Study Guide

1

Study Guide in Introductory Accounting for Service Business Benedick Manalaysay Accountancy Department De La Salle University – Manila

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2 TABLE OF CONTENTS

Lesson Number

Topic

Starting Page

1

Introduction to Accounting

3

2

Transaction Analysis

12

3

General Journal, General Ledger, Trial Balance

22

4

Financial Statements

29

5

Statement of Cash Flows

36

6

Correcting Entries

38

7

Payroll Accounting

40

8

Accounting for Promissory Notes

43

9

Accrued Income

52

10

Accrued Expense

55

11

Prepaid Expense

58

12

Unearned Income

62

13

Depreciation

66

14

Doubtful Accounts

71

15

Closing Entries, Post-Closing Trial Balance

76

16

Reversing Entries

82

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3 LESSON 1 INTRODUCTION TO ACCOUNTING

Study Objectives After studying this lesson, you should be able to: Achievement of Objective (Put a Check mark) 1

Learn the history of accounting

2

Define accounting

3

Know the accounting

4

Know the branches of accounting

5

Distinguish the forms of business organizations according to ownership and according to activity

6

Know the role of Certified Public Accountant in the society

7

Know the functions of different government agencies and professional bodies relevant to the accounting profession

8

Know the purposes of the business documents

9

Define financial statements and its components, generally accepted accounting principles (GAAP), Financial Reporting Standards Council (FRSC), and users of the financial statements

10

Explain the different basic accounting concepts or assumptions

11

Know other terms related to basic accounting

difference

between

bookkeeping

and

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4 Objective 1 History of Accounting Accounting has a long history. Some scholars claim that writing arose in order to record information. Account records date back to the ancient civilizations of China, Babylonia, Greece and Egypt. The rulers of these civilizations used accounting to keep track of the cost of labor and materials used in building structures like the great pyramids. (Source: Horngren, Harrison and Robinson, 1995) Accounting developed as a result of the information needs of merchants in the city-states of Italy during the 1400s. In that commercial climate a monk, Luca Pacioli, a mathematician and friend of Leonardo da Vinci, published the first known description of double-entry bookkeeping entitled Summa de Arithmetica, Geometria, Proportioni et Proportionalite, which means Everything about Arithmetic, Geometry, and Proportion published in Venice in November 1494. This book contained primarily principles of mathematics and incidentally a set of accounting procedures. The pace of accounting development increased during the Industrial Revolution as the economies of developed countries began to mass-produce goods. Until that time, merchandise was priced based on managers’ hunches about cost but increased competition required merchants to adopt more sophisticated accounting system. In the nineteenth century, the growth of corporations especially those in the railroad and steel industries, spurred the developed of accounting. Corporate owners were no longer necessarily the managers of their business. Managers had to create accounting systems to report to the owners how well their businesses were doing. Government played a role in leading more development in the field of accounting when it started using the income tax. Accounting supplied the concept of income. Also, government at all levels has assumed expanded roles in health, education, labor and economic planning. To ensure that the information that it uses to make decisions is reliable, the government has required strict accountability in the business community. At the beginning of the third millennium, there would still be significant developments in the field of accounting. The great challenge of globalization and the effects of new technologies (e.g. super computers, robotics, inter and intra-net, etc.) pose a shift in the structure and pattern in this field. More and better accounting information are now being required and therefore, accounting, being the means used in communicating business and financial information, must also evolve into a more efficient level. Reference: Workbook in Introductory Accounting for Service Business

Accounting as “Language of Business” The primary objectives of the business are: 1. To generate profits 2. To properly manage limited and scarce resources With these objectives, a business must prepare financial reports and interpret these reports as an aid in decision-making. In making decisions, accounting is used as a tool for communication. Confidentiality Requirement This material is prohibited for reproduction or distribution without prior consent from the author.

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5

Objective 2 Definition of Accounting 1. Accounting is a service activity. a. Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions. 2. Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information. a. Identifying – this accounting process is the recognition or nonrecognition of business activities as “accountable events” (Valix, 2005). There are 3 types of transactions: i. Business transaction – 1. transactions which are recorded in the financial books. Example is investment of the owner. ii. Personal transaction – 1. transactions which are not recorded in the financial books. Example is purchase of house and lot of a business owner using his personal money. iii. Neither business nor personal transaction – 1. Business events that are not recorded in the financial books. Examples are hiring of employees, death of the owner, entering into a contract etc. b. Measuring – this accounting process is the assigning of Peso amounts to the accountable economic transactions and events (Valix, 2005) c. Communicating – is the process of preparing financial statements and interpreting the results thereof

3. Accounting is 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 a financial character, and interpreting the results thereof. 4. Accounting is an information system that measures, processes, and communicates financial information about an identifiable economic entity.

Objective 3 Difference between Bookkeeping and Accounting Bookkeeping

Accounting

 Recording of transactions

 Recording of transactions

 Preparing financial reports

 Preparing financial reports  Analyzing financial reports  Decision-making

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6

Objective 4 Branches of Accounting 1. Financial Accounting – is primarily concerned with the recording of business transactions and the eventual preparation of financial statements (Valix, 2005). 2. Cost Accounting – is primarily concerned with proper accumulation of costs such as materials, labor and overhead, proper costing of inventories and study of different costing methods. 3. Management Accounting – is the preparation of financial reports and management research intended for management use and interpretation of these reports and researches. Examples of financial reports are Sales reports, Cost of Production reports, Budgets etc. Example of management research is evaluation of a business process and management consulting. 4. Taxation – deals with the study of provisions of the law with regard to Philippine taxation system and proper computation of taxes such as income tax, value-added tax, withholding tax and other taxes. 5. Auditing – basically deals with the examination of the financial statements by an independent party (auditor) to ascertain whether such financial statements are in conformity with Philippine Accounting Standards.

Objective 5 Forms of Business Organizations 1. According to ownership a. Sole-proprietorship – owned by only one person called sole-proprietor b. Partnership – owned by 2 or more persons called partners c. Corporation – owned by 5 or more persons called shareholders 2. According to activity a. Service – renders services to the public such accounting firms, law firms, consulting firms, SPA, medical clinics, dental clinics, schools etc b. Merchandising – buys and sells merchandise to the public c. Manufacturing – buys raw materials and converts them into finished goods to be sold to the public

Objective 6 Certified Public Accountant (CPA) - is an accounting professional doing accounting, audit, tax, management consulting, education and research work. - Types of Accountants o Private Accountant / Management Accountant  is an accounting professional employed in a private company or organization Confidentiality Requirement This material is prohibited for reproduction or distribution without prior consent from the author.

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7 o

o o

Public Accountant / Auditor  is an accounting professional independent from the private organizations and is usually employed in an auditing firm Government Accountant  is an accounting professional employed in a government agency Accounting Educator and Researcher  is an accounting professional employed in a university, college or research organization

Objective 7 Government Agencies and Professional Bodies 1. Bureau of Internal Revenue (BIR) – agency in charge of proper collection of taxes from the public 2. Securities and Exchange Commission (SEC) – agency in charge of accumulating audited financial statements of organizations, regulating companies issuing securities such as stocks and bonds to the public, and monitoring companies in the insurance industry. This agency also facilitates the registration of partnerships and corporations. 3. Bangko Sentral ng Pilipinas (BSP) / Central Bank of the Philippines – agency in charge of regulating Philippine bank operations, setting Philippine monetary policies etc. 4. Philippine Stock Exchange (PSE) – agency in charge of monitoring securities transactions of companies listed in the stock exchange. 5. Department of Trade and Industry (DTI) – agency in charge of facilitating registration of sole-proprietorship businesses and regulating consumer commodity transactions. 6. Commission on Audit (COA) – agency in charge of auditing government-related transactions 7. Board of Accountancy (BOA) - is an accounting body in charge of administering licensure examination for accountants 8. Professional Regulation Commission (PRC) - government agency in charge of issuing licenses to successful examinees in board exams 9. Philippine Instititute of Certified Public Accountants (PICPA) - Professional organization of accountants in the Philippines 10. City Hall and Baranggay – these political subdivisions issues business permits and collects business taxes.

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8 Objective 8 Business Documents 1. 2. 3. 4. 5. 6.

Purchase Order – shows items to be ordered by the business Delivery Receipt – shows items to be delivered in the business Sales Invoice – shows items that were sold to the business Statement of Account – shows the summary of sales invoices Cash Voucher – shows the liability of the business to be paid in the future Official Receipt – shows the amount received by the business

Objective 9 Financial Statements - Shows the results of the recording of the business transactions and are expressed in terms of assets, liabilities, equity, income and expenses. -

Six (6) Components o Balance Sheet / Statement of Financial Position  Presents the financial condition of the business through its assets, liabilities and capital / owner’s equity o Income Statement  Presents the financial performance of the business through its income and expenses o Statement of Changes in Owner’s Equity  Presents the changes in capital such as additional investments, withdrawals, net income and/or net loss o Statement of Cash Flows  Presents the cash inflows and outflows of the business through its operating, investing and financing activities o Statement of Comprehensive Income  Presents gains and losses that were not presented in the Income statement. Examples are Unrealized gain on sale of trading securities, Foreign exchange gain on translation etc. o Notes to the Financial Statements  Presents the details of the line items in the Balance Sheet and Income Statement

Generally Accepted Accounting Principles (GAAP) - Refers to rules, procedures, practice and standards followed in the preparation and presentation of financial statements (Valix, 2005). Financial Reporting and Standards Council (FRSC) - The council establishes and improves accounting standards that will be generally accepted in the Philippines (Valix, 2005)

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9 Users of the Financial Statements Internal Users 1. Management 2. Employees

External Users 1. Investors 2. Creditors / Lenders 3. Suppliers / Vendors 4. Government 5. Public

Objective 10 Basic Accounting Concepts / Assumptions 1. Entity a. Under this concept, the business enterprise is viewed as separate from the owners, managers, and employees of the business (Valix, 2005) 2. Time period a. This concept requires that the indefinite life of an enterprise is subdivided into time periods which are usually of equal length (Valix, 2005) b. Calendar year is a 12-month period that ends on December 31, otherwise it is called Natural business year or Fiscal year (Valix, 2005) 3. Monetary unit a. This concept assumes that financial transactions be measured in terms of money or currency of the Philippines 4.

Cost a. This concept requires that assets should be recorded initially at original acquisition cost (Valix, 2005)

5. Adequate disclosure a. This concept requires that all significant and relevant information leading to the preparation of financial statements should be clearly reported (Valix, 2005) 6. Materiality a. This concept relates to the significance of an item to the overall presentation of the financial statements. Information is material if its omission could influence the economic decision of the users of the financial statements (Valix, 2005) 7. Accrual a. This concept requires the income earned must be recognized in the financial statements whether cash is received or not. b. This concept also requires the expenses incurred must be recognized in the financial statements whether cash is paid or not. c. Because of this concept, organizations are preparing adjusting journal entries to recognize accrued income and accrued expenses. d. Accrued income refers to income earned but not yet received. e. Accrued expense refers to expense incurred but not yet paid. Confidentiality Requirement This material is prohibited for reproduction or distribution without prior consent from the author.

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10 8. Consistency a. This concept requires that the accounting methods and practices should be applied on a uniform basis from one time period to another (Valix, 2005). 9. Comparability a. There are 2 kinds of comparability: Comparability within an enterprise and Comparability between enterprises (Valix, 2005) b. Comparability within an enterprise is the quality of information that allows comparisons within a single enterprise from one time period to the next (Valix, 2005) c. Comparability between enterprises is the quality of information that allows comparisons between two or more enterprises engaged in the same industry (Valix, 2005) 10. Going Concern a. This concept assumes that business will operate indefinitely and there is no intention of liquidating or closing down the business 11. Revenue recognition a. Same as accrued income concept 12. Expense recognition a. Same as accrued expense concept 13. Matching a. This concept requires that costs and expenses incurred in earning a revenue should be reported in the same period when the revenue or income is earned (Valix, 2005) 14. Conservatism a. Under this concept, when alternatives exist, the alternative which has the least effect on net income or owner’s equity should be chosen (Valix, 2005) b. Conservatism is synonymous with Prudence. Prudence is the desire to exercise care and caution when dealing with the uncertainties in the measurement process such as assets or income are not overstated and liabilities or expenses are not understated (Valix, 2005) 15. Objectivity a. This concept requires that financial transactions that were recorded be supported by business documents

Objective 11 Other Terms Liquidity Solvency - Refers to the ability of the organization - Refers to the ability of the organization to pay its short-term (current) to pay its long-term (noncurrent) obligations obligations Stock Certificate – evidence certifying the ownership of shares of stock of a shareholder Confidentiality Requirement This material is prohibited for reproduction or distribution without prior consent from the author.

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11 Further Readings Kieso, D., Kimmel, P. and Weygandt, J. (2008). Accounting Principles, 8th edition. New Jersey: John Wiley and Sons, Inc. pages 2 – 11, 21, 25, 29 – 31, 92 – 94 Kimwell, Mercedes (2009). Fundamentals of Accounting, 2nd edition. Manila: GIC Enterprises & Co., Inc. Valencia, E., and Roxas, G. (2009). Basic Accounting, 3rd edition. Baguio City: Valencia Educational Supply. Cabrera, M.E.B, Ledesma, E.F., and Lupisan M.C.Y. (2007). Fundamentals of Accounting Vol. 1. Manila: GIC Enterprises & Co., Inc. Chalmers, K., Fyfe, M., Kieso, D., Kimmel, P., Mitrione, L., and Weygandt, J. (2007). Principles of Financial Accounting. John Wiley and Sons Australia, Ltd.

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12 LESSON 2 TRANSACTION ANALYSIS

Study Objectives After studying this lesson, you should be able to: Achievement of Objective (Put a Check mark) 1

Define the accounting equation and know the effects of the financial transactions on the accounting equation

2

Familiarize with the types of accounts for assets, liabilities, capital, income and expenses

Objective 1 The Accounting Equation

Assets = Liabilities + Capital

The equation states that business assets are financed by two parties. They are the creditors or vendors (liabilities) and the owner (capital). Income will increase assets as well as capital and expenses will decrease assets as well as capital. Business transactions will have an effect on the accounting equation. The following are the basic financial transactions and the effects on the accounting equation.

Transaction

ASSETS

LIABILITIES

CAPITAL

Investment of the owner

▲

▲

Investment

Withdrawal of the owner

▼

▼

Withdrawal

▼

Interest expense

Borrowed money by issuing a promissory note Payment of the principal and interest of the promissory note

▲

▲

▼

▼

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13

Purchase of short-term investment for cash Sale of short-term investment at a gain

Sale of short-term investment at a loss

Cash advance employee

to

an

Purchase of supplies for cash Purchase of supplies on account Purchase of a fixed asset for cash Purchase of a fixed asset on account Partial / Full payment of accounts payable Sale of a fixed asset at a gain

Sale of a fixed asset at a loss Rendered services for cash Rendered account

services

on

▲▼ ▲▼

▲

▲▼

▼

Gain on sale of investment in trading securities Loss on sale of investment in trading securities

▲▼ ▲▼ ▲

▲

▲▼ ▲

▲

▼

▼

▲▼

▲

Gain on sale of equipment

▲▼

▼

Loss on sale of equipment

▲

▲

Service Income

▲

▲

Service Income

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14

Partial / Full collection of accounts receivable Received cash commission income

for

Payment of expenses for cash

▲▼ ▲

▲

Commission Income

▼

▼

Expense

Objective 2 Types of Accounts CATEGORY

DEFINITION

ACCOUNT TITLE

DEFINITION / EXAMPLES

ASSETS CASH

This includes bills and coins, bank check, bank accounts.

INVESTMENT IN TRADING SECURITIES

This refers to shortterm, highly liquid investment in securities such as stocks and bonds.

TRADE AND OTHE RECEIVABLES

These refer to amounts collectible from a person or a company

PETTY CASH FUND

Cash used to pay petty or small amount of expenses.

CASH ON HAND

Cash in the possession and custody of the business.

CASH IN BANK

Self-explanatory

ACCOUNTS RECEIVABLE

Amount collectible from clients or customers for services rendered or sale of goods

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15 ALLOWANCE FOR DOUBTFUL ACCOUNTS

Is a Contra-asset account that represents provision for estimated doubtful accounts

NOTES RECEIVABLE

Same with Accounts Receivable but is evidenced by a promissory note

INTEREST RECEIVABLE

Amount collectible in a loan transaction

COMMISSION RECEIVABLE RENT RECEIVABLE ADVANCES TO EMPLOYEES

PREPAID EXPENSES

These refer to expenses that are paid in advance

Cash advance given to employees

PREPAID RENT

PREPAID INSURANCE PREPAID ADVERTISING PREPAID SUBSCRIPTIONS OFFICE SUPPLIES STORE SUPPLIES PROPERTY, PLANT AND EQUIPMENT

These refer to items that are useful for more than 1 year

LAND

OFFICE EQUIPMENT STORE EQUIPMENT

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Computer, Fax machine Cash register machine

16 TRANSPORTATION EQUIPMENT

Delivery Van, Motorcycle, Cars, Trucks

FURNITURE AND FIXTURES

Cabinets, Tables, Chairs

MACHINERY BUILDING

Office building, Factory plant

ACCUMULATED DEPRECIATION

Is a Contra-asset account that represents cumulative depreciation for depreciable fixed assets

LIABILITIES TRADE AND OTHER PAYABLES

These refer to amounts payable to a person or a company

ACCOUNTS PAYABLE

Amount payable to supplier, creditor or vendor for money, supplies, goods or property loaned

NOTES PAYABLE

Same with Accounts Payable but is evidenced by a promissory note

DISCOUNT ON NOTES PAYABLE

Is a Contra-liability account that represents unamortized interest on the promissory note

INTEREST PAYABLE

Amount payable in a loan transaction

TAXES AND LICENSES PAYABLE

Unpaid taxes and licenses to be remitted / paid to the government

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17 UTILITIES PAYABLE

Unpaid communication, light and water bills

SALARIES AND WAGES PAYABLE

Unpaid salaries and wages of the employees

UNEARNED INCOME

This refers to cash received in advance but not yet earned

UNEARNED RENT UNEARNED ADVERTISING UNEARNED SUBSCRIPTIONS UNEARNED COMMISSION

MORTGAGE PAYABLE

This refers to bank loan with assets such as house and lot or vehicle as collaterals

BONDS PAYABLE

This refers to loan that is evidenced by a bond certificate or indenture

CAPITAL / OWNER’S EQUITY OWNER, CAPITAL

This refer to claim or interest of the owner

OWNER, DRAWING

This refer to temporary withdrawal of the owner of cash, supplies, goods or

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18 property

INCOME SERVICE INCOME

Income derived from rendering of services Primary income for service business

OTHER INCOME

Secondary income for service business

INTEREST INCOME

Income from loan transactions

DIVIDEND INCOME

Income from stock investments

RENT INCOME GAIN ON SALE OF EQUIPMENT

Excess of selling price over the net book value of the fixed asset

EXPENSES EMPLOYEE BENEFIT COST

Expenses related to employee benefits

SALARIES AND WAGES EXPENSE

Represents the total gross salary or wages of the employees

SSS PREMIUMS EXPENSE

Represents total SSS (health benefit) contributions of the employer and the employees

PHILHEALTH CONTRIBUTIONS EXPENSE

Represents total Philhealth (health benefit) contributions of the employer and the employees

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19 PAG-IBIG CONTRIBUTIONS EXPENSE

RENT EXPENSE PROFESSIONAL FEES

Expense related to professional services of accountants, lawyers etc

ADVERTISING EXPENSE COMMISSION EXPENSE

Expense related to payment of commission to agents

REPAIR AND MAINTENANCE EXPENSE SUPPLIES EXPENSE INSURANCE EXPENSE REPRESENTATION AND ENTERTAINMENT EXPENSE

Expense related to cost of meetings with clients such as meals

TRANSPORTATION EXPENSE

Expense related to commuting from the office to client’s office

FUEL AND OIL EXPENSE UTILITIES EXPENSE

Expense related to communication such as telephone, Internet, electricity and water

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Represents total Pag-IBIG (housing benefit) contributions of the employer and the employees

20

TAXES AND LICENSES EXPENSE

Expense related to business taxes and permits from the city hall

CHARITABLE CONTRIBUTION EXPENSE

Expense related to donations

DEPRECIATION EXPENSE

Noncash expense that represents the total depreciation of the depreciable fixed assets for the year

DOUBTFUL ACCOUNTS EXPENSE

Noncash expense that represents the total estimated doubtful accounts for the year

BAD DEBTS EXPENSE

Noncash expense that represents the total accounts receivable that were written-off / removed from the financial books due to its proven uncollectibility

MISCELLANEOUS EXPENSE OTHER EXPENSE

LOSS ON SALE OF EQUIPMENT

Excess of net book value over the selling price of the fixed asset

FINANCE COST

INTEREST EXPENSE

Expense from loan transactions

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21 Further Readings Kieso, D., Kimmel, P. and Weygandt, J. (2008). Accounting Principles, 8th edition. New Jersey: John Wiley and Sons, Inc. pages 14 – 20, 26 – 27, 159 – 164 Kimwell, Mercedes (2009). Fundamentals of Accounting, 2nd edition. Manila: GIC Enterprises & Co., Inc. Valencia, E., and Roxas, G. (2009). Basic Accounting, 3rd edition. Baguio City: Valencia Educational Supply. Cabrera, M.E.B, Ledesma, E.F., and Lupisan M.C.Y. (2007). Fundamentals of Accounting Vol. 1. Manila: GIC Enterprises & Co., Inc. Chalmers, K., Fyfe, M., Kieso, D., Kimmel, P., Mitrione, L., and Weygandt, J. (2007). Principles of Financial Accounting. John Wiley and Sons Australia, Ltd.

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22 LESSON 3 GENERAL JOURNAL, GENERAL LEDGER TRIAL BALANCE

Study Objectives After studying this lesson, you should be able to: Achievement of Objective (Put a Check mark) 1

Know the concept of double-entry bookkeeping and the appropriate accounting tool for financial transactions

2

Understand the concept of journalizing and prepare journal entries

3

Post journal entries to the general ledgers

4

Prepare the trial balance

Objective 1 Double-entry Bookkeeping This concept uses the tools debit and credit to record financial transactions. Further, this concept dictates that “for every debit, there is at least one credit and vice-versa”. Appropriate Accounting Tool The table shows the appropriate accounting tool for the effects of the financial transactions on assets, liabilities, capital, income and expenses.

Asset Liability Capital Income Expense

Increase

Decrease

Debit Credit Credit Credit Debit

Credit Debit Debit

Objective 2 Journalizing This refers to the process of recording the financial transactions in the General Journal. General Journal is also known as “Book of Original Entry”. The following are examples of Journal Entries: Adapted from Exercise 6-8 of Workbook in Introductory Accounting for Service Business Confidentiality Requirement This material is prohibited for reproduction or distribution without prior consent from the author.

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23 Journalize the following selected transactions of MJ Dry Cleaning. The following transaction occurred during June 2010. 1

MJ Flores invested in the business the following: P 250,000 cash and P 420,000 worth of dry cleaning equipment with fair value of P 400,000 but with existing liability of P 100,000 which is to be assumed by the business

2

Purchased dry cleaning supplies from Wilson Cleaners for P 22,100, payable after 20 days

4

Bought cash register from Carter Equipment, P 45,800. Terms: 30% down payment, balance on account

7

Dry cleaning services rendered for the week totaled P 25,250 cash

GENERAL JOURNAL

Date 2010 Jun 01

02

04

07

Particulars

Page xx

F

Debit

Cash Dry Cleaning Equipment Accounts Payable MJ Flores, Capital Investment of the owner

101 110 210 320

250 000 400 000

Dry Cleaning Supplies Accounts Payable Purchase of supplies on account

108 210

22 100

Office Equipment Cash Accounts Payable Purchase of cash register

111 101 210

45 800

Cash Dry Cleaning Service Income Rendered dry cleaning service for cash

101 410

25 250

Credit

100 000 550 000

22 100

13 470 32 060

25 250

Simple entry and Compound entry Simple entry is a journal with only one debit and one credit. Compound entry is a journal entry with at least two debits or at least two credits.

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24 Objective 3 Posting This refers to the process of transferring the debit and credit amounts to the appropriate ledger accounts. Ledger accounts are placed in a financial book called General Ledger. This is also known as “Book of Final Entry”. After the amounts have been posted, one should post the ledger account number back to the general journal. This process is known as “cross-referencing”. Chart of Accounts This chart lists the account titles to be used by the business and the related account numbers. The following is a typical example of chart of accounts. ASSETS

100

OWNER’S EQUITY

300

Cash Investment in Trading Securities Accounts Receivable Allowance for Doubtful Accounts Notes Receivable Advances to Employees Prepaid Rent Dry Cleaning Supplies Land Dry Cleaning Equipment Office Equipment Building Accumulated Depreciation – Dry Cleaning Equipment Accumulated Depreciation – Office Equipment Accumulated Depreciation – Building

101 102 103 104 105 106 107 108 109 110 111 120 130

MJ Flores, Drawing MJ Flores, Capital

310 320

INCOME

400

Dry Cleaning Service Income Interest Income

410 420

EXPENSES

500

Salaries and Wages Expense

510

131

Rent Expense

520

140

LIABILITIES

200

Accounts Payable Notes Payable Discount on Notes Payable Unearned Advertising Mortgage Payable

210 220 230 240 250

Advertising Expense Commission Expense Dry Cleaning Supplies Expense Insurance Expense Transportation Expense Utilities Expense Taxes and Licenses Expense Depreciation Expense Interest Expense

530 540 550 560 570 580 590 591 592

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25 General Ledger Postings

CASH Date 2010 Jun 01 07

Particulars

F

101

Debit

GJ1 GJ1 Totals Balance

Date 2010 250 000 Jun 04 25 250 275 250 261 780

Particulars F GJ1

Particulars

F

Debit

GJ1

Date

108 Particulars F

Particulars

F

Debit

GJ1

Date

110 Particulars F

Particulars

F

Debit

GJ1

Date

111 Particulars F

Particulars

F

Credit

45 800

ACCOUNTS PAYABLE Date

Credit

400 000

OFFICE EQUIPMENT Date 2010 Jun 04

Credit

22 100

DRY CLEANING EQUIPMENT Date 2010 Jun 01

13 470 13 470

DRY CLEANING SUPPLIES Date 2010 Jun 02

Credit

Debit

Date 2010 Jun 01 02 04

210 Particulars F

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GJ1 GJ1 GJ1

Credit 100 000 22 100 32 060

26

MJ FLORES, CAPITAL Date

Particulars

F

Debit

Date 2010 Jun 01

320 Particulars F GJ1

DRY CLEANING SERVICE INCOME Date

Particulars

F

Debit

Date 2010 Jun 07

550 000

410 Particulars F GJ1

Normal Balances of the Accounts Assets Contra-assets Liabilities Contra-liabilities Capital Drawing Income Expenses

Credit

Debit Credit Credit Debit Credit Debit Credit Debit

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Credit 25 250

27

Objective 4 Trial Balance This refers to the summary of balances in the ledger accounts. The accounts are arranged in the order of assets, liabilities, equity, income and expenses.

PATRICE CONSULTING SERVICES Trial Balance July 31, 2010

Debit Cash Accounts Receivable Office Supplies Prepaid Insurance Office Equipment Accounts Payable Notes Payable Simone Patrice, Capital Simone Patrice, Drawing Consulting Fees Salaries and Wages Expense Rent Expense Transportation Expense Utilities Expense Advertising Expense Miscellaneous Expense Totals

Credit P 56 300 77 500 2 100 2 200 120 000 P 23 020 15 000 172 880 2 000 253 000 168 200 11 000 7 800 8 200 5 500 3 100

_______

P 463 900 ========

P 463 900 ========

Adapted from Workbook in Introductory Accounting for Service Business A balanced trial balance means that journal entries are properly posted and ledger accounts are properly balanced.

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28 Further Readings Kieso, D., Kimmel, P. and Weygandt, J. (2008). Accounting Principles, 8th edition. New Jersey: John Wiley and Sons, Inc. pages 46 – 56, 57 – 73 Kimwell, Mercedes (2009). Fundamentals of Accounting, 2nd edition. Manila: GIC Enterprises & Co., Inc. Valencia, E., and Roxas, G. (2009). Basic Accounting, 3rd edition. Baguio City: Valencia Educational Supply. Cabrera, M.E.B, Ledesma, E.F., and Lupisan M.C.Y. (2007). Fundamentals of Accounting Vol. 1. Manila: GIC Enterprises & Co., Inc. Chalmers, K., Fyfe, M., Kieso, D., Kimmel, P., Mitrione, L., and Weygandt, J. (2007). Principles of Financial Accounting. John Wiley and Sons Australia, Ltd.

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29 LESSON 4 FINANCIAL STATEMENTS

Study Objectives After studying this lesson, you should be able to: Achievement of Objective (Put a Check mark) 1

Understand the procedures in preparing the income statement

2

Understand the procedures in preparing the statement of changes in owner’s equity

3

Understand the procedures in preparing the balance sheet

4

Understand the procedures in preparing the notes to the financial statements

5

Compute the missing amounts in relation to changes in capital

Objective 1 Income Statement To recall, the Income Statement presents the financial performance of the business through its income and expenses. Net Income refers to the excess of income over expenses, otherwise it is called Net Loss. There are two types of presentation for income statement. 1. Natural form a. In this presentation, income and expense accounts are grouped according to nature. Secondary income such as interest income, dividend income etc are grouped under line item “Other Income”. On the other hand, expenses are arranged from highest to lowest, except for Miscellaneous Expense, Other Expense and Finance Cost. These line items are the last 3 line items in the expense section. 2. Functional form a. In this presentation, expenses are grouped according to function. The 4 classification of expenses are: i. Distribution cost ii. General and administrative expenses iii. Other operating expenses iv. Finance cost

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30 Objective 2 Statement of Changes in Owner’s Equity To recall, this component presents the changes in capital such as additional investments, withdrawals, net income and/or net loss. The following are the effects to the capital or equity: EFFECTS Investment Withdrawal Income Expense Net Income Net Loss

Increase Decrease Increase Decrease Increase Decrease

The Income Statement is connected to this component through Net Income or Net Loss and this component is connected to the Balance Sheet through the Ending balance of the capital account. The equation for computing Ending Capital Balance is

Owner, Capital – beginning + Additional Investments + Net Income – Withdrawals – Net Loss = Owner, Capital – ending

Using the accounting equation, the equation for computing Beginning Capital Balance is

Assets, beginning – Liabilities, beginning = Owner, Capital (beginning)

On the other hand, the alternative equation for Ending Capital Balance is

Assets, ending – Liabilities, ending = Owner, Capital (ending)

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31 Objective 3 Balance Sheet or Statement of Financial Position To recall, the Balance Sheet presents the financial condition of the business through its assets, liabilities and capital / owner’s equity There are 2 forms of Balance Sheet: 1. Account-form a. This form presents assets on the left side and liabilities and capital on the right side 2. Report-form a. This form presents assets on the upper side and liabilities and capital on the lower side Assets Assets are classified into 2: 1. Current Assets a. These refer to assets that are useful to the business within one year. Examples are Cash, Investment in Trading Securities, Trade and Other Receivables, Merchandise Inventory and Prepaid Expenses. 2. Noncurrent Assets a. These refer to assets that are useful to the business for more than one year. Examples are Property, Plant and Equipment, Long-term investments and Intangible assets. Assets are arranged in order of liquidity. Cash is the first line item because it is the most liquid asset.

Liabilities Liabilities are classified into 2: 1. Current liabilities a. These refer to liabilities that are payable and will mature within one year. Examples are Trade and Other Payables and Current-portion of long-term notes payable. 2. Noncurrent liabilities a. These refer to liabilities that are payable and will mature beyond one year. Examples are Noncurrent-portion of long-term notes payable, Mortgage Payable, and Bonds Payable. Liabilities are arranged in order of maturity. For Noncurrent liabilities, the order is usually Notes Payable, Mortgage Payable and Bonds Payable. The reason is Notes Payable will normally mature first before mortagage and bonds.

Capital or Owner’s Equity This represents the ending balance of capital from the statement of changes in owner’s equity.

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32 Objective 4 Notes to the Financial Statements To recall, this component presents the details of the line items in the Balance Sheet and Income Statement

Trade and Other Receivables For this category, the first line item is Accounts Receivable followed by Allowance for Doubtful Accounts. The difference between these two line items is called “Net Realizable Value”. Net realizable value represents the estimated amount to be collected from the clients / customers after deducting doubtful accounts. After Allowance for Doubtful Accounts, the next line item is Notes Receivable then followed by account titles which have the word “Receivable”. They are arranged from highest to lowest since their nature are the same. “Receivable” accounts are synonymous with “Accrued Income”. For example, Interest receivable is the same with Accrued Interest Income. The last line item is Advances to employees.

Prepaid Expenses The items for this category are arranged from highest to lowest since their nature are the same.

Property, Plant and Equipment The tabular presentation for this note is as follows: Cost

Land Transportation Equipment Building Equipment Furniture and Fixtures Total

Accumulated Depreciation

Net Carrying Value

P 400,000 530,000 360,000 240,000 110,000

P 30,000 60,000 40,000 10,000

P 400,000 500,000 300,000 200,000 100,000

P 1,640,000 =========

P 140,000 ========

P 1,500,000 =========

Adapted from the exhibits of the Workbook The fixed asset items are arranged from highest acquisition cost to lowest acquisition cost. The difference between the acquisition cost and accumulated depreciation is called the Net carrying value or Net book value.

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33 Trade and Other Payables Line Item 1st 2nd 3rd 4th – nth Last

Accounts Payable Notes Payable Discount on Notes Payable Account with the word “Payable” Unearned income

For the 4th line item, the accounts are arranged from highest to lowest since their nature are the same. “Payable” accounts are synonymous with “Accrued Expense”. For example, Rent payable is the same with Accrued Rent expense.

Objective 5 Problems in connection to Statement of Changes in Owner’s Equity

1. A firm has just completed its first year of operations. During the year, the owner withdrew P 50,000 and by the end of the year his equity stood at P 70,000, which was a P 10,000 increase from his initial investment. If revenues generated during the year totaled P 400,000, then expenses incurred during the year must have been ______________.

Owner, Capital – beginning + Additional Investments + Income – Withdrawals – Expense = Owner, Capital – ending Expense = Owner, Capital – beginning + Additional Investments + Income – Withdrawals – Owner, Capital – ending

Solution in good accounting form Beginning capital Income Withdrawals Ending capital Expenses

P 60,000 400,000 (50,000) (70,000) P 340,000 ========

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34 2. A business had assets of P 210,000 and liabilities of P 140,000 on January 1, 2008. Six months later, the assets totaled P 170,000 while outstanding debts amounted P 95,000. During the six-month period, the proprietor withdrew cash of P 12,000 and supplies worth P 5,000. During the same period, he also made additional investments of P 24,000 cash and a second-hand equipment originally costing P 45,000 but with a fair market value of P 20,000. The result of operations was a ___________ of ____________. Ending capital Beginning capital Additional investments Withdrawals Net Loss

P 75,000 (70,000) (44,000) 17,000 P 22,000 ========

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35 Further Readings Kieso, D., Kimmel, P. and Weygandt, J. (2008). Accounting Principles, 8th edition. New Jersey: John Wiley and Sons, Inc. pages 21 – 24, 12 – 13 Kimwell, Mercedes (2009). Fundamentals of Accounting, 2nd edition. Manila: GIC Enterprises & Co., Inc. Valencia, E., and Roxas, G. (2009). Basic Accounting, 3rd edition. Baguio City: Valencia Educational Supply. Cabrera, M.E.B, Ledesma, E.F., and Lupisan M.C.Y. (2007). Fundamentals of Accounting Vol. 1. Manila: GIC Enterprises & Co., Inc. Chalmers, K., Fyfe, M., Kieso, D., Kimmel, P., Mitrione, L., and Weygandt, J. (2007). Principles of Financial Accounting. John Wiley and Sons Australia, Ltd.

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36 LESSON 5 STATEMENT OF CASH FLOWS

Study Objectives After studying this lesson, you should be able to: Achievement of Objective (Put a Check mark) 1

Recall the definition of Statement of Cash Flows and classify the transactions as operating activity, investing activity and financing activity

2

Prepare the Statement of Cash Flows and connect the Ending cash balance to the Balance Sheet

Objective 1 Statement of Cash Flows To recall, the Statement of Cash Flows presents the cash inflows and outflows of the business through its operating, investing and financing activities. Business Activities 1. Financing activities a. These activities pertain to transactions such as i. Investments of the owner ii. Loans whether short term or long term iii. Withdrawal of the owner iv. Payment of the principal of the loans 2. Investing activities a. These activities pertain to transactions such as i. Sale of property, plant and equipment ii. Purchase of property, plant and equipment 3. Operating activities a. These activities pertain to transaction such as i. Payment of the interest of the loans ii. Other transactions not enumerated above

Objective 2 Connection of the Statement of Cash Flows to the Balance Sheet The ending cash balance in the Statement of Cash Flows represents the cash balance in the Balance Sheet.

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37 Further Readings Kieso, D., Kimmel, P. and Weygandt, J. (2008). Accounting Principles, 8th edition. New Jersey: John Wiley and Sons, Inc. pages 718 – 726 Kimwell, Mercedes (2009). Fundamentals of Accounting, 2nd edition. Manila: GIC Enterprises & Co., Inc. Valencia, E., and Roxas, G. (2009). Basic Accounting, 3rd edition. Baguio City: Valencia Educational Supply. Cabrera, M.E.B, Ledesma, E.F., and Lupisan M.C.Y. (2007). Fundamentals of Accounting Vol. 1. Manila: GIC Enterprises & Co., Inc. Chalmers, K., Fyfe, M., Kieso, D., Kimmel, P., Mitrione, L., and Weygandt, J. (2007). Principles of Financial Accounting. John Wiley and Sons Australia, Ltd.

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38 LESSON 6 CORRECTING ENTRIES Study Objectives After studying this lesson, you should be able to: Achievement of Objective (Put a Check mark) 1

Know the different accounting errors

2

Prepare correcting entries

Objective 1 Accounting Errors 1. Transposition error a. Error in the position of figures. Example: 123 is written as 132 2. Transplacement error / Slide a. Error in the placement of decimal point. Example: 1000.90 is written as 100.09 Objective 2 Correcting journal entries - entries to correct incorrect journal entries On September 15, a temporary withdrawal of P 12,000 by X, the owner was recorded as a debit to Salaries and Wages Expense and a credit to Cash. The correcting entry was made at month-end. Recorded entry Date 2009 Sep 15

Particulars Salaries and Wages Expense Cash Withdrawal of the owner

Debit

Credit

12 000 12 000

Correct entry Date 2009 Sep 15

Particulars X, Drawing Cash Withdrawal of the owner

Debit

Credit

12 000 12 000

Correcting Entry Date 2009 Sep 30

Particulars X, Drawing Salaries and Wages Expense Correcting entry

Debit

Credit

12 000

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12 000

39 Further Readings Kieso, D., Kimmel, P. and Weygandt, J. (2008). Accounting Principles, 8th edition. New Jersey: John Wiley and Sons, Inc. pages 68 – 69, 156 – 158 Kimwell, Mercedes (2009). Fundamentals of Accounting, 2nd edition. Manila: GIC Enterprises & Co., Inc. Valencia, E., and Roxas, G. (2009). Basic Accounting, 3rd edition. Baguio City: Valencia Educational Supply. Cabrera, M.E.B, Ledesma, E.F., and Lupisan M.C.Y. (2007). Fundamentals of Accounting Vol. 1. Manila: GIC Enterprises & Co., Inc. Chalmers, K., Fyfe, M., Kieso, D., Kimmel, P., Mitrione, L., and Weygandt, J. (2007). Principles of Financial Accounting. John Wiley and Sons Australia, Ltd.

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40 LESSON 7 PAYROLL ACCOUNTING

Study Objectives After studying this lesson, you should be able to: Achievement of Objective (Put a Check mark) 1

Understand the concept of employee benefits and compensation and the related terms such as Payroll Register and payroll deductions

2

Prepare journal entries pertaining to payroll accounting

Objective 1 Employee Compensation and Benefits Organizations normally monitor the attendance of the employees through time clock cards. These cards show the time in and time out of the employees. Further, organizations also prepare and distribute pay slips. These slips show the gross salary of an employee and the related deductions. The normal deductions from the gross salary are SSS, Philhealth, Pag-IBIG, Withholding tax and Cash advances. Organizations also prepare the Payroll Register which shows the summary of the employees’ pay slips. The following is the tabular format of the Payroll Register Employee Name

Gross Salary

Overtime, Bonus and Other Benefits

Total Salary

SSS

Philhealth

PagIBIG

Withholding Tax

Cash Advance

Net Salary

Alpha Beta Charlie TOTAL

Objective 2 Payroll Example and Journal Entries

SSS Philhealth Pag-IBIG

Total Employee Contributions 30,000 10,000 5,000

Total Employer Contributions 60,000 10,000 5,000

Assume Total gross salaries and wages is P 200,000, Total withholding taxes payable is P 20,000, and Total advances to employees is P 10,000 Confidentiality Requirement This material is prohibited for reproduction or distribution without prior consent from the author.

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41

Salaries and Wages of the employees Date 2009 Sep 30

Particulars Salaries and Wages Expense SSS Premiums Payable Philhealth Contributions Payable Pag-IBIG Contributions Payable Withholding Tax Payable Advances to Employees Cash Salaries and Wages of the employees

Debit

Credit

200 000 30 000 10 000 5 000 20 000 10 000 125 000

Employer Contributions Date 2009 Sep 30

Particulars SSS Premiums Expense Philhealth Contributions Expense Pag-IBIG Contributions Expense SSS Premiums Payable Philhealth Contributions Payable Pag-IBIG Contributions Payable Employer Contributions

Debit 60 000 10 000 5 000

Credit

60 000 10 000 5 000

Remmittance to the government agencies Date 2009 Sep 30

Particulars SSS Premiums Payable Philhealth Contributions Payable Pag-IBIG Contributions Payable Withholding Tax Payable Cash Remmittance to the government agencies

Debit 90 000 20 000 10 000 20 000

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Credit

140 000

42 Further Readings Kimwell, Mercedes (2009). Fundamentals of Accounting, 2nd edition. Manila: GIC Enterprises & Co., Inc. Valencia, E., and Roxas, G. (2009). Basic Accounting, 3rd edition. Baguio City: Valencia Educational Supply. Cabrera, M.E.B, Ledesma, E.F., and Lupisan M.C.Y. (2007). Fundamentals of Accounting Vol. 1. Manila: GIC Enterprises & Co., Inc.

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43 LESSON 8 ACCOUNTING FOR PROMISSORY NOTES

Study Objectives After studying this lesson, you should be able to: Achievement of Objective (Put a Check mark) 1

Understand the concept of promissory notes and its parts and prepare the journal entries in relation to issuance of promissory notes and payment on the maturity date

2

Understand the concept of discounting of customer’s note and prepare the necessary journal entries

3

Understand the concept of discounting of own note and prepare the necessary journal entries

Objective 1 Promissory Notes A promissory note is an unconditional promise in writing made by one person to another, signed by the maker, engaging to pay on demand or at a fixed or determinable future time a sum certain in money to order or to bearer (Valix, 2005). Parts of a Promissory note

March 24, 2009

I promise to pay X, P 5,000 on April 7, 2009 with 12% interest.

(Sgd) Y

1. 2. 3. 4. 5. 6.

Date of the note – March 24, 2009 Maturity date – April 7, 2009 Maker – Y Payee – X Face value / Principal – P 5,000 Interest rate – 12%

Given the above promissory note, how much is the Maturity value?

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44

Maturity value = Principal + Interest Interest = Principal x Interest rate x Term / 360

Term refers to the period between the date of the note and the maturity date. 360 represents the number of days in a year in accordance to Banker’s rule. In the above example the term is 14 days. 7 days in March (31-24) and 7 days in April. For years 2000, 2004, 2008 and so on, remember that there are 29 days in February.

Interest = 5,000 x 12% x 14/360 = 23 Maturity value = 5,000

Journal Entries Date of the note Books of the Maker Date 2009 Mar 24

Particulars

Debit

Cash Notes payable Issuance of promissory note

Credit 5 000 5 000

Books of the Payee Date 2009 Mar 24

Particulars Notes receivable Cash Receipt of promissory note

Debit

Credit 5 000

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5 000

45 Maturity Date Books of the Maker Date 2009 Apr 07

Particulars

Debit

Notes payable Interest expense Cash Payment of promissory note

Credit 5 000 23 5 023

Books of the Payee Date 2009 Apr 07

Particulars

Debit

Cash Notes receivable Interest income Collection of principal and interest

Credit 5 023 5 000 23

Dishonoring of promissory note When the maker fails to pay the principal and interest on the maturity date, then the promissory note is considered dishonored. For the journal entry in the books of the maker, instead of crediting Cash, Accounts payable is credited. On the other hand in the books of the payee, instead of debiting Cash, Accounts receivable is debited. Maturity Date Books of the Maker Date 2009 Apr 07

Particulars

Debit

Notes payable Interest expense Accounts payable Payment of promissory note

Credit 5 000 23 5 023

Books of the Payee Date 2009 Apr 07

Particulars Accounts receivable Notes receivable Interest income Collection of principal and interest

Debit

Credit 5 023

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5 000 23

46 Discounting of promissory notes When a promissory note is negotiable, the payee may obtain cash before maturity date by discounting the note at a bank or other financing company. To discount the note, the payee must endorse it. Thus, legally the payee becomes an endorser and the bank becomes an endorsee (Valix, 2005). Two types of discounting 1. Discounting of customer’s note 2. Discounting of own note

Objective 2 Discounting of Customer’s note Using the above example, assume that the maker discounted the note on April 2 at a discount rate of 15%. The necessary equations for note discounting are as follows:

Interest on discounting = Maturity value x Discount rate x Discount period / 360 Cash proceeds = Maturity value – Interest on discounting

Discount period refers to the period between the discount date and the maturity date. For this example, the discount period is 5 days (April 7 – 2).

Interest on discounting = 5,023 x 15% x 5 / 360 = 10 Cash proceeds = Maturity value – Interest on discounting = 5,023 – 10 = 5,013

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47 Discount Date Books of the Maker Date 2009 Apr 02

Particulars

Debit

Credit

Debit

Credit

No journal entry Books of the Payee

Date 2009 Apr 02

Particulars Cash Interest expense Notes receivable – discounted Interest income Discounting of note

5 013 10 5 000 23

Notes receivable – discounted is classified as a Contra-asset account and is presented as a deduction from Notes receivable Notes receivable Less: Notes receivable – discounted

P xxx xxx P xxx

On the discount date, the payee needs to inform the maker that the note is discounted. On the maturity date, the maker should directly pay to the bank or financing company.

Maturity Date Books of the Maker Date 2009 Apr 07

Particulars

Debit

Notes payable Interest expense Cash Payment of promissory note

Credit 5 000 23 5 023

Books of the Payee Date 2009 Apr 07

Particulars Notes receivable – discounted Notes receivable Cancellation of contingent liability

Debit

Credit 5 000

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5 000

48

Types of endorsement 1. Endorsement with recourse a. This type requires the endorser to pay the endorsee if the maker dishonors the note. This is the contingent or secondary liability of the endorser. 2. Endorsement without recourse a. This type does not impose contingent liability on the endorser. In the absence of any evidence to the contrary, endorsement is assumed to be with recourse (Valix, 2005).

Assume that in the above example, the maker dishonored the note and the bank charged a protest fee of P 500. Maturity Date Books of the Maker Date 2009 Apr 07

Particulars

Debit

Notes payable Interest expense Miscellaneous expense Accounts payable Dishonoring of note

Credit 5 000 23 500 5 523

Books of the Payee Date 2009 Apr 07

Particulars

Debit

Credit

Accounts receivable Cash Payment of promissory note plus protest fees in behalf of the maker

5 523

Notes receivable – discounted Notes receivable Cancellation of contingent liability

5 000

Principal Interest Protest fees Total payment

5 523

P 5,000 23 500 P 5,523 ======

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5 000

49 Objective 3 Discounting of own note In this type of discounting, the maker issues a promissory note to obtain cash. Interest on discounting is deducted in advance and is debited using the account title “Discount on Notes Payable”. Example 1: On July 14, 2009, for money borrowed, X discounted its own 30-day, 12% P 10,000 note with Y.

Interest on discounting = Principal x Interest rate x Term / 360 = 10,000 x 12% x 30 / 360 = 100

Discount Date Books of the Maker Date 2009 Jul 14

Particulars

Debit

Cash Discount on notes payable Notes payable Discounting of note

Credit 9 900 100 10 000

Maturity Date Books of the Maker Date 2009 Aug 13

Particulars

Debit

Credit

Notes payable Cash Payment of promissory note

10 000

Interest expense Discount on note payable Amortization of discount

100

10 000

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100

50 Example 2: On December 14, 2009, for money borrowed, X discounted its own 30-day, 12% P 10,000 note with Y. The accounting period ends on December 31.

Year-end amortization Amortization = Discount x (Year-end date – Discount date) / Discount period = 100 x (31-14) / 30 = 57

Discount Date Books of the Maker Date 2009 Dec 14

Particulars

Debit

Cash Discount on notes payable Notes payable Discounting of note

Credit 9 900 100 10 000

Amortization at year-end Books of the Maker Date 2009 Dec 31

Particulars

Debit

Interest expense Discount on note payable Amortization of discount

Credit 57 57

Presentation Notes payable Less: Discount on notes payable

P 10,000 43

P 9,957

Maturity Date Books of the Maker Date 2010 Jan 13

Particulars

Debit

Credit

Notes payable Cash Payment of promissory note

10 000

Interest expense Discount on note payable Amortization of discount

43

10 000

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43

51 Further Readings Kieso, D., Kimmel, P. and Weygandt, J. (2008). Accounting Principles, 8th edition. New Jersey: John Wiley and Sons, Inc. pages 396 – 400, 473 – 474 Kimwell, Mercedes (2009). Fundamentals of Accounting, 2nd edition. Manila: GIC Enterprises & Co., Inc. Valencia, E., and Roxas, G. (2009). Basic Accounting, 3rd edition. Baguio City: Valencia Educational Supply. Cabrera, M.E.B, Ledesma, E.F., and Lupisan M.C.Y. (2007). Fundamentals of Accounting Vol. 1. Manila: GIC Enterprises & Co., Inc. Chalmers, K., Fyfe, M., Kieso, D., Kimmel, P., Mitrione, L., and Weygandt, J. (2007). Principles of Financial Accounting. John Wiley and Sons Australia, Ltd.

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52 LESSON 9 ACCRUED INCOME

Study Objectives After studying this lesson, you should be able to: Achievement of Objective (Put a Check mark) 1

Understand the concept of adjusting entries and the reasons for providing adjusting entries at year-end

2

Recall the concept of accrued income and prepare adjusting entry in relation to accrued income

Objective 1 Adjusting Entries Adjusting entries refer to journal entries made at the end of the year for the following reasons: 1. Accrued income a. There may be unrecorded income and there is a need to accrue income or recognize receivables. 2. Accrued expense a. There may be unrecorded expenses and there is a need to accrue expenses or recognize payables. 3. Prepaid expense a. There may be a consumed or used portion in the recorded prepaid expense or there may be an unconsumed or unused portion in the recorded expense. 4. Unearned income a. There may be an earned portion in the recorded unearned income or there may be an unearned portion in the recorded income. 5. Depreciation a. There is a need to provide depreciation for depreciable fixed assets. 6. Doubtful accounts a. There is a need to provide estimated doubtful accounts in relation to accounts receivable.

Objective 2 Accrued income To recall, accrued income refers to income earned but not yet received. The following are the examples of accrued income to be recognized at year-end: 1. Accrued commission income a. It is possible that the company has already rendered the service pertaining to commission but it has not yet received the commission as of year-end. 2. Accrued rent income Confidentiality Requirement This material is prohibited for reproduction or distribution without prior consent from the author.

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53 a. It is possible that the company or lessor has already earned the rent but it has not yet received the rent payment as of year-end. 3. Accounts receivable a. It is possible that the company has not yet recorded as of year-end the service rendered. 4. Accrued interest income a. It is possible that the company has not yet recorded the interest that is earned in relation to notes receivable from the date of the promissory note until year-end date. Accrued income is the same with accrued interest income is the same with interest receivable.

receivable.

For

example,

Pro-forma Entry Date xxxx Dec 31

Particulars

Debit

_____ receivable _____ income Recognition of accrued income

Credit xxx xxx

Example 1: A company leases an office space for P 14,000 per month. As of December 31, 2009, company’s year-end, the tenant has not yet paid its rent for two months. Adjusting entry Date 2009 Dec 31

Particulars Rent receivable Rent income (14, 000 x 2) Recognition of accrued rent

Debit

Credit

28,000 28,000

Example 2: As of December 31, 2009, ABC Hotel has generated lodging revenue of P 127,000 from guests whose payments are not yet received until they check out. Adjusting entry Date 2009 Dec 31

Particulars Lodging receivable Lodging income Recognition of accrued lodging

Debit

Credit

127,000 127,000

If the company did not recognize accrued income at year-end, then the financial statements will be misstated showing understated assets and understated income. Confidentiality Requirement This material is prohibited for reproduction or distribution without prior consent from the author.

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54 Further Readings Kieso, D., Kimmel, P. and Weygandt, J. (2008). Accounting Principles, 8th edition. New Jersey: John Wiley and Sons, Inc. pages 95 – 96, 103 – 104 Kimwell, Mercedes (2009). Fundamentals of Accounting, 2nd edition. Manila: GIC Enterprises & Co., Inc. Valencia, E., and Roxas, G. (2009). Basic Accounting, 3rd edition. Baguio City: Valencia Educational Supply. Cabrera, M.E.B, Ledesma, E.F., and Lupisan M.C.Y. (2007). Fundamentals of Accounting Vol. 1. Manila: GIC Enterprises & Co., Inc. Chalmers, K., Fyfe, M., Kieso, D., Kimmel, P., Mitrione, L., and Weygandt, J. (2007). Principles of Financial Accounting. John Wiley and Sons Australia, Ltd.

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55 LESSON 10 ACCRUED EXPENSE

Study Objectives After studying this lesson, you should be able to: Achievement of Objective (Put a Check mark) 1

Recall the concept of accrued expense and prepare adjusting entry in relation to accrued expense

Objective 1 Accrued expense To recall, accrued expense refers to expense incurred but not yet paid. The following are the examples of accrued expense to be recognized at year-end: 1. Accrued interest expense a. It is possible that the company has not yet recorded the interest that is incurred in relation to notes payable from the date of the promissory note until year-end date. 2. Accrued salaries and wages expense a. It is possible that as of year-end, the company has not yet paid the employees because the year-end date is not the same with the payroll date. 3. Accrued rent expense a. It is possible that the company or lessee has already incurred the rent but it has not yet paid the rent as of year-end. 4. Accrued utilities expense a. It is possible that as of year-end, the company has not yet paid the utilities or the billing statements of the utilities have not yet received by the company. 5. Accrued taxes and licenses expense a. It is possible that as of year-end, the company has already earned from services rendered and sale of goods but has not yet paid the related taxes. Accrued expense is the same with interest expense is the same with interest payable.

payable. For example, accrued

Accrued expense is the opposite of accrued income. When one party recognize accrued income, the other party should recognize accrued expense.

Pro-forma Entry Date Xxxx Dec 31

Particulars _____ expense _____ payable Recognition of accrued expense

Debit

Credit xxx

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xxx

56 Example 1: Property taxes for three months estimated to total P 13,300 have accrued. Adjusting entry Date 2009 Dec 31

Particulars Taxes and Licenses expense Taxes and Licenses payable Recognition of accrued taxes and licenses

Debit

Credit

13,300 13,300

Example 2: Electricity consumption for the month of December amounting to P 7,100 is not yet paid. Adjusting entry Date 2009 Dec 31

Particulars Utilities expense Utilities payable Recognition of accrued utilities

Debit

Credit 7,100 7,100

If the company did not recognize accrued expense at year-end, then the financial statements will be misstated showing understated liabilities and understated expense.

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57 Further Readings Kieso, D., Kimmel, P. and Weygandt, J. (2008). Accounting Principles, 8th edition. New Jersey: John Wiley and Sons, Inc. pages 104 – 108 Kimwell, Mercedes (2009). Fundamentals of Accounting, 2nd edition. Manila: GIC Enterprises & Co., Inc. Valencia, E., and Roxas, G. (2009). Basic Accounting, 3rd edition. Baguio City: Valencia Educational Supply. Cabrera, M.E.B, Ledesma, E.F., and Lupisan M.C.Y. (2007). Fundamentals of Accounting Vol. 1. Manila: GIC Enterprises & Co., Inc. Chalmers, K., Fyfe, M., Kieso, D., Kimmel, P., Mitrione, L., and Weygandt, J. (2007). Principles of Financial Accounting. John Wiley and Sons Australia, Ltd.

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58 LESSON 11 PREPAID EXPENSE

Study Objectives After studying this lesson, you should be able to: Achievement of Objective (Put a Check mark) 1

Recall the concept of prepare expense and prepare adjusting entry using the Asset method

2

Prepare adjusting entry using the Expense method

Prepaid expense To recall, prepaid expense is an asset that is paid in advance but not yet consumed or used. Companies have two options or methods in recording prepaid items. They may use the Asset method or the Expense method.

Objective 1 Asset Method If the company chooses to use the Asset method, then upon purchasing the prepaid item the proforma entry will be:

Date xxxx xxx xx

Particulars

Debit

Prepaid _____ expense Cash Purchase of prepaid item

Credit xxx xxx

It is possible that in this recorded prepaid expense there may be consumed or used portion. To adjust the recorded prepaid expense, the pro-forma entry will be: Date zxxx Dec 31

Particulars _____ expense Prepaid _____ expense Recognition of consumed or used portion of the recorded prepaid expense

Debit

Credit xxx

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xxx

59 Example: On March 15, 2009, XYZ Company purchased office supplies for cash, P 100,000. At the end of the year, record shows that 25% worth of supplies have been used. Date 2009 Mar 15

Particulars Office supplies Cash Purchase of prepaid item

Debit

Credit

100,000 100,000

Adjusting entry Date 2009 Dec 31

Particulars Office supplies expense Office supplies Recognition of used portion of the recorded office supplies

Debit

Credit

25,000 25,000

If the prepaid expense account is not adjusted at year-end, then the financial statements will be misstated showing overstated assets and understated expenses. If the adjusted Office supplies of P 75,000 is fully consumed in the following year, then the entire P 75,000 will be transformed to Office supplies expense also in the following year.

Objective 2 Expense Method On the other hand, if the company chooses to use the Expense method, then the pro-forma entry to record the purchase of prepaid item is: Date xxxx xxx xx

Particulars

Debit

_____ expense Cash Purchase of prepaid item

Credit xxx Xxx

It is possible that in this recorded expense there may be unconsumed or unused portion. To adjust the recorded expense, the pro-forma entry will be: Date xxxx Dec 31

Particulars Prepaid _____ expense _____ expense Recognition of unconsumed or unused portion of the recorded expense

Debit

Credit xxx

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Xxx

60 Example: Assume the same example in asset method but this time the company will use the expense method. Date 2009 Mar 15

Particulars Office supplies expense Cash Purchase of prepaid item

Debit

Credit

100,000 100,000

Adjusting entry Date 2009 Dec 31

Particulars Office supplies Office supplies expense Recognition of unused portion of the recorded expense

Debit

Credit

75,000 75,000

If the expense account is not adjusted at year-end, then the financial statements will be misstated showing understated assets and overstated expenses. Notice that whether the company uses the asset method or expense method, the financial statements will show same amounts for assets and expenses. In the above example, both methods will show Office supplies adjusted balance of P 75,000 and Office supplies expense adjusted balance of P 25,000.

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61 Further Readings Kieso, D., Kimmel, P. and Weygandt, J. (2008). Accounting Principles, 8th edition. New Jersey: John Wiley and Sons, Inc. 96 – 100, 115 – 117 Kimwell, Mercedes (2009). Fundamentals of Accounting, 2nd edition. Manila: GIC Enterprises & Co., Inc. Valencia, E., and Roxas, G. (2009). Basic Accounting, 3rd edition. Baguio City: Valencia Educational Supply. Cabrera, M.E.B, Ledesma, E.F., and Lupisan M.C.Y. (2007). Fundamentals of Accounting Vol. 1. Manila: GIC Enterprises & Co., Inc. Chalmers, K., Fyfe, M., Kieso, D., Kimmel, P., Mitrione, L., and Weygandt, J. (2007). Principles of Financial Accounting. John Wiley and Sons Australia, Ltd.

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62 LESSON 12 UNEARNED INCOME

Study Objectives After studying this lesson, you should be able to: Achievement of Objective (Put a Check mark) 1

Recall the concept of unearned income and prepare adjusting entry using the Liability method

2

Prepare adjusting entry using the Income method

Unearned income To recall, unearned income is a liability that is received in advance but not yet earned. Unearned income is the opposite of prepaid expense. If one party has recorded a prepaid item, then the other party has to record an unearned item. Companies have two options or methods in recording unearned items. They may use the Liability method or Income method.

Objective 1 Liability Method If the company chooses to use the liability method, then upon receiving the unearned item the pro-forma entry will be:

Date Xxxx xxx xx

Particulars

Debit

Cash Unearned _____ income Receipt of unearned item in advance

Credit xxx Xxx

It is possible that in this recorded unearned income there may be earned portion. To adjust the recorded unearned income, the pro-forma entry will be: Date Xxxx Dec 31

Particulars Unearned _____ income _____ income Recognition of earned portion of the recorded unearned income

Debit

Credit xxx

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xxx

63 Example: On October 1, 2009, the company received from the tenant the advance rent payment of P 100,000 representing 10-month rent. Date 2009 Oct 01

Particulars Cash Unearned rent income Receipt of unearned item in advance

Debit

Credit

100,000 100,000

Adjusting entry Date 2009 Dec 31

Particulars Unearned rent income Rent income 100,000 / 10 = 10,000 x 3 Recognition of earned portion of the recorded unearned rent

Debit

Credit

30,000 30,000

If the unearned income account is not adjusted at year-end, then the financial statements will be misstated showing overstated liabilities and understated income. If the adjusted Unearned rent income of P 70,000 is fully earned in the following year, then the entire P 70,000 will be transformed to Rent income also in the following year.

Objective 2 Income Method On the other hand, if the company chooses to use the Income method, then the pro-forma entry to record the unearned item is: Date xxxx xxx xx

Particulars

Debit

Cash _____ income Receipt of unearned item in advance

Credit xxx xxx

It is possible that in this recorded income there may be unearned portion. To adjust the recorded income, the pro-forma entry will be: Date xxxx Dec 31

Particulars _____ income Unearned _____ income Recognition of unearned portion of the recorded income

Debit

Credit xxx

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xxx

64 Example: Assume the same example in liability method but this time the company will use the income method. Date 2009 Oct 01

Particulars Cash Rent income Receipt of unearned item in advance

Debit

Credit

100,000 100,000

Adjusting entry Date 2009 Dec 31

Particulars Rent income Unearned rent income 100,000 / 10 = 10,000 x 7 Recognition of unearned portion of the recorded income

Debit

Credit

70,000 70,000

If the income account is not adjusted at year-end, then the financial statements will be misstated showing understated liabilities and overstated income. Notice that whether the company uses the liability method or income method, the financial statements will show same amounts for liabilities and income. In the above example, both methods will show Unearned rent income adjusted balance of P 70,000 and Rent income adjusted balance of P 30,000.

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65 Further Readings Kieso, D., Kimmel, P. and Weygandt, J. (2008). Accounting Principles, 8th edition. New Jersey: John Wiley and Sons, Inc. pages 100 – 103, 117 – 118 Kimwell, Mercedes (2009). Fundamentals of Accounting, 2nd edition. Manila: GIC Enterprises & Co., Inc. Valencia, E., and Roxas, G. (2009). Basic Accounting, 3rd edition. Baguio City: Valencia Educational Supply. Cabrera, M.E.B, Ledesma, E.F., and Lupisan M.C.Y. (2007). Fundamentals of Accounting Vol. 1. Manila: GIC Enterprises & Co., Inc. Chalmers, K., Fyfe, M., Kieso, D., Kimmel, P., Mitrione, L., and Weygandt, J. (2007). Principles of Financial Accounting. John Wiley and Sons Australia, Ltd.

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66 LESSON 13 DEPRECIATION

Study Objectives After studying this lesson, you should be able to: Achievement of Objective (Put a Check mark) 1

Understand the concept of depreciation and its kinds

2

Enumerate the factors of depreciation and compute depreciation using the straight line method

Objective 1 Concept of depreciation Property, plant and equipment, except land, normally are usable for a number of years after which they have relatively little value either for service or for sale. The difference between the original cost of a property and any remaining value when it is retired or worn out is an expense that should be distributed to the periods during which the asset is used (Valix, 2000). Depreciation accounting - Is a system of accounting which aims to distribute the cost of the depreciable fixed asset less salvage value, if any, over the estimated useful life of the asset in a systematic and rational manner. It is a process of allocation, not of valuation (Valix, 2000). - The objective of depreciation accounting is to have each period benefitting from the use of the asset bear an equitable share of the asset cost (Valix, 2000). Depreciation - Is the portion of the cost of the asset charged as expense during an accounting period (Valix, 2000). Kinds of depreciation (Valix, 2000) 1. Physical depreciation a. Is related to the depreciable asset’s wear and tear and deterioration over a period. This also results to the ultimate retirement of the property or termination of the service of the asset. b. Physical depreciation may be caused by: i. Wear and tear due to frequent use ii. Passage of time due to nonuse iii. Action of the elements such as wind, sunshine, rain or dust iv. Accidents such as fire, flood, earthquake and other natural disaster v. Diseases in animals and wooden buildings 2. Functional or economic depreciation a. Arises from obsolescence or inadequacy of the asset to perform efficiently. i. Obsolescence may arise from the following:

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67 1. When there is no future demand for the product which the depreciable asset produces 2. When a new depreciable asset becomes available and the new asset can perform the same function for substantially less cost ii. Inadequacy arises when the asset is no longer useful to the firm because of an increase in the volume of operations.

Objective 2 Factors of depreciation (Valix, 2000) In order to properly compute the amount of depreciation to be charged as expense during an accounting period, three factors are necessary, namely: 1. Cost 2. Scrap value a. Is the amount estimated to be recovered when the asset is retired from use. b. It is also known as Residual value or Salvage value. c. From the practical standpoint, the scrap value is often considered as zero because the valuation is usually very small or not capable of estimation. 3. Estimated useful life a. Is the expected service or economic life of the asset.

Straight line method of depreciation (Valix, 2000) Under the straight line method, the annual depreciation charge is calculated by allocating the amount to be depreciated equally over the number of years of estimated useful life. The formula for the computation of the annual depreciation following the straight line method is as follows:

Annual depreciation = Cost minus scrap Life in years

Cost minus scrap value equals Depreciable cost. Depreciable cost multiplied by the Annual depreciation rate also gives the amount of annual depreciation. The Annual depreciation rate is determined by dividing 100% by the life of the asset in years. For example, if the life of the asset is 5 years, then the depreciation rate is 20% (100% / 5). The straight line method is based on the theory that periods benefited by the use of the asset should bear an equal or equitable share of the asset cost because the straight line approach considers depreciation as a function of time rather than as a function of usage.

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68 Pro-forma Adjusting Entry Date xxxx Dec 31

Particulars

Debit

Depreciation expense Accumulated depreciation – Depreciation of fixed asset

Credit xxx xxx

Example: Assume the following data for 2011 Equipment cost, purchased on January 1, 2011 Scrap value Life in years

P 105,000 P 5,000 5 years

A depreciation table may appear as follows: Year

Depreciation

Acquisition cost 2011 2012 2013 2014 2015

Accumulated depreciation

20,000 20,000 20,000 20,000 20,000

20,000 40,000 60,000 80,000 100,000

Net carrying value 105,000 85,000 65,000 45,000 25,000 5,000

Adjusting entry for 2011 Date 2011 Dec 31

Particulars

Debit

Depreciation expense Accumulated depreciation – Equipment Depreciation of equipment for 2011

Credit

20,000 20,000

Note xx – Property, Plant and Equipment Cost

Land Transportation Equipment Building Equipment Furniture and Fixtures Total

Accumulated Depreciation

Net Carrying Value

P xxx,xxx xxx,xxx xxx,xxx 105,000 xxx,xxx

P xxx,xxx xxx,xxx 20,000 xxx,xxx

P xxx,xxx xxx,xxx xxx,xxx 85,000 xxx,xxx

P xxx,xxx =========

P xxx,xxx ========

P xxx,xxx =========

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69 Adjusting entry for 2012 Date 2012 Dec 31

Particulars

Debit

Depreciation expense Accumulated depreciation – Equipment Depreciation of equipment for 2012

Credit

20,000 20,000

Note xx – Property, Plant and Equipment Cost

Land Transportation Equipment Building Equipment Furniture and Fixtures Total

Accumulated Depreciation

Net Carrying Value

P xxx,xxx xxx,xxx xxx,xxx 105,000 xxx,xxx

P xxx,xxx xxx,xxx 40,000 xxx,xxx

P xxx,xxx xxx,xxx xxx,xxx 65,000 xxx,xxx

P xxx,xxx =========

P xxx,xxx ========

P xxx,xxx =========

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70 Further Readings Kieso, D., Kimmel, P. and Weygandt, J. (2008). Accounting Principles, 8th edition. New Jersey: John Wiley and Sons, Inc. pages 422 – 431, 435 – 436 Kimwell, Mercedes (2009). Fundamentals of Accounting, 2nd edition. Manila: GIC Enterprises & Co., Inc. Valencia, E., and Roxas, G. (2009). Basic Accounting, 3rd edition. Baguio City: Valencia Educational Supply. Cabrera, M.E.B, Ledesma, E.F., and Lupisan M.C.Y. (2007). Fundamentals of Accounting Vol. 1. Manila: GIC Enterprises & Co., Inc. Chalmers, K., Fyfe, M., Kieso, D., Kimmel, P., Mitrione, L., and Weygandt, J. (2007). Principles of Financial Accounting. John Wiley and Sons Australia, Ltd.

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71 LESSON 14 DOUBTFUL ACCOUNTS

Study Objectives After studying this lesson, you should be able to: Achievement of Objective (Put a Check mark) 1

Understand the concept of doubtful accounts

2

Compute doubtful accounts using the percent of accounts receivable approach

3

Compute doubtful accounts using the aging analysis approach

Objective 1 Accounting for Doubtful Accounts Business enterprises sell on credit rather than only for cash to increase total service income or sales and thereby increase income. However, an enterprise that sells on credit assumes the risk that some clients or customers will not pay their accounts (Valix, 2005). When an account becomes uncollectible, the enterprise has sustained a bad debt loss. This loss is simply one of the costs of doing business on credit. Two methods are followed in accounting for this bad debt loss, namely: 1. Allowance method 2. Direct write-off method For ACTBAS1, only the allowance method will be discussed. Allowance method The allowance method requires recognition of doubtful accounts expense even if some of the accounts receivable are doubtful of collection. The adjusting entry to recognize doubtful accounts is: Date xxxx Dec 31

Particulars

Debit

Doubtful accounts expense Allowance for doubtful accounts Recognition of doubtful accounts

Credit xxx

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xxx

72 Basis for computing doubtful accounts There are two bases or approaches for computing doubtful accounts. 1. Balance sheet approach a. Percent of Accounts receivable balance b. Aging analysis 2. Income statement approach For ACTBAS1, only the balance sheet approach will be discussed.

Objective 2 Percent of Accounts receivable balance A certain rate is multiplied to the accounts receivable balance in order to get the required allowance balance. The rate used is usually determined from past experience of the company (Valix, 2005). Example 1: Assume accounts receivable balance of P 2,000,000 and doubtful accounts are estimated to be 3% of accounts receivable are given in 2009 financial records Adjusting entry Date 2009 Dec 31

Particulars

Debit

Doubtful accounts expense Allowance for doubtful accounts (2,000,000 x 3%) Recognition of doubtful accounts

Credit

60,000 60,000

Note xx – Trade and Other Receivables Accounts receivable P 2,000,000 Less: Allowance for doubtful accounts 60,000

P 1,940,000

Example 2: Assume accounts receivable balance of P 2,000,000 and doubtful accounts are estimated to be 3% of accounts receivable are given in 2010 financial records. Assume also that Allowance for doubtful accounts has a balance of P 10,000 before adjustment. Adjusting entry Date 2009 Dec 31

Particulars

Debit

Doubtful accounts expense Allowance for doubtful accounts (2,000,000 x 3%) – 10,000 Recognition of doubtful accounts

Credit

50,000

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50,000

73 Note xx – Trade and Other Receivables Accounts receivable P 2,000,000 Less: Allowance for doubtful accounts 60,000

P 1,940,000

Objective 3 Aging analysis The aging of accounts receivable involves an analysis of the accounts where they are classified into not due or past due. Past due accounts are further classified in terms of the length of the period they are past due. The most common classifications are: 1. 2. 3. 4. 5. 6. 7. 8. 9.

Not due 1 to 30 days past due 31 to 60 days past due 61 to 90 days past due 91 to 120 days past due 121 to 180 days past due 181 to 365 days past due More than 1 year past due Bankrupt or under litigation

The allowance is then determined by multiplying the total of each classification by the rate or percent loss experienced by the company for each category. The major argument for the use of this method is the more accurate and scientific computation of the allowance for doubtful accounts, and consequently, the accounts receivable are fairly presented in the balance sheet at net realizable value (Valix, 2005). Example: The following data are summarized in aging the accounts at the end of the period:

Not due

Accounts receivable balance 500,000

Experience rate

Required allowance 1%

5,000

1 to 30 days past due

300,000

2%

6,000

31 to 60 days past due

200,000

4%

8,000

61 to 90 days past due

100,000

7%

7,000

91 to 180 days past due

50,000

10%

5,000

181 to 365 days past due

30,000

30%

9,000

More than 1 year past due

20,000

50%

10,000

Totals

1,200,000

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50,000

74

The amount computed by aging of accounts receivable represents the required allowance for doubtful accounts at the end of the period. Thus, if the Allowance for doubtful accounts has a credit balance of P 10,000 before adjustment, the doubtful accounts expense is determined as follows:

Adjusting entry Date 2009 Dec 31

Particulars

Debit

Doubtful accounts expense Allowance for doubtful accounts 50,000 – 10,000 Recognition of doubtful accounts

Credit

40,000 40,000

Note xx – Trade and Other Receivables Accounts receivable P 1,200,000 Less: Allowance for doubtful accounts 40,000

P 1,160,000

When is an account past due? The credit terms will determine whether an account is past due. For instance, if the credit terms were 2/10 n/30, and the account is 45 days old, it is considered to be 15 days past due. Net realizable value - This represents the estimated amount to be collectible from the clients or customers after deducting the allowance for doubtful accounts.

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75 Further Readings Kieso, D., Kimmel, P. and Weygandt, J. (2008). Accounting Principles, 8th edition. New Jersey: John Wiley and Sons, Inc. pages 387 – 388, 391 – 393, 105 – 118 Kimwell, Mercedes (2009). Fundamentals of Accounting, 2nd edition. Manila: GIC Enterprises & Co., Inc. Valencia, E., and Roxas, G. (2009). Basic Accounting, 3rd edition. Baguio City: Valencia Educational Supply. Cabrera, M.E.B, Ledesma, E.F., and Lupisan M.C.Y. (2007). Fundamentals of Accounting Vol. 1. Manila: GIC Enterprises & Co., Inc. Chalmers, K., Fyfe, M., Kieso, D., Kimmel, P., Mitrione, L., and Weygandt, J. (2007). Principles of Financial Accounting. John Wiley and Sons Australia, Ltd.

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76 LESSON 15 CLOSING ENTRIES, POST-CLOSING TRIAL BALANCE

Study Objectives After studying this lesson, you should be able to: Achievement of Objective (Put a Check mark) 1

Understand the concept of closing entries and prepare closing entries

2

Prepare the Post-Closing Trial Balance

Objective 1 Closing entries After the preparing the financial statements, one needs to close the nominal accounts or income statement accounts. If these accounts are not closed at the end of the year, then these accounts will be carried forward to the next accounting period. If that happens, the following accounting period will show a misstated income statement. The following are the procedures in closing the nominal accounts. 1. Debit the income accounts and credit the Income summary account. Closing entry Date xxxx Dec 31

Particulars

Debit

_____ income _____ income Income summary Closing entry for income accounts

Credit xxx xxx xxx

2. Debit the Income summary account and credit the expense accounts. Closing entry Date xxxx Dec 31

Particulars

Debit

Income summary _____ expense _____ expense _____ expense _____ expense _____ expense Closing entry for expense accounts

Credit xxx

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xxx xxx xxx xxx xxx

77

3. Close the Income summary account to the Owner, drawing account. If the Income summary has a credit balance, it means Net income, otherwise it means Net loss. Closing entry representing Net income Date xxxx Dec 31

Particulars

Debit

Income summary Owner, drawing Closing of income summary to drawing account

Credit xxx xxx

Closing entry representing Net loss Date xxxx Dec 31

Particulars

Debit

Owner, drawing Income summary Closing of income summary to drawing account

Credit xxx xxx

4. Close the Owner, drawing account to the Owner, capital account. Owner, drawing has a debit balance before closing entry Date Xxxx Dec 31

Particulars

Debit

Owner, capital Owner, drawing Closing of drawing account to capital account

Credit xxx xxx

Owner, drawing has a credit balance before closing entry Date Xxxx Dec 31

Particulars

Debit

Owner, drawing Owner, capital Closing of drawing account to capital account

Credit xxx

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78 Example: Given the following Trial Balance after adjusting entries (Adjusted trial balance), prepare the necessary closing entries at fiscal-year ended September 30, 2010. Adapted from Workbook in Introductory Accounting for Service Business

KIM SAM SOON COMPANY Adjusted Trial Balance September 30, 2010

Debit Cash on hand Cash in bank Accounts Receivable Prepaid Office Supplies Prepaid Insurance Office Furniture Accumulated Depreciation – Office Furniture Delivery Equipment Accumulated Depreciation – Delivery Equipment Accounts Payable Accrued Salaries and Wages Expense Accrued Rent Expense Accrued Interest Expense Notes Payable Unearned Service Income Kim Sam Soon, Capital Kim Sam Soon, Drawing Service Income Depreciation Expense Office Supplies Expense Utilities Expense Salaries and Wages Expense Rent Expense Interest Expense Insurance Expense Totals

Credit

P 6 000 30 200 150 450 7 800 1 330 120 600 P 17 340 156 000 33 150 33 100 12 670 12 000 3 500 120 000 9 600 130 100 29 370 242 000 26 860 3 100 4 960 39 620 24 000 12 300 870

_________

P 613 460 ========

P 613 460 ========

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79 Closing entry Date 2010 Sep 30

Particulars Service income Income summary Closing entry for income accounts

Debit

Credit

242,000 242,000

Closing entry Date 2010 Sep 30

Particulars Income summary Depreciation Expense Office Supplies Expense Utilities Expense Salaries and Wages Expense Rent Expense Interest Expense Insurance Expense Closing entry for expense accounts

Debit

Credit

111 710 26 860 3 100 4 960 39 620 24 000 12 300 870

Closing entry representing Net income Date 2010 Sep 30

Particulars Income summary Kim Sam Soon, Drawing (242,000 – 111, 710) Closing of income summary to drawing account

Debit

Credit

130, 290 130, 290

Owner, drawing has a credit balance before closing entry Date 2010 Sep 30

Particulars Kim Sam Soon, Drawing Kim Sam Soon, Capital (130,290 – 29,370) Closing of drawing account to capital account

Debit

Credit

100,920

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100,920

80 Objective 2 Post-Closing Trial Balance After posting the closing entries, one needs to prepare the Trial balance after closing entries or the Post-Closing Trial Balance.

KIM SAM SOON COMPANY Post-Closing Trial Balance September 30, 2010

Debit Cash on hand Cash in bank Accounts Receivable Prepaid Office Supplies Prepaid Insurance Office Furniture Accumulated Depreciation – Office Furniture Delivery Equipment Accumulated Depreciation – Delivery Equipment Accounts Payable Accrued Salaries and Wages Expense Accrued Rent Expense Accrued Interest Expense Notes Payable Unearned Service Income Kim Sam Soon, Capital Totals

Credit

P 6 000 30 200 150 450 7 800 1 330 120 600 P 17 340 156 000

_________

33 150 33 100 12 670 12 000 3 500 120 000 9 600 231 020

P 472 380 ========

P 472 380 ========

Notice that in the Post-Closing Trial Balance, the income statement accounts and the drawing account are not anymore included because they already have zero balances. In this trial balance, the only remaining accounts are the real accounts or balance sheet accounts. Notice also that after the closing entries, Kim Sam Soon, Capital increased from P 130,100 to P 231,020. This is due to the addition of P 100,920, which is the amount in the last closing entry. If the Post-Closing Trial Balance shows equal totals, then the books of accounts are ready for the recording of transactions in the next accounting period.

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81 Further Readings Kieso, D., Kimmel, P. and Weygandt, J. (2008). Accounting Principles, 8th edition. New Jersey: John Wiley and Sons, Inc. pages 140 – 159, 166 – 167 Kimwell, Mercedes (2009). Fundamentals of Accounting, 2nd edition. Manila: GIC Enterprises & Co., Inc. Valencia, E., and Roxas, G. (2009). Basic Accounting, 3rd edition. Baguio City: Valencia Educational Supply. Cabrera, M.E.B, Ledesma, E.F., and Lupisan M.C.Y. (2007). Fundamentals of Accounting Vol. 1. Manila: GIC Enterprises & Co., Inc. Chalmers, K., Fyfe, M., Kieso, D., Kimmel, P., Mitrione, L., and Weygandt, J. (2007). Principles of Financial Accounting. John Wiley and Sons Australia, Ltd.

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82 LESSON 16 REVERSING ENTRIES

Study Objectives After studying this lesson, you should be able to: Achievement of Objective (Put a Check mark) 1

Understand the concept of reversing entries and prepare reversing entries

Objective 1 Reversing Entries Reversing entries are optional entries that are prepared on the first day of the next accounting period. The benefit of these entries is convenience in the recording of the journal entries which are related to adjusting entries. The following adjusting entries may be reversed: 1. Accrued income 2. Accrued expense 3. Prepaid expense (Expense method only) 4. Unearned income (Income method only)

Pro-forma Entries Accrued income Date xxxx Jan 01

Particulars

Debit

_____ Income _____ Receivable Reversing entry for accrued income

Credit xxx xxx

Accrued expense Date xxxx Jan 01

Particulars

Debit

_____ Payable _____ Expense Reversing entry for accrued expense

Credit xxx

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xxx

83 Prepaid expense (Expense method only) Date xxxx Jan 01

Particulars

Debit

_____ Expense Prepaid _____ Expense Reversing entry for prepaid expense

Credit xxx xxx

Unearned income (Income method only) Date xxxx Jan 01

Particulars

Debit

Unearned _____ income _____ income Reversing entry for unearned income

Credit xxx

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84 Further Readings Kieso, D., Kimmel, P. and Weygandt, J. (2008). Accounting Principles, 8th edition. New Jersey: John Wiley and Sons, Inc. pages 156, 169 – 171 Kimwell, Mercedes (2009). Fundamentals of Accounting, 2nd edition. Manila: GIC Enterprises & Co., Inc. Valencia, E., and Roxas, G. (2009). Basic Accounting, 3rd edition. Baguio City: Valencia Educational Supply. Cabrera, M.E.B, Ledesma, E.F., and Lupisan M.C.Y. (2007). Fundamentals of Accounting Vol. 1. Manila: GIC Enterprises & Co., Inc. Chalmers, K., Fyfe, M., Kieso, D., Kimmel, P., Mitrione, L., and Weygandt, J. (2007). Principles of Financial Accounting. John Wiley and Sons Australia, Ltd.

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