
be cleared and made ready for recording another set of revenues and expenses for the next accounting period.
 The closing process involves the following: a. Close the Revenue accounts to the title “Income Summary”; b.
Close the Expense accounts to “Income Summary”; c. Close the Income Summary to Owner’s Capital; d. Close
the Drawing account to Owner’s Capital
 A Post-Closing Trial Balance is prepared after the closing entries to determine if the equality of balances is still
maintained. It shows the real or permanent accounts that should be opened for the next accounting period.

Learning Module on FAR101A