Accounting-1 Reading Materials#1

ACCOUNTING 1 READING MATERIALS
WHAT IS ACCOUNTING?
ACCOUNTING is famously known as the "language of business". Through the financial

statements, the end-product reports in accounting, it delivers information to different users.
Accounting is a means through which information about a business entity is communicated.
ACCOUNTING DEFINITION
Technical definitions of accounting have been published by different accounting bodies.
The American Institute of Certified Public Accountants (AICPA) defined ACCOUNTING as:
"the art of recording, classifying, and summarizing in a significant manner and in terms of
money, transactions and events which are, in part at least of financial character, and interpreting
the results thereof."
The AICPA also provided this definition: "ACCOUNTING is a service activity. Its function is
to provide quantitative information, primarily financial in nature, about economic entities that is
intended to be useful in making economic decisions, in making reasoned choices among
alternative courses of action."
The American Accounting Association (AAA) defined ACCOUNTING as: "the process of
identifying, measuring and communicating economic information to permit informed judgment
and decision by users of the information."
ACCOUNTING is considered an art because it requires the use of skills and creative
judgment. One has to be trained in this discipline to be able to perform accounting functions
well. It is the “language of business”. Through the accounting data prepared the business
communicates to the different interested parties the results of its operation and its financial
condition. Aside from this, the accountant’s opinion and estimation are needed in preparing
accounting data and reports.
ACCOUNTING is also considered a science because it is a body of knowledge. Accounting,

however, is not only an art but also a science in a way there are accounting principles that serve
as guide in accomplishing data and preparing reports.
Based on the above definitions and the very nature of accounting as the language of business, it
is evident that the basic purpose of accounting is to provide information needed by users in
making economic decisions.
Accounting Information
Here's a list of the different types of information provided by accounting reports.
1. Results of Operations. This pertains to the profit generated by the company for a certain
span of time (for a year, for a quarter, for a month, etc.). This is measured by deducting
all expenses from all income. The resulting amount is called net income.
2. Financial Position. How much resources does the entity currently have? How much does
the entity owe third parties? How much is left for the owners after we pay all obligations
ACCOUNTING-1 READING MATERIALS#1 Page 1

using our resources? The first question refers to the entity's total assets; the second
to liabilities, and the third to capital.
3. Solvency and Liquidity. Solvency refers to the entity's ability to pay obligations when
they become due. Liquidity pertains to its ability to meet short-term obligations.
4. Cash flows. The financial statements also show the inflows and outflows of cash in the
different activities of the business (operating, investing, and financing activities).
5. Other Information. The financial statements provide qualitative, quantitative, and
financial information. One of the characteristics of the financial statements is relevance.
Any information that could affect the decisions of users should be included in the
financial reports.
ROLE AND PURPOSE OF ACCOUNTING IN BUSINESS

1. It provides information useful for decision making
2. It records and analyzes business transactions
3. It provides useful information both inside and outside stakeholders of the organization in
assessing the economic performance and condition of the business
WHY STUDY ACCOUNTING?

In order to appreciate and understand the financial reports of the business, one should have an
understanding of how data are gathered and recorded. All these understandings are gained in the
study of accounting. Accounting can also be one’s profession –a work which is interesting and
highly rewarding.
BRIEF HISTORY OF ACCOUNTING
Accounting history can be traced back to a book called Summa de arithmetica, geometria,
proportioni et proportionalita, written by the Italian mathematician, Luca Pacioli, in A.D. 1494.
(He is considered as the father of accounting.)
Today, this book is regarded as an important document in accounting history: it included the first
printed work on algebra and also recorded for the very first time the system of the double-entry
accounting system that became popular with Italian merchants during the Renaissance.
The book also included illustrations and diagrams drawn by Pacioli's friend, Leonardo Da Vinci.
In this book, Luca Pacioli described the use of journals and ledgers, and warned that a merchant
should not rest until the debits equalled the credits! His ledger had accounts for assets, liabilities,
capital, income and expenses. He also demonstrated year-end closing entries and proposed a trial
balance be used to prove a balanced ledger.
The industrial revolution spurred the need for more advanced cost accounting systems, and the
development of corporations created much larger classes of external capital providers -
shareowners and bondholders - who were not part of the firm's management but had a vital
interest in its results. The rising public status of accountants helped to transform accounting into
a profession, first in the United Kingdom and then in the United States. In 1887, thirty-one
accountants joined together to create the American Association of Public Accountants. The first
standardized test for accountants was given a decade later, and the first CPAs were licensed in
1896.

The 19th century is a witness to the massive development of trade and industry and the simple
structure of a business change to a more complex one with the formation of business
combinations, mergers and consolidations. It became necessary to improve the process of
recording and reporting financial information. With the advent of the information age driven by
electronic devices such as the computer, the design for processing information turned from
manual to one that is electronically assisted
BRANCHES OF ACCOUNTING AND AREAS OF PRACTICE
Accounting is one of the oldest business disciplines. It has never failed to provide opportunities
to career-seekers. The high demand for accounting services makes it a stable profession amidst
economic fluctuations.
Different fields of specialization have evolved over the years. Today, holding a certification in a
specific field gives the holder an edge over those who are uncertified.
The branches of accounting (fields of specialization) include: financial accounting, management

accounting, cost accounting, auditing, tax accounting, accounting information systems, fiduciary,
and forensic accounting.
Accounting professionals work in at least one of the 4 major areas of accounting practice: public
accounting, private accounting, government accounting, and accounting education.
Accounting professionals in public accounting work in CPA firms or individually in providing

accounting and auditing services to clients. An accountant in private accounting is hired by a
business to work as an employee of that entity. Government accountants work in the
government and its agencies. Accounting education or academe includes accountants who
pursue careers as instructors, reviewers, researchers, and authors.
As a result of economic, industrial, and technological developments, different specialized fields

in accounting have emerged.
MAJOR AREAS OF ACCOUNTING

FINANCIAL ACCOUNTING – focuses on the development and communication of financial
information for external users.
MANAGEMENT ACCOUNTING – is concerned primarily with financial reporting for

internal users. Internal users, especially management, have control over the accounting system
and can specify precisely what information is needed and how the information is to be reported.
GOVERNMENT ACCOUNTING – focuses on the accounting development and

communication of financial affairs of governmental agencies.
THE FAMOUS BRANCHES OR TYPES OF ACCOUNTING INCLUDE:

1. Financial Accounting
Financial accounting involves recording and classifying business transactions, and preparing and
presenting financial statements to be used by internal and external users.

In the preparation of financial statements, strict compliance with generally accepted accounting
principles or GAAP is observed. Financial accounting is primarily concerned in
processing historical data.
2. Managerial Accounting
Managerial or management accounting focuses on providing information for use by internal
users, the management. This branch deals with the needs of the management rather than strict
compliance with generally accepted accounting principles.
Managerial accounting involves financial analysis, budgeting and forecasting, cost analysis,
evaluation of business decisions, and similar areas.
3. Cost Accounting
Sometimes considered as a subset of management accounting, cost accounting refers to the
recording, presentation, and analysis of manufacturing costs. Cost accounting is very useful in
manufacturing businesses since they have the most complicated costing process.
Cost accountants also analyze actual and standard costs to help managers determine future
courses of action regarding the company's operations.
4. Auditing
External auditing refers to the examination of financial statements by an independent party with
the purpose of expressing an opinion as to fairness of presentation and compliance with
GAAP. Internal auditing focuses on evaluating the adequacy of a company's internal control
structure by testing segregation of duties, policies and procedures, degrees of authorization, and
other controls implemented by management.
5. Tax Accounting
Tax accounting deals with tax matters affecting firms, individuals, trust and estates. It helps
clients follow rules set by tax authorities. It includes tax planning and preparation of tax returns.
It also involves determination of income tax and other taxes, tax advisory services such as ways
to minimize taxes legally, evaluation of the consequences of tax decisions, and other tax-related
matters.
6. Accounting Systems
Accounting systems involves the development, installation, implementation, and monitoring of
accounting procedures and systems used in the accounting process. It includes the employment
of business forms, accounting personnel direction, and software management.
7. Fiduciary Accounting
Fiduciary accounting involves handling of accounts managed by a person entrusted with the
custody and management of property of or for the benefit of another person. Examples of
fiduciary accounting include trust accounting, receivership, and estate accounting.
8. Forensic Accounting
Forensic accounting involves court and litigation cases, fraud investigation, claims and dispute
resolution, and other areas that involve legal matters. This is one of the popular trends in
accounting today.

9. Accounting Research – is a branch of accounting that deals with the creation of new
knowledge. It is the continuous improvement of the accountancy field through research and
studies.
USERS OF ACCOUNTING INFORMATION - INTERNAL & EXTERNAL
Accounting information helps users to make better financial decisions. Users of financial
information may be both internal and external to the organization.
Internal users are parties inside the reporting entity or company who are interested in
accounting information.
External users are parties outside the reporting entity or company who are interested in the
accounting information.
Internal users (Primary Users) of accounting information include the following:

 Management: for analyzing the organization's performance and position and taking
appropriate measures to improve the company results.
 Employees: for assessing company's profitability and its consequence on their future
remuneration and job security.
 Owners: for analyzing the viability and profitability of their investment and determining
any future course of action.
Accounting information is presented to internal users usually in the form of management

accounts, budgets, forecasts and financial statements.
External users (Secondary Users) of accounting information include the following:

 Creditors: for determining the credit worthiness of the organization. Terms of credit are
set by creditors according to the assessment of their customers' financial health. Creditors
include suppliers as well as lenders of finance such as banks.
 Tax Authorities: for determining the credibility of the tax returns filed on behalf of the
company.
 Investors: for analyzing the feasibility of investing in the company. Investors want to
make sure they can earn a reasonable return on their investment before they commit any
financial resources to the company.
 Customers: for assessing the financial position of its suppliers which is necessary for
them to maintain a stable source of supply in the long term.
 Regulatory Authorities: for ensuring that the company's disclosure of accounting
information is in accordance with the rules and regulations set in order to protect the
interests of the stakeholders who rely on such information in forming their decisions.
External users are communicated accounting information usually in the form of financial
statements. The purpose of financial statements is to cater for the needs of such diverse users of
accounting information in order to assist them in making sound financial decisions.
FORMS OF BUSINESS ORGANIZATION

These are the basic forms of business ownership:
1. Sole Proprietorship
A sole proprietorship is a business owned by only one person. It is easy to set-up and is the least
costly among all forms of ownership. The owner faces unlimited liability; meaning, the creditors
of the business may go after the personal assets of the owner if the business cannot pay them.
The sole proprietorship form is usually adopted by small business entities.
2. Partnership
A partnership is a business owned by two or more persons who contribute resources into the
entity. The partners divide the profits of the business among themselves. In general
partnerships, all partners have unlimited liability. In limited partnerships, creditors cannot go
after the personal assets of the limited partners.
3. Corporation
A corporation is a business organization that has a separate legal personality from its owners.
Ownership in a stock corporation is represented by shares of stock. The owners (stockholders)
enjoy limited liability but have limited involvement in the company's operations. The board of
directors, an elected group from the stockholders, controls the activities of the corporation.
4. Cooperative
A cooperative is a business organization owned by a group of individuals and is operated for
their mutual benefit. The persons making up the group are called members. Some examples of
cooperatives are: water and electricity (utility) cooperatives, cooperative banking, credit unions,
and housing cooperatives.
3 TYPES OF BUSINESS
There are three major types of businesses:

1. Service Business
A service type of business provides intangible products (products with no physical form).
Service type firms offer professional skills, expertise, advice, and other similar products.
Examples of service businesses are: schools, repair shops, hair salons, banks, accounting firms,
and law firms.
2. Merchandising Business
This type of business buys products at wholesale price and sells the same at retail price. They are
known as "buy and sell" businesses. They make profit by selling the products at prices higher
than their purchase costs.
A merchandising business sells a product without changing its form. Examples are: grocery
stores, convenience stores, distributors, and other resellers.
3. Manufacturing Business
Unlike a merchandising business, a manufacturing business buys products with the intention of
using them as materials in making a new product. Thus, there is a transformation of the products
purchased.
A manufacturing business combines raw materials, labor, and factory overhead in its production
process. The manufactured goods will then be sold to customers.
Hybrid Business

Hybrid businesses are companies that may be classified in more than one type of business. A
restaurant, for example, combines ingredients in making a fine meal (manufacturing), sells a cold
bottle of wine (merchandising), and fills customer orders (service).
Nonetheless, these companies may be classified according to their major business interest. In that
case, restaurants are more of the service type – they provide dining services.
BASIC ACCOUNTING PRINCIPLES AND CONCEPTS
In order to become effective in carrying out the accounting procedure, as well as in
communicating the financial information of the business, there is a widely accepted set of rules,
concepts and principles that governs the application of the accounting procedures, and it is
referred to as the Generally Accepted Accounting Principles or GAAP. It is relevant to
understand it because you need to abide by these concepts and principles every time you analyze
record, summarize, report and interpret financial transactions of a business.
Guidelines on Basic Accounting Principles and Concepts
GAAP is the framework, rules and guidelines of the financial accounting profession with a
purpose of standardizing the accounting concepts, principles and procedures. Here are the basic
accounting principles and concepts under this framework:
1. Business Entity
A business is considered a separate entity from the owner(s) and should be treated separately.
Any personal transactions of its owner should not be recorded in the business accounting book,
vice versa. Unless the owner’s personal transaction involves adding and/or withdrawing
resources from the business.
2. Going Concern
It assumes that an entity will continue to operate indefinitely. In this basis, assets are recorded
based on their original cost and not on market value. Assets are assumed to be used for an
indefinite period of time and not intended to be sold immediately.
3. Monetary Unit
The business financial transactions recorded and reported should be in monetary unit, such as US
Dollar, Canadian Dollar, Euro, Peso, etc. Thus, any non-financial or non-monetary information
that cannot be measured in a monetary unit are not recorded in the accounting books, but instead,
a memorandum will be used.
4. Historical Cost
All business resources acquired should be valued and recorded based on the actual cash
equivalent or original cost of acquisition, not the prevailing market value or future value.
Exception to the rule is when the business is in the process of closure and liquidation.
5. Matching
This principle requires that revenue recorded, in a given accounting period, should have an
equivalent expense recorded, in order to show the true profit of the business.
6. Accounting Period

This principle entails a business to complete the whole accounting process of a business over a
specific operating time period. It may be monthly, quarterly or annually. For annual accounting
period, it may follow a Calendar or Fiscal Year.
7. Conservatism
This principle states that given two options in the valuation of business transactions, the amount
recorded should be the lower rather than the higher value.
8. Consistency
This principle ensures consistency in the accounting procedures used by the business entity from
one accounting period to the next. It allows fair comparison of financial information between
two accounting periods.
9. Materiality
Ideally, business transactions that may affect the decision of a user of financial information are
considered important or material, thus, must be reported properly. This principle allows errors or
violations of accounting valuation involving immaterial and small amount of recorded business
transaction.
10. Objectivity
This principle requires recorded business transactions should have some form of impartial
supporting evidence or documentation. Also, it entails that bookkeeping and financial recording
should be performed with independence, that’s free of bias and prejudice.
11. Accrual
This principle requires that revenue should be recorded in the period it is earned, regardless of
the time the cash is received. The same is true for expense. Expense should be recognized and
recorded at the time it is incurred, regardless of the time that cash is paid.
BASIC ELEMENTS OF ACCOUNTING:
The elements of accounting pertain to assets, liabilities, and capital. Assets are resources owned
by a company; liabilities are obligations to creditors and lenders; and capital refers to the interest
of the owners in the business after deducting all liabilities from all assets (or, what is left for the
owners after all company obligations are paid).
BALANCE SHEET (Financial Condition):
A. ASSETS – economic resources of value that is owned by the business. They include
properties and other things of value the ownership title of which is the name of business.
Assets are classified into two: current assets and non-current assets. Current Assets are those
that are expected to be realized or used within the company's normal operating cycle or 1 year,
whichever is longer. They include properties that are held primarily for the purpose of selling
them in the near future. In essence, current assets are short-term in nature. Non-Current
Assets, on the other hand, are properties held for a long period of time (i.e. more than 1 year).
Here's a list of asset accounts under each line item, and classified into current and non-current:
CURRENT ASSETS
1. Cash and Cash Equivalents
 Cash on Hand - consists of un-deposited collections
 Cash in Bank - made up of bank accounts that are unrestricted as to withdrawal
 Short-term cash funds such as Petty Cash Fund, Payroll Fund, Tax Fund, etc.
 Cash Equivalents are short-term investments with very near maturity dates making them
assets that are "as good as cash".
2. Accounts Receivable - receivables from customers arising from rendering of services or sale
of goods
3. Notes Receivable - receivables from customers which are backed up by promissory notes.
4. Inventories -are assets that are held for sale in the normal operations of the business. A
service business normally has no inventory account. Merchandising businesses normally
maintain one inventory account –Merchandise Inventory. Manufacturing businesses have
several inventories: Raw Materials Inventory, Work in Process Inventory, Finished Goods
Inventory, and Factory Supplies Inventory.
5. Prepaid Expenses or Prepayments -Prepayments consists of costs already paid but are yet to
be used or incurred. Common prepaid expense accounts include: Office Supplies, Service
Supplies, Prepaid Rent, and Prepaid Insurance.
NON-CURRENT ASSETS
1. Property, Plant, and Equipment (PPE) also known as Fixed Assets
PPE includes tangible assets that are expected to be used for more than one year. PPE
accounts include: Land, Building, Machinery, Service Equipment, Computer, Furniture and
Fixtures, Leasehold Improvements, etc.
2. Long-Term Investments
Investment in Long-Term Bonds, Investment Property, Long-Term Funds; these are
investments that are intended to be held for more than one year.
3. Intangibles
An intangible has no physical form but from which benefits can be derived and its cost can be
measured reliably. Intangibles include Patent for inventions, Copyright for authorship,
compositions and other literary works, Trademark, Franchise, Lease Rights, and Goodwill.
4. Other Non-Current Assets
Assets which cannot be classified under the usual non-current asset categories
Includes: Advances to Officers, Directors, and Employees not collectible within one
year, Cash in Closed Banks, and Abandoned or Idle Property
Usually asset accounts will have debit balances.

Contra assets are asset accounts with credit balances. (A credit balance in an asset account is
contrary—or contra—to an asset account's usual debit balance.) Examples of contra asset
accounts include:
 Allowance for Doubtful Accounts or Bad Debts
 Accumulated Depreciation-Machinery
 Accumulated Depreciation-Buildings
 Accumulated Depreciation-Equipment
B. LIABILITIES – economic or legal obligations that a business owes to other businesses or

individuals. Liabilities are classified into two: current liabilities and non-current
liabilities. Current Liabilities are those that entity expects to settle within the entity's normal
operating cycle or 1 year, whichever is longer. They also include liabilities that are held for
trading purposes. Current liabilities are short-term in nature. In contrast, Non-Current
Liabilities are long-term obligations, i.e. expected to be settled beyond one year.
Here is a list of current and non-current liabilities:

CURRENT LIABILITIES
1. Accounts Payable - refers to indebtedness that arise from purchase of goods, materials,
supplies or services and other transaction in the normal course of business operations.
2. Notes Payable - obligations that are evidenced by promissory notes that are to be paid within
one (1) year.
3. Income Tax Payable - current income tax obligation of the company payable to the
government
4. Accrued Expenses - expenses already incurred but not yet paid. Accrued expense accounts
include: Salaries Payable, Rent Payable, Utilities Payable, Interest Payable, Utilities Payable,
and other unpaid expenses.
5. Unearned Revenues or Income- represents advanced payments from customers which
require settlement through delivery of goods or services in the future.
6. Any Other Short-Term Payable, i.e. any obligation that is to be paid within 1 year after the
balance sheet date
NON-CURRENT LIABILITIES
1. Long-Term Notes Payable - obligations evidenced by promissory notes which are to be paid
beyond 1 year; also commonly referred to as Loans Payable
2. Bonds Payable - liabilities supported by a formal promise to pay a specified sum of money at
a future date and pay periodic interests. A bond has a stated face value which is usually the
final amount to be paid. Bonds can be traded in bond markets.
3. Mortgage Payable - long-term obligation to a bank or other financial institution, secured by
real properties of the business.
` Any Other Long-Term Payable, i.e. any obligation that is to be paid beyond 1 year.
C. OWNER’S EQUITY – is the owner’s interest in, claim to the assets of a business. In other
words, equity is equal to assets minus liabilities. The term used for equity depends upon the
form of business organization:
For sole proprietorships, it is known as owner's equity.
For partnerships, it is called partners' equity.
For corporations, we use stockholders' equity.
Contra owner's equity accounts are a category of owner equity accounts with debit balances. (A
debit balance in an owner's equity account is contrary—or contra—to an owner's equity account's
usual credit balance.) An example of a contra owner's equity account is Mary Santos, Drawing
(where Mary Santos is the owner of the sole proprietorship). An example of a contra
stockholders' equity account is Treasury Stock.
INCOME STATEMENT (RESULTS OF OPERATIONS):

A. REVENUES – inflows of assets resulting from the sale of goods or services. Revenues
increase owner’s equity. Revenues (or income) refer to economic benefits received from
business activities.
List of Revenue Accounts
 Service Revenue - revenue earned from rendering services. Other account titles may
be used depending on the industry of the business, such as Professional Fees for
professional practice and Tuition Fees for schools.
 Sales - revenue from selling goods to customers. It is the principal revenue account of
merchandising and manufacturing companies.
 Sales Discounts - a contra-revenue account that represents reduction in the amount
paid by customers for early payment. It is shown in the income statement as a
deduction to Sales.
 Sales Returns and Allowances - also a contra-revenue account and therefore shown
as a deduction to Sales. Sales return occurs when there is actual return of a defective
item. Sales allowance happens when the customer is willing to keep the item with a
reduction in its selling price.
 Rent Income - earned from leasing out commercial spaces such as office space,
stalls, booths, apartments, condominiums, etc.
 Interest Income - revenue earned from lending money
 Commission Income - earned by brokers and sales agents
 Royalty Income - earned by the owner of a property, patent, or copyrighted work for
allowing others to use such in generating revenue
 Franchise Fee - earned by a franchisor in a franchise agreement
In the income statement, net income is computed by deducting all expenses from all
revenues. Revenues are presented at the top part of the income statement before the expenses.
B. EXPENSES – outflows of assets resulting from cash spent or liability incurred in order to
produce revenue. Expenses refer to costs incurred in conducting business. Expenses decrease
owner’s equity.
List of Expense Accounts

 Cost of Sales - also known as Cost of Goods Sold, it represents the value of the
items sold to customers before any mark-up. In merchandising companies, cost of
sales is normally the purchase price of the goods sold, including incidental costs. In
manufacturing businesses, it is the total production cost of the units sold. Service
companies do not have cost of sales.
 Purchases - cost of merchandise acquired that are to be sold in the normal course of
business. At the end of the period, this account is closed to Cost of Sales.
 Freight in - If the business shoulders the cost of transporting the goods it purchased,
such cost is recorded as Freight-in. This account is also closed to Cost of Sales at the
end of the period.
 Advertising Expense - costs of promoting the business such as those incurred in
newspaper publications, television and radio broadcasts, billboards, flyers, etc.
 Bank Service Charge - costs charged by banks for the use of their services

 Delivery Expense - represents cost of gas, oil, courier fees, and other costs incurred
by the business in transporting the goods sold to the customers. Delivery expense is
also known as Freight-out.
 Depreciation Expense - refers to the portion of the cost of fixed assets (property,
plant, and equipment) used for the operations of the period reported
 Insurance Expense - insurance premiums paid or payable to an insurance company
who accepts to guarantee the business against losses from a specified event
 Interest Expense - cost of borrowing money.
 Rent Expense - cost paid or to be paid to a lessor for the right to use a commercial
property such as an office space, a storeroom, a building, etc.
 Repairs and Maintenance - cost of repairing and servicing certain assets such as
building facilities, machinery, and equipment
 Representation Expense - entertainment costs for customers, employees and owners.
It is often coupled with traveling, hence the account title Travel and Representation
Expense.
 Salaries Expense - compensation to employees for their services to the company.
 Supplies Expense - cost of supplies (ball pens, ink, paper, spare parts, etc.) used by
the business. Specific accounts may be in place such as Office Supplies Expense,
Store Supplies Expense, and Service Supplies Expense.
 License Fees and Taxes - business taxes, registration, and licensing fees paid to the
government
Expenses are deducted from revenues to arrive at the company's net income.
C. NET INCOME (LOSS) – the excess (deficit) of revenue over expenses for an accounting
period. Net income increases owner’s equity while net loss decreases owner’s equity.
BASIC ACCOUNTING EQUATION

The accounting equation shows the relationships between the accounting elements: assets,
liabilities and capital/owner’s equity. The accounting equation (or basic accounting equation)
offers us a simple way to understand how these three amounts relate to each other. The
accounting equation for a sole proprietorship is: ASSETS = LIABLITIES + OWNER’S
EQUITY
The accounting equation for a corporation is:

ASSETS = LIABLITIES + STOCKHOLDER’S EQUITY
The accounting equation must always balance. The amount on the left side of the equation
should always equals on the right side of the equation.
The left side of the equation represents what the company owns. These are resources that the
entity controls in order to attain future benefits. On the other hand, the right side represents the
claims of the different parties to the company’s assets. Liabilities represent the claims of the
entity’s creditors while the equity represents the residual interest of the owners of the equity.
When business transactions take place, the values of the elements in the accounting equation
change. Nonetheless, the equation always stays in balance. This is due to the two-fold effect of

transactions. The total change on the left side is always equal to the total change on the right.
Thus, the resulting balances of both sides are equal.
The accounting equation may be rewritten as:
LIABILITIES = ASSETS – CAPITAL/OWNER’EQUITY, OR

CAPITAL/OWNER’S EQUITY = ASSETS - LIABILITIES.
Accounting Equation is the foundation of double-entry bookkeeping system. Double Entry

Bookkeeping System is recording of transaction that requires equal balance of the total amount
both debits and credits.
DOUBLE ENTRY ACCOUNTING SYSTEM

The double entry accounting system recognizes a two-fold effect in every transaction. Thus,
business transactions are recorded in at least two accounts.
Under the double entry accounting system, transactions are recorded through debits and credits.
Debit means left. Credit means right. The effect of recording in debit or credit depends upon the
normal balance of the account debited or credited.
The general rules are: to increase an asset, you debit it; to decrease an asset, you credit it. The
opposite applies to liabilities and capital: to increase a liability or a capital account, you credit
it; to decrease a liability or a capital account, you debit it. Expenses are debited when incurred,
and income is credited when earned.
RULES OF DEBIT AND CREDIT:

Debits and credits are used to record the increases and decreases of each account affected by a
business transaction. The rules of debit and credit vary according to whether an account is
classified as an asset, liability or an owner’s equity.
RULES FOR ASSET ACCOUNTS:

1. An asset account is increased (+) on the debit side.
2. An asset account is decreased (-) on the credit side.
3. The normal balance for an asset account is a debit balance.
RULES FOR LIABILITY AND OWNER’S EQUITY ACCOUNTS:

1. The liability and capital accounts are increased (+) on the credit side.
2. The liability and capital accounts are decreased (-) on the debit side.
3. The normal balance for the liability and capital accounts is a credit balance.
To Sum It Up
Here's a table summarizing the normal balances of the accounting elements, and the actions to
increase or decrease them. Notice that the normal balance is the same as the action to increase
the account.
Accounting Element Normal Balance To Increase To Decrease
1. Assets Debit Debit Credit

Accounting Element Normal Balance To Increase To Decrease
2. Liabilities Credit Credit Debit

3. Capital Credit Credit Debit
4. Withdrawal Debit Debit Credit
5. Income Credit Credit Debit
6. Expense Debit Debit Credit
FOUR PHASES OF ACCOUNTING
Based on the definition, accounting has 4 phases:
1. RECORDING – this is technically called bookkeeping. In this phase, business

transactions are recorded systematically and chronologically in the proper accounting
books. The data that we are record in the accounting books are called transactions.
Transactions are the economics activities of the firm.
2. CLASSIFYING – in this phase, items are sorted and grouped. Similar items are
classified under the same name. They may be classified as asset accounts, liability
accounts, capital accounts, revenue accounts and expense accounts. This classification is
useful to the needs of management.
3. SUMMARIZING – after each accounting period, data recorded are summarized through
financial statements. These reports are submitted to the management at the end of
accounting period or as the need arise.
4. INTERPRETING – usually, due to the technicality of accounting reports, the
accountant’ interpretation on the financial statement is needed. In this case, analysis
reports are submitted together with the financial statements.
BUSINESS TRANSACTION FLOW
Source Journal Ledger Trial Financial

Documents to Entries to Accounts to Balance to Statements
THE ACCOUNTING CYCLE OR ACCOUNTING PROCESS

Accounting is a measurement and communication process designed to provide useful and timely
financial information. The accounting cycle, also commonly referred to as accounting process, is
a series of procedures in the collection, processing, and communication of financial information.
Financial information is presented in reports called financial statements. But before they can be
prepared, accountants need to gather information about business transactions, record and collate
them to come up with the values to be presented in the reports.
The cycle does not end with the presentation of financial statements. Several steps are needed to
be done to prepare the accounting system for the next cycle.
ACCOUNTING CYCLE – is the complete series of steps used to account for a business’s
financial transactions during a fiscal period. These are the steps:

1. Collecting and analyzing the source documents
2. Journalizing the business transactions.
3. Posting to the ledger accounts
4. Preparing the trial balance
5. Determining which accounts needs adjustments
6. Completing the end-of-year worksheets.
7. Preparing the financial statements.
8. Journalizing and posting adjusting and closing entries.
9. Preparing the post-closing trial balance.
ACCOUNTING CYCLE STEPS
1. IDENTIFYING AND ANALYZING BUSINESS TRANSACTIONS

The accounting process starts with identifying and analyzing business transactions and events.
Not all transactions and events are entered into the accounting system. Only those that pertain to
the business entity are included in the process.
The transactions identified are then analyzed to determine the accounts affected and the amounts
to be recorded.
What is a business transaction?

A business transaction is an activity or event that can be measured in terms of money and which
affects the financial position or operations of the business entity. In other words, it has an effect
on any of the accounting elements – assets, liabilities, capital, income, and expense.
Transactions may be classified as exchange and non-exchange. Exchange transactions involve

physical exchange such as purchasing, selling, collection of receivables, and payment of
accounts.
Non-exchange transactions are events that do not involve physical exchanges but where
changes in monetary values are determinable, e.g. wear and tear of equipment, fire loss, typhoon
loss, etc.
To qualify as an accountable/recordable business transaction, the activity or event must:

1. Be a transaction involving the business entity
The separate entity concept or accounting entity assumption clearly establishes a distinction
between transactions of the business and those of its owner/s.
If Mr. Bright, owner of Bright Productions, buys a car for personal use using his own money, it
will not be reflected in the books of the company. Why? Because it does not have anything to do
with the business. Now if the company purchases a delivery truck, then that would be a business
transaction of the company.
If Mr. Grim invests 20,000 into the company, would that be recorded in the books of the
business? Ask this: Does it have anything to do with the company? Yes. Then, that would be a
recordable business transaction.
In any case, always remember that a business is treated as an individual entity, separate and
distinct from its owners.
2. Be of a financial character (in a certain amount of money)

Transactions must involve monetary values, meaning a certain amount of money must be
assigned to the elements or accounts affected.
For example, Bright Productions renders video coverage services and expects to collect $10,000
after 10 days. In this case, it's explicit. The income and receivable can be measured reliably at the
$10,000.
Fire, typhoon and other losses may be estimated and assigned with monetary values.
The mere request (order) of a customer is not a recordable business transaction. There should be
an actual sale or performance of service first to give the company a right over the income or
revenue.
3. Have a dual or "two-fold" effect on the accounting elements
Every transaction has a dual or two-fold effect. For every value received, there is a value given;
or for every debit, there is a credit. This is the concept of double-entry accounting.
For example, Bright Productions purchased tables and chairs for 6,000. The company received
tables and chairs thereby increasing its assets (increase in Office Equipment). In return, the
company paid cash; thus, there is an equal decrease in assets (decrease in Cash).
4. Be supported by a source document
As part of good accounting and internal control practice, business transactions must be supported
by source documents. The source documents serve as bases in recording transactions in the
journal.
The first step in the accounting process is actually to prepare the source document and determine
the effects of the business transaction to the accounts of the company. After which, the
accountant records the transaction through a journal entry.
Source Document – is a paper prepared as evidence to support business transactions. Examples

of source documents are: Official Receipt issued whenever cash is received, Sales Invoice for
sales transactions, and Cash Voucher for payment in cash, Statement of Account from suppliers,
Vendor's Invoice, Promissory Notes, and other business documents (deposit slips, check stubs,
cash register tapes and payroll time cards).
2. RECORDING IN THE JOURNALS

After analyzing and preparing business documents, the transactions are then recorded in the
books of the company. In double-entry accounting, transactions are recorded in the 'journal'
through journal entries.
Business transactions are recorded using the double-entry bookkeeping system. They are
recorded in journal entries containing at least two accounts (one debited and one credited). To
simplify the recording process, special journals are often used for.
JOURNAL – is called a book of original entry. It is the book where all transactions initially
recorded in chronological order of the day to day transactions. The process of recording a
business transaction in a journal is called journalizing.
There are two kinds of journal – The General Journal and Special Journal.
General Journal – is the simplest form of journal wherein a two-column form may be used. It is
an all-purpose journal which can be used by a business having simple operations and limited
transaction.

Special Journals – are used to record typical and similar type of transactions. The number of
special journals managed by a company is dependent on the types of transactions that occur
frequently. Some of the most common special journals are:
 Sales Journal – used in journalizing all sales of merchandise on account.
 Cash Receipts Journal – used in journalizing all cash received (including cash sales).
 Purchase Journal – used in journalizing all purchases of merchandise on account.
 Cash Payments Journal – used in journalizing all cash paid (including cash purchases).
CHART OF ACCOUNTS
Before recording transactions into the journal, we should first know what accounts to use. This is
where a chart of accounts comes in handy.
An Account – is the record used to classify and store information about increases and decreases
in an item.
A Chart of Accounts is a list of all accounts and their account (code) numbers used by a
company for journalizing business transaction or in its accounting system. It makes the
bookkeeper's work easier.
The accounts included in the chart of accounts must be used consistently to prevent clerical or
technical errors in the accounting system.
Nevertheless, take note that chart of accounts vary from company to company. The contents
depend upon the needs and preferences of the company using it.
Accounts are classified into assets, liabilities, capital, income, and expenses; and each is given a
unique account number. A coding system is used to organize the accounts. Here's a sample chart
of accounts for a small sole proprietorship business:
Chart of Accounts Example

Blue Electronic Repair Services
Chart of Accounts
ASSETS (1000-1999)
1000 Cash
1010 Accounts Receivable
1011 Allowance for Doubtful Accounts
1020 Notes Receivable
1030 Interest Receivable
1040 Service Supplies
1510 Leasehold Improvements
1520 Furniture and Fixtures
1521 Accumulated Depreciation – Furniture and Fixtures
1530 Service Equipment

1531 Accumulated Depreciation – Service Equipment
LIABILITIES (2000-2999)
2000 Accounts Payable
2010 Notes Payable
2020 Salaries Payable
2030 Rent Payable
2040 Interest Payable
2050 Unearned Revenue
2060 Loans Payable
OWNER'S EQUITY (3000-3999)

3000 Blue, Capital
3010 Blue, Drawing
REVENUES (4000-4999)
4000 Service Revenue
4010 Interest Income
4020 Gain on Sale of Equipment
4999 Income Summary
EXPENSES (5000-5999)
5000 Rent Expense
5010 Salaries Expense
5020 Supplies Expense
5030 Utilities Expense
5040 Interest Expense
5050 Taxes and Licenses
5060 Depreciation Expense
5070 Doubtful Accounts Expense
Additional accounts can be added as the need arises. For bigger companies, the accounts may be
divided into several sub-accounts.

For example, employee salaries may have various accounts for different departments and be
included in the chart of accounts as:
5011 Salaries Expense – Administrative,
5012 Salaries Expense – Servicing,
5013 Salaries Expense – Marketing,
Again, take note that the chart of accounts of one company may not be suitable for another
company. It all depends upon the company's needs. In any case, the chart of accounts is a useful
tool for bookkeepers in recording business transactions.
JOURNAL ENTRY – is a record of business transactions in the journal. There are two types of
journal entry:
 Simple Journal Entry – which contains only one debit and one credit account.
 Compound Journal Entry – which contains either one debit or two or more credits; or
two or more debits and one credit or two or more debits and two or more credits.
After analyzing and preparing business documents, the transactions are then recorded in the
books of the company. In double-entry accounting, transactions are recorded in the 'journal'
through journal entries.
A journal, also known as Books of Original Entry, keeps records of transactions in chronological
order.
In other words, transactions are recorded in the journal as they occur, one after the other.
A simple journal looks like this:
Date
Particulars Debit Credit
yyyy
mmm dd Account debited amount
Account credited amount
dd Account debited amount

Account credited amount
A column for posting reference or folio may also be included to facilitate easier tracking and
cross-referencing with the ledger. Also, an explanation of the transaction may be included below
the row for account credited. The journal would then look like this:
Date
Particulars PR Debit Credit
yyyy
mmm dd Account debited ref. amount
Account credited ref. amount
Short explanation or annotation.
RECORDING OF BUSINESS TRANSACTIONS:

BUSINESS TRANSACTIONS:
The data that we record in accounting books are called transactions. Transactions are the
economic activities of the firm. When there is a transaction there is an exchange of value for
value. In every transaction, there is always a value received and a value parted with. These
values received and parted with may either be money, property or services. In short the business
DEBIT/S CREDIT/S
Value/s received = Value/s parted with
ILLUSTRATION
Transaction Value Received Value Parted with
1. Purchased office furniture Office Furniture Cash or Money
2.Purchased repair Equipment Obligation to pay or Debt
equipment on credit
3.Paid the monthly electric Services Cash or Money
bill
4.Customers pay cash for Cash Services
auto repairs rendered
5. Repair services rendered Receivables Services
on account or credit.
Transactions are always looked upon from the business point of view, which is separate and
distinct from owner’s point of view. This refers to the principle of Entity Concept.
Illustrative example: A form of property is received in exchange for money parted with
On June 3, 20x2, AAA Trucking Services Company bought for P890,000.00 cash a Toyota
Innova to be used as company service vehicle.
HOW TO RECORD THE ABOVE TRANSACTION

Step 1
Remember the guiding principle.
DEBIT the Value Received
CREDIT the Value Parted With
Applicable debit and credit rules
Rule 1
When the value received is a thing of value, an asset is increased.
Therefore, debit the asset account title of that thing of value with the amount of increase.
Rule 2
When the value parted with is a thing of value, an asset is decreased.
Therefore, credit the asset account title of that thing of value with the amount of decrease.
Step 2-Analyze the business transaction or economic event
 What is the value received - Toyota Innova

 What is the value parted with - Money
 Assign the account title for the value received - Service Vehicle
 Assign the account title for the value parted with - Cash
 What is the effect of the value received in the accounting equation - Increase in Asset

 What is the effect of the value parted with in the accounting equation - Decrease in Asset
 Measure the amount equivalent of the value received - P890,000.00
 Measure the amount equivalent of the value parted with - P890,000.00
Step 3-Record the journal entry

 Record the date of the transaction-Date of transaction: June 3, 20x2
 Record the debit with the amount of the value received
Debit the value received: Service Vehicle P890,000.00
 Record the credit with the amount of the value parted with
Credit the value parted with: Cash P890,000.00
 Write the explanation of the transaction or events.
Brief Explanation:
To record the acquisition of Toyota Innova for company use.
The finished journal entry of the above transaction
Date
Particulars PR Debit Credit
20X2
June 03 Service Vehicle 890,000
Cash 890,000
To record the acquisition of Toyota Innova for
company use
Here are some more examples of business transactions and their journal entries.
The transactions here pertain to Blue Electronic Repair Services, our imaginary small sole
proprietorship business.
All transactions are assumed and simplified for illustration purposes.
Note: We will also be using this set of transactions and journal entries in later lessons when we
discuss the other steps of the accounting process.
Transaction #1: On December 1, 2014, Mr. Martin Blue started Blue Electronic Repair Services
by investing 10,000. The journal entry should increase the company's Cash, and increase
(establish) the capital account of Mr., Blue; hence:
Date
2014
Dec 1 Cash 10,000.00
Blue, Capital 10,000.00

Transaction #2: On December 5, Blue Electronic Repair Services paid registration and licensing
fees for the business, 370.
First, we will debit the expense (to increase an expense, you debit it); and then, credit Cash to
record the decrease in cash as a result of the payment.
5 Taxes and Licenses 370.00

Cash 370.00
Transaction #3: On December 6, the company acquired tables, chairs, shelves, and other fixtures
for a total of 3,000. The entire amount was paid in cash.
There is an increase in an asset account (Furniture and Fixtures) in exchange for a decrease in
another asset (Cash).
6 Furniture and Fixtures 3,000.00

Cash 3,000.00
Transaction #4: On December 7, the company acquired service equipment for 16,000. The
company paid a 50% down payment and the balance will be paid after 60 days.
This will result in a compound journal entry. There is an increase in an asset account
(debit Service Equipment, 16,000), a decrease in another asset (credit Cash, 8,000, the amount
paid), and an increase in a liability account (credit Accounts Payable, 8,000, the balance to be
paid after 60 days).
7 Service Equipment 16,000.00

Cash 8,000.00
Accounts Payable 8,000.00
Transaction #5: Also on December 7, Blue Electronic Repair Services purchased service
supplies on account amounting to 1,500.
The company received supplies thus we will record a debit to increase supplies. By the terms "on
account", it means that the amount has not yet been paid; and so, it is recorded as a liability of
the company.
7 Service Supplies 1,500.00

Transaction #6: On December 9, the company received 1,900 for services rendered. We will then
record an increase in cash (debit the cash account) and increase in income (credit the income
account).
9 Cash 1,900.00
Service Revenue 1,900.00

Transaction #7: On December 12, the company rendered services on account, 4,250.00. As per
agreement with the customer, the amount is to be collected after 10 days. Under the accrual basis
of accounting, income is recorded when earned.
In this transaction, the services have been fully rendered (meaning, we made an income; we just
haven't collected it yet.) Hence, we record an increase in income and an increase in a receivable
account.
12 Accounts Receivable 4,250.00

Transaction #8: On December 14, Mr. Blue invested an additional 3,200.00 into the business.
The entry would be similar to what we did in transaction #1, i.e. increase cash and increase the
capital account of the owner.
14 Cash 3,200.00
Transaction #9: Rendered services to a big corporation on December 15. As per agreement, the
3,400 amount due will be collected after 30 days.
15 Accounts Receivable 3,400.00

Transaction #10: On December 22, the company collected from the customer in transaction #7.
We will record an increase in cash by debiting it. Then, we will credit accounts receivable to
decrease it. We are reducing the receivable since it has already been collected.
17 Cash 4,250.00
Accounts Receivable 4,250.00
Actually, we simply transferred the amount from receivable to cash in the above entry.
Transaction #11: On December 23, the company paid some of its liability in transaction #5 by
issuing a check. The company paid 500 of the 1,500 payable.
To record this transaction, we will debit Accounts Payable for 500 to decrease it by the said
amount. Then, we will credit cash to decrease it as a result of the payment. The entry would be:
20 Accounts Payable 500.00

Cash 500.00
Accounts payable would now have a credit balance of 1,000 (1,500 initial credit in transaction #5
less 500 debit in the above transaction).
Transaction #12: On December 25, the owner withdrew cash due to an emergency need. Mr.
Blue withdrew 7,000 from the company.

We will decrease Cash since the company paid Mr. Blue 7,000. And, we will record withdrawals
by debiting the withdrawal account – Blue, Drawings.
25 Blue, Drawings 7,000.00

Cash 7,000.00
Transaction # 13: On December 29, the company paid rent for December, 1,500. Again, we will
record the expense by debiting it and decrease cash by crediting it.
29 Rent Expense 1,500.00

Cash 1,500.00
Transaction #14: On December 30, the company acquired a 12,000 short-term bank loan; the
entire amount plus a 10% interest is payable after 1 year.
Again, the company received cash so we increase it by debiting Cash. The company now has a
liability. We will record it by crediting the liability account – Loans Payable.
30 Cash 12,000.00
Loans Payable 12,000.00
Transaction #15: On December 31, the company paid salaries to its employees, 3,500.
For this transaction, we will record/increase the expense account by debiting it and decrease cash
by crediting it. (Note: This is a simplified entry to present the payment of salaries. In actual
practice, different payroll accounting methods are applied.)
31 Salaries Expense 3,500.00

Cash 3,500.00
3. POSTING TO THE LEDGER -THE CLASSIFYING PHASE
After journalizing the business transactions in the general journal and special journal, the next
process is posting. Posting refers to the process of transferring entries in the journal into the
accounts in the ledger. Posting to the ledger is the classifying phase of accounting.
LEDGER– An accounting ledger refers to a book that consists of all accounts used by the
company, the debits and credits under each account, and the resulting balances. While
the journal is referred to as Books of Original Entry, the Ledger is known as Books of Final
Entry.
The simpler form of a ledger is the T-Account.
THE T ACCOUNT – so called because of its T shape, is used to show the increase or decrease
in an account to analyses the parts of transactions. The T account has a top, a left side, and a
right side. On the top of the T is the title of the account. The left side of the T account is always
used for debit amounts. The right side of the T account is always used for credit amounts.

Accountants and bookkeepers often use T-accounts as a visual aid for seeing the effect of the
debit and credit on the two (or more) accounts.
There are two kinds of ledgers: General Ledger and Subsidiary Ledger.
General Ledger – contains all the asset, liability and owner’s equity accounts of the company.
The general ledger aids in knowing the balances of each of the accounts at any given time.
A general ledger contains accounts that are broad in nature such as Cash, Accounts Receivable,
Supplies, and so on.
Subsidiary Ledger – consists of accounts within accounts For example, Accounts Receivable
may be made up of subsidiary accounts such as Accounts Receivable – Customer A, Accounts
Receivable – Customer B, Accounts Receivable – Customer C, etc. It is a group of accounts with
similar characteristics (e.g. accounts receivables and accounts payable). It is an additional record
to the general ledger utilized by the company to track per individual accounts of the company’s
customers, creditors and the like.
The two most common types of subsidiary ledgers are the accounts receivable ledger and
accounts payable ledger:
Accounts Receivable Ledger – is used mainly to track the individual account balances
of the company’s customers.
Accounts Payable Ledger – used in tracking individual accounts payable balances of
company’s creditors.
Also known as Books of Final Entry, the ledger is a collection of accounts that shows the
changes made to each account as a result of past transactions, and their current balances. After
the posting all transactions to the ledger, the balances of each account can now be determined.
For example, all journal entry debits and credits made to Cash would be transferred into the Cash
account in the ledger. We will be able to calculate the increases and decreases in cash; thus, the
ending balance of Cash can be determined.
Example: Posting Process

Illustration how accounting ledgers and the posting process work using the same transactions we
had in our journal entries
Take transaction #1 first.

Date
2014
Dec 1 Cash 10,000.00
Now, go to the ledger and find the accounts. Post the amounts debited and credited to the
appropriate side. Debits go to the left and credits to the right. After posting the amounts, the cash
and capital account would look like:
Cash Blue, Capital

10,000.00 10,000.00
Explanation: First, we posted the entry to Cash. Cash in the journal entry was debited so we
placed the amount on the debit side (left side) of the account in the ledger. For Blue, Capital, it
was credited so the amount is placed on the credit side (right side) of the account. And that's it.
Posting is simply transferring the amounts from the journal to the respective accounts in the
ledger.
Note: The ledger accounts (or T-accounts) can also have fields for account number, description
or particulars, and posting reference.
To post the second transaction;

5 Taxes and Licenses 370.00
Cash 370.00
After posting the above entry, the affected accounts in the ledger would look like these:
Cash Taxes and Licenses
10,000.00 370.00 370.00
There was a debit to Taxes and Licenses so we posted that in the left side (debit side) of the
account. Cash was credited so we posted that on the right side of the account.
Notice that after posting transaction #2, we now can get a more updated balance for each
account. Cash now has a balance of 9,630 (10,000 debit and 370 credit). Post all the other
entries and we will be able to get the balances of all the accounts.
In the above discussion, we posted transactions #1 and #2 into the ledger.

After all accounts are posted, we can now derive the balances of each account. So how
much Cash do we have at the end of the month? How about accounts receivable? Accounts
payable? You can find them all in the ledger.
Because of technological advancements however, most accounting systems today

perform automated posting process. Nonetheless, the above example shows how a ledger works.
4. UNADJUSTED TRIAL BALANCE

After all transactions have been entered in the appropriate T accounts, each account must be
totaled to determine the balance. The account balances are ruled (double lined) to make a
distinction and would make an easy reference when you prepare a trial balance.
After all transactions have been posted, you can create a trial balance. List each account and the
corresponding debit or credit balance for each account.
TRIAL BALANCE – is a listing of all accounts in the general ledger and the sum of debit and
credit amounts of their balances.
A trial balance is prepared to test the equality of the debits and credits. All account balances are
extracted from the ledger and arranged in one report. Afterwards, all debit balances are added.
All credit balances are also added. Total debits should be equal to total credits.

When errors are discovered, correcting entries are made to rectify them or reverse their effect.
Take note however that the purpose of a trial balance is only test the equality of total debits and
total credits and not to determine the correctness of accounting records.
Some errors could exist even if debits are equal to credits, such as double posting or failure to
record a transaction.
It is a list of accounts with open balances in the general ledger. It proves the equality of the
debits and the credits in the general ledger.
 Not technically a financial statement
 It is the first step to creating statements
TWO TYPES OF TRIAL BALANCE:
1. TRIAL BALANCE OF BALANCES – contains accounts with open balances. Accounts

with open balances either have a debit balance or a credit balance. An account is said to
have a debit balance if the debit total is more than the credit total and is said to have a
credit balance if the credit balance is more than the debit total. It the debit side and credit
side are equal, the account is zero balance or closed account.
2. TRIAL BALANCE OF TOTALS – in this form, the total of the debits and the total of
credits of each account are listed.
PROCEDURE IN TRIAL BALANCE PREPARATION
1. Write the heading of the trial balance. The heading of the trial balance includes the
following:
a. The Name of the Business or the Owner
b. Title of the list or Trial Balance
c. Date of the Trial Balance
2. Provide a column for the accounts and two money columns- a debit and a credit.
3. The accounts should be written in just one column arranged in the following sequence:
a. Assets
b. Liabilities
c. Capital
d. Income
e. Expenses
4. Write the amounts opposite the corresponding accounts under the debit money column if
the account is a debit balance and under the credit money column if the account is a
credit balance.
5. Foot or add the money columns. Double rule the totals.
ERROR IN TRIAL BALANCE

If total debits do not equal total credits, then there is an error. The causes of errors are the
following:
1. Posting an item twice.
2. Posting to the wrong side of the account.
3. Omission of posting.
4. Wrong footings of the ledger.

5. Wrong transferring of account from the ledger to the trial balance.
FINDING AND CORRECTING ERRORS IN THE TRIAL BALANCE

Tips for finding errors
Is the difference equal to the amount of a transaction? Possibly you only posted half of the
transaction.
Are the difference / 2 equal to the amount of a transaction? Possibly you posted both parts of the
transaction as a debit or both parts as a credit.
Is the difference evenly divisible by 9? Most likely you have a transposition error or a slide error
TRANSPOSITION ERROR: Digits in a number are reversed, for example the number 827
entered as 872
SLIDE ERROR: The decimal place moves to the right or left. Examples: 250 entered as 2500 or
853 entered as 85.30.
UNADJUSTED TRIAL BALANCE - This is prepared after journalizing transactions and

posting them to the ledger. Its purpose is to test the equality between debits and credits after the
recording phase.
5. ADJUSTING ENTRIES
Step 5 of the accounting process involves the preparation of adjusting entries. Adjusting journal
entries are made to update the accounts and bring them to their correct balances.
The preparation of adjusting entries is an application of the accrual concept of accounting and
the matching principle.
The accrual concept states that income is recognized when earned regardless of when collected
and expense is recognized when incurred regardless of when paid.
The matching principle aims to align expenses with revenues. Expenses should be recognized in
the period when the revenues generated by such expenses are recognized.
Adjusting entries are prepared as an application of the accrual basis of accounting. At the end of
the accounting period, some expenses may have been incurred but not yet recorded in the
journals.
Some income may have been earned but not entered in the books. Adjusting entries are prepared
to update the accounts before they are summarized in the financial statements.
PURPOSE OF ADJUSTING ENTRIES

The main purpose of adjusting entries is to update the accounts to conform to the
accrual concept. At the end of the accounting period, some income and expenses may have not
been recorded, taken up or updated; hence, there is a need to update the accounts.
If adjusting entries are not prepared, some income, expense, asset, and liability accounts may not
reflect their true values when reported in the financial statements. For this reason, adjusting
entries are necessary.

TYPES OF ADJUSTING ENTRIES
Generally, there are 4 types of adjusting entries. Adjusting entries are prepared for the following:
Accrued Income – income earned but not yet received
Accrued Expense – expenses incurred but not yet paid
Deferred Income – income received but not yet earned
Prepaid Expense – expenses paid but not yet incurred
Also, adjusting entries are made for:

Depreciation
Doubtful Accounts or Bad Debts, and other allowances
COMPOSITION OF AN ADJUSTING ENTRY

Adjusting entries affect at least one nominal account and one real account.
A Nominal Account is an account whose balance is measured from period to period. Nominal
accounts include all accounts in the Income Statement, plus owner's withdrawal. They are also
called temporary accounts or income statement accounts.
Examples of nominal accounts are: Service Revenue, Salaries Expense, Rent Expense, Utilities
Expense, Blue, Drawing, etc.
A real account has a balance that is measured cumulatively, rather than from period to period.
Real accounts include all accounts in the balance sheet. They are also called permanent
accounts or balance sheet accounts.
Real accounts include: Cash, Accounts Receivable, Rent Receivable, Accounts Payable, Blue,
Capital, and others.
All adjusting entries include at least a nominal account and a real account.
Note: "Adjusting entries" refer to the 6 entries mentioned above. However, in some branches of
accounting (especially auditing), the term adjusting entries could refer to any entry that aims to
adjust incorrect account balances.
As a result, there is little distinction between "adjusting entries" and "correcting entries" today.
In the traditional sense, however, adjusting entries are those made at the end of the period to take
up accruals, deferrals, prepayments, depreciation and allowances.
Adjusting Entry for Accrued Income or Accrued Revenue

Accrued income (or accrued revenue) refers to income already earned but has not yet been
collected. At the end of every period, accountants should make sure that they are properly
included as income.
When a company has performed services or sold goods to a customer, it should be recognized as
income even if the amount is still to be collected at a future date. If no journal entry was ever
made for the above, then an adjusting entry is necessary.
Pro-Forma Entry

The adjusting entry to record an accrued revenue is:
mmm dd Receivable account* x,xxx.xx
Income account** x,xxx.xx
*Appropriate receivable account such as Accounts Receivable, Rent Receivable, Interest
Receivable, etc.
**Income account such as Service Revenue, Rent Income, Interest Income, etc.
Here's an Example
In our previous set of transactions, assume this additional information:
On December 31, 2014, Blue Electronic Repair Services rendered 300 worth of services to a
client. However, the amount has not yet been collected. It was agreed that the customer will pay
the amount on January 15, 2015. The transaction was never recorded in the books of the
company.
In this case, we should make an adjusting entry to recognize the income since it has already been
earned. The adjusting entry would be:
Dec 31 Accounts Receivable 300.00
Service Revenue 300.00
More Examples: Adjusting Entries for Accrued Income
Example 1: Company ABC leases its building space to a tenant. The tenant agreed to pay
monthly rental fees of 2,000 covering a period from the 1st to the 30th or 31st of every month.
On December 31, 2014, ABC Company did not receive the rental fee for December yet and no
record was made in the journal.
Under the accrual basis, the rent income above should already be recognized because it has
already been earned even if it has not yet been collected. The adjusting journal entry would be:
Dec 31 Rent Receivable 2,000.00
Rent Income 2,000.00
Example 2: ABC Company lent 9,000 at 10% interest on December 1, 2014. The amount will be
collected after 1 year. At the end of December, no entry was entered in the journal to take up the
interest income.
Interest is earned through the passage of time. In the case above, the 9,000 principal plus a 900
interest will be collected by the company after 1 year. The 900 interest pertains to 1 year.
However, 1 month has already passed. The company is already entitled to 1/12 of the interest, as
prorated. Therefore the adjusting entry would be to recognize 75 (i.e. 900 x 1/12) as interest
income:
Dec 31 Interest Receivable 75.00
Interest Income 75.00

The basic concept you need to remember is recognition of income. When is income recognized?
Under the accrual concept of accounting, income is recognized when earned regardless of when
collected.
If the company has already earned the right to it and no entry has been made in the journal, then
an adjusting entry to record the income and a receivable is necessary.
Adjusting Entry for Accrued Expenses

Accrued Expenses refer to expenses that are already incurred but have not yet been paid. At the
end of period, accountants should make sure that they are properly recorded in the books of the
company.
Here's the rule. If a company incurred, used, or consumed all or part of an expense, that expense
or part of it should be properly recognized even if it has not yet been paid.
If such has not been recognized, then an adjusting entry is necessary.
Pro-Forma Entry
The pro-forma adjusting entry to record an accrued expense is:
mmm dd Expense account* x,xxx.xx
Liability account** x,xxx.xx
*Appropriate expense account (such as Utilities Expense, Rent Expense, Interest Expense, etc.)
**Appropriate liability account (Utilities Payable, Rent Payable, Interest Payable, Accounts
Payable, etc.)
For Example
For the month of December 2014, Blue Electronic Repair Services used a total of 1,800 worth of
electricity and water. The company received the bills on January 10, 2015. When should the
expense be recorded, December 2014 or January 2015?
Answer – in December 2014. According to the accrual concept of accounting, expenses are
recognized when incurred regardless of when paid. The amount above pertains to utilities used in
December. Therefore, if no entry was made for it in December then an adjusting entry is
necessary.
Dec 31 Utilities Expense 1,800.00
Utilities Payable 1,800.00
In the adjusting entry above, Utilities Expense is debited to recognize the expense and Utilities
Payable to record a liability since the amount is yet to be paid.
Here are some more examples.
More Examples: Adjusting Entries for Accrued Expense

Example 1: VIRON Company entered into a rental agreement to use the premises of DON's
building. The agreement states that VIRON will pay monthly rentals of 1,500. The lease started
on December 1, 2014. On December 31, the rent for the month has not yet been paid and no
record for rent expense was made.
In this case, VIRON Company already incurred (consumed/used) the expense. Even if it has not
yet been paid, it should be recorded as an expense. The necessary adjusting entry would be:
Dec 31 Rent Expense 1,500.00
Rent Payable 1,500.00
Example 2: VIRON Company borrowed 6,000 at 12% interest on August 1, 2014. The amount
will be paid after 1 year. At the end of December, the end of the accounting period, no entry was
entered in the journal to take up the interest.
Let's analyze the above transaction.

VIRON will be paying 6,000 principal plus 720 interest after a year. The 720 interest covers 1
year. At the end of December, a part of that is already incurred, i.e. 720 x 5/12 or 300. That
pertains to interest for 5 months, from August 1 to December 31. The adjusting entry would be:
Dec 31 Interest Expense 300.00
Interest Payable 300.00
Expenses are recognized when incurred regardless of when paid. What you need to remember
here is this: when it has been consumed or used and no entry was made to record the expense,
then there is a need for an adjusting entry.
Adjusting Entry for Unearned Revenue or Deferred Income

Unearned Revenue (also known as deferred revenue/income) represents revenue already
collected but not yet earned. Hence, they are also called "advances from customers".
It is to be noted that under the accrual concept, income is recognized when earned regardless of
when collected.
And so, unearned revenue should not be included as income yet; rather, it is recorded as a
liability.
This liability represents an obligation of the company to render services or deliver goods in the
future. It will be recognized as income only when the goods or services have been delivered or
rendered.
At the end of the period, unearned revenues must be checked and adjusted if necessary. The
adjusting entry for unearned revenue depends upon the journal entry made when it was initially
recorded.
There are two ways of recording unearned revenue: (1) the liability method, and (2) the
income method.
Liability Method of Recording Unearned Revenue

Under the liability method, a liability account is recorded when the amount is collected. The
common accounts used are: Unearned Revenue, Deferred Income, Advances from
Customers, etc. For this illustration, let us use Unearned Revenue.
Suppose on January 10, 2015, ABC Company made 30,000 advanced collections from its
customers. If the liability method is used, the entry would be:
Jan 10 Cash 30,000.00
Unearned Revenue 30,000.00

Take note that the amount has not yet been earned, thus it is proper to record it as a liability.
Now, what if at the end of the month, 20% of the unearned revenue has been rendered? This will
require an adjusting entry.
The adjusting entry will include: (1) recognition of 6,000 income, i.e. 20% of 30,000, and (2)
decrease in liability (unearned revenue) since some of it has already been rendered. The
adjusting entry would be:
Jan 31 Unearned Revenue 6,000.00
Service Income 6,000.00
We are simply separating the earned part from the unearned portion. Of the 30,000 unearned
revenue, 6,000 is recognized as income. In the entry above, we removed 6,000 from the 30,000
liability. The balance of unearned revenue is now at 24,000.
Income Method of Recording Unearned Revenue

Under the income method, the accountant records the entire collection under an income account.
Using the same transaction above, the initial entry for the collection would be:
Jan 10 Cash 30,000.00
Service Income 30,000.00
If at the end of the year the company earned 20% of the entire 30,000, then the adjusting entry
would be:
Jan 31 Service Income 24,000.00
Unearned Income 24,000.00
By debiting Service Income for 24,000, we are decreasing the income initially recorded. The
balance of Service Income is now 6,000 (30,000 - 24,000), which is actually the 20% portion
already earned. By crediting Unearned Income, we are recording a liability for 24,000.
Notice that the resulting balances of the accounts under the two methods are the same (Cash:
30,000; Service Income: 6,000; and Unearned Income: 24,000).
Another Example
On December 1, 2014, DRG Company collected from TRM Corp. a total of 60,000 as rental fee
for three months starting December 1.
Under the liability method, the initial entry would be:

Dec 1 Cash 60,000.00
Unearned Rent Income 60,000.00
On December 31, 2014, the end of the accounting period, 1/3 of the rent received has already
been earned (prorated over 3 months).
We should then record the income through this adjusting entry:
Dec 31 Unearned Rent Income 20,000.00

In effect, we are transferring 20,000, one-third of 60,000, from the Unearned Rent Income (a
liability) to Rent Income (an income account) since that portion has already been earned.
If the company made use of the income method, the initial entry would be:
Dec 1 Cash 60,000.00
In this case, we must decrease Rent Income by 40,000 because that part has not yet been earned.
The income account shall have a balance of 20,000. The amount removed from income shall be
transferred to liability (Unearned Rent Income). The adjusting entry would be:
Dec 31 Rent Income 40,000.00
Unearned Rent Income 40,000.00
Make sure that the earned part is included in income and the unearned part into liability. The
adjusting entry will always depend upon the method used when the initial entry was made.
Adjusting Entry for Prepaid Expense

Prepaid expenses (a.k.a. prepayments) represent payments made for expenses which have not
yet been incurred.
In other words, these are "advanced payments" by a company for supplies, rent, utilities and
others that are still to be consumed.
Expenses are recognized when they are incurred regardless of when paid. Expenses are
considered incurred when they are used, consumed, utilized or has expired.
Because prepayments they are not yet incurred, they are not recorded as expenses. Rather, they
are classified as current assets.
Prepaid expenses may need to be adjusted at the end of the accounting period. The adjusting
entry for prepaid expense depends upon the journal entry made when it was initially recorded.
There are two ways of recording prepayments: (1) the asset method, and (2) the expense method.
Asset Method
Under the asset method, a prepaid expense account (an asset) is recorded when the amount is
paid. Prepaid expense accounts include: Office Supplies, Prepaid Rent, Prepaid Insurance, and
others.
In one of our previous illustrations (if you have been following our comprehensive illustration
for Blue Electronic Repair Services), we made this entry to record the purchase of service
supplies:
Dec 7 Service Supplies 1,500.00
Cash 1,500.00
Take note that the amount has not yet been incurred, thus it is proper to record it as an asset.
Suppose at the end of the month, 60% of the supplies have been used. Thus, out of the 1,500, 900
worth of supplies have been used and 600 remain unused. The 900 must then be recognized as
expense since it has already been used.

In preparing the adjusting entry, our goal is to transfer the used part from the asset initially
recorded into expense – for us to arrive at the proper balances shown in the illustration above.
The adjusting entry will include: (1) recognition of expense and (2) decrease in the asset initially
recorded (since some of it has already been used). The adjusting entry would be:
Dec 31 Service Supplies Expense 900.00
Service Supplies 900.00
The "Service Supplies Expense" is an expense account while "Service Supplies" is an asset.
After making the entry, the balance of the unused Service Supplies is now at 600 (1,500 debit
and 900 credit). Service Supplies Expense now has a balance of 900.
Expense Method
Under the expense method, the accountant initially records the entire payment as expense. If the
expense method was used, the entry would have been:
Dec 7 Service Supplies Expense 1,500.00
Cash 1,500.00
Take note that the entire amount was initially expensed. If 60% was used, then the adjusting
entry at the end of the month would be:
Dec 31 Service Supplies 600.00
Service Supplies Expense 600.00
This time, Service Supplies is debited for 600 (the unused portion). And then, Service Supplies
Expense is credited thus decreasing its balance. Service Supplies Expense is now at 900 (1,500
debit and 600 credit).
Notice that the resulting balances of the accounts under the two methods are the same (Cash
paid: 1,500; Service Supplies Expense: 900; and Service Supplies: 600).
Another Example
GVG Company acquired a six-month insurance coverage for its properties on September 1, 2014
for a total of 6,000.
Under the asset method, the initial entry would be:
Sep 1 Prepaid Insurance 6,000.00
Cash 6,000.00
On December 31, 2014, the end of the accounting period, part of the prepaid insurance already
has expired (hence, expense is incurred). The expired part is the insurance from September to
December. Thus, we should make the following adjusting entry:
Dec 31 Insurance Expense 4,000.00
Prepaid Insurance 4,000.00
Of the total six-month insurance amounting to 6,000 (1,000 per month), the insurance for 4
months has already expired. In the entry above, we are actually transferring 4,000 from the asset
to the expense account (i.e., from Prepaid Insurance to Insurance Expense).
If the company made use of the expense method, the initial entry would be:
Sep 1 Insurance Expense 6,000.00
Cash 6,000.00
In this case, we must decrease Insurance Expense by 2,000 because that part has not yet been
incurred (not used/not expired). Insurance Expense shall then have a balance of 4,000. The
amount removed from the expense shall be transferred to Prepaid Insurance. The adjusting entry
would be:
Dec 31 Prepaid Insurance 2,000.00
Insurance Expense 2,000.00
Adjusting Entry for Depreciation Expense

When a fixed asset is acquired by a company, it is recorded at cost (generally, cost is equal to the
purchase price of the asset). This cost is recognized as an asset and not expense.
The cost is to be allocated as expense to the periods in which the asset is used. This is done by
recording depreciation expense.
There are two types of depreciation – physical and functional depreciation.
Physical depreciation results from wear and tear due to frequent use and/or exposure to elements
like rain, sun and wind.
Functional or economic depreciation happens when an asset becomes inadequate for its purpose
or becomes obsolete. In this case, the asset decreases in value even without any physical
deterioration.
Understanding the Concept of Depreciation

There are several methods in depreciating fixed assets. The most common and simplest is
the straight-line depreciation method.
Under the straight line method, the cost of the fixed asset is distributed evenly over the life of the
asset.
For example, ABC Company acquired a delivery van for 40,000 at the beginning of 2012.
Assume that the van can be used for 5 years. The entire amount of 40,000 shall be distributed
over five years, hence a depreciation expense of 8,000 each year.
Straight-line depreciation expense is computed using this formula:
Depreciable Cost – Residual Value / Estimated Useful Life
Depreciable Cost: Historical or un-depreciated cost of the fixed asset

Residual Value or Scrap Value: Estimated value of the fixed asset at the end of its useful life
Useful Life: Amount of time the fixed asset can be used (in months or years)
In the above example, there is no residual value. Depreciation expense is computed as:
= 40,000 – 0 /5 years
= 8,000 / year
With Residual Value

What if the delivery van has an estimated residual value of 10,000? The depreciation expense
then would be computed as:
= 40,000 – 10,000/5 years
= 30,000 /5 years
= 6,000/year
How to Record Depreciation Expense

Depreciation is recorded by debiting Depreciation Expense and crediting Accumulated
Depreciation. This is recorded at the end of the period (usually, at the end of every month,
quarter, or year).
The entry to record the 6,000 depreciation every year would be:
Dec 31 Depreciation Expense 6,000.00
Accumulated Depreciation 6,000.00
Depreciation Expense: An expense account; hence, it is presented in the income statement. It is

measured from period to period. In the illustration above, the depreciation expense is 6,000 for
2012, 6,000 for 2013, 6,000 for 2014, etc.
Accumulated Depreciation: A balance sheet account that represents the accumulated balance of
depreciation. It is continually measured; hence the accumulated depreciation balance is 6,000 at
the end of 2012, 12,000 in 2013, 18,000 in 2014, 24,000 in 2015, and 30,000 in 2016.
Accumulated depreciation is a contra-asset account. It is presented in the balance sheet as a
deduction to the related fixed asset. Here's a table illustrating the computation of the carrying
value of the delivery van.
Notice that at the end of the useful life of the asset, the carrying value is equal to the residual
value.
Adjusting Entries for Bad Debt Expense

Companies provide services or sell goods for cash or on credit. Allowing credit tends to
encourage more sales. However, businesses that allow credit are faced with the risk that their
receivables may not be collected.
Accounts receivable should be presented in the balance sheet at net realizable value, i.e. the most
probable amount that the company will be able to collect.
Net realizable value for accounts receivable is computed like this:
Accounts Receivable - Gross Amount 100,000
Less: Allowance for Bad Debts 3,000
Accounts Receivable - Net Realizable Value 97,000
Allowance for Bad Debts (also often called Allowance for Doubtful Accounts) represents the
estimated portion of the Accounts Receivable that the company will not be able to collect.
Take note that this amount is an estimate. There are several methods in estimating doubtful
accounts. The estimates are often based on the company's past experiences.

To recognize doubtful accounts or bad debts, an adjusting entry must be made at the end of the
period. The adjusting entry for bad debts looks like this:
Dec 31 Bad Debts Expense xxx.xx
Allowance for Bad Debts xxx.xx
Bad Debts Expense a.k.a. Doubtful Accounts Expense: An expense account; hence, it is
presented in the income statement. It represents the estimated uncollectible amount for credit
sales/revenues made during the period.
Allowance for Bad Debts a.k.a. Allowance for Doubtful Accounts: A balance sheet account
that represents the total estimated amount that the company will not be able to collect from its
total Accounts Receivable.
What is the difference between Bad Debts Expense and Allowance for Bad Debts?
Bad Debts Expense is an income statement account while the latter is a balance sheet account.
Bad Debts Expense represents the uncollectible amount for credit sales made during the period.
Allowance for Bad Debts, on the other hand, is the uncollectible portion of the entire Accounts
Receivable.
You can also use Doubtful Accounts Expense and Allowance for Doubtful Accounts in lieu of
Bad Debts Expense and Allowance for Bad Debts. However, it is a good practice to use a
uniform pair.
Here's an Example
Blue Electronic Repair Services estimates that 100.00 of its credit revenue for the period will not
be collected. The entry at the end of the period would be:
Dec 31 Bad Debts Expense 100.00
Allowance for Bad Debts 100.00
Again, you may use Doubtful Accounts. Just be sure to use a logical (and uniform) pair every
time. For example:
Dec 31 Doubtful Accounts Expense 100.00
Allowance for Doubtful
100.00
Accounts
If the company's Accounts Receivable amounts to 3,400 and its Allowance for Bad Debts is 100,
then the Accounts Receivable shall be presented in the balance sheet at 3,300 – the net realizable
value.
Accounts Receivable (Gross Amount) 3,400
Less: Allowance for Bad Debts 100
Accounts Receivable - Net Realizable Value 3,300
An adjusted trial balance is prepared after adjusting entries are made and posted to the ledger.
This is the second trial balance prepared in the accounting cycle.

To illustrate how it works, here is a sample unadjusted trial balance:

Unadjusted Trial Balance
December 31, 2014
Debit Credit
Account Title
Cash P 7,480.00
Service Supplies 1,500.00
Furniture and Fixtures 3,000.00
Service Equipment 16,000.00
Accounts Payable P 9,000.00
Blue, Drawing 7,000.00
Rent Expense 1,500.00
Salaries Expense 3,500.00
Taxes and Licenses 370.00
Totals P 43,750.00 P 43,750.00
At the end of the period, the following adjusting entries were made:
Dec 31 Accounts Receivable 300.00
Service Revenue 300.00
31 Utilities Expense 1,800.00

31 Service Supplies Expense 900.00

31 Depreciation Expense 720.00

Accumulated Depreciation 720.00
After posting the above entries, the values of some of the items in the unadjusted trial
balance will change. Take the first adjusting entry. Accounts Receivable is debited hence is
increased by 300. Service Revenue is credited for 300.
The balance of Accounts Receivable is increased to 3,700, i.e. 3,400 unadjusted balance plus 300
adjustment. Service Revenue will now be 9,850 from the unadjusted balance of 9,550.

Next entry. Utilities Expense and Utilities Payable did not have any balance in the unadjusted
trial balance. After posting the above entries, they will now appear in the adjusted trial balance.
Third. Service Supplies Expense is debited for 900. Service Supplies is credited for 900. The
Service Supplies account had a debit balance of 1,500. After incorporating the 900 credit
adjustment, the balance will now be 600 (debit).
And fourth. There were no Depreciation Expense and Accumulated Depreciation in the
unadjusted trial balance. Because of the adjusting entry, they will now have a balance of 720 in
the adjusted trial balance.
6. ADJUSTED TRIAL BALANCE

An adjusted trial balance may be prepared after adjusting entries are made and before the
financial statements are prepared. This is to test if the debits are equal to credits after adjusting
entries are made.
An adjusted trial balance contains nominal and real accounts. Nominal accounts are those that
are found in the income statement, and withdrawals. Real accounts are those found in the balance
sheet.
Adjusted Trial Balance Example

After incorporating the adjustments above, the adjusted trial balance would look like this. Just
like in the unadjusted trial balance, total debits and total credits should be equal.

Adjusted Trial Balance
December 31, 2014
Account Title Debit Credit

Cash P 7,480.00
Accumulated Depreciation P 720.00
Utilities Expense 1,800.00
Depreciation Expense 720.00
Totals P 46,570.00 P 46,570.00
7. FINANCIAL STATEMENTS
When the accounts are already up-to-date and equality between the debits and credits have been
tested, the financial statements can now be prepared. The financial statements are the end-
products of an accounting system.
A complete set of financial statements is made up of: (1) Statement of Income, (2) Statement of
Changes in Equity, (3) Statement of Financial Position or Balance Sheet, (4) Statement of Cash
Flows.
FINANCIAL STATEMENTS – are accounting reports that provide the financial information of
the transactions that have been recorded and summarized. The principal financial statements of a
single proprietorship are:
INCOME STATEMENT – is a summary of the revenue and expenses for a specific period of
time such as a month or a year.
STATEMENT OF OWNER’S EQUITY - is a summary of the changes in owner’s equity that

have occurred during a specific period of time, such as a month or a year.
BALANCE SHEET – is a list of assets, liabilities and owner’s equity as of specific date at the
end of the month or year.
STATEMENT OF CASH FLOWS – is a summary of cash inflows and cash outflows for a
specific period of time, such as a month or a year.
HOW TO PREPARE FINANCIAL STATEMENTS

The preparation of financial statements is easy once you mastered the accounting elements and
know the different accounts that comprise them. In fact, most businesses today have automated
accounting systems. Financial statements can be prepared with a few clicks of a button.
However, as accountants, we need to know how they work and, you know, make it a part of our
system. This way, we will also be able to understand and interpret financial statements better.
HOW TO PREPARE INCOME STATEMENT

An income statement contains information about a company's revenues and expenses and the
resulting net income.
Net income is computed by deducting all expenses from all revenues. It is the primary measure
of the company's ability to make money.
Step 1: Gather the necessary information

In an accounting system, the best tool to take information from would be the "adjusted trial
balance". This is the most updated trial balance (i.e. prepared after considering adjustments to
several accounts). In any case, any report that shows a complete listing of company accounts can
be used.

Step 2: Start by making the heading
The heading of a financial statement is made up of three lines. The first line contains the name of
the company (Blue Electronic Repair Services). The second line shows the title of the report
(Income Statement). And the third line indicates the period reported.
For income statements, we use For the Year Ended..., For the Quarter Ended..., For the Month
Ended..., etc., depending on the period covered in the report. Nonetheless, some annual income
statements omit the "For the Year Ended" phrase.
Step 3: Report all revenue accounts

From the trial balance, we will look for and report all income or revenue accounts. You will need
to be familiar with different income accounts such as Service Revenue, Sales, Professional Fees,
Interest Income, etc.
Step 4: Report all expense accounts

From the adjusted trial balance again, we will take all expenses and include them in the report.
Once they are all listed, we will get the sum of all the expenses.
Step 5: Compute for the net income

Net income is equal to total revenues minus total expenses.

Income Statement
For the Year Ended December 31, 2014
Service Revenue P 9,850

Less: Operating Expenses
Salaries Expense P 3,500
Utilities Expense 1,800
Rent Expense 1,500
Service Supplies Expense 900
Depreciation Expense 720
Taxes and Licenses 370 8,790
Net Income P 1,060
HOW TO PREPARE STATEMENT OF OWNER’S EQUITY

The "Statement of Owner's Equity", or "Statement of Changes in Owner's Equity", summarizes
the items affecting the capital account of a sole proprietorship business.
A sole proprietorship's capital is affected by four items: owner's contributions, owner's
withdrawals, income, and expenses.
Step 1: Gather the needed information

The Statement of Changes in Owner's Equity is prepared second to the Income Statement. We
will still be using the same source of information. Again, the most appropriate source would be
the adjusted trial balance. Nonetheless, any report with a complete list of updated accounts may
be used.
Step 2: Prepare the heading

Like any financial statement, the heading is made up of three lines. The first line contains the
name of the company. The second line shows the title of the report. In this case, it would
be Statement of Changes in Owner's Equity, Statement of Owner's Equity, or simply Statement
of Changes in Equity. Any of the three would be okay.
The third line shows the period covered. The report covers a span of time, hence we use For the
Year Ended, For the Quarter Ended, For the Month Ended, etc. Some annual financial statements
omit the "For the Year Ended" phrase.
Step 3: Capital at the beginning of the period

Report the capital balance at the beginning of the period reported – or the amount at the end of
the previous period. Remember that the ending balance of the last period is the beginning
balance of the current period.
Step 4: Add additional contributions

Contributions from the owner increases capital, hence added to the capital balance.
Step 5: Add net income

Net income increases capital hence it is added to the beginning capital balance. Net income is
equal to all revenues minus all expenses. We can also refer to the income statement we
previously prepared for the amount.
Step 6: Deduct owner's withdrawals

Withdrawals made by the owner is recorded separately from contributions. You can easily find it
in the adjusted trial balance as "Owner, Drawings", "Owner, Withdrawals", or any other
appropriate account. Withdrawals decrease capital, hence are deducted.
Step 7: Compute for the ending capital balance

Compute for the balance of the capital account at the end of the period and draw the lines. One
horizontal line means that a mathematical operation has been performed. Two horizontal lines
(double-rule) are drawn below the final amount.

Statement of Changes in Owner's Equity
For the Year Ended December 31, 2014
Blue, Capital - beginning P 0

Add: Additional Contributions 13,200
Net Income 1,060
Less: Blue, Drawings 7,000
Blue, Capital - ending P 7,260
So there you have the preparation of a Statement of Changes in Owner's Equity. It is a report that
shows the items that affect the capital or equity account. Simply, we are just presenting this
formula in a formal report:
Capital, ending = Capital, beg. + Additional Contributions + Net Income - Withdrawals
where: Net Income = Income - Expenses
HOW TO PREPARE BALANCE SHEET

The "Balance Sheet", also known as "Statement of Financial Position", shows a company's
financial condition as of a certain date. Financial condition is presented by reporting how much
assets the company owns, how much liabilities it owes to others, and its equity or capital (assets
minus liabilities).
Step 1: Gather the needed information

Like in any other financial statement, we need to gather information to be used in preparing a
balance sheet. Any source that shows updated account balances can be used. The most
appropriate tool for this, however, would be the adjusted trial balance.
Step 2: Prepare the heading

The first line contains the name of the company. The second line shows the title of the report.
We can use either "Balance Sheet" or "Statement of Financial Position". The third line indicates
the date of the report.
The income statement, statement of changes in equity, and statement of cash flows use For the
Year Ended, For the Month Ended, For the Quarter Ended, etc. However, we cannot use any of
those phrases in a balance sheet since we are not reporting information for a period of time, but
rather, information as of a certain date. Therefore, we shall use "As of...” Though, some balance
sheets omit the phrase.
Step 3: Report all company assets

From the trial balance, we take all assets and report them in the balance sheet. Current assets are
normally reported first before non-current assets. After which, we will compute for total current
assets, total non-current assets, and total assets. A single line is drawn every time a mathematical
operation is made. The amount of total assets is double-ruled.
Step 4: Report all liabilities

After the "assets" portion, we will now present "liabilities and capital". We will start by
presenting current liabilities, followed by non-current liabilities. After that, we will take the
totals of each as well as the amount of total liabilities – just like what we did for assets.
Step 5: Report the ending balance of capital after total liabilities

The trial balance above does not show the ending balance of capital. The ending balance of
capital can be taken from the Statement of Changes in Equity. In any case, any source may be
used as long as it gives you the ending balance of capital. After including capital, we will take
the total amount of "liabilities and capital". That amount is double-ruled. Total assets should be
equal to total liabilities and capital. If they are not, then something must have gone wrong during
the process.
Balance Sheet
As of December 31, 2014
ASSETS

Current Assets:
Cash P 7,480
Accounts Receivable 3,700
Service Supplies 600
Total Current Assets 11,780
Non-Current Assets:
Furniture and Fixtures P 3,000
Service Equipment 16,000
Less: Accumulated Depreciation 720
Total Non-Current Assets 18,280
TOTAL ASSETS P 30,060
LIABILITIES AND CAPITAL

Current Liabilities:
Accounts Payable 9,000
Utilities Payable 1,800
Total Current Liabilities 10,800
Non-Current Liabilities:
Loans Payable 12,000
Total Non-Current Liabilities 12,000
Total Liabilities 22,800
Blue, Capital – ending 7,260
TOTAL LIABILITIES AND CAPITAL P 30,060
Total assets should be equal to total liabilities and capital. If they are not, then something must
have gone wrong during the process.
The balance sheet we have just prepared is for a sole proprietorship business. In a partnership,
several capital accounts will have to be presented – one for each partner. In a corporation, the
capital portion is known as stockholders' equity and is made up of capital stock, reserves, and
ending balance of retained earnings.
8. CLOSING ENTRIES
Closing journal entries are made at year-end to prepare temporary accounts for the next
accounting period.
Temporary or nominal accounts, i.e. income statement accounts, are closed to prepare the system
for the next accounting period. Temporary accounts include income, expense, and
withdrawal accounts. These items are measured periodically. The amounts in one accounting
period should be closed or brought to zero so that they won't be mixed with those of the next
period.
The accounts are closed to a summary account (usually, Income Summary) and then closed
further to the appropriate capital account. Take note that closing entries are made only for
temporary accounts. Real or permanent accounts, i.e. balance sheet accounts, are not closed.
Four Steps in Preparing Closing Entries

1. Close all income accounts to Income Summary

2. Close all expense accounts to Income Summary
3. Close Income Summary to the appropriate capital account
4. Close withdrawals to the capital account/s (this step is for sole proprietorship and
partnership only)
9. POST-CLOSING TRIAL BALANCE

The last step in the accounting cycle is to prepare a post-closing trial balance. A post-closing trial
balance is prepared after closing entries are made and posted to the ledger. It is the third trial
balance prepared in the accounting cycle.
For a recap, we have three types of trial balance. They all have the same purpose (i.e. to test the
equality between debits and credits) although they are prepared at different stages in the
accounting cycle.
1. Unadjusted Trial Balance - This is prepared after journalizing transactions and
posting them to the ledger. Its purpose is to test the equality between debits and credits
after the recording phase.
2. Adjusted Trial Balance - This is prepared after adjusting entries are made and posted.
Its purpose is to test the equality between debits and credits after adjusting entries are
prepared. It is also the basis in preparing the financial statements. An adjusted trial
balance contains nominal and real accounts. Nominal accounts are those that are found in
the income statement, and withdrawals. Real accounts are those found in the balance
sheet.
3. Post-Closing Trial Balance - This is prepared after closing entries are made. Its
purpose is to test the equality between debits and credits after closing entries are prepared
and posted. The post-closing trial balance contains real accounts only since all nominal
accounts have already been closed at this stage.
To illustrate, here is a sample adjusted trial balance:

Adjusted Trial Balance
December 31, 2014

Cash P 7,480.00
Accumulated Depreciation P 720.00
Totals P 46,570.00 P 46,570.00
At the end of the period, the following closing entries were made:
Dec 31 Service Revenue 9,850.00
Income Summary 9,850.00
31 Income Summary 8,790.00

31 Income Summary 1,060.00

31 Blue, Capital 7,000.00

After posting the above entries, all the nominal accounts would zero-out, hence the term "closing
entries".
In the first closing entry, Service Revenue was debited. Before that, it had a credit balance of
9,850 as seen in the adjusted trial balance above. Now its balance would be zero.
Second entry. All expenses were credited. Before that, they had debit balances for the same
amounts. They would now have zero balances.
In the first and second closing entries, the balances of Service Revenue and the various expense
accounts were actually transferred to Income Summary, which is a temporary account. The
Income Summary account would have a credit balance of 1,060 (9,850 credit in the first entry
and 8,790 debit in the second).
Income Summary is then closed to the capital account as shown in the third closing entry.
And finally, in the fourth entry the drawing account is closed to the capital account. At this point,
the balance of the capital account would be 7,260 (13,200 credit balance, plus 1,060 credited in
the third closing entry, and minus 7,000 debited in the fourth entry).
Post-Closing Trial Balance Example

After incorporating the closing entries above, the post-closing trial balance would look like this:

Post-Closing Trial Balance
December 31, 2014

Cash P 7,480.00
Accumulated Depreciation P720.00
Totals P 30,780.00 P 30,780.00
The balances of the nominal accounts (income, expense, and withdrawal accounts) have been
absorbed by the capital account – Blue, Capital. Hence, you will not see any nominal account in
the post-closing trial balance.
And just like any other trial balance, total debits and total credits should be equal.
REVERSING ENTRIES
Reversing entries are made at the beginning of the new accounting period to enable a smoother
accounting process. This step is optional and is especially useful to companies that use the cash
basis method.
In this step, adjusting entries made at the end of the previous accounting period are simply
reversed, hence the term "reversing entries". However, not all adjusting entries qualify for this
step.
The following are the only types that can be reversed:

Adjusting entry for accrued income,
Adjusting entry for accrued expense,
Adjusting entry for unearned revenue using the income method, and
Adjusting entry for prepaid expense using the expense method.
Adjusting entries for unearned revenue under the liability method and for prepaid expense under
the asset method are never reversed. Adjusting entries for depreciation, bad debts and other
allowances are also never reversed.

MERCHANDISING CONCERN
Another type of business according to the nature of its operation is a merchandising concern. The
steps in the accounting cycle for merchandising concern are the same as those for a service
business. However, additional accounts and entries and the manner of their presentation in the
financial statements are needed for merchandising transactions such as sale of merchandise and
cost of goods sold.
WORK SHEET OF A MERCHANDISING CONCERN:
Worksheet is a useful tool for preparing adjusting entries, closing entries, and financial
statements. The work sheet of a merchandising business is basically the same, as that of a service
business except that it has to deal with the new accounts that are needed to handle merchandising
transactions. These accounts include sales, sales returns and allowances, purchases, purchases
returns and allowances, purchases discounts, freight-in, and merchandise inventory. In the
records, they are transferred to the profit and loss account in the closing process. On the work
sheet they are extended to the Income Statement columns.
THE FOLLOWING ARE THE TRADING ACCOUNTS USED BY A MERCHANDISING

CONCERN
1. SALES – is an income account which is credited when goods or merchandise are sold
either for cash or on account basis.
2. SALES RETURNS AND ALLOWANCES – result from the return of any
unsatisfactory merchandise. This account is a deduction from sales and is debited when
defective goods are returned by the buyer.
3. SALES DISCOUNTS – is an amount deducted from the regular price of goods that is
granted for early payments. This is debited when an amount of discount is granted to the
buyer. This account can be deducted from sales or maybe considered as other expenses.
4. REVENUE FROM SALES OR NET SALES –consists of gross sales less returns,
allowances and discounts. Thus in the income statement presentation, it is shown as
follows:
Sales P xxx
Less: Sales returns and allowances P xxx
Sales discount xxx xxx_
Net Sales P xxx_
5. GROSS PROFIT FROM SALES – is derived by subtracting cost of sales from net
sales. In the income statement it will be shown as follows:
Net Sales P xxx

Less: Cost of Sales xxx_
Gross Profit From Sales P xxx_
6. PURCHASES – purchases account is accumulated cost of all merchandise bought for
resale during an accounting period. It is debited when goods or merchandise are bought
either on account or on cash basis.

7. PURCHASE RETURNS AND ALLOWANCES – this is a deduction from purchases.
This is credited when defective merchandise are returned to the supplier.
8. PURCHASE DISCOUNT – this account is a deduction from purchases.
9. FREIGHT IN – this is debited if the business shoulders the payment for the delivery of
good bought. This is added to purchases and a part of cost of sales.
10. FREIGHT OUT – this is one of the operating expenses of the business. This is debited
upon payment for the delivery of goods sold.
11. MERCHANDISE INVENTORY – Goods for sale.
12. COST OF GOOD SOLD – Consists of the cost of merchandise on hand at the beginning
of the accounting period, net cost of merchandise purchased including cost of
transporting the goods bought during the period, and cost of unsold merchandise at the
end of the accounting period. This is presented in the income statement as follows:
COST OF GOOD SOLD:

MERCHANDISE INVENTORY, BEGINNING P XXX
ADD: PURCHASES P XXX
FREIGHT-IN XXX
GROSS
TOTAL PURCHASES
GOODS PURCHASED XXX
LESS : PURCHASE RETURNS AND ALLOWANCES P XXX
PURCHASE DISCOUNT XXX XXX XXX
TOTAL GOODS AVAILABLE FOR SALE P XXX
LESS : MERCHANDISE INVENTORY, END XXX
COST OF GOODS SOLD P XXX
There are two groups of merchandise inventory in an accounting period, namely the merchandise
inventory, beginning, and the merchandise inventory, end.
Merchandise inventory beginning consists of the initial inventory of the business if it is the first
year of the business operation. If the business has been going on for quite some time, the
inventory at the beginning of the period consists of the unsold goods in the previous year of
operation.
Merchandise inventory at the end of the accounting period includes those sold unsold good at the
current period of the operation. This will eventually be the beginning inventory of the next
accounting period.
Operating expenses make up the third major part of the income statement for a merchandising
concern. As noted earlier they are expenses, other than the cost of goods sold that is necessary to
run the business. It is Customary to group operating expenses into useful categories. For
example, selling expenses and general and administrative expenses are common categories.
Selling expenses include all expenses of storing and preparing goods for sale, displaying,
advertising, and otherwise promoting sales, making the sales, and delivering the goods to the
buyer if the seller bears the cost of delivery. Among the general and administrative expenses are
general office expenses, those for accounting, personnel, and credit and collections, and any
other expenses that apply to the overall operation of the company. Although general occupancy
expenses, such as rent expense and utilities expenses are often classified as general and
administrative, they are sometimes allocated or divided between the selling and the general and
administrative categories on the basis determined by management.
SPECIAL JOURNALS

Some businesses encounter voluminous quantities of similar and recurring transactions, which
may create congestion if these transactions are recorded repeatedly in a single day or monthly in
the general journal. The use of special journals will eliminate this problem.
The following are the commonly used special journals:

1. Cash Receipts Journal –used to record all cash that had been received
2. Cash Disbursements Journal –used to record all transactions involving cash payments
3. Sales Journal (Sales on Account Journal) –used to record all sales on credit (on account)
4. Purchase Journal (Purchase on Account Journal) –used to record all purchases of inventory
on credit (or on account)
INVENTORY SYSTEMS
Maintaining inventory items is a unique set-up in a merchandising business. There are two
methods of accounting for inventory, namely: Perpetual Inventory System and Periodic
Inventory System.
Merchandising entities may use either of the following inventory systems:

1. PERPETUAL SYSTEM — Detailed records of the cost of each item are maintained, and the
cost of each item sold is determined from records when the sale occurs. For example, a car
dealership has separate inventory records for each vehicle.
• Record purchase of Inventory.
• Record revenue and record cost of goods sold when the item is sold.
• At the end of the period, no entry is needed except to adjust inventory for losses, etc.
2. PERIODIC SYSTEM — Cost of goods sold is determined only at the end of an accounting
period. This system involves:
• Record purchase of Inventory.
• Record revenue only when the item is sold.
• At the end of the period, you must compute cost of goods sold (COGS):
1. Determine the cost of goods on hand at the beginning of the accounting period
(Beginning Inventory = BI),
2. Add it to the cost of goods purchased (COGP),
3. Subtract the cost of goods on hand at the end of the accounting period
4. (Ending Inventory = EI)
ADDITIONAL CONSIDERATIONS:
• Perpetual systems have traditionally been used by companies that sell merchandise with high
unit values such as automobiles, furniture, and major home appliances. With the use of
computers and scanners, many companies now use the perpetual inventory system.
• The perpetual inventory system is named because the accounting records continuously —
perpetually —show the quantity and cost of the inventory that should be on hand at any time.
The periodic system only periodically updates the cost of inventory on hand.
• A perpetual inventory system provides better control over inventories than a periodic inventory,
since the records always show the quantity that should be on hand. Then, any shortages from the
actual quantity and what the records show can be investigated immediately.

PERIODIC INVENTORY SYSTEM
Recording purchases under the Periodic Inventory System
PURCHASES OF MERCHANDISE: PERIODIC SYSTEM

1. When merchandise is purchased for resale to customers, the account, Purchases, is debited for
the cost of goods purchased.
2. Like sales, purchases may be made for cash or on account (credit).
3. The purchase is normally recorded by the purchaser when the goods are received from the
seller.
• Each credit purchase should be supported by a purchase invoice.
• A purchase invoice received by the buyer is actually a sales invoice or a charge invoice
prepared by the supplier or vendor.
• Note that only purchases of merchandise are debited to the ‘Purchase’ account.
Acquisition (purchases) of other assets: supplies, equipment, and similar items are
debited to their respective accounts.
PERPETUAL INVENTORY SYSTEM
Recording Purchases under the Perpetual Inventory System
PURCHASES OF MERCHANDISE: PERPETUAL SYSTEM

• When merchandise is purchased for resale to customers, the account, Merchandise Inventory, is
debited for the cost of goods purchased.
• Like sales, purchases may be made for cash or on account (credit).
• The purchase is normally recorded by the purchaser when the goods are received from the
seller.
• Each credit purchase should be supported by a purchase invoice.
• A purchase invoice received by the buyer is actually a sales invoice or a charge invoice
prepared by the supplier or vendor.
• Note that only purchases of merchandise are debited to Merchandise Inventory.
Purchases of other assets: supplies, equipment, and similar items are debited to their
respective accounts.
PERPETUAL AND PERIODIC INVENTORY SYSTEM COMPARED

Journal Entries:
PERPETUAL SYSTEM PERIODIC SYSTEM
Purchase Transactions: Purchase Transactions:
Merchandise Inventory xxx Purchases xxx

Cash xxx Cash xxx
(purchase merchandise for cash) (purchase merchandise for cash)

Sales Transactions: Sales Transactions:
Cash xxx Cash xxx

Sales xxx Sales xxx
(sold merchandise for cash) (sold merchandise for cash)
Cost of Goods Sold xxx

Merchandise Inventory xxx
(To charge merchandise sold to
Cost of Goods Sold)
*Merchandise Inventory and Cost of Goods Sold
* observe that Merchandise Inventory and Cost of are not constantly updated. Cost of merchandise
Goods Sold are always updated in the accounting acquired is charged to Purchases. The cost of
records. unsold merchandise will constitute the
merchandise inventory at the end of the
accounting period and can be determined by a
physical count.
Perpetual - Illustrative Example:

On May 4, Hyundex Auto Center, a dealer of imported vans paid cash for the purchased of two
units of Hyundai Starex vans at P720,000 per unit. On May 7, it sold one unit for P800,000 cash
Journal Entries:
May 4 Merchandise Inventory 1,440,000

Cash 1,440,000
(Purchased 2 vans @ P720,000/unit for cash)
May 7 Cash 800,000

Sales 800,000
(Sold one van for cash)
Cost of Goods Sold 720,000

Merchandise Inventory 720,000
(To charge merchandise sold to cost of goods sold)
Periodic - Illustrative Example:
On May 4, Hard Hardware, paid cash for the purchased of 200 pieces of hammers at P100 per
unit. On May 7, it sold 50 pieces of hammers for 150 per unit.
Journal Entries:
May 4 Purchases 20,000

Cash 20,000
(Purchased 200 hammers @ P100/unit for cash)
May 7 Cash 7,500

Sales 7,500
(Sold 50 pieces hammers @ P150/unit for cash)

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ACCOUNTING 1 READING MATERIALS

ACCOUNTING is famously known as the "language of business". Through the financial

ACCOUNTING is also considered a science because it is a body of knowledge. Accounting,

ACCOUNTING-1 READING MATERIALS#1 Page 1

ROLE AND PURPOSE OF ACCOUNTING IN BUSINESS

WHY STUDY ACCOUNTING?

BRIEF HISTORY OF ACCOUNTING

ACCOUNTING-1 READING MATERIALS#1 Page 2

BRANCHES OF ACCOUNTING AND AREAS OF PRACTICE

The branches of accounting (fields of specialization) include: financial accounting, management

Accounting professionals in public accounting work in CPA firms or individually in providing

As a result of economic, industrial, and technological developments, different specialized fields

MAJOR AREAS OF ACCOUNTING

MANAGEMENT ACCOUNTING – is concerned primarily with financial reporting for

GOVERNMENT ACCOUNTING – focuses on the accounting development and

THE FAMOUS BRANCHES OR TYPES OF ACCOUNTING INCLUDE:

ACCOUNTING-1 READING MATERIALS#1 Page 3

ACCOUNTING-1 READING MATERIALS#1 Page 4

USERS OF ACCOUNTING INFORMATION - INTERNAL & EXTERNAL

Internal users (Primary Users) of accounting information include the following:

Accounting information is presented to internal users usually in the form of management

External users (Secondary Users) of accounting information include the following:

FORMS OF BUSINESS ORGANIZATION

There are three major types of businesses:

ACCOUNTING-1 READING MATERIALS#1 Page 6

Guidelines on Basic Accounting Principles and Concepts

ACCOUNTING-1 READING MATERIALS#1 Page 7

BASIC ELEMENTS OF ACCOUNTING:

BALANCE SHEET (Financial Condition):

Usually asset accounts will have debit balances.

B. LIABILITIES – economic or legal obligations that a business owes to other businesses or

Here is a list of current and non-current liabilities:

INCOME STATEMENT (RESULTS OF OPERATIONS):

ACCOUNTING-1 READING MATERIALS#1 Page 10

List of Expense Accounts

ACCOUNTING-1 READING MATERIALS#1 Page 11

BASIC ACCOUNTING EQUATION

The accounting equation for a corporation is:

ACCOUNTING-1 READING MATERIALS#1 Page 12

The accounting equation may be rewritten as:

LIABILITIES = ASSETS – CAPITAL/OWNER’EQUITY, OR

Accounting Equation is the foundation of double-entry bookkeeping system. Double Entry

DOUBLE ENTRY ACCOUNTING SYSTEM

RULES OF DEBIT AND CREDIT:

RULES FOR ASSET ACCOUNTS:

RULES FOR LIABILITY AND OWNER’S EQUITY ACCOUNTS:

Accounting Element Normal Balance To Increase To Decrease

1. Assets Debit Debit Credit

ACCOUNTING-1 READING MATERIALS#1 Page 13

2. Liabilities Credit Credit Debit

FOUR PHASES OF ACCOUNTING

Based on the definition, accounting has 4 phases:

1. RECORDING – this is technically called bookkeeping. In this phase, business

BUSINESS TRANSACTION FLOW

Source Journal Ledger Trial Financial

THE ACCOUNTING CYCLE OR ACCOUNTING PROCESS

ACCOUNTING-1 READING MATERIALS#1 Page 14

ACCOUNTING CYCLE STEPS

1. IDENTIFYING AND ANALYZING BUSINESS TRANSACTIONS

What is a business transaction?

Transactions may be classified as exchange and non-exchange. Exchange transactions involve

To qualify as an accountable/recordable business transaction, the activity or event must:

ACCOUNTING-1 READING MATERIALS#1 Page 15