ACTBAS 1 Lecture 7 Notes

ACCOUNTING CYCLE OF A SERVICE BUSINESS

Part I: Journalizing, Posting and Trial Balance
Overview
The analysis of business transactions using the accounting equation is useful in determining the effects
of transactions on the elements of the financial statements. This approach, however, is not practical
when there is a high volume of transactions. The accounting for business transactions and preparation
of financial statements can only be accomplished in an efficient and timely manner through a process
called the accounting cycle.
STEPS IN THE ACCOUNTING CYCLE
The steps in the accounting cycle are:
1. Analyzing business transactions through source documents.
2. Journalizing, or the recording of transactions in a journal.
3. Posting or transferring of the entries from the journal to the ledger.
4. Balancing the accounts and preparing the trial balance.
5. Preparing a worksheet
6. Journalizing and posting adjusting entries
7. Preparing the financial statements based on adjusted account balances.
8. Recording and posting of closing entries.
9. Balancing the accounting and preparing a post-closing trial balance.
10. Journalizing and posting reversing entries.
The Double-Entry System
This system of recording business transactions is based on the dual aspect concept which means
that for every change in financial set up (transaction), there would always be a two-sided effect to the
extent of the same amount in the accounting books. The first is the assets of the business and the
second is the claims against the assets. From this, the basic accounting equation, "Assets =
Liabilities + Capital" was derived.
Debit (Lat. Debitum, a "debtor" or "borrower") is the value received in a business. The place of debit
in the equation is on the left-hand side. The word "charge" in accounting would also mean debit.
Credit (Lat. creditum, a "creditor" or "lender") is the corresponding value parted with of the debit. The
piece of credit in the equation is on the right-hand side.
The double-entry is the basis of modern accounting theory. It is known as the most acceptable
accounting system in recording accountable transactions and events due to the following reasons:
1. It results in more accurate accounting records and financial reports.
2. It allows a more convenient means of recording business transactions and events.
3. It also provides numerous ways to safeguard and check intentional and unintentional errors
committed by accountants.

BOOKS OF ACCOUNTS
The Journal
The journal is the book where transactions are initially recorded in a systematic and chronological order
(hence, journals are called the books of original entry). For each transaction, a journal shows the debit
and the credit effects of transactions on specific accounts.
The most basic form of a journal is the general journal. The journal may be part of either a manual
accounting system or a computerized accounting system.

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Procedures for recording journal entries
The following procedures are used when recording journal entries in a two-column general journal,
assuming a manual accounting system is in place:
1. Analyze the business transaction. The entry to be made should reflect a transaction's economic
substance rather than its legal form. Proper analysis of a transaction can only be done by
reviewing the source documents that support the transaction.
2. Write the date of the entry in the Date column. The date can be readily determined based on the
date per source document.
Write the year in small figures at the top of the column. The month is written below the
year, on the first line.
Write the day of the month on the first line in the second column immediately after the
name of the month.
The date is written only once for each entry. The month need not be repeated for other
entries within the same month.
3. Record the debit part of the entry.
Write the account title at the extreme left edge of the Account Title Column. Write the
amount of the account in the Debit column.
4. Record the credit part of the entry.
Indent each account title one-half inch from the left edge of the Account Title column.
Write the amount of the credit item in the Credit column.
5. Provide a brief description of the transaction to explain the journal entry made.
Indent each line of the description about one inch from the left edge of the Account
Title column.
Posting Reference (PR)
The information contained in the journal entries made during a period are transferred (posted) to the
ledger. To control the posting of entries from journal to ledger, a posting reference (PR) is used. The
use of the PR column allows an accountant to cross-reference between the journal and the ledger.
Other things to remember when recording entries
1. The accountant should have a clear understanding of what the transaction is all about in order to
permit the selection of the appropriate accounts to debit and to credit.
2. If there is only one account debited and one account credited, the entry is known as a simple
journal entry. Where more than one account is involved in a single entry, it is known as a
compound journal entry.
3. Using peso signs in columnar books of accounts is not required - unless otherwise stated, the
amounts are assumed to be in Philippine peso.
4. Sometimes, the account makes an entry in narrative format - there are no accounts debited or
credited. An entry which has no debit or credit, which shows only the date and a brief
explanation or reminder, is known as a memorandum entry.
5. If an error is made in writing any part of the entry, the entry is corrected by drawing a line through
the incorrect part and writing the correction immediately above it.
The Normal Balance of Accounts
The accounting equation is divided into two sides (left and right) which are accounted for to always
maintain a balanced amount.
In other words, if a SFP is constructed immediately after each transaction, it should always be that the
total assets must be equal to the totals of the aggegate liabilities and owner's equity.

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Normal Balance of Statement of Financial Position Accounts
DEBIT

CREDIT

Assets

Liabilities and Capital

Debit means the value received.

Assets are initially recorded on the
debit side of the equation. To debit
an asset is to increase an asset. To
credit an asset is to decrease it.

Credit means the value parted with.

Liabilities and capital are initially recorded on
the credit side. To credit a liability and/or
capital is to increase them. To debit liability
and/or capital is to decrease them.

Normal Balance of Income Statement Accounts

DEBIT

CREDIT

Expenses

Revenue

Expenses are initially recorded on the

dxebit side. To debit an expense means
to increase an expense. To credit an
expense is to decrease it.

Revenues are initially recorded on the credit

side. To credit revenue means to increase an
income. To debit revenue means to decrease
it.

The "two sides " of accounting equation is an application of the dual aspect concept which provides
that every value received must have a corresponding value parted with. This concept is the basis of
the debit and credit in recording economic transactions and event.
The two equal sides define the foundation of the rules of debti and credit.
The Rules of Debit and Credit
The rules of debit and credit are based on the normal balance of an accounting element or account. The
term "normal balance of account" refers to the usual position of an account in the T-account.
Asset accounts are normally in the debit side while the liability and owner's capital accounts are
normally in the credit side.
The normal balance of an account provides the basis in analyzing when to debit and credit an account.
The following rules must be observed when to debit or credit an asset, liability and capital accounts.

Rule 1 - Assets:

Debit to increase the amount of asset.

Credit to decrease its amount.
Asset Account

Rule 2 - Liability:

Debit

Credit

Increases

Decreases

Credit to increase the amount of liability.

Debit to decrease its amount.

Liability Account
Debit

Credit

Decreases

Increases
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Rule 3 - Owner's Equity:

Credit to increase the capital account.

Debit to decrease its amount.
Owner's Equity Account
Debit
Decreases

Rule 4 - Revenue:

Credit
Increases

Credit to increase the revenue account.

Debit to decrease its amount.
Revenue Account

Rule 5 - Expenses:

Debit

Credit

Decreases

Increases

Debit to increase the expense account.

Credit to decrease its amount.
Expense Account
Debit

Credit

Increases

Decreases

Summary of Debit and Credit Analysis

The T-account, when used as a tool to analyze the effect of business transaction, maintains the
equation, DEBITS = CREDITS.
Reflecting the rules of debit and credit in the T-account could be summarized as follows:

Accounting Elements
Debit

Credit

Increases in:
Assets
Expenses
Losses

Decreases in:
Assets
Expenses
Losses

Decreases in:
Liabilities
Capital
Revenue
Profit

Increases in:
Liabilities
Captail
Revenue
Profit

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The Account and Book of Accounts
An Account is an accounting form of record in which the effect of similar business transactions are
grouped or classified. This is an accounting device to record the increase and decreases of a specific
asset, liability, owner's equity, revenue or expense.
An account could be in the form of a column on a spreadsheet, a separate card or piece of paper, or a
specified location in a computer memory.
The "Journals" and the "Ledgers" are the books of accounts that are commonly used in recording
economic transactions and events.
The journal, which is also called the "book of original entry," is an accounting book that is used to
initially record business transactions and events. The ledger, on the other hand, is an accounting book
in which the accounts and their related amounts as recorded in the journal are posted and summarized
periodically. This accounting book is known as the "book of final entry" because the balances of
accounts contained in it are used to prepare the financial reports.
The T-Account
An account may be expressed in a "T" device form where the debits are recorded on the left-hand side
and the credits are recorded on the right-hand side of the letter T. As implied in its form, this device
is called a "T-account."
To debit is to record the value received in an economic transaction. To credit is to record the value
parted with in an economic transaction.
For every transaction, the value of debit is always equal to the value of credit.
Basically. a T-account has three parts, the account title (name), the debit side, and the credit side.
An account title describes the specific item of account involved in a transaction.
The debit is found on the left-hand side of the T-account. It contains the amounts involved in
accounting transactions and their respective dates arranged in a chronological order.
Debit represents increases in assets and expenses, and decreases in liability, capital and revenue.
The credit is found on the right-hand side of the T-account. It contains the amounts involved in
accounting transactions and their respective dates arranged in a chronological order.
Credit represents decreases in assets and expesnes, and increases in liability, capital and revenue.
The difference between the total debits and credits in the accounts is called the account balance. If
the total debit exceeds the total credits, the account has a debit balance. If the total credits exceed the
total debits, the account has a credit balance.
The Chart of Accounts
A chart of account is a list of all the accounts of the business and their respective account numbers.
Using a chart of accounts would reduce confusion as to the choice of account titles and permits
uniformity in recording routine transactions. The accounts are arranged in the following order:
Assets, Liabilities, Equity, Income and Expenses. Ordinarily, the chart of accounts is prepared by the
accountant who set up the accounting system of the business.
Procedures for posting journal entries

The process of transferring the entries from the journal to the accounts in a ledger is called posting.
Normally, posting is done at the end of the month, when all journal entries for the month have been
recorded. The following steps are observed during posting.
1. Using the account number (as provided for in the chart of accounts) locate the account title in
the ledger.

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2. Write the date of the journal entry in the date column of the ledger.
3. Write in the reference column (posting reference or PR) the page of the journal where the journal
entry came from.
4. Write the debit amount in the Debit column or the credit amount in the Credit column.
Trial Balance
After all transactions for the period have been posted to the ledger accounts, the balance for each
account is determined. Every account will either have a debit balance, a credit balance, or a zero
balance. A trial balance is a list of all accounts and their balances. It indicates whether total debits
equal total credits. This only proves however, that all entries recorded have equal debits and credits;
it does not guarantee that all transactions have been recorded.
The trial balance is a summary of accounts with open balances (accounts with a debit balance or a
credit balance). An account is said to be an open account if it has a balance, either on the debit or
credit side. An account is a closed account if the debits equal the credits. The trial balance is
commonly taken every month-end (after posting procedures) to check the equality of debits and credits.
Procedures for preparing a trial balance
1. On a separate sheet of paper, indicate the heading. The heading is composed of three items
namely, the name of the company, the title of the report and the date.
2. Review the general ledger and note all open accounts.
3. Immediately below the heading, transfer the account numbers, account titles and account balances
of all accounts with open balances. List down the accounts in the following order: Assets,
Liabilities, Equity, Income and Expenses.
4. Determine the total debits and the total credits. Both totals should be equal.
When the trial balance . is NOT balanced
If total debits and credits do not balance, it signifies that there was an error committed along the
process, which may be any of the following:
a.
b.
c.
d.
e.

Error in footing the debit and credit columns

Error in transferring from the ledger to the trial balance
Errors in posting, say posting a debit entry to the credit side of an account
Error in journalizing, for example, if the debit side is not equal to the credit side of an entry
Error of omission, when the debit is posted but the credit is not posted

The "working back method" proves effective in locating the error. This means that you start re-checking
the correctness of the accounting procedures you performed in reverse chronological order, i.e., start
with the trial balance and work backwards towards the entries in the general journal.
1. Recheck the footing of the debit columns and credit columns of the trial balance.
If the footings are correct and totals are not equal, determine the difference between debit and
credit columns. A possible reason for the difference would be erroneously listing a debit balance
account as part of the credit column, or vice versa. An error of this type would cause a difference

between debits and credits which is twice the amount of the account involved.
2. If the error is still unlocated, check if the difference between debit and credit columns is divisible by 9.
If it is divisible by 9, this suggests either a transplacement error or a transposition error.

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3. Where the error is still unlocated, perform the following:

a. Compare the amounts and accounts in the trial balance with those in the ledger and correct any
discrepancies or omissions.
b. Recheck the footing of the accounts in the general ledger.
c. Trace the postings from the journal to the ledger. Be alert for possible omissions (i.e.
transaction's debit side is posted but the credit side is not).
d. Recheck the entries made in the journal and ensure that total debit amounts are equal to total
credit amounts.
The Ledgers
Ledger refers to the accounting book in which the accounts and their related amounts as recorded in
the journal are posted periodically. This book is known as the "book of the final entry" because the
balance of accounts in the ledger is used to prepare financial statements.
The basic form of a ledger account is the T-account. Hence, it is sometimes called the "modified T
account". There are two kinds of ledgers: general ledger and subsidiary ledgers.
A general ledger is a grouping of all accounts used in preparing the financial statements. It is generally
called a controlling account because it reports in summarized form the activities that have taken place
as recorded in its subsidiary ledger.
The parts of the formal general ledger are as follows:
The General Ledger
(Two-column Ledger)
1. Name of the account (Cash, Accounts Receivable, etc.)
2. Item describes the nature of transaction in which the account is involved.
3. An account number which is assigned to each account title is used to facilitate recording
and cross-referencing.
4. Date identifies when the transaction happened.
5. PR identifies the page number of general journal from which the information was taken
6. The transaction columns are used for recording the amount of transaction from the general journal.
Peso sign and decimal point are ignored.

The parts of a subsidiary ledger are as follows:

The Subsidiary Ledger
1.
2.
3.
4.
5.
6.
7.

Name and address of the customer.

The description column describes the nature of transaction.
A customer's number is used as a reference in keeping customer's record.
The date should be the same on the general journal and the general ledger.
The () in the post-reference column (PR) indicates that the posting has been effected and checked.
The transaction columns reflect the debits and credits of the speciifc customer's account.
The totals of the running balances comprise the total amount in the general ledger.

Posting to the Ledger

After the transactions are recorded initially in the journal books, they are transferred to the general ledger,
a process referred to by the accountants as "posting."
While the journal records the transactions in their chronological order, the ledger organizes the
information by account.

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Using the general journal for the purpose of knowing the balance of an account could be very
inconvenient because accounts are not recorded as a group in the journal. Gathering information about
a particular account, one would need to scan all the pages of the journal. Accordingly, the ledger
ccomplements the journal by providing the running balance of an account.
Examples of the different forms of a ledger are as follows:
1. The two-money column ledger is a conventional form of a ledger as shown below:

GENERAL LEDGER
Account No: ________
Account Name/Title
Date

Item

PR

Dr.

Date

Item

PR

Cr

Observe that the ledger is hust an expanded T-account with the addition of date, item and post
reference (PR) columns.
2. The three-money column ledger is a balance column ledger account as shown below:

GENERAL LEDGER
Account No: ________
Account:
Date

Item

PR

Transaction
Debit
Credit

Balance

3. The four-money column ledger is also a balance-column ledger account which is as follows:
GENERAL LEDGER
ACCOUNT:

Date

Account No:

Item

PR

Transaction
Debit
Credit

Balance
Debit
Credit

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Steps in Posting from the Journal to the Ledger

To effect the posting of economic transactions from the general journal to the general ledger, the
following procedures are generally observed:
In the Ledger:
1. Locate the corresponding account in the ledger.
2. Transfer the following information from the journal to the respective account ledger:
Date
Explanation
Debit or credit amount
3. Place the page of the journal where the information transferred is located in the post-reference
column of the ledger account.
In the Journal:
4. Place in the post-reference column of the journal the number of the account as indicated in the
ledger.
Posting to the ledger is usually made periodically. The transactions recorded in the general journal
are posted to the general ledger at the end of each day, week or month depending on the needs of
the business for an updated account balances.
The Trial Balance
A Trial Balance is a device used to periodically test the equality of debits and credits as recorded in the
ledger accounts. This device is a presumptive proof of recording correctly the account's debits and
credits. The transfer of the ledger accounts' open balances to another accounting form in order to
check the accuracy of the debit and credit totals is the basic procedure in the making of the trial balance.
A trial balance is useful to an accountant whenever periodic financial statements are to be prepared.
Although it is possible for the accountant to prepare such financial statements by working directly from
the ledger, it is much easier to use the account balances shown in the trial balance.
Footing the General Ledger Accounts (Manual Accounting)
Before a trial balance is made, each general ledger account with more than one entry on either or both
sides is footed. This means that the amounts on each side of the account are totaled.
The debit totals and credit totals are written neatly in small pencil figures just below the last entry on the
"accounts' debit or credit side. This is done in such a way that the footing can be readily distinguished
and will not interfere with the subsequent regular entries in the account. A wrong footing may be
erased and corrected.

Footing is usually made if the ledger is a two-column ledger. However, if the ledger were a three-column
or a four-column ledger, footing would not be necessary because the ledger accounts have their
respective running balances already.
Open and Closed Accounts
When the debit total and the credit total of an account are equal, the account is said to be a closed
account. This means that the account title shall not be transferred anymore to the trial balance because
the account has a zero-balance.
On the other hand, when the debit total and the credit total of an account are not equal, the account is
called an open account because it has a remaining ending balance. In this case, the account title
shall be transferred to the trial balance with its corresponding account balance.

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The difference between the debit and credit total of an open account is called the account balance. If
the debit total is greater than the credit total, the account has a debit balance. If the credit total is
greater than the debit total, the account has a credit balance.
Steps in Preparing the Trial Balance (Manual Accounting)
The following steps are recommended in preparing a trial balance:
1. On a two-column journal paper, write the heading at the top. The heading shows the name of the
business on the first line, trial balance on the second line, and the date or month and year for which
the trial balance is being prepared on the third line. Each line of the heading is preferably centered
on the page.
2. Determine all open accounts in the ledger. Closed accounts should be excluded from a trial balance
of balances. Write the title of each open account in the description column of the trial balance. If it
has a debit balance, write the balance in the debit amount column of the trial balance; otherwise,
write it in the credit amount column.
3. All debit and credit account titles in the trial balance are written with the same margin from the left
side of the page; that is, credit account titles should not be indented.
4. Add each amount column and write the totals in small pencil figures in the uppermost portion of the
space below the single ruling. If the two totals are equal, write them in ink on the line.
5. Draw double lines under the totals of the debit and credit columns. Do not write the totals in ink and
do not draw the double lines until the debit total equals the credit total.
Trial Balance with Equal Sides
When the debit and credit totals of the trial balance are equal, the trial balance is said to be in balance
or equal. However, this only proves that the debits and credits in the ledger are equal in amount but
it does not guarantee the correctness of the bookkeeping records.
There are some errors, like errors of principles and errors of omission, which do not affect the equality
of the trial balance. Thus an error committed by debiting and crediting the wrong account in either the
journal or ledger will not be detected in the trial balance.
If a journal entry for a transaction had been entirely omitted or a whole journal entry had not been posted
to the ledger, the trial balance would also balance but would not be completely correct.
Hence, the trial balance is more of a check on the mathematical correctness of the bookkeeping records
rather than an absolute guarantee that all the generally accepted accounting principles and procedures
had been followed correctly.

Trial Balance Out-of-Balance

If the trial balance totals are not equal, the trial balance is said to be out-of-balance. This is a positive
proof of the existence of one or more errors. The main causes of the errors are the following:
1.
2.
3.
4.
5.

Posting of an item to the wrong side of the account;

Erroneous copying when transferring a balance from the ledger accounts to the trial balance;
Omission of the posting of either a debit or credit entry in the journal;
Posting the same account twice; and/or
Wrong addition or subtraction in determining the balance of an account.

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Hints for Locating Errors

The following guides may help in the expedient location of causes of out of balance trial balance:
1. A difference of P.01, P.10, P1.00, P10, P100, etc. suggests that an error has been made in addition
or subtraction.
2. A difference of P9 or multiple of 9 indicates transposition, meaning the order of figures is reversed.
Example: P25 is written as P52 or P23 is written as P32.
3. A difference divisible by 2 indicates an error in posting to the wrong column of the trial balance, as
when a credit balance of an account is transferred to the debit column of the trial balance.
4. A difference divisible by 9 or 99 indicates a slide or misplacement of decimal point. Example: P100
is written as P10, or P55 is written as P5.50

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