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Marivic D. Valenzuela-Manalo Page 1of A
Unit I
Introduction
Overview
Background The evolution of accounting is attributed to the social and economic needs of
society. As business and society become more complex, accounting develops
new concepts, methods and techniques to meet the ever changing and
increasing needs for financial information. Without the necessary information
furnished by accounting, many complex social programs and economic
development may never have been realized.
Information, in any market economy, assists decision-makers in making wise
choices regarding the use of limited resources under their control. When
decision-makers are able to make well-informed decisions, resources are
allocated in a manner that better meets the needs and goals of companies
within the given market.
The Philippines, being a developing country, would need a great deal of
reliable and timely information to compete in the global market and
accounting will play an important role in this prevailing competitive global
structure of the economy. Companies use accounting information to evaluate
the business situations around the world. It is therefore necessary that future
accountants, businessmen, entrepreneurs and economists must be trained
properly on how to generate and interpret this financial information.
Purpose The purpose of Unit I “Introduction to Accounting and Basic Accounting
Principles” is to provide students with brief descriptions of the nature and
scope of accounting. This unit also includes simple explanation of the 13
basic accounting concepts.
In this unit This unit contains the following topics:
Topics See Page
Nature and Scope of Accounting 2 of A
History of Accounting Thought 5 of A
Users of Financial Statements 6 of A
Forms of Business Organizations 8 of A
Basic Accounting Concepts 9 of A
The Accounting Profession 17 of A
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Nature and Scope of Accounting
Overview The two terms accounting and bookkeeping have been used interchangeably
and without distinction. This line of thought finds support based on the
condition prevailing during the early times when businesses were not as
complex and multifarious as they are nowadays. However, recognition of the
importance of accounting in the development of modern business methods,
the industrial revolution and the growth of unlimited companies that provided
the impetus for the development of accounting as a profession has led to the
distinction in the concepts and effects of bookkeeping as against accounting.
Definition The following definitions differentiates bookkeeping from accounting:
• Bookkeeping deals primarily with the systematic method of recording and
classifying financial transaction of business. It is considered to be the
procedural element of accounting as arithmetic is a procedural element of
mathematics. Normally, books are set up and prepared in a manner that
ensures an orderly recording and classification of business transactions.
However, because of the rapid economic growth and technological changes,
which necessitate the mechanization of the bookkeeping job, the demand
for bookkeepers has been reduced. The bookkeeping process is now
basically done through the use of computers and soft wares designed for
such purpose.
• Accounting as differentiated from bookkeeping has been authoritatively
defined by the American Institute of Certified Public Accountants (AICPA),
as the art of recording, classifying and summarizing in a significant manner
and in terms of money, transactions and events that are, in part at least, of a
financial character, and interpreting the results thereof. Accounting is also
defined by the Philippine Institute of Certified Public Accountants (PICPA)
as a system that measures business activities, processes given information
into reports, and communicates those findings to decision-makers.
Continued on next page
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Nature and Scope of Accounting, Continued
Definition,
con’t The “art” in AICPA’s definition connotes that accounting is an art of
communication. Although the primary function of accounting is to supply of
financial information, it also provides non-financial information.
Moreover, accounting is referred to as a science in the sense that is a
systematized knowledge. A growing body of accounting theories seeks to
place accounting in the context of human knowledge and activity in general.
Hence, an accountant is a bookkeeper and more, for he must not only be well-
versed with the recording process but must also be concerned with the
functions of interpretation and analysis of financial statements which require
the exercise of reason, judgment and intelligence of a higher order. It is these
functions that best distinguish accounting from bookkeeping.
Language of
Business Accounting is a special kind of language. It is often described as the
“language of business” because it is the medium of communication between
a business firm and the various parties interested in its financial activities. It is
the tool, which enables firms to communicate to various interested third
parties certain quantitative information about the financial activities of a
business.
Accounting is often utilized whenever there are business transactions. And
business transactions normally involve people. One cannot engage in business
without involving and affecting other persons. The activities of a business
enterprise involve and affect many parties -- management, owners, short-term
and long-term creditors, employees, prospective investors, the government,
and even the general public. All these interested parties need to be informed
about the financial affairs of a business enterprise. Accounting, therefore,
serves this need of providing quantitative information, primarily financial in
nature, about economic entities that is useful in making economic decisions.
The principal accounting reports are the financial statements, i.e., the balance
sheet, income statement and the cash flow statement. As the major end
products of accounting, these statements convey to management and/or
interested outsider(s) the messages about the financial activities of the
business.
Continued on next page
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Nature and Scope of Accounting, Continued
Language of
Business, con’t. Information needed by different parties is of three kinds:
• The financial condition or position of the business, i.e., the amounts and
kinds of its assets and liabilities, and the status of the owners’ interest at a
given point in time.
• The financial performance or results of operations, i.e., whether the
business operating activities during a given period of time resulted in net
income or a loss.
• The financing and investing activities that are responsible for the changes in
the financial resources of the business, i.e., the sources and applications of
fund during a given period of time.
This information, furnished through accounting, are utilized by end-users as
basis for reaching important decisions affecting themselves, the business
enterprise, the government and other parties.
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History of Accounting Thought
Overview Accounting has a long history. Some scholars claim that writing arose in
order to record accounting 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.
History 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 (Everything about
Arithmetic, Geometry, and Proportion), published in Venice in November
1494. This book contained primarily principles of mathematics and
incidentally set of accounting procedures. (Horngren, Harison and
Robinson,1995).
The pace of accounting development increased during the Industrial
Revolution as the economics 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 development 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 economics 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 millenium, there would still be a lot of
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 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.
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Users of Financial Statements
Overview Today's accountant focuses on the ultimate needs of decision-makers who use
accounting information, whether decision makers are inside or outside the
business. Accounting "is not an end in itself," but is an information system
that measures, processes, and communicates financial information about an
identifiable economic entity (Needles, Belverd, et al, 1999). It provides a
vital service by supplying the information decision-makers needs to make
"reasoned choices among alternative uses of scarce resources in the conduct
of business and economic activities.”
Internal Users Those who are directly involved in the business enterprise such as:
• Owners. The owner provides the money/capital that the business needs to
begin operations. Through the financial reports, the owner can properly
manage and monitor the business, analyzing whether or not he can expect
reasonable return from his investment.
• Management. Managers of business use accounting information to set
goals for the organization, to evaluate the progress made toward those goals,
and to take corrective action if necessary.
External Users Those who are not directly involved in the operation of the business such as:
• Potential investors. Investors use financial reports in evaluating what
income they can reasonably expect from their investment.
• Creditors. Potential lenders or current creditors determine the borrower’s
ability to meet scheduled payments.
• Taxing authorities. Local and national government levy taxes on
individuals and businesses. The amount of the tax is determined using
accounting information.
Continued on next page
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Users of Financial Statements, Continued
External Users,
con’t. Those who are not directly involved in the operation of the business such as:
• Government regulation agencies. Most organizations face government
regulation. For example, the Securities and Exchange Commission (SEC)
requires businesses to disclose certain financial information to the public.
The SEC, like many government agencies, bases its regulatory activity in
part on the accounting information it receives from firms.
• Nonprofit organizations. Nonprofit organizations, e.g., churches, most
hospitals, government agencies, and colleges, which operates for purposes
other than to earn a profit use accounting information in much the same way
that profit-oriented businesses do.
• Other users. Employees and labor unions may make wage demands based
on the accounting information that shows their employer’s reported income.
Consumer groups and the general public may also be interested in the
amount of income that the businesses earned.
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Forms of Business Organization
Based on
Ownership There are three basic forms of business organization according to
ownership. This classification is based on owner/s investing or putting capital
on a business being started.
• Sole or single proprietorship. When only one person makes the
investment.
• Partnership. When two or more persons agree to operate the business as
co-owners under certain conditions. The persons owning this form of
business are called partners.
• Corporation. A body formed and authorized by law to act as a single
person although constituted by one or more persons and legally endowed
with various rights and duties. This is the more popular form of business
organization today. Persons who put in capital in a corporation are called
stockholders.
Based on
Operations or
Activity
Business may also be classified according to business operations or activity
after the necessary capital has been received from the owner or owners and
the business starts its operations. The purpose for which the business has
been formed will determine the nature of its activities.
• Service concern. Businesses engage in the rendering of services to others
for a fee, like the beauty parlor, law firm, dental clinic, and medical clinic.
• Merchandising or trading concern. Businesses that are into the buying
and selling of goods or commodities like the grocery store, drug store and
department store.
• Manufacturing concern. Businesses that are engaged in the processing of
products or the conversion of raw materials into finished goods that are then
sold like the furniture factory and shoe factory. A trading or merchandising
business differs from a manufacturing concern in that the former buys
finished goods, which are ready for sale, while the latter produces or
manufactured the goods that it sells.
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Basic Accounting Concepts
Overview The Generally Accepted Accounting Principles (GAAP), also known, as
the basic accounting concepts are the ground rules that govern how
accountants measure, process and communicate financial information. These
principles have been developed by the accounting profession over the years to
provide a consistent system of financial reporting in a constantly changing
business environment (Smith, Keith, et al, 1993).
These concepts assure users of financial statements that the reports are
prepared in specific ways so that they are reliable and comparable for the
usefulness of these reports rests on their reliability and comparability.
Purpose Generally accepted accounting principles serve three basic purposes:
• They help increase the confidence of financial statement users that the
financial statements are representationally faithful.
• They provide companies and accountants who prepare financial statements
with guidance on how to account for and report economic activities.
• And they provide independent auditors of financial statements with basis for
evaluating the fairness and completeness of those statements (Chasteen, l.,
Flaherty, R., O'Connor, M., 1998).
Entity Concept For accounting purposes, an entity is the organizational unit for which
accounting records are maintained, e.g., Joseph Labrador Accounting Firm.
Under entity concept, the business is regarded as having a separate and
distinct personality from that of the owner/s – generating its own revenue,
incurring its own expenses, owning its own assets, and owing its own
liabilities (Smith, Keith, et al, 1993). This means that the personal
transactions of owners must not be combined with transactions of the
business.
This concept also requires that an accountant record only those financial
activities that occur between the entity being accounted for and other parties.
Thus, the accounting entity assumption establishes boundaries or limits as to
what information should be included in the financial statements of a given
company.
Continued on next page
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Basic Accounting Concepts, Continued
Entity Concept,
con’t Business Transaction. A business event that can be measured in terms of
money that affects the enterprise. This would give rise to an exchange
between the business and another party: “value received and value parted
with”.
Example: A barber provides services to a customer by trimming the latter's
hair: “value parted with” by the barber will be his service and time; and the
“value received” is the payment made by the client.
Monetary
Concept Money is a common unit of measure that we can use to record economic
transactions and prepare financial statements. Under this concept, money is
used as the unit of measure in preparing the various financial reports of the
company (example of these would be in terms of Peso ( P ), Dollar ( $ ), etc.).
It is a common belief that everybody understands money—it's universally
available, its certainly relevant to financial transactions and its easy to use.
But money, the "peso" in our case, as a measure of economic activity does not
have a constant value especially in recent years. It is not time in itself that
causes the change in the value of money but economic events, e.g., change in
government leadership, chaos in the stocks markets, etc. The stable money
concept assumes that, monetary unit of measure does not change value
overtime, even if in fact it does. The assumption is made in order to ensure
objectivity in reporting data on the financial statements.
Time Period
Concept It is also known as periodicity concept. It divides the life of the business into
regular intervals (usually one year) at the end of which financial statements
are prepared. This means that the economic activities undertaken during the
life of an accounting entity are assumed to be divisible into various artificial
time periods for financial reporting purposes. For example, it is assumed that
a reasonable report of income earned can be made annually or quarterly, even
though the revenue generating activities of a business are continuous.
Continued on next page
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Basic Accounting Concepts, Continued
Time Period
Concept, con’t. This is the assumption that implies that it is necessary to measure accounting
income for periods of time less than the life of a firm and that measurement
will not be precise but will be timely and therefore useful (Smith, Keith, et al,
1993).
• In choosing one year, the business has two options:
• Calendar Year. A twelve-month period beginning with January 1 and
ending December 31.
• Fiscal Year. The length of the fiscal period is determined by the nature of
the business and the frequency of the need for data regarding the financial
condition and progress of the business. A yearly fiscal period does not
start with January 1 and end on December 31. (e.g., educational
institutions normally follows a fiscal year beginning May 1 and ending
April 30).
Revenue
Realization
Concept
Revenue or income is the inflow of assets that results from producing goods
or rendering services. Revenue is not earned all at one point in time. Instead,
the earning process extends over a considerable length of time.
The revenue realization concept provides that income is recognized when
earned regardless whether cash is received. This means that both of the
following conditions are met:
• The earning process is essentially complete;
• An exchange has taken place (Smith, Keith, et al, 1993).
These two conditions for most of the companies are met at the time goods are
sold or services rendered. To wit:
• Two points of income recognition:
• Income is considered earned when services are fully rendered.
• Income is considered earned when goods or merchandise are fully
delivered.
Continued on next page
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Basic Accounting Concepts, Continued
Accrual
Concept This concept requires that income be recorded when earned regardless
whether cash is received. And an expense be recognized when incurred (e.g.,
when services or benefits have already been received) regardless whether
payment is made.
To apply the accrual concept, accountants have developed the accrual
accounting. The accrual method of accounting attempts to record the financial
effects on a company of transactions and other events and circumstances in
the periods in which those transactions, events, and circumstances occur
rather than only the periods in which cash is received or paid by the firm. This
means that accrual accounting consists of all techniques developed by
accountants to apply both the accrual and matching concepts (Needlers,
Powers, et al, 1999).
Throughout this study guide we illustrate the accrual basis of accounting,
which is required under the Generally Accepted Accounting Principles.
Essentially, the accrual basis records expenses (i.e., cost of items used or
consumed in business operations, e.g., electricity, water, supplies, etc.) when
incurred and revenues (i.e., price of goods sold or services rendered, e.g.,
service income, sales) when earned.
It is also worth mentioning here that other than the accrual basis, we also have
what we call the cash basis of accounting, which generally records a journal
entry upon exchange of cash, typically does not require many adjusting entries
(Dyckman, T., Dukes, Davis, C., 1998).
Matching
Concept This concept states that all expenses incurred to generate revenues must be
recorded in the same period that the income are recorded to properly
determine net income or net loss of the period. There is a cause-and-effect
relationship between revenue and expense recognition implicit in this
definition
Revenues are inflows of resources resulting from providing goods or services
to customers. For merchandising companies like Shoe Mart, the main source
of income is sales revenue derived from selling merchandise. Service firms
such as SGV and Company generate revenue by providing services.
Continued on next page
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Basic Accounting Concepts, Continued
Matching
Concept, con’t Expenses on the other hand are outflows of resources incurred in generating
revenue. They represent the costs of providing goods and services. The
matching principle is a key player in the way we measure expenses. We
attempt to establish a causal relationship between revenues and expenses. If
causality can be determined, expenses are reported in the same period that the
revenue is recognized. If the causal relationship cannot be established, the
expense is either related to a particular period. Allocated over several periods,
or expensed as incurred (Spiceland, D., Sepe, J., 1998).
Example:
Revenues earned in June and collected in June P30,000
Revenues earned in June but collected in July 20,000
Revenues earned in May but collected only in June 10,000
Expenses incurred in June and paid in June 10,000
Expenses incurred in June but payable in July 15,000
Expenses incurred in May but paid in June 7,000
Net Income or Net loss is computed by deducting total expenses of the period
to total revenue of the same period. If total revenue is greater than total
expenses, the company’s result of business operation is a net income. But if
total expense is greater, the result is a net loss.
Net Income for June:
Revenues (30,000 + 20,000) P50,000
Expenses (10,000 + 15,000) 25,000
Net Income P25,000
======
Objectivity
Concept This principle requires that all transactions must be evidenced by business
documents free from personal biases and independent experts (e.g., CPA) can
verify reports.
Example: Official receipts, invoices, vouchers, etc.
Continued on next page
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Basic Accounting Concepts, Continued
Cost Concept Assets, i.e., resources acquired by the business, must be recorded at
acquisition price (i.e., what you have to give up in exchange for an ownership
of an asset) and no adjustments are to be made on this valuation in later
periods.
The cost principle assumes that assets are acquired in business transactions
conducted at arm's length transactions, i.e., transactions between a buyer and
a seller at the fair value prevailing at the time of the transaction. For non
cash transactions conducted at arm's length, the cost principle assumes that
the market value of the resources given up in the transaction provides reliable
evidence for the valuation of the item acquired (Dyckman, T., Dukes, Davis,
C., 1998).
The cost principle provides guidance primarily at the initial acquisition date.
Once acquired, the original cost basis of some assets is then subjected to
depreciation, depletion, amortization, etc. over time to reflect the said assets
in the balance sheet in a more realistic valuation.
Going Concern
Concept In the absence of information to the contrary, this concept assumes that the
business is to continue its operations indefinitely. This means that the
business will stay in operation for a period of time sufficient to carry out
contemplated operations, contracts, and commitments. This non liquidation
assumption provides a conceptual basis for many of the classifications used in
accounting. Assets and liabilities, for example, are classified as either current
or long term on the basis of this assumption. If continuity is not assumed, the
distinction between current and long term loses its significance; all assets and
liabilities become current. Continuity supports the measurement and recording
of assets and liabilities at historical costs and not at their liquidation values
(i.e., estimated net realizable amounts) (Dyckman, t., Dukes, Davis, C.,
1998).
Continued on next page
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Basic Accounting Concepts, Continued
Conservatism
Concept This concept has a powerful influence in valuing assets and measuring net
income. When faced which uncertainties, the accountant traditionally leans
towards the direction of caution, choosing the method that would give the
business a less favorable financial condition and lowers net income.
The reasoning behind this assumption is that investors prefer information that
does not unnecessary raise expectations. For example:
• In recognizing assets, preferably the lower of two alternative valuations
would be recorded.
• In recognizing liabilities, preferably the higher of two alternative amounts
would be recorded.
• In recording revenues, expenses, gains, and losses where there is reasonable
doubt as to the appropriateness of alternative amounts, the one having the
least favorable effect on net income should be preferred.
Conservatism assumes that when uncertainty exists, the users of financial
statements are better served by understatement than by overstatement of net
income and assets (Dyckman, t., Dukes, Davis, C., 1998).
Consistency
Concept This concept states that once a method is adopted, it must not be changed
from year to year to allow comparability of financial statements between years
and between businesses.
For example if the First In First Out (FIFO) method was used by the firm in
valuing their inventories, the firm should not change the method into Last In
First Out (LIFO) in the following year and then go back again to FIFO on the
next year.
Consistency in this case means that the reported information conforms with
procedures that remain unchanged from period to period. Comparison
overtime are difficult unless there is consistency in the way accounting
principles are applied across accounting year.
Continued on next page
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Basic Accounting Concepts, Continued
Materiality
concept This concept refers to relative importance of an item or event. An item/event
is considered material if knowledge of it would influence the decision of
prudent users of financial statements.
To illustrate an instance where strict conformity with GAAP is not necessary
because an item is immaterial, consider a low-cost asset, such as a P150 waste
can. This item can be recorded as an expense in full when purchased rather
than an asset subject to depreciation. The peso amount involved is simply too
small for external users of financial reports to worry about.
Disclosure
concept All relevant and material events affecting the financial condition/position of a
business and the results of its operations must be communicated to users of
financial statements.
We must remember that the purpose of accounting is to provide information
that is useful to decision-makers. So, naturally, if there is accounting
information not included in the primary financial statements that would
benefit users, that information should be provided to.
Supplemental information is disclosed in a variety of ways including:
• Parenthetical comments or modifying comments placed on the face of the
financial statements.
• Disclosure notes conveying additional insights about company operations,
accounting principles, contractual agreements, and pending litigation.
• Supplemental financial statements that report more detailed information
than is shown in the primary financial statements. (Spiceland, D., Sepe, J.,
1998)
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The Accounting Profession
Overview The success of the accountant in the accounting profession depends on how
well he understands the accounting procedures and principles, and on how
clearly and accurately he can communicate financial information to the users
of the statements.
Classification The nature of these works though relies on the position, which the accountant
holds in his field. The positions in the field of accounting are generally
classified into two, namely, public accounting and private accounting.
• Public Accountants are those who serve the general public and collect
professional fees for their work such as doctors and lawyers do. Their work
include auditing, income tax planning and preparation and management
consulting. Those public accountants who have certain professional
requirements are designated as Certified Public Accountants (CPAs).
• Private Accountants work for a single business, e.g. PLDT, Meralco,
Jollibee, etc. Charitable organizations, educational institutions and
government employ private accountants. Some accountants would also
pursue a career in education and research
Certified Public
Accountant A Certified Public Accountant (CPA) is a professional accountant who earns
his title through a combination of education, qualifying experience, and an
acceptance score in the written national examination given by the Board of
Accountancy.
The Board of Accountancy prepares, grades and gives the results of the
examination to the Professional Regulation Commission (PRC) who then
issues licenses that allow qualifying examinees to practice accounting as
CPAs.
CPAs must also be of good moral character and must carry on their
professional practices according to a code of professional conduct.
Continued on next page
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The Accounting Profession, Continued
Organizations The Philippine Institute of Certified Public Accountants (PICPA) is the
national professional organization of CPAs in the country.
In order to formalize the accounting standard-setting function in the
Philippines, the Philippine Institute of Certified Public Accountants (PICPA)
established the Accounting Standards Council (ASC).
The Accounting Standards Council's main function is to establish and
improve accounting standards that will be generally accepted in the
Philippines (Preface to Statements of Financial Accounting Standards of
ASC, 1999).
The Accounting Standards Council (ASC) is the same body that formulates
the Generally Accepted Accounting Principles (GAAP). These principles are
the most important accounting guidelines that provide the general framework
determining what information is included in financial statements and how this
information is to be presented.
The ASC has approved in November 2004 the adoption of International
Accounting Standards (IAS) 1, Presentation of Financial Statements, issued
by the International Accounting Standards Boars (IASB), as the Philippine
Financial Reporting Standards(Preface to Philippine Accounting Standard
(PAS) 1 of ASC, 2005).
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Unit II
Balance Sheet
Overview
Background As a means of telling interested people about business operations, accounting
performs important tasks of recording daily transactions, classifying recorded
data, summarizing recorded and classified data and interpreting the
summarized facts. In all business enterprises, accounting information is
summarized in at least two basic financial reports.
One of these financial reports shows what the business is worth in terms of
the properties it owns (i.e., the assets), the debts it owes (i.e., the liabilities),
and the investment of its owner/s (i.e., the proprietorship). This report is
called the balance sheet and this statement informs the users of the financial
condition of the business at a given date, usually at the end of an accounting
period.
Purpose The purpose of Unit II “The Balance Sheet - Assets, Liabilities and Owner’s
Equity (Service Business)” is to illustrate different forms of balance sheet and
how to prepare them. Students will also be introduced in analyzing business
transactions using the accounting equation.
In this unit This unit contains the following topics:
Topics See Page
Forms of Balance Sheet 2 of B
Parts of the Balance Sheet 5 of B
Accounting Equation 7 of B
Current Assets 8 of B
Plant, Property and Equipment 10 of B
Current Liabilities 12 of B
Long-Term Liabilities 13 of B
Owner’s Equity 14 of B
Debit and Credit of Balance Sheet Items 15 of B
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Forms of Balance Sheet
Overview As provided in the revised Philippine Accounting Standard (PAS) 1 based on
the International Accounting Standards (IAS), the balance sheet should be
prepared following the new accounting concept of materiality and
aggregation, i.e., a separate schedule would be attached to the report to
explain the amounts with corresponding "notes". It is also required that a
separate statement of changes in equity be prepared, and therefore, the owner's
equity section of the balance sheet would show only the ending balance of the
capital account as shown in the given illustration.
The following discussions will provide readers information on how the
account and report format of balance sheets may be prepared.
Account Form In the account form of balance sheet, the assets are listed on the left side of
the report and the liabilities and proprietorship on the right side. The example
below illustrate the account form:
JOSEPH LABRADOR, COMPANY Balance Sheet
December 31, 20XI
ASSETS LIABILITIES AND OWNER'S EQUITY
Current Assets Current Liabilities
Cash & cash equivalents (7) P 20,000 Trade & Other Payables (11) P 55,000 Investments in trading securities 10,000 Current Portion of
Trade & Trade Receivables (8) 30,000 mortgage Payable 20,000
Prepaid Expenses (9) 29,000
Total Current Assets P 89,000 Total Current Liabilities P 75,000
Non Current Assets Non Current Liabilities
Property, Plant & Equip (10) 791,000 Notes Payable
(due in 3 years) P 70,000
Mortgage payable 180,000
Total non current liabilities 250,000
Total liabilities P 325,000
Owner's Equity
Labrador, Capital 555,000
TOTAL LIABILITIES
TOTAL ASSETS P880,000 AND OWNER'S EQUITY P 880,000 ======= =======
Continued on next page
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Forms of Balance Sheet, Continued
Report Form A balance sheet prepared in report form shows the assets on the top section of
the statement and the liabilities and owner’s equity on the bottom section. The
example below illustrate the report form:
JOSEPH LABRADOR, COMPANY Balance Sheet
December 31, 20X1
A S S E T S
Current Assets Notes Cash & cash equivalents (7) P 20,000
Investments in Trading Securities 10,000
Trade & Other Receivables (8) 30,000
Prepaid Expenses (9) 29,000
Total Current Assets P 89,000
Non Current Assets Property, plant & equipment (10) 791,000
TOTAL ASSETS P 880,000
=======
LIABILITIES AND OWNER'S EQUITY
Current Liabilities Trade & other payables (11) P 55,000
Current portion of mortgage payable 20,000
Total Current Liabilities P 75,000
Non Current Liabilities Notes Payable (due in 3 years) P 70,000
Mortgage Payable 180,000
Total No Current Liabilities 250,000
Total Liabilities P 325,000
Owner’s Equity
Joseph, Capital 555,000
TOTAL LIABILITIES AND OWNER'S EQUITY P 880,000
=======
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Forms of Balance Sheet, Continued
Notes Note 7 - Cash & cash equivalents
Cash on Hand P 5,000
Cash in Bank 15,000
Total cash and cash equivalents P 20,000
======
Note 8 – Trade & other receivables
Accounts Receivable P 20,000
Less: Allowance for Doubtful Accounts 1,200 P 18,800
Notes Receivable 7,500
Interest Receivable 700
Advances to Employees 3,000
Total trade & other receivables P 30,000
=====
Note 9 – Prepaid expenses
Office Supplies on Hand P 6,000
Prepaid Insurance 20,000
Prepaid Advertising 3,000
Total Prepaid expenses P 29,000
=====
Note 10 – Property, plant & equipment
Land 300,000
Building 450,000
Less: Accumulated Depreciation 70,000 380,000
Office Equipment 110,000
Less: Accumulated Depreciation 20,000 90,000
Furniture & Fixtures 25,000
Less: Accumulated Depreciation 4,000 21,000
Total Carrying value 791,000
=====
Note 11 – Trade & other payables
Accounts Payable 20,000
Notes Payable 18,000
Interest Payable 2,000
Accrued Salaries Expense 5,000
Unearned Rent Income 10,000
Total trade & other payables 55,000
=====
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Parts of the Balance Sheet
Overview This portion will enumerate the different parts of a balance sheet and their
corresponding placement in the financial report being prepared.
Statement
Heading Includes the name of the business, tells the kind of statement it is, and gives
the date for which the report is prepared
Asset, Liability,
Proprietorship Items are grouped and each group of items is identified by special captions.
Captions Classification of each group of items appear against the left margin of the
statement.
Account titles Individual account titles in each classification are indented.
Current Assets The individual current assets are usually listed in order of their liquidity, with
the most liquid asset, “Cash” appearing first.
Plant,
Property,
Equipment
The plant assets are often listed in order of their expected useful life with the
assets with the longest expected useful life, “Land” appearing first.
Note (#) The separate schedule attached to the report explaining in detail the
aggregated amount presented on the face of the financial statement.
Continued on next page
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Parts of the Balance Sheet, Continued
Current
Liabilities The current liabilities are in theory listed in order of due date, with the debt
with the earliest due date appearing first.
Captions
Indicating
Totals
Each group of items (i.e., total current assets, total plant, property and
equipment, total current liabilities, etc.) is indented further.
Single Rule
Line The last figure in each group of items is underlined.
Final Totals The two final totals (i.e., total assets and total liabilities and owner’s equity)
appear as the last line in their respective sections and are underlined twice
(double ruled) to indicate a final total.
Peso Sign Peso signs are used (a) to the left of the first amount of a group of amounts
being combined and (b) to the left of each final total.
Peso Amount The peso amount for the detailed items is shown in one column; the total of
each classification is extended into the last column on the right-hand side of
the statement.
Marivic D. Valenzuela-Manalo Page 7 of B
Accounting Equation
Overview One important feature of the balance sheet relates to a very simple fact. The
balance sheet of any business must show total assets exactly equal in amount
to the sum of the liabilities and the capital. This relationship exists regardless
of the size of the enterprise or the variety of its assets, liabilities and
ownership interest. This identity is called the basic accounting equation.
Often it is stated as:
ASSETS = LIABILITIES + OWNER’S EQUITY
Which means, assets equal liabilities plus proprietorship. Other times the
equation appears as:
ASSET - L IABILITIES = OWNER’S EQUITY
or
ASSET - OWNER’S EQUITY = L IABILITIES
Assets This includes anything owned or possessed by the business which is capable
of being expressed in terms of money or possessing monetary values, and
which, consequently, is available for the payment of the debt of the business.
In short, assets represent the resources of the business.
Liabilities Economic obligations (i.e., debts) payable to an individual or an organization
outside the business.
Owner’s Equity The claim of an owner of a business over the assets of the business after the
claims of the creditors have been satisfied.
Marivic D. Valenzuela-Manalo Page 8 of B
Current Assets
Overview This includes cash and any other assets that are reasonably expected to be
converted into cash or consumed during one year or one operating cycle, i.e.,
whichever is longer.
Cash Currency, coins and checks that the business has received from customers and
other sources that have not yet been deposited in its bank account, as well as
the amount the business has on deposit in its bank account, against which
checks may be drawn in payment of bills.
Investments in
Trading
Securities
Short-term investment in stocks of other business (also known as marketable
securities).
Notes
Receivable The amount due in the near future from persons or companies on the basis of
their formal, written promises to pay cash to the business on the date specified
in the promissory note.
Interest
Receivable The amount of interest due as of the balance sheet date on notes received from
customers.
Accounts
Receivable The total amount owed to the business by charge account customers.
Advances to
employees Cash advance given to an employee to be liquidated in the form of service.
Continued on next page
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Current Assets, Continued
Merchandise
inventory The purchase price of the particular line of goods the business expects to sell
to its customers for cash or on a charge account basis. This represents goods
on hand as of the balance sheet date.
Accrued
Income Income already earned but not yet collected, such as interest earned on
promissory note issued by the customer before the maturity date of the note.
Supplies on
hand The cost value of such things as wrapping paper and packaging tape and
twine, (Store Supplies on Hand), computer ribbons, envelopes, stamps, paper
(Office Supplies on Hand) , and other assets of a similar nature that the
business will use up in performing its activities.
Prepaid
insurance That part of the premium cost of all kinds of insurance carried by the business
after the balance sheet date. Prepaid insurance is always classified as a
current assets even if the amount of the unexpired premiums cover a period
longer than one year, the time limit used in defining current assets.
Prepaid rent Rent paid by the business for facilities to be used after the balance sheet date.
For example, on December 1, 20X1, a business paid P30,000 for December,
January, and February rent. On a balance sheet dated December 31, 20X1, the
amount of Prepaid Rent would be shown as P20,000 the amount paid for the
use of the facilities for January and February, 20X2.
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Plant, Property and Equipment
Overview Assets are classified as plant, property and equipment if they meet the
following criteria: (1) they must have physical existence; (2) they must be
more or less permanent in nature; (3) they must not be for sale; (4) they must
be used in business operations; and (5) they must undergo depreciation
(except land). (Pefianco, E., Mercado,R., 1983)
Land The cost of land the business uses to carry on its activities - the lot on which
its factory or office building stands.
Building The original cost less accumulated depreciation is shown to give the
depreciated value of the structures in which the business carries on its
operation. This item could be separated into such things as Factory Building,
Office Building, Warehouse, and any other type of building the business
wishes to show on its statement of financial position.
Equipment The original cost less accumulated depreciation is shown to give the
depreciated value of the equipment used in the operations of the business.
The title equipment may also be separated into whatever special assets of this
type the business cares to identify. The business may use such titles as Office
Equipment for the value of the adding machines, calculators, and typwritters
the office employees use, and Delivery Equipment, for the value of the trucks
and automobiles the business uses to deliver its merchadise to customers. A
manufacturing enterprise would probably show the value of the machines in
its factory as Factory Machinery and Equipment.
Continued on next page
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Plant, Property and Equipment, Continued
Furniture and
Fixtures The original cost less accumulated depreciation is shown to give the
depreciated value of furniture and fixtures used in the operation of the
business. The title Furniture and fixtures almost explains itself and may also
be subdivided. Desks and chairs and counters used by office employees might
be listed as Office Furniture and Fixtures. Display cases, chairs used by
customers, and merchandise counters in a department store could be entitled
Store Furniture and Fixtures.
Accumulated
Depreciation All property and equipment accounts except land are subject to depreciation.
Depreciation is the allocation of the cost of a property account to its period of
usefulness in order to recognize a decline in its value because of wear and
tear, obsolescence or inadequacy. The total amount of depreciation
accumulated over a number of years is called accumulated depreciation.
Marivic D. Valenzuela-Manalo Page 12 of B
Current Liabilities
Overview Current liabilities are debts or obligations of a business that are expected to be
liquidated by the use of assets classified as current or by the creation of
another current liability.
Accounts
payable The total amount owed by the business as of balance sheet date for purchases
of merchandise, supplies, and services made on a charge account basis and
due within one year from the balance sheet date.
Notes Payable The amounts owed by the business on the basis of formal, signed notes such
as the thirty-day or six-month notes signed when borrowing from a bank. If
merchandise is bought and the creditor requires the business to sign a note for
the amount of the purchase, the title Notes Payable is used. If the same
business borrowed from a bank, the liability may be shown also as Notes
Payable. This is classified as current liability if the note is due within one
year.
Interest
Payable The amount of interest owed by the business as of balance sheet date for
money borrowed on interest bearing promissory notes issued by the firm.
This interest debt builds up each day. The loan is outstanding-the interest
accrues-and it is shown as a separate liability apart from the face value of the
note, which appears in the Notes Payable account.
Deferred
Income Income already collected but not yet earned. Rental payment received by the
lessor from the lessee may be treated as unearned rent income by the former.
Taxes Payable The amount of taxes owed by the business as of balance sheet date.
Marivic D. Valenzuela-Manalo Page 13 of B
Long-Term Liabilities
Overview Long-term liabilities are debts or obligations that will become due and
payable after one year from balance sheet date.
Notes Payable
Long Term Amounts on signed formal notes due after one-year from the date of the
balance sheet.
Installment
Contracts
Payable
Amounts payable after one year from the balance sheet date on long-term
installment notes, such as those signed by the consumers when buying
automobiles and household appliances. Installments due within one year from
the balance sheet date are listed as current liabilities.
Mortgage
Payable A debt due after one year from the balance sheet date that has some of the
business property, such as land, buildings, or equipment-pledged as security.
Marivic D. Valenzuela-Manalo Page 14 of B
Owner’s Equity
Overview Owner’s equity or sometimes called capital or proprietorship is the excess of
assets over liabilities of a business.
Capital The amount invested in the business by the owner as of the balance sheet date.
Withdrawal When the owner withdraws cash or other assets from the business for personal
use, its assets and its owner’s equity both decrease. The amounts taken out of
the business appear in a separate account entitled Withdrawals, or Drawing.
If withdrawals were recorded directly in the capital account, the amount of
owner withdrawals would be merged with owner investments. To separate
these two amounts for decision-making, businesses used a separate account
for Withdrawals. This account shows a decrease in owner’s equity.
Marivic D. Valenzuela-Manalo Page 15 of B
Debit and Credit of Balance Sheet Items
Overview Analyzing business transactions would involve a dual effect in any of the
elements of the accounting equation. These dual effects would be analyzed
and recorded in terms of debit and credit. This part of the study guide will
introduce the readers on the basic understanding of the rules of debit and
credit affecting balance sheet items.
Account The basic summary device of accounting is the account. This is a detailed
record of the changes that have occurred in a particular asset, liability or
owner’s equity during a period of time.
T-Account For the purpose of analyzing the balance items into debit and credit, we will
be using in our illustrations the T-account. It takes the form of the capital
letter “T”. The vertical line in the letter divides the account into its left and
right sides. The account title rests on the horizontal line.
For example, the cash account of a business appears in the following T-
account format:
CASH
Left side
Debit
Right side
Credit
The left side of the account is called the debit side, and the right side is
called the credit side. Often beginners in the study of accounting are
confused by the words debit and credit. To become comfortable using
them, simply remember
debit = left side
credit = right side
The type of an account determines how increases and decreases in it are
recorded. Increases in assets are recorded in the left (the debit) side of
the account. Decreases in the assets are recorded in the right (the
credit) side of the account. Conversely, increases in liabilities and
owner’s equity are recorded by credits. Decreases are recorded by
debits.
Continued on next page
Marivic D. Valenzuela-Manalo Page 16 of B
Debit and Credit of Balance Sheet Items, Continued
Accounting
Equation This pattern of recording debits and credits is based on the accounting
equations:
ASSETS = LIABILITIES + OWNER’S EQUITY
Rules of Debit Credit Debit Credit Debit Credit
Debit and for for for for for for
Credit Increase Decrease Decrease Increase Decrease Increase
Illustration The following examples illustrate the accounting equations:
Joseph Labrador invested P100,000 cash to begin his accounting
business.
ASSETS = LIABILITIES + OWNER’S EQUITY
Cash Labrador, Capital
Debit
for increase
Php 100,000
Credit
for increase
Php 100,000
The business purchased office supplies on account for P5,000.
ASSETS = LIABILITIES + OWNER’S EQUITY
Office Supplies Accounts Payable
Debit
for increase
Php 5,000
Credit
for increase
Php 5,000
Continued on next page
Marivic D. Valenzuela-Manalo Page 17 of B
Debit and Credit of Balance Sheet Items, Continued
Illustration,
con’t. The following examples illustrate the continuation of the accounting
equations:
The business paid one year rental for its office space, P24,000.
ASSETS = LIABILITIES + OWNER’S EQUITY
Prepaid Rent Cash
Debit
for increase
Php 24,000
Credit
for increase
Php 24,000
The business paid ½ of the amount owed in buying office supplies.
ASSETS = LIABILITIES + OWNER’S EQUITY
Accounts Payable Cash
Debit
for increase
Php 2,500
Credit
for increase
Php 2,500
Marivic D. Valenzuela-Manalo Page 1of C
Unit III and IV
Income Statement and Statement of Equity
Overview
Background Owners, management and other stakeholders of the business would want to
know whether the business is earning from its operations. The results of
business operations are summarized and reported in the financial statement
called income statement.
The interval covered by the income statement is known as the accounting
period, i.e., any period usually of twelve months during which business
transactions are recorded and reported upon. When the accounting period
ends on December 31, it is called a calendar period. When it ends on any
month, it is called a fiscal period.
Purpose The purpose of Unit III “Income Statement” is to illustrate how an income
statement may be prepared and the nature of the different accounts included in
the said statement.
Income Statement provides financial information regarding the results of
business operations for a given period of time. It is a report that shows
whether or not the business achieved its primary objective of earning a profit
or net income.
An income statement is prepared by listing
• the revenues earned during the period;
• the expenses incurred in earning the revenue;
• and subtracting the expenses from the revenue to determine if a net income
or a net loss was incurred.
The purpose of Unit IV “Statement of Owner’s Equity” is to show how the
capital statement may be prepared and how withdrawals of proprietor and the
firm’s financial performance may effect the balance of capital at the end of
every accounting period.
In this unit This unit contains the following topics:
Topics See Page
Forms of Income Statement 2 of C
Income Accounts 7 of C
Expense Accounts 8 of C
Debit and Credit of Income Statement
Accounts
10 of C
Statement of Equity or Capital Statement 12 of C
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Forms of Income Statement
Overview The forms of income statement that a business prepares depend on the nature
of the business activity undertaken by the firm. As provided in the revised
Philippine Accounting Standard (PAS). 1, service oriented businesses
normally prepare the natural form, formerly known as the single step income
statement and trading and manufacturing firms normally use the functional
form, formerly known as the multiple-step income statement format.
Natural Form The income statement presentation under this form arranges all income
accounts in one group, all expense accounts in another group and then deducts
the total expenses from the total income in a single-step operation of
subtraction to arrive at the final result of net income or net loss.
Illustration Below is an illustration of a natural form income statement:
JOSEPH LABRADOR CONSULTANCY
Income Statement
For the year ended December 31, 20X1 Revenues: Note
Service Income P 650,000
Other Income (1) 50,000 P 700,000
Less: Operating Expenses
Employee Costs (2) P 250,000
Travel & Transportation 100,000
Rent Expense 80,000
Supplies Expense 70,000
Utilities Expense (3) 50,000
Janitorial & Security 32,000
Depreciation Expense (4) 28,000
Commission Expense 17,000
Insurance 14,000
Representation & entertainment 12,000
Repairs & maintenance 9,500
Taxes & Licenses 4,000
Doubtful Accounts 2,000
Miscellaneous Expense 4,000 672,500
Net Income P 27,500
Continued on next page
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Forms of Income Statement, Continued
Notes to the
Natural Form The following are the notes to the natural form income statement:
Note 1 - Other Income
Interest income P 28,000
Dividend income 22,000
Total other income P 50,000
Note 2 - Employee Costs
Professional fees P 175,000
Salaries & Employee Benefits 75,000
Total employee costs P 250,000
Note 3 - Utilities expense
Telephone & communication P 30,000
Light & Water 20,000
Total utilities expense P 50,000
Note 4 - Depreciation
Depreciation - office equipment 18,000
Depreciation - furniture & fixtures 10,000
Total depreciation P 28,000
Continued on next page
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Forms of Income Statement, Continued
Functional
Form
The income statement presentation under this form clearly shows specific sections
of income, costs and expenses in a series of arithmetic operations. This form
requires that cost of goods sold and the expenses be subtracted in steps to arrive at
the net income. Merchandising businesses uses this format.
Illustration Below is an illustration of a functional form income statement:
Joseph Labrador Consultancy Income Statement
For the year ended December 31, 20X1
Note
Net sales revenue 1 P 193,000
Cost of sales 2 (145,000)
Gross profit P 48,000
Other operating income 3 3,000
Gross profit and other operating income P 51,000
Operating expenses:
Selling expenses 4 P 14,000
Administrative expenses 5 24,000
Other operating expenses 6 1,000
Interest expense 1,000 (40,000)
Net income P 11,000
Continued on next page
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Forms of Income Statement, Continued
Notes to the
Functional
Form
The following are the notes to the functional form income statement:
Note 1 - Net sales revenue
Gross sales P 200,000
Less: Sales Returns & Allowances P 5,000
Sales Discount 2,000 7,000
Net sales revenue P 193,000
Note 2 - Cost of sales
Merchandise Inventory, Jan. 1 P 5,000
Add: Net cost of purchases
Purchases P 175,000
Less: Purchase Returns & Allowances P 3,000
Purchase Discounts 2,000 5,000
Net purchase P 170,000
Add: Freight-in 1,000 171,000
Cost of goods available for sale P 176,000
Less: Merchandise Inventory, Dec. 31 31,000
Cost of sales P 145,000
Note 3 - Other operating income
Rent Income P 1,500
Dividend Income 800
Interest Income 500
Gain on Sale of Furniture & Fixtures 200
Total other income P 3,000
Continued on next page
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Forms of Income Statement, Continued
Notes to the Functional Form (continued)
Note 4 - Selling expenses
Salesmen's Salaries and Commissions P 9,000
Representation and Entertainment 1,200
Depreciation - Store Equipment 1,000
SSS & Philhealth Premiums 900
Freight-out 800
Miscellaneous Selling Expense 1,100
Total selling expenses P 14,000
Note 5 - Administrative expenses
Salaries Expense P 15,000
Light, Water and Telephone 3,500
Uncollectible Accounts 2,000
Depreciation Expense 1,500
SSS & Philhealth Premiums 1,300
Miscellaneous General Expense 700
Total administrative expenses P 24,000
Note 6 - Other operating expenses
Loss on Sale of Equipment P 800
Discount Lost 200
Total other operating expenses P 1,000
Marivic D. Valenzuela-Manalo Page 7of C
Income Accounts
Overview The following are the usual income statement account found in a single-step
income statement
Service Income Different businesses have different ways of earning income. The term that is
generally used to refer to any kind of income from services rendered is service
income. This represents the inflow of cash or non-cash assets arising from
services rendered. Other account names that may be used to refer to income
from services describes the specific nature of the service rendered: (Pefianco,
E., Mercado, R., 1983)
• Professional Fees. These indicate income from rendering professional
services without specifying the particular nature of professional service
rendered.
• Medical Fees. This refers to income received from rendering medical
services.
• Legal Fees. This refers to income received from rendering legal services.
• Dental Fees. This refers to income received from rendering dental services.
• Accounting Fees. This refers to income received from rendering
accounting services.
• Management Fees. This refers to income received from rendering various
management consultancy services.
Other Income This refer to income from sources other than the principal line of activity of
the business.
The examples of other income are:
• Interest Income. The revenue to the payee for loaning out a principal
amount to a borrower. This may also refer to income earned from money
deposited in a bank.
• Dividend Income. Income earned in investing cash in stocks of other
businesses.
Marivic D. Valenzuela-Manalo Page 8of C
Expense Accounts
Overview Expenses are the cost of goods or services that are used or consumed in the
operations of a particular business activity. In service businesses, the
following are the common expenses
Salaries This is the cost of services rendered by the employees and/or laborers of a
business firm. This account may be used to include the cost of all emergency
allowances, 13th month pay, and other employee fringe benefits.
Rent The rental cost of office space, equipment, etc.
Office Supplies This refers to the cost of office stationery; coupon bond, carbon paper,
typewriter or computer ribbons, envelopes, pencils, ball pens, and office
supply items that are consumed in business operations.
Utilities This refers to the cost of light and water consumed as well as the cost of using
telephone facilities.
Taxes and
Licenses This refers to all payments required to be made to the Bureau of Internal
Revenue and the Municipal Treasurer for privilege taxes, mayor’s permits,
municipal taxes and licenses, business taxes and others.
Transportation This is the cost incurred by office employees when commuting from the office
to the place of business of clients, e.g., jeepney fares, taxi fares, and bus fares.
Also included are transportation fares from the office to any place on official
business. Travelling Expense is used when business trips are made out of
town, the cost of transportation fares by plane, by boat, or by bus.
Continued on next page
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Expense Accounts, Continued
Gas and oil This refers to the cost of gas and oil consumed whenever transportation
vehicles or company cars are used in official business trips.
Representation The cost incurred when entertaining clients or prospective clients. Included
are the costs incurred when office employees represent the firm in some
official functions.
Depreciation This refers to the expense associated with the use of the company’s plant
assets, i.e., spreading (allocating) the cost of a plant asset over its useful life.
Bad Debts Selling or rendering services on credit create both a benefit and a cost. Credit
customers who fail to pay their liabilities will create an expense in the
company. The allocation or provision for this future uncollectibility of some
of the accounts of credit customers is called bad debts expense or doubtful
accounts expense or uncollectible account expense.
Donations and
Contributions This refers to contributions made to charitable institutions or any other
worthwhile projects.
Miscellaneous Any other costs of operations that may not be sufficiently big in amount to be
classified separately are charged to this account.
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Debit and Credit of Income Statement Accounts
Overview A business transaction is an activity that involves the exchange of values. This
exchange would result to a situation or receiving a value equal to the value
given away. In this part, we would learn the simple mechanics of these
activities which bring about changes in the income statement.
Revenues The purpose of a business, other than to render service to the community, is to
increase assets and owner’s equity through revenues, which are amounts
earned by delivering goods or services to customer. Revenues increase
owner’s equity because they increase the business’s assets but not its
liabilities. As a result, the owner’s interest in the assets of the business
increases.
• Example: Jose Labrador earns service income by providing professional
accounting service for his clients. Assume he earns P10,000 and collects
this amount in cash. The effect on the accounting equation is an increase in
the asset cash and an increase in Labrador Capital due to the income
generated.
Assets - Cash = Liabilities + Labrador, Capital
10,000 increase 10,000 increase - Service income
Expenses In earning revenue, a business incurs expenses. Expenses are decreases in
owner’s equity that occur in the course of delivering goods and service to
clients. Expenses decrease owner’s equity because they use up the business
assets.
• Example: During the month, Labrador paid the salary of the company
secretary for P5,000. The effect on the accounting equation is a decrease in
the asset, cash and a decrease in capital due to the expense incurred.
Asset - Cash = Liabilities + Labrador, Capital
5,000 decrease 5,000 decrease - Salaries expense
Continued on next page
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Debit and Credit of Income Statement Accounts, Continued
Normal
Balance Upon analyzing the effects of income and expense accounts in the owner’s
equity, one may conclude that, since owner’s equity or capital has a normal
credit balance, it must follow that all income accounts will also have normal
credit balances since they cause an increase in the capital account. On the
contrary, since expenses have a decreasing effect in the capital account, the
normal balance of all expense accounts would be debit.
The illustration presents two main sources of owner’s equity, namely:
investments and revenues. On the other hand, withdrawals and expenses
decrease the owner’s equity.
INCREASES DECREASES
Expenses Revenues
Owner ‘s Equity
Owner withdrawals
from the business Owner investments
in the business
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Statement of Equity or Capital Statement
Overview Capital Statement or Statement of Owner’s Equity presents a summary of
the changes that occurred in the owner’s equity of the entity during a specific
time period, e.g., month or a year. Increases in owner’s equity arise from
investments by the owner and net income earned. Net loss for the period
causes the owner’s equity to decrease. Net Income or net loss comes directly
from the income statement. Investments and withdrawals by the owner are
capital transactions between the business and its owner, so they do not affect
the income statement.
Withdrawals The owner of the firm would at times withdraw assets from the business for
personal use. These personal withdrawals would be treated differently
depending on the intention of the owner in withdrawing such assets
Types of
Withdrawals • Temporary Withdrawal. The owner withdraws business assets (e.g. cash)
for personal use in anticipation of profits derived from the operations of the
business. This type of withdrawal uses the drawing account when recorded
in the books of the company.
The pro-forma entry to record this type of withdrawal is:
Joseph Labrador, Drawing xxx
Cash or Other Assets xxx
To record withdrawal of owner for personal use
• Permanent Withdrawal. Capital withdrawal that is substantial in amount.
The owner in this type of withdrawal of the assets has the intentions of
removing the asset permanently from the business operations. This type of
drawing uses the capital account.
The pro-forma entry to record this type of withdrawal is:
Joseph Labrador, Capital xxx
Cash or Other Assets xxx
To record permanent withdrawal of asset of owner from the business.
Continued on next page
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Statement of Equity or Capital Statement, Continued
Statement of
Owner’s Equity The statement of owner’s equity opens with the owner’s capital balance at the
beginning of the period. Add net income, (deduct in the case of net loss)
which directly comes from the income statement. Subtract withdrawals by the
owner and the statement ends with owner’s capital balance at the end of the
period.
Illustration Below is the illustration of the statement of the owner’s equity.
JOSEPH LABRADOR, CPA
Statement of Owner’s Equity
For the year ended December 31, 20X1
Joseph Labrador, Capital, January 1 P 620,500
Add: Net Income 34,500
Sub-Total P 655,000
Less: Joseph Labrador, drawing 10,000
Joseph Labrador, Capital, December 31 P 645,000
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Unit V
Statement of Cash Flows
The basic financial statements we have presented so far provide only limited information about
the company’s asset “Cash”. For example, balance sheet shows how much cash the business
owns on the date the report was prepared but it does not indicate the amount of cash generated by
operating activities, or financing activities. The income statement may show expenses and
revenues that may have an effect to cash but will not provide reader of this report how these
income and expenses affected “Cash” account. The capital statement shows what happened to
the capital balance of the owner during the year. None of these statements presents a detailed
summary of where cash came from and how it was used.
Statement of Cash Flows Defined
The statement of cash flows reports the cash receipts, cash payments, and net change in cash
resulting from operating, investing, and financing activities during a period.
Usefulness of the Statement of Cash Flows
The information in a statement of cash flows should help investors, creditors, and others assess:
1. The entity’s ability to generate future cash flows. By examining relations between
items in the statement of cash flows, investors and others can make predictions of the
amounts, timing, and uncertainty of future cash flows better than they can from accrual
basis data.
2. The entity’s ability to pay dividends and meet obligations. If a company does not
have adequate cash, it cannot pay employees, settle debts, or pay dividends. Employees,
creditors, and stockholders should be particularly interested in statement, because it alone
shows the flows of cash in a business.
3. The reasons for the difference between net income and net cash provided (used) by
operating activities. Net income provides information on the success or failure of a
business enterprise. However, some are critical of accrual basis net income because it
requires many estimates. As a result, the reliability of number is often challenged. Such
is not the cash with cash. Many readers of statement of cash flows want to know the
reasons for the difference between net income and net cash provided by operating
activities. Then they can assess for themselves the reliability of the income number.
4. The cash investing and financing transactions during the period. By examining a
company’s investing and financing transactions, a financial statement reader can better
understand why assets and liabilities changed during the period.
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Classification of Cash Flows
The cash flows shown in the statement are grouped into three major categories: (1) operating
activities. (2) investing activities, and (3) financing activities. We will now look briefly at the
way cash flows are classified among these three categories.
Operating Activities. The operating activities section shows the cash effects of revenue and
expense transactions. Stated another way, the operating activities section of the statement of cash
flows includes the cash effects of those transactions reported in the income statement. To
illustrate this concept, consider the effects of credit sales. Credit sales are reported in the income
statement in the period when the sales occur. But the cash effects occur later – when the
receivables are collected in cash. If these events occur in different accounting periods, the
income statement and the operating activities section of the statement of cash flows will differ.
Similar differences may exist between the recognition of an expense and the related cash
payment. Consider, for example, the expense of postretirement benefits earned by employees
during the current period. If this expense is not funded with a trustee, the cash payments may not
occur for many years – after today’s employees have retired.
Cash flows from operating activities include:
Notice that receipts and payments of interest are classified as operating activities, not as investing
or financing activities because these are shown in the income statement.
Investing Activities. Cash flows relating to investing activities present the cash effects of
transactions involving plant assets, intangible assets, and investments. They include:
Cash Receipts Cash Payments
------------------------------------------------------ --------------------------------------------------
Collections from customers for sales of Payment to suppliers of merchandise
goods and services and services, including payments to
Interest and dividends received Payments of interest
Other receipts from operations; for Payments of income taxes
example, proceeds from settlement of Other expenditures relating to operations;
litigation for example, payments in settlement of
litigation
Cash Receipts Cash Payments
----------------------------------------------------- --------------------------------------------------
Cash proceeds from selling investments and Payments to acquire investments and plant
plant assets assets
Cash proceeds from collecting principal Amounts advanced to borrowers
Amounts on loans
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Financing Activities. Cash flows classified as financing activities include the following items
that result from debt and equity financing transactions:
Repayment of amounts borrowed refers to repayment of loans, not to payments made on
accounts payable or accrued liabilities. Payments of accounts payable and of accrued liabilities
are considered payments to suppliers of merchandise and services and are classified as cash
outflows from operating activities. Also, remember that all interest payments are classified as
operating activities.
The following illustration lists typical cash receipts and cash payments within each of the
three classifications. Study the list carefully. It will prove very useful in solving homework
exercises and problems.
Cash Receipts Cash Payments
------------------------------------------------------- --------------------------------------------------
Proceeds from both short-term and long-term Repayment of amounts borrowed (excluding
borrowing interest payments)
Cash received from owners (for example, Payments to owners, such as cash withdrawals
From investment)
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Note the following general guidelines: (1) Operating activities involve income statement
items. (2) Investing activities involve cash flows resulting from changes in investment and long-
term asset items. (3) Financing activities involve cash flows resulting from changes in long-term
liability and owner’s equity items.
Some cash flows related to investing or financing activities are classified as operating
activities. For example, receipts of investment revenue (interest and dividends) are classified as
operating activities. So are payments of interest to lenders. Why are these considered operating
activities? Because these items are reported in the income statement, where results of
operations are shown.
Types of Cash Inflows and Outflows
Operating activities – Income statement items
Cash inflows:
From sale of goods or services.
From returns on loans (interest received) and on equity securities (dividends received).
Cash outflows:
To suppliers for inventory.
To employees for services.
To government for taxes.
To lenders for interest.
To lenders for interest.
To others for expenses.
Investing activities – Changes in investments and long-term assets
Cash inflows:
From sale of property, plant, and equipment.
From sale of debt or equity securities of other entities.
From collection of principal on loans to other entities.
Cash outflows:
To purchase property, plant, and equipment.
To purchase debt or equity securities of other entities.
To make loans to other entities.
Financing activities – Changes in long-term liabilities and stockholders’ equity
Cash inflows:
From owner’s investments
From issuance of debt (bonds and notes).
Cash outflows:
Withdrawal of cash by the owner
To redeem long-term debt
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Unit VI – Part 1
General Journal, General Ledger, Trial Balance Overview
Background The work for each accounting period follows a cycle, which is called the
accounting cycle. This refers to a series of sequential steps or procedures
performed to accomplish the accounting process.
1. Journalizing
2. Posting to the General Ledger
3. Trial Balance Preparation
4. Adjusting the Books
5. Preparing Financial Statements
6. Closing the Books
7. Preparing Post Closing Trial Balance
8. Reversing Entries
Purpose The purpose of Unit IV “General Journal, General Ledger, Trial Balance ” is
to introduce the student on the use of a general journal, general ledger and the
preparation of the trial balance.
In this unit This unit contains the following topics:
Topics See Page
Journalizing (Step 1) 2 of D
Journal Rules 4 of D
Journal Entries 6 of D
The General Ledger 9 of D
The Chart of Accounts 11 of D
Posting to the General Ledger (Step 2) 13 of D
Balancing Accounts 16 of D
Trial Balance 17 of D
Limitations of the Trial Balance 19 of D
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Journalizing (Step 1)
Overview Bookkeeping is the systematic and chronological recording of transactions in
books of accounts following a series of steps and procedures commonly
referred to as the accounting cycle. This bookkeeping procedure begins with
journalizing which is the first part of this unit.
Journal Accounting is based on double-entry bookkeeping, which means that
accountants record the dual effects of a business transaction. The basic
recording procedure in accounting involves a device called a journal. A
journal is a daily record of business transactions that shows in one place the
complete debit and credit effect of each transaction on the accounts of the
business in chronological order. The general journal is also known as the
book of original entries.
Journalizing The chronological recording of the business transactions in the book of
original entry.
Illustration Below is an example of a typical journal.
JOURNAL
PAGE
Date P A R T I C U L A R S P/R DEBIT CREDIT
Continued on next page
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Journalizing (Step 1), Continued
Legend The definitions below illustrate the legend:
• Date, is used to show the day of the month on which each transaction takes
place.
• Particulars column or sometimes called the Account Titles and Explanation
column, is used to show every account title affected by each transaction and
to give some explanation or justification of the debits and credits being
made to the accounts.
• P/R (Posting Reference) column is important because it indicates the
numbers of the accounts in the ledger to which the debits and credits
recorded in the journal have been transferred. In manual systems, these
account numbers are inserted at the proper time in the P/R column of the
journal.
• Debit and credit columns indicate the amounts to be debited or credited to
the account titles written in the particulars column.
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Journal Rules
Overview The following guidelines will be useful when recording transactions in a
general journal.
Journal Rules The recording process follows these five steps:
• 1. Transactions are first analyzed, identifying the transaction from business
source documents, e.g., official receipts, cash vouchers, etc. All
transactions recorded in journals must be based upon some objective
verifiable evidence. Business documents are formal written records that
provide information to everyone with an understanding of accounting to
measure the amount of the transaction and to analyze it in the same way.
The data used for the journal entry are verifiable if it is possible to trace the
transaction to its point of origin.
• 2. The day on which the transaction took place is written in the Date
column.
• 3. The account titles affected by the transactions are put into the particulars
column. It is an accepted practice to list first in each transaction the account
title/s being debited, followed by the account title/s being credited. The
debited account titles are written against the left margin of the particulars
column. The accounts being credited are indented from the left margin of
the particulars column. If any single transaction requires several debits and
credits, all account titles receiving the debits will be listed first, followed by
the indented account titles receiving the credits. At the same time each
account title is written in the journal, the peso amount is inserted in the
appropriate Debit or Credit column. For each journal entry, the total debits
must equal the total credits.
Continued on next page
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Journal Rules, Continued
Journal Rules,
con’t. Continuation of the steps:
• 4. A brief explanation is written immediately below the last account title
credited. This gives the reason why the accounts are being debited or
credited and verifies the amounts used. The explanations follow no rigid
rules. The accountant uses his own wording in every explanation. He must
keep in mind, however, that other readers must understand the transaction
and the manner in which it was recorded.
• 5. It is advisable to leave a blank line following the explanation to help
distinguish one journal entry from the next. Thus, each journal entry
consists basically of four parts:
• Transaction date
• Debit entry
• Credit entry
• Explanation
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Journal Entries
Journal Entries The following transactions of Joseph Labrador, CPA will show the ways in
which the rules mentioned in the previous section are applied to a general
journal. The transactions are described first and the proper method of
recording the transactions follows in the illustrative journal form.
Transaction
Date Description of Transaction
September 1 Mr. Joseph Labrador began his accounting firm by
investing cash of P300,000 and furniture of
P50,000.
2 Paid the business tax to the City Treasurer, P5,000.
3 Purchased a computer from CompuCenter for
P40,000 on account
4 Purchased various office supplies from National
Bookstore, P7,000.
5 Sent charge bills to ABC Co. for accounting
services rendered, P10,000.
6 Made a partial payment of P10,000 to
CompuCenter
7 Received P5,000 in cash for services rendered to
XYZ Co.
8 Mr. Labrador withdrew P8,000 cash for personal
use.
9 Paid repairman for repair service on the office
furniture, P500.
10 Paid in cash the following:
Secretary’s salary P3,500
PLDT & MWSS Bills 1,500
Continued on next page
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Journal Entries, Continued
Example of
Journal entries Below is a typical journal with journal entries:
P a g e 1
DATE P A R T I C U L A R S P/R D E B I T C R E D I T
Sept. 1 Cash 3 0 0 0 0 0
Labrador, Capital 3 0 0 0 0 0
To record initial investment
1 Office Furniture and Fixtures 5 0 0 0 0
Labrador, Capital 5 0 0 0 0
To record initial investment
2 Taxes and Licenses Expense 5 0 0 0
Cash 5 0 0 0
Tax paid to City Treasurer.
3 Office Equipment 4 0 0 0 0
Accounts payable-CompuCenter 4 0 0 0 0
Bought computer on credit
4 Office Supplies 7 0 0 0
Cash 7 0 0 0
Purchased various office supplies
5 Accounts Receivable 1 0 0 0 0
Services Income 1 0 0 0 0
Services delivered on credit
6 Accounts Payable-CompuCenter 1 0 0 0 0
Cash 1 0 0 0 0
Made partial payment
7 Cash 5 0 0 0
Service Income 5 0 0 0
Service income in cash.
8 Labrador, Drawing 8 0 0 0
Cash 8 0 0 0
Withdrawal of cash by the owner
9 Repairs and Maintenance 5 0 0
Cash 5 0 0
Paid for the repair of furniture
10 Salaries & Wages Expense 3 5 0 0
Cash 3 5 0 0
Paid secretary's salary.
10 Utilities Expense
Cash 1 5 0 0
Paid bills of PLDT & MWSS 1 5 0 0
Continued on next page
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Journal Entries, Continued
Compound
Journal Entry A compound entry (i.e., entry with more than one debit or more than one
credit or more than one debit and credit) is optional to be used on the part of
the recorder. Compounding an entry, however, is not to be used to serve
laziness at the sacrifice of clarity. Compound entries should be used only for
similar transactions.
The event in September 1 and 10 may be journalized by two simple journal
entries as shown in the illustration. But it can also be recorded by one
compound journal entry as follows:
Sept. 1 Cash 300,000
Office furniture & fixture 50,000
Joseph, Capital 350,000
To record initial investment
Sept. 10 Salaries & wages expense 3,500
Utilities expense 1,500
Cash 5,000
Paid salary of secretary & PLDT
& MWSS bill
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The General Ledger
Overview Since transactions are recorded in the journal according to their dates of
occurrences, items of similar nature are not grouped together. Information in
the general journal is spread among the various transactions recorded. If
information regarding an item is desired, say, cash, for example, it is still
necessary to gather the information from the scattered pages of the journal.
Due to this inconvenience, there is a need for another record in which data
appearing in the journal may be summarized to show the status of each item.
Each item is represented by an account. A group of accounts constitutes a
ledger. The general ledger is also known as the book of final entry
(Punzalan, J., Santos, M., 1969).
Forms of
General Ledger There are two possible forms of general ledger account. These are:
• Standard Form
The standard form of the account looks like this:
ACCOUNT NO.
Date I T E M S P/R DEBIT Date I T E M S P/R CREDIT
The headings in each column of this form indicate the type of
information that is recorded. There is a complete set of columns,
Date, Items or Explanation, P/R, Amount, for each side (debit and
credit of the account). The Date column shows the day each
transaction affecting the account took place. The Item column,
which is rarely used, gives information about unusual transactions
recorded in the account. The P/R column is called a posting
reference column and tells the source of the debit or the credit being
entered in the account. The debit and credit columns show the peso
amount for each transaction recorded in the account.
Continued on next page
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The General Ledger, Continued
Forms of a
ledger The other account form is
• Running Balance Form
ACCOUNT NO.
Date I T E M S P/R DEBIT CREDIT BALANCE
This type of account permits an analysis of transactions in terms of
debits and credits, but the arrangement of the columns is different
from the standard account form. The sample shows this running
balance form of account; its use will be deferred until you have
become more familiar with recording transactions in the standard
account format.
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The Chart of Accounts
Overview An accountant usually prepares a chart of accounts, which is the listing of all
the account titles being used by the business in its operations including their
respective account numbers, at the time the business is organized. At that
time, he considers the nature of the business, the kinds of transactions, which
are likely, and the names of the accounts needed to record the information.
He prepares the chart of accounts in a ledger order, which is also the financial
statement order. Whenever necessary, the accountant or a newly trained
employee may refer to the chart for specific account titles and for the position
of such accounts in the ledger or in the statements.
Illustration The chart of accounts prepared for Joseph Labrador, CPA follows:
Account No. Account Title
ASSETS
101 Cash
102 Marketable Securities
103 Notes Receivable
104 Accounts Receivable
104-A Allowance For Doubtful Accounts
105 Interest Receivable
106 Advances To Employees
107 Office Supplies
108 Prepaid Rent
109 Prepaid Insurance
201 Land
202 Building
202-A Accumulated Depreciation-Building
203 Office Equipment
203-A Accumulated Depreciation-Office Equipment
204 Office Furniture And Fixture
204-A Accumulated Depreciation-Office Furniture &
Fixture
Continued on next page
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The Chart of Accounts, Continued
Illustration (continued)
LIABILITIES
301 Accounts Payable
302 Notes Payable
303 Interest Payable
304 Salaries & Wages Payable
305 Withholding Taxes Payable
306 SSS & Medicare Premium Payable
307 Pag-Ibig Contributions Payable
321 Mortgage Payable
PROPRIETORSHIP
401 Labrador, Capital
401-A Labrador, Drawing
402 Income & Expense Summary
REVENUES
501 Service Income
502 Interest Income
503 Dividend Income
EXPENSES
601 Advertising Expense
602 Depreciation Expense
603 Doubtful Accounts Expense
604 Gas & Oil Expense
605 Insurance Expense
606 Interest Expense
607 Miscellaneous Expense
608 Office Supplies Expense
609 Postage & Telegraph Expense
610 Rent Expense
611 Repair & Maintenance Expense
612 Salaries & Wages Expense
613 SSS & Medicare Premium Expense
614 Taxes & Licenses Expense
615 Transportation Expenses
616 Utilities Expense
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Posting to the General Ledger (Step 2)
Overview Journals are called books of original entry because the information from the
underlying business papers, i.e., receipts, invoices, etc., is recorded here first.
In most businesses, accounting transactions seldom go to the ledger accounts
without first having been recorded in a journal. The journalized transactions
must, however, be transferred to the ledger accounts so that the changes in
individual asset, liability, proprietorship, revenue and expense items may be
accumulated. The process of transferring the data from journal entries to the
individual account in the ledger is called posting. Posting simply involves
transferring the journalized debit and credit data to each account name in the
journal entry. The amounts are written on the side of the accounts as
specified in the journal entry.
Journal Entry The journal entry and the procedure for posting the debit portion of this
transaction to the proper account are illustrated below:
PAGE 1
Date P A R T I C U L A R S P/R DEBIT CREDIT
20X1
Sept. 1 Cash 101 1 5 0 0 0 0
Labrador , Capital 1 5 0 0 0 0
Initial Investment
Debit Posting
procedure On the debit side of the account, in the ledger:
1. Enter the year (where needed), the month (where needed), and the day in
the Date column of the account affected.
2. Enter the amount in the debit column of the amount affected.
3. Enter the journal posting reference (journal symbol, e.g., GJ for general
journal and page number) in the P/R column to show the source of the
data posted.
4. In the journal, enter the ledger posting reference (account number) in the
P/R column for the debit part of the transaction, indicating the completion
of the posting.
Continued on next page
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Posting to the General Ledger (Step 2), Continued
Illustration Below is the illustration of the debit posting procedure.
Debit Posting Illustrated
CASH ACCOUNT NO. 101
Date I T E M S P/R DEBIT Date I T E M S P/R CREDIT
20X1
Sept. 1 GJ1 1 5 0 0 0 0
Journal Entry The journal entry and the procedure for posting the credit portion of the given
transaction follow:
PAGE 1
Date P A R T I C U L A R S P/R DEBIT CREDIT
20X1
Sept. 1 Cash 101 1 5 0 0 0 0
Labrador , Capital 401 1 5 0 0 0 0
Initial Investment
Credit Posting
Procedure On the credit side of the account in the ledger:
1. Enter the year (where needed), the month (where needed), and the day in
the Date column of the account affected.
2. Enter the amount in the credit column of the account affected.
3. Enter the journal posting reference (journal symbol and page number) in
the P/R column to show the source of the data posted.
4. In the journal, enter the ledger posting reference (account number) in the
P/R column for the credit part of the transaction, indicating the completion
of the posting.
Continued on next page
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Posting to the General Ledger (Step 2), Continued
Illustration Below is the illustration of the credit posting procedure.
Credit Posting Illustrated Labrador, Capital ACCOUNT NO. 401
Date I T E M S P/R DEBIT Date I T E M S P/R CREDIT
20X1
Sept. 1 GJ1 1 5 0 0 0 0
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Balancing Accounts
Overview The general ledger accounts provide a means for determining the amount for
each of these items that exist at the end of each accounting period or at any
other time. This information is obtained by balancing the accounts.
Balancing accounts in the general ledger is a simple procedure. First, the debit
and credit sides of each account are footed (totaled) whenever more than one
figure appears in a column, and the totals are inserted in small penciled
figures immediately below the last entry on each side of the account. Second,
the total of the debits in each account is compared with the total of the credits.
Third, when the total of the debits is greater than the total of the credits, the
difference between the two totals is inserted in pencil on the debit side of the
account following the line with the penciled footing. If the total of the credits
is more than the total of the debits, the difference is inserted in pencil on the
credit side next to the penciled footing. Asset and expense accounts will
normally have debit balances. Liability capital and revenue accounts will
normally have credit balances.
Illustration Below is an illustration of Posting the Cash Account transactions of J.
Labrador from September 1 to 10:
CASH ACCOUNT NO. 101
Date I T E M S P/R DEBIT Date I T E M S P/R CREDIT
20X1
Sept. 1 GJ1 3 0 0 0 0 0 Sept. 2 GJ1 5 0 0 0
7 GJ1 5 0 0 0 4 GJ1 7 0 0 0
6 GJ1 1 0 0 0 0
8 GJ1 8 0 0 0
9 GJ1 5 0 0
10 GJ1 3 5 0 0
10 GJ1 1 5 0 0
3 0 5 0 0 0 3 5 5 0 0
10 Balance 2 6 9 5 0 0
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Trial Balance
Overview The trial balance is a list of schedule of open accounts in the general ledger
with their corresponding account balances, i.e., the difference between the
total debits and total credits of an account in the ledger. It is prepared to
verify the equality of debits and credits in the ledger at the end of each
accounting period or at any time the postings are updated.
The previous section has shown the procedure for entering transactions
directly in the ledger accounts and the way to determine the balances of
accounts after the transactions for an accounting period has been recorded. At
this point in the sequence, it is advisable to check the work for arithmetic
accuracy. Preparing the trial balance does this. The trial balance summarizes
all the accounts in the general ledger and thus, provides a check on the
equality of the debits and credit entries in the ledger. This schedule has the
following characteristics:
• It is a list of accounts.
• The list of accounts is unclassified; it does not attempt to state whether
accounts listed are assets or liabilities, current or long term.
• The accounts listed are normally those with open balances, that is, they have
peso amount balances.
• The accounts are listed in ledger orders.
If the accounts have been debited and credited with equal amounts for each
transaction during the accounting period, and if the balances of all accounts
have been accurately calculated, the sum of the debit balance accounts (the
assets and the expenses) will equal the sum of the credit balance accounts (the
liabilities, proprietor’s capital and revenues).
It is important to note that the trial balance is a list prepared for all accounts
with open (debit or credit) balances. Accounts with zero balances are
excluded.
Continued on next page
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Trial Balance, Continued
Reminder The trial balance is not a complete proof of the correctness of the accounting
entries recorded. It is possible to debit on asset account instead of an expense
account, credit a revenue account instead of a liability account, make
compensating arithmetic errors (errors that offset each other), or debit and
credit the appropriate accounts but for the incorrect amount, and still produce
a trial balance in which the debit balances equal the credit balances. All that
the trial balance really proves is that the transactions were recorded so that
debits and credits are equal in amount. In spite of the limitations of the trial
balance, it is nevertheless an important tool in checking the equality of the
debit and credit balances in the general ledger. In addition to providing a kind
of proof of work done the trial balance may also be used as a source of
information for the preparation of balance sheet and income statement.
Illustration Below is the trial balance of Joseph Labrador, CPA:
Joseph Labrador, CPA
Trial Balance
September 10, 20X1
ACCOUNT TITLES
DEBIT
CREDIT
Cash 269,500
Accounts Receivable 10,000
Office Supplies 7,000
Office Equipment 40,000
Office Furniture & Fixture 50,000
Accounts Payable 30,000
Labrador, Capital 350,000
Labrador, Drawing 8,000
Service Income 15,000
Taxes & Licenses Expense 5,000
Repair & Maintenance Expense 500
Salaries & Wages Expense 3,500
Utilities Expense 1,500 __________
395,000
=========
395,000
=======
Marivic D. Valenzuela-Manalo Page 19of D
Limitations of the Trial Balance
Overview The Trial Balance provides proof that the ledger is in balance. The agreement
of the debit and credit totals of the trial balance gives assurance that
• Equal debits and credits have been recorded for all transactions.
• The debit or credit balance of each account has been correctly computed.
• The addition of the account balances in the trial balance has been correctly
performed.
Limitations Experience proves that not all the trial balances that we prepare are balanced.
There are many instances that the debit total is not similar to that of the credit
total. The following are the steps in locating errors in the trial balance:
• Prove the addition of the trial balance by adding columns in the opposite
direction from that previously followed.
• If the error does not lie in the addition, determine the exact amount by
which the trial balance is out of balance. The amount of the discrepancy is
often a clue to the source of the error.
• If the difference is divisible by 9, this suggests either a:
• Transposition Error. An interchange in the order of the digits of a
number, e.g., 87 for 78; 453 for 354; 1234 for 4231; etc. The first is
called a one-column transposition, the second, a two-column transposition
and the third, a three-column transposition. An error caused by a one-
column transposition is divisible by 9, by a two column transposition by
99, by a three-column transposition by 999, and so on.
Continued on next page
Marivic D. Valenzuela-Manalo Page 20of D
Limitations of the Trial Balance, Continued
Limitations,
cont. Below is the continuation of steps in locating errors in the trial balance:
• Transplacement Error. Also known as sliding error, occurs when some or
all the digits of a number are moved one or more places to the left or right,
e.g., 450.00 written as 45.00 or as 4.50 or as 4005.00. The first is called a
one-column slide, and the next two as two column slides. The error
caused by a one-column slide is divisible by 9, by a two column slide by
99, and soon. After the division is performed, the quotient always
indicates the figure transplaced.
• If the difference is an even number, divide it by 2. The quotient could be
the balance of an account that is erroneously copied to the trial balance on
the wrong side or the amount of a journal entry that is posted on the wrong
side of the ledger.
• Compare the amounts in the trial balance with the balances in the ledger.
Be sure that no account is omitted.
• Recompute the balance of each ledger account.
Trace all postings from the journal to the ledger accounts. As this is done,
place a check mark in the journal and in the ledger after each figure is
verified. When the operation is completed, look through the journal and the
ledger for unchecked amounts. In tracing postings, be alert not only for errors
in amount but also for debits entered as credits, or vice versa.
Marivic D. Valenzuela-Manalo Page 1of E
Unit VI – Part 2
Accounting for Salaries
Overview
Background Every business that has employees is required to keep some kind of record of
wages and salaries paid. A business must have correct information about the
reported earnings of its employees in order to make proper payment to them
and in order to debit the amounts they have earned to the correct accounts.
All businesses are required by law to keep earnings records for each employee
and must be able to prove the correctness of the various required government
deductions and contributions (e.g., taxes, SSS, Philhealth, etc.), which
employers and employees pay. Employees want to be sure that the amounts
they receive on payday are the amounts to which they are rightfully entitled.
The summary of the employees’ salary is prepared in a report called payroll
register. This is accomplished depending on the payroll period being
followed by the company either in a weekly, semi-monthly or monthly basis.
Purpose The purpose of “Accounting for Salaries” is to provide students a simple
working knowledge on how to record salaries paid to employees with
deductions required by the government and the corresponding remittances of
those deductions made to proper government agencies.
In this unit This unit contains the following topics:
Topics See Page
Recording Salary Expenses 2 of E
Marivic D. Valenzuela-Manalo Page 2of E
Recording Salary Expenses
Overview All business entities normally hire employees to perform its various
operations. Salaries of these employees must be properly computed and paid
at a specified time (e.g. weekly, bi-monthly, monthly).
In this section, readers will be introduced on how to journalize transactions
affecting payment of employees’ salaries with corresponding deductions as
required by law or due to some other reasons such as loans made by
employees from the company.
Social Security
System Under PD No. 24, “no person shall be employed unless he has a social
security number.” It is therefore a requirement that all employees in the
private sector be members of the Social Security System (SSS). The system
provides benefits and services to its members which include the following:
salary loans, educational loans, housing loans, sickness and death benefits,
unemployment benefits, disability benefits, pension benefits and
reimbursement of funeral expenses for deceased members. In consideration
for all these benefits, the employee is required to make a monthly contribution
in accordance with a contribution table provided by the SSS. This
contribution of the employee is deducted from his salary. The corresponding
contribution of the employer is an operating expense, i.e., SSS Contribution
Expense.
Philhealth The Philippine Medical Care Commission (PMCC) was established to
provide hospitalization and other medical benefits to its members and their
dependents. Contributions are made according to a given table. Similar to
SSS, the contribution is shared between the employee and his employer. The
contribution of the employee is deducted from his salary. The contribution of
the employer is an operating expense, i.e., Philhealth Contribution Expense.
Pag-ibig Fund The Pag-ibig Fund is a provident savings and housing fund for employees
established under P.D. No. 1752. It aims to generate mass savings geared
towards financing homes for its members. All private employees who are
members of the SSS and their employers are covered by the fund
compulsorily. The employer and its employees in accordance with the pag-
ibig contribution table make contributions to the Pag-ibig Fund.
Continued on next page
Marivic D. Valenzuela-Manalo Page 3of E
Recording Salary Expenses, Continued
Witholding
Income Tax Under the Bureau of Internal Revenue regulations, every employer is required
to deduct and withhold income tax from the salary of its employees in
accordance with a withholding tax table. The amount of income tax to be
withheld from the employees will depend on whether the employee is single,
married, a head of the family, a married woman whose husband is also
working, and on the number of his qualified dependents.
Illustration
No. 1 The following is an illustration of how to record salary expense with various
deductions:
September 30, 20X1 transaction:
J. Labrador, CPA paid salaries to employees, P32,500. Deductions were made
for the following: SSS, P966.75; Philhealth, P343.75; Pag-ibig, P650 and
withholding taxes, P2,850.
Sept. 30 Salaries And Wages Expense 32,500
SSS Premiums Payable 966.75
Philhealth Contributions Payable 343.75
Pag-Ibig Contribution Payable 650.00
Withholding Taxes Payable 2,850.00
Cash 27,689.50
To record payment of salaries for the
period Sept. 1-30
Continued on next page
Marivic D. Valenzuela-Manalo Page 4of E
Recording Salary Expenses, Continued
Illustration
No. 2 The following are illustrations of how to record remittances made to different
government agencies:
October 10, 20X1 transaction:
Remitted to Bureau of Internal Revenue (BIR) the tax withheld from
employees’ salaries for the period Sept. 1-30.
October 10 Withholding Taxes Payable 2,850
Cash 2,850
To record remittance made to BIR.
October 20, 20X1 transaction:
Remitted the amount due to SSS and Philhealth and Pag-ibig computed as
follows:
Employer’s share Employees’ share
SSS 3,048.50 966.75
Philhealth 687.50 343.75
Pag-ibig 950.50 650.00
Total 4,686.50 1,960.50
============= ==============
October 20 SSS and Philhealth Contributions Expense 3,736.00
Pag-ibig Contributions expense 950.50
SSS Premiums Payable 966.75
Philhealth Contributions Payable 343.75
Pag-ibig Contributions payable 650.00
Cash 6,647
To record remittances made to SSS, Philhealth,
and Pag-ibig.
Marivic D. Valenzuela-Manalo Page 1of F
Unit VI
Accounting for Promissory Note
Overview
Background A promissory note is a written promise made by a maker, i.e., the person or
business that signs the note, promising to pay the payee, i.e., the creditor, a
certain amount of money at a fixed determinable future time which may or
may not include interest.
Purpose The purpose of Unit VIII “Accounting for Promissory Note” is to illustrate
how an issued promissory note would be recorded in the books of both the
maker and the payee. A lengthy discussion of discounting customers’
promissory note is also included in this unit.
In this unit This unit contains the following topics:
Topics See Page
Promissory Note 2 of F
Typical Transactions 4 of F
Interest on Notes 5 of F
Discounting a Note Receivable 6 of F
Endorsement or Discounting with Recourse 7 of F
Notes Receivable Discounted in the Balance
Sheet
12 of F
Discounting Own Note Issued 13 of F
Review Questions 14 of F
Exercises 15 of F
Marivic D. Valenzuela-Manalo Page 2of F
Promissory Note
Overview A promissory note is an unconditional promise to pay a definite sum of
money on demand or at a future date (Needles, Belverd, et al, 1999). This
written promise made by a maker promising to pay a payee a sum certain in
money at a fixed or determinable future time may or may not include interest.
Illustration The payee regards all promissory notes it holds that are due in less than a year
as Notes Receivable in the current assets section of the balance sheet. The
maker regards them as Notes Payable in the current liabilities section of the
balance sheet (Needles, Belverd, et al, 1999). The following is an example of
a simple promissory note.
Quezon City, Philippines
P10,000.00
July 1, 20X1
PROMISSORY NOTE
FOR VALUE RECEIVED, I promise to pay Joseph Labrador the amount
of Ten Thousand Pesos (P10,000.00) on August 30, 20X1 plus interest at the
annual rate of 12 percent.
(Signed) Mary de Jesus
Continued on next page
Marivic D. Valenzuela-Manalo Page 3of F
Promissory Note, Continued
Components The components of a promissory note are as follows:
� Maker. The person or business that signs the note and promises to
pay the amount required by the agreement. The maker is the debtor.
In the illustration – Mary de Jesus.
� Payee. The person or business to whom the maker promises future
payment. The payee is the creditor. In the illustration – Joseph
Labrador.
� Principal amount or principal. The amount loaned out by the payee
and borrowed by the maker of the note. In the illustration –
P10,000.00.
� Interest. The revenue to the payee for loaning out principal and the
expense to the maker for borrowing the principal.
� Interest period or term of the note. The period of time during which
interest is to be computed. It extends from the date of the note to
maturity date.
� Interest rate. The percentage rate that is multiplied to the principal
amount and the term of the note in computing for the interest.
� Maturity date or due date. The date on which final payment of the
note is due.
� Maturity value. The sum of principal and interest due at the maturity
date of note.
� Place of issue. The locality where the maker executed the note. In the
illustration – Quezon City.
Marivic D. Valenzuela-Manalo Page 4of F
Typical Transactions
Overview A promissory note may arise from any of the following transactions:
1. A client receives services on goods for which he issues a promissory note
in favor of the company. The client is a debtor and is the maker of the
note. The company to whom the note was issued is a creditor and is the
payee of the note.
2. The client has an outstanding account with the company, which will
become due. If the client is not in a position to pay, he could offer a
promissory note to extend time for the payment of his account.
3. A loan is extended to a borrower who issues a promissory note. The
borrower is a maker-debtor and the lender is a payee-creditor.
Illustration
No.1 Note arising from services rendered or goods sold. When a company renders
services or sells merchandise to a customer and receives a promissory note in
consideration for such goods or services, the transaction is recorded as:
Notes Receivable
Service Income or Sales
Received note for services rendered or goods sold.
xxx
xxx
Illustration
No. 2 Note arising to extend an account. If the sample promissory note illustrated is
given to extend payment of an account, the transaction will be recorded as:
Notes Receivable
Account Receivable
Received note to extend payment of an account.
xxx
xxx
Illustration
No. 3 Note arising from a loan transaction. If the note was received in consideration
of a loan, the transaction will be recorded as:
Notes Receivable
Cash
Received note for a loan granted.
xxx
xxx
Marivic D. Valenzuela-Manalo Page 5of F
Interest on Notes
Overview A promissory note may either be a non-interest or an interest-bearing note. A
non-interest bearing note is a promissory note, which does not provide any
payment for interest so that the amount to be paid at maturity is equal to the
face value of the note. An interest-bearing note, on the other hand, is a note
which provides for payment of the interest so that the amount to be paid at
maturity is equal to the maturity value, i.e., sum of the principal and interest
Illustration The sample promissory note illustrated above issued by Mary de Jesus in
favor of Joseph Labrador for P10,000 is an interest-bearing note. The note
will become due on August 30, 20X1. On this date Labrador will receive full
payment on the note.
Interest is computed using the formula: Principal x Rate x Time.
Therefore:
Interest (P10,000 x 12% x 60/360) P 200
Principal 10,000
Maturity Value P 10,200
=======
The entry to record collection of the note at maturity is:
Cash
Notes Receivable
Interest Income
Collected note on the date of maturity
10,200
10,000
200
Marivic D. Valenzuela-Manalo Page 6of F
Discounting a Note Receivable
Overview A promissory note is a negotiable instrument. This means that a note is readily
transferable from one business or person to another and may be sold for cash.
To obtain quick cash, payees sometimes sell or endorse a note received from
another party before it matures. The payee normally endorses the note to a
bank, which in turn collects the maturity value from the maker at maturity
date.
Note
Receivable
Discounting
Endorsing a note receivable before maturity is called discounting a note
receivable because the payee of the note receives less than its maturity value.
This lower amount decreases the amount of interest income the payee earns
on the note. Giving up some of this interest is the price the payee is willing to
pay for the convenience of receiving cash early.
Endorsement When a note is discounted at the bank before maturity, the bank advances the
money equal to its value on the date of discounting computed on the bank rate
of discount. The endorsement to the bank may either be
• with recourse or
• without recourse.
Marivic D. Valenzuela-Manalo Page 7of F
Endorsement or Discounting with Recourse
Overview The holder of the note (usually the payee) endorses the note and delivers it to
the bank. The bank in turn pays the amount equal to the net cash proceeds
(i.e., maturity value less the discount charged by the bank) to the endorser
(usually the payee of the note). The bank expects to collect the maturity value
of the note on the maturity date but also has recourse against the endorser or
seller of the note. If the maker fails to pay on maturity date, the endorser is
liable to the bank for payment (Needles, Belverd, et al, 1999). The endorser
has a contingent liability in the amount equal to the maturity value of the note
plus any protest fee that may be charged by the bank for the dishonoring of
the note by the maker.
Illustration Endorsement or discounting with recourse, therefore, has the effect of
guaranteeing the payment of the note at maturity by the maker. If the maker
does not pay, the endorser is liable to pay the bank. To illustrate,
Joseph de Jesus, the maker, gives a 60-day, 12%, P10,000 note to Maria de la
Cruz, the payee, on July 1, 20X1. On July 27, 20X1, de la Cruz endorses the
note to Cocobank for discounting. On Aug. 30, 20X1, the maker de Jesus,
should pay the bank. If he fails to do so, Cocobank can collect from the
endorser, de la Cruz.
The endorser, i.e., Maria de la Cruz, discounting the note with recourse, by
such endorsement, incurs a liability depending upon a contingent event. This
event is the failure of the maker, i.e., Joseph de Jesus, to pay the note at
maturity. Not until after this event may the endorser be held liable for
payment by the bank. This is known in accounting as a contingent liability.
Continued on next page
Marivic D. Valenzuela-Manalo Page 8of F
Endorsement or Discounting with Recourse, Continued
Without
Recourse Endorsement or discounting without recourse is done by writing the words
without recourse in the endorsement. Example of such endorsement is:
The effect of an endorsement without recourse is to exempt the endorser from
any liability, if the maker does not pay at maturity with certain exceptions.
Generally, therefore, the endorser in this case does not incur any liability, even
if only a contingent one. This type of discounting (without recourse) has the
effect of collecting the note from a party (the bank), which assumes the role of
the creditor. As such the credit entry is to Notes Receivable (Pasion, D.,
Pasion, W., Pasion, E., 1990).
Illustration of
discounting
with recourse
The following discussions will pertain only to discounting of notes with recourse.
There are three dates encountered in the computation of the amount to be received
from the bank for a note receivable discounted.
To Illustrate, assume the following transactions:
July 1, 20X1 - For merchandise sold, Mary de la Cruz received from Joseph de
Jesus a P10,000 note, dated today, due in 60 days at 12%.
July 27, 20X1 - Mary de la Cruz discounted the note of Joseph de Jesus at BPI. Bank
discount rate is 14%.
The above may be diagrammed as follows:
60 days
Date of 26 days Date of 34 days Date of
note ____________________Discounting ______________ Maturity
July 1 July 27 Aug. 30 The diagram illustrates that the entire term of the note is for 60 days. The start
of the line diagram, i.e., July 1 represents the date Joseph issued the note (i.e.,
to Mary). There are 26 days considered the note was expired From July 1 to
July 27, which is the date the note was discounted. The term of the note of 60
days less the expired days of 26 is equal to 34 days, which in turn represent the
discount period (i.e., the period from the date the note was discounted up to
maturity date).
Continued on next page
Without recourse
Marivic D. Valenzuela-Manalo Page 9of F
Endorsement or Discounting with Recourse, Continued
Computing for
the Net
Proceeds
Steps in computing for the net proceeds, i.e., the amount to be paid by the
bank to the endorser of the note.
I. Determine the maturity value.
Principal 10,000
Add: Interest (10,000 x 12% x 60/360) 200
Maturity Value 10,200
=====
II. Count the number of days from the date of discounting to the date of
maturity. This is the discount period.
Discount period = July 27 to August 30
July (31-27) exclude 27 = 4
August = 30
Discount period = 34 days
=======
III. Compute the discount. In computing for the discount, the bank
normally gives a higher discount rate but if no rate was given, use the
interest rate of the note.
Discount = Maturity Value x Discount Rate x Discount Period
10,200 x 14% x 34/360 = 134.87
IV. Compute for the net cash proceeds
Net Proceeds = Maturity Value - Discount
Maturity Value 10,200.00
Less: Discount 134.87
Net Proceeds 10,065.13
=======
- The amount to be paid by
BPI to de la Cruz on July 27.
Continued on next page
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Endorsement or Discounting with Recourse, Continued
Journal Entries The following are the journal entries:
Date Joseph de Jesus’ Book Mary de la Cruz’s Book
July 1 Purchases 10,000 Notes Receivable 10,000
Notes Payable 10,000 Sales 10,000
Purchased Merchandise Sold - Merchandise
Discounted Joseph's note at 14%.
I
27 Cash 10,065.13
Interest Expense 134.87
Interest Income 200
Notes Receivable Discounted 10,000
Discounted note at 14% to BPI.
Assuming Joseph paid the note at maturity.
II
Aug. 30 Notes Payable 10,000 Notes Receivable Discounted 10,000
Interest Expense 200 Discounted
Cash 10,200 Notes Receivable 10,000
Paid Note at maturity To close contingent liability
Sept. 1 Assuming Joseph failed to honor the note at maturity and BPI charged a protest fee of P500.
III
*** Notes Payable 10,000 Accounts Receivable 10,700
Interest Expense 700 Cash 10,700
Accounts Payable 10,700 Paid dishonored note with protest fee.
Dishonored note at maturity.
Notes Receivable Discounted 10,000
Notes Receivable 10,000
To close contingent liability
*** In theory, this entry must be effected, but actual experience shows
that a maker does not ordinarily prepare this entry but instead prepares
an entry only when the note is finally paid.
Continued on next page
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Endorsement or Discounting with Recourse, Continued
Discussion The following are the explanations for the different parts of the discounting
process:
I - As per computations, the net proceeds of the note is P10,065.13.
The interest for 26 days (July 1 to July 27) amounting to P86.67 is
considered earned by de la Cruz. As a contingent liability is
incurred, Mary de Jesus should credit a contingent liability account,
Notes Receivable Discounted. It would not be proper to credit
Notes Receivable, as this procedure would not show the contingent
liability in the accounts.
II - The payment made by Joseph to the bank has two effects: (1) it
discharges Mary from the guarantee Joseph has made to the bank and
(b) Mary has no more claim from Joseph. These two effects are
shown in the entry above.
III - Non-payment by Joseph to the bank has two effects: (1) it makes
Mary a guarantor/endorser liable to the bank and thus, making her
pay the maturity value of the note plus any protest fee that may be
charged by the bank. (2) Payment by Mary to the bank does not
release Joseph from his liability. Although the note is no longer
binding, he is still liable to Mary to an amount equal to maturity
value plus protest fee.
Marivic D. Valenzuela-Manalo Page 12of F
Notes Receivable Discounted in the Balance Sheet
Overview We have learned that in a discounting with recourse, we are creating a new
account title called “Notes Receivable Discounted” to indicate the presence of
a contingent liability in the books of the endorser. How do we present this in
the balance sheet would be the focus of the following discussions.
Four Methods There are four methods of presenting the contingent liability on notes
discounted in the balance sheet. They are the following:
1. As a contingent liability on the liability side
BALANCE SHEET
Current Assets: Current Liabilities:
Notes Receivable P50,000 Long Term Liabilities:
Plant, Property & Equipment: Contingent Liabilities:
Notes Receivable Discounted P10,000
2. As a deduction form Notes Receivable on the asset side:
BALANCE SHEET
Current Assets:
Notes Receivable P50,000
Less: Notes Receivable Discounted 10,000 P40,000
3. As a footnote to the Balance Sheet with the Notes Receivable being shown as net.
BALANCE SHEET
Current Assets:
Notes Receivable P40,000
FOOTNOTE: There is a P10,000 note discounted at BPI.
4. As a parenthetical note in the Balance Sheet
BALANCE SHEET
Current Assets:
Notes Receivable (Discounted, P10,000) P40,000
Marivic D. Valenzuela-Manalo Page 13of F
Discounting Own Note Issued
Overview It will be noted in the illustrations on Joseph de Jesus’ book that interest is not
recorded at the time the note is issued. Payment of interest is usually made on
maturity date of the note.
There is another method of issuing promissory note where the creditor would
collect the interest on the note being issued by the maker on the same day the
loan was granted. This scheme in paying interest in advance for the note
issued is called discounting one’s own note. In this case, there are two
alternative methods of recording such transactions, either the expense, Interest
Expense account or the asset, Prepaid Interest account may be debited. Notes
Payable account is credited at face value of the note and Cash account is
debited for the net amount, i.e., face value of the note minus the interest.
Illustration On July 1, for money borrowed, Joseph de Jesus discounted its own 30-day,
12% P10,000 note with Mary de la Cruz.
The following will be the possible entries to record the July 1 transaction:
de Jesus’ Book
July 1 Cash 9,900
Interest Expense 100
Notes Payable 10,000
Discounted own note.
or
Cash 9,900
Prepaid Interest 100
Notes Payable 10,000
Discounted own note.
When the maker pays the discounted note on the date of maturity, he will
pay only an amount equal to the face value of the note issued. Since the
payee deducted already from the amount loaned to the maker the interest
that the former will be earning from the note on maturity date, the maker
will no longer pay the interest. Thus, if de Jesus pays the note on July
31, he would be paying only P10,000, the principal amount of the note.
de Jesus’ Book
July 31 Notes Payable 10,000
Cash 10,000
Settled discounted note.