The Basic Accounting Environment recording and summarizing business

and financial transactions and

WHAT IS ACCOUNTING?
analyzing, verifying, and reporting the
• According to American Accounting results; also : the principles and
Association [AAA]-1941, "Accounting procedures of this system"
refers to the process of identifying,
• Accounting is a discipline, well-
measuring and communicating
equipped with techniques and methods
economic information to permit
through which all types of transactions
informed judgements and decisions by
measurable in terms of money or
users of the information."
money's worth can be recorded,
• According to Weygandt, Kieso and classified and summarized in a proper
Kimmel, "Accounting is and information and systematic way.
system that identifies, records and ACCOUNTING AND BUSINESS
communicates the economic events of
and organization to interested users." • Accounting is considered to be a
"language of business"
• According to A.W.Johnson, "Accounting
may be defined as the collection • Accounting is a bridge between the
compilation and systematic recording of company and the statement users.
business transactions in terms of
• It speaks in a language that users must
money, the preparation of financial
understand.
reports, the analysis and interpretation
of these reports and the use of these
reports for the information and
guidance of management."

• According to Financial Accounting

Standard Board [FASB], "Accounting is
the process used to measure and report
to various users relevant financial
information regarding the economic
activities of an organization or unit."

• According to American Institute of

Certified Public Accountants[AICPA]-
1966, "Accounting is the art of
recording, classifying and summarizing USERS OF FINANCIAL INFORMATION
in a significant manner and in-terms of • They were also called as "Stakeholders"
money transactions and events which
are in part atleast of a financial • A stakeholder is a person or entity who
character and interpreting the results has a "stake" or interest in the business.
thereof."
• They can be classified as follows:
• According to Miriam-Webster
– Internal Stakeholders/Users -
Dictionary, "Accounting is the system of
from inside an organization
 – External Stakeholders/Users -
from outside an organization
• Direct Users
• Indirect Users
INTERNAL USERS
• Owners
• Managers
• Employees
EXTERNAL USERS
• Lender/Creditor
• Supplier
• Customer
• Goverment Agencies
• Other that have interest to the financial
information (i.e. stock exchange, trade
associations, regulatory bodies,
financial analysts, etc)
ACCOUNTING AS INFORMATION PROVIDER
TYPES OF ACCOUNTING AND THE REPORTS
PREPARED
• Internal reports are called managerial
reports are prepared for management
use for their decision making. -
Management Accounting
• The main source of information of
stakeholders or users are the financial
reports or the so called general
purpose financial statements. -
Financial Accounting
• All firms are required to pay taxes to
BIR. - Tax Accounting.
• Special Reports to be submitted to
certain regulatory bodies.
• Internal reports are called managerial
reports are prepared for management
use for their decision making. -
Management Accounting
• The main source of information of
stakeholders or users are the financial
reports or the so called general
purpose financial statements. -
Financial Accounting
• All firms are required to pay taxes to
BIR. - Tax Accounting.
• Special Reports to be submitted to
certain regulatory bodies.
CHANNELS OF ACCOUNTING INFORMATION
FLOW
FORMS OF BUSINESS
• Sole Proprietorship - is a business set up
and managed by one person.
• Parnership - is a business owned by two
or more persons.
• Corporation - a business organized as a
separate legal entity from the owners.
 FORMS OF BUSINESS
Characteristics SOLE PROPRIETORSHIP
Ownership owned by one person
Organization invested solely by the owner
Size most small companies are
sole-proprietor-owned.
Management managed by the owner
Sole Proprietorship
Advantages • Only a small amount of
capital is needed
• Its operation can be
managed easily
• The owner or proprietor
gets all the profit
• Ease in formation
Disadvantages • Difficult to expand
• No indefinite life
• Unlimited liability
PARTNERSHIP
owned by two or more
persons
invested by the partners
who contribute money,
property and talent into a
common fund for the
purpose of profit-sharing
small to medium sized
business. Professional firms
are also under this category.
most often the partners are
also the managers
Partnership
• Ease in managing the
business and in
attracting clients
• Management is more
efficient
• No indefinite life
• Unlimited liability
CORPORATION
organized as a separate
legal entity from the owners
an investor simply buys
shares of stocks in a
corporation and become a
shareholder.
medium to large sized
companies.
this has been managed by
the Board of Directors
elected by the shareholders
from among themselves.
Corporation
• More capital can be
raised
• Can afford to hire
experts
• Can exist for an
indefinite period of time
• More stable than
partnership
• Higher amounts of
profit can be obtained
• Shareholders has no
unlimited liability
• Subject to more legal
and tax requirements

TYPES OF BUSINESS OPERATIONS
• Service - which provides service for a
fee to clients or customers
• Merchandising - which buys and sells
goods or merchandise
• Manufacturing - which buys raw
materials, process these into finished
goods and then sells these to
customers.
FINANCIAL REPORTS
• Income Statement - shows how wealth
is produced by listing the revenues
earned and expenses incurred by the
business
• Statement of Equity - shows why net
worth changed by listing the activities
that caused it to increase or decrease.
• Statement of Cash Flow - shows what
happened to the cash by enumerating
the activities of cash received and cash
used by the business
• Statement of Financial Position - shows
how the wealth of the business stands
enumerating the assets, liabilities and
net worth of the business.
• THE DEMANDS OF A GLOBAL BUSINESS
WORLD
CURRENT CHANGES IN THE BUSINESS
ENVIRONMENT
1. Artificial Intelligence Drives Customer
Experience
• Abuse of power by the
Board of Directors could
certainly affect the
corporation
2. Communities Embrace Live Interactions
Over Social Media
3. Millennials Welcome Generation Z
– “Gen-Z” (those born after 1998)
– Gen Z is the first generation
born with devices in hand and
are radically different than
Millennials.
4. Wages and More On The Rise
5. Social Learning Outperforms Remote
Learning
– Social learning is the process of
learning through peer social
interaction
6. Live Streaming Video Content Gains
Momentum
7. Serve Your Community Not Just Buyers
8. Marketing Drives Results With A Focus
On Problems
9. Subject Matter Experts Open Doors
10. Blockchain Embraced By Big Players
HOW DO BUSINESS FIRMS ADDRESS THESE
CHALLENGES?
• World-Class Product and Service
– Creative and Innovative
• Mergers and Partnerships
– Emergence of Business
Outsourcing
 • Sustainability
– financial, social and economic
performance
– profit skill - financial
performance
– people skill - social performance
– planet skill - environmental
performance
QUALITIES NEEDED TO BE GLOBALLY
COMPETITIVE
• Effective Communication Skills
• Integrity
• Positive Attitude
• Competency
• Flexible and Adaptable
• Creative and Innovative
• Critical Mind
• Interpersonal Skills
• Intellectual Skills
– analytical thinker, problem
solver and decision-maker
THE ACCOUNTANT OF THE 21st CENTURY
• Accountants is not simply expected to
keep records and financial reports. Here
are the following roles that an
accountant should be also involved
with:
– Business Planner
– Economic Forecaster
– Financial Analyst
– Management Consultant
– System Analyst
• CPAs can also get additional
certifications such as Certified
Management Accountant (CMA),
Certified Financial Analyst, Certified
Internal Auditor (CIA) and the like.
CARRER OPPORTUNITIES IN ACCOUNTING
• Public Accounting - services offered to
the public such as bookkeeping,
auditing, accounting, tax and financial
planning.
• Industry Accounting - served to
different companies. They can be
employed as financial accountant,
controller, budget officer, internal
auditor, electronic data processing head
or cost accountant.
• Government and Not-for-profit
Accounting - where one works as an
accountant, auditor, budget officer and
the like to different government
agencies and not-for-profit
organizations.
• Research and Education - where the
accountant assumes the role of a
researcher, teacher or reviewer.
ACCOUNTING AREAS
• Basic Accounting or Bookkeeping
• Financial Accounting
• Cost Accounting
• Management Accounting
• Auditing
• Government and Not-for-profit
Accounting
• Tax Accounting
• Forensic Accounting
PROFESSIONAL REGULATORY BODIES
• Philippine Institute of Certified Public
Accountants (PICPA)
– established in 1929
ASEAN Mutual Recognition Arrangement
– accredited by BOA and the PRC
per PRC Accreditation No. 15
dated Oct. 2, 1975
– considered as the integrated
national professional
organization of CPAs.
– has a basic authority of setting
up and implementing rules vital
to the accounting profession.
– created Philippine Financial
Reporting Standards Council
(PFRSC) and Philippine
Interpretation Council last 2006
to formulate and promulgate
standards and make
interpretations to those
standards.
• National Association of Certified Public
Accountants in Education (NaCPAE)
• Association of Government Accountant
of the Philippines (AGAP)
INTERNATIONAL ACCOUNTING STANDARDS
• Association of Certified Public
Accountants in Commerce and Industry
(ACPACI)
• Association of Certified Public
Accountants in Public Practice (ACPAPP)
• Bangko Sentral ng Pilipinas (BSP)
– regulates the operation of all
banks and financing institutions
– tasked to promote and
maintain pero stability
• Bureau of Internal Revenue (BIR)
– exacts tax and license
compliance from people and
business entities earning
income.
• The ASEAN Mutual Recognition
Arrangement (MRA) for Accountancy
Services was signed last November
2014 by all ASEAN member states.
• This MRA is intended to provide
mobility of accountants in the ASEAN
where there will be minimal restrictions
imposed on accountants working in the
various countries in the region.
• Filipino CPAs will be able to take
advantage of the demand for
accountants in Singapore, Malaysia, and
the other ASEAN member states and
consider employment in these
countries.
• The Philippines has organized a
Monitoring Committee for the MRA
implementation which will soon be
releasing the guidelines on how to
become ASEAN Chartered Professional
Accountants (ACPAs).
• formulated by International Accounting
Standards Board (IASB) - formerly
known as International Accounting
Standards Committee (IASC).
• IASB is tasked to formulate new
standards for financial reporting and
measurement called International
Financial Reporting Standards (IFRS).
• IASB is working actively with different
national standard setting groups to
bring convergence to the national
accounting standards and the IFRS.
 • Started in 1996, the Philippines has
aligned its accounting standards to IAS,
IFRS and its Interpretations.
THE ACCOUNTANCY ACT OF 2004
• Also known as the Republic Act 9298
• The objectives of this law are:
a) Standardization and regulation
of accounting education
b) Examination for registration of
certified public accountants
c) Supervision, control and
regulation of the practice of
accountancy in the Philippines
THE ACCOUNTANCY LAW OF 2004
1. Defines the standard of practice and
service of accountancy
2. Mandates the creation of standard
setting bodies:
a) Financial Reporting Standards
Council (FRSC)
b) Auditing and Assurance
Standard Council (AASC)
3. Mandates the creation of Education
Technical Council
4. Requires taking of the licensure
examinations, registration and licensing
of certified public accountants.
a) to pass the CPA board exam,
the candidate must obtain a
general average of 75%, with no
grade in any subject below 65%.
5. A professional identification card shall
be issued to the registrant.
6. Enumerates prohibitions, vested rights
and limitations in the practice of
accountancy.
7. Requires certificate of accreditation for
individual certified public accountants
(CPAs), as well as firms and partnerships
of CPAs.
– Quality Review Council was
created to review the quality
control measures instituted by
the CPAs.
8. Promulgation by PRC of a continuing
professional education (CPE) for all
CPAs, as a pre-requisite for renewal of
license to practice.
– CPE Council was created which
will be responsible for
implementing this requirement.
CONCEPTUAL FRAMEWORK OF ACCOUNTING
• The Framework is a pervasive structure
which sets the boundaries of the
accounting practice with its basic rules,
objectives and assumptions.
• The framework provides formation of
accounting standards which prescribe
the nature of financial reporting.
• The framework serves as a guide to:
a) FRSC in developing future and
reviewing existing Financial
Reporting Standards
b) Preparers of financial
statements in applying Financial
Reporting Standards
c) Users of financial statement in
interpreting the information
contained herein
d) Auditors in forming an opinion
as to fairness in the
 presentation of the financial
statements.
• If a conflict should arise between the
Financial Reporting Standard and a
concept within the accounting
framework, the standard shall prevail.
• The framework deals with the
following:
1. Objective of financial
statements
2. Qualitative characteristics of
financial information
3. Definition, measurement and
recognition of the elements of
the financial statements
4. Concepts of capital and capital
maintenance
• Objectives of Financial Statements
1. It provides financial information
in answer to the common needs
of stakeholders
2. It reports accountability of
managers in handling the
business resources -
Stewardship Management
ANALYZING TRANSACTIONS TO START A
BUSINESS
ASSETS = LIABILITIES + EQUITY
• ASSETS
• economic resources owned by
the business.
• used in operating the business
and are expected to benefit the
business over a number of
years.
• as per Framework, asset defines
as a resource obtained and
controlled by the enterprise as
a result of a past event and
from which probable future
economic benefits are expected
to flow to the enterprise.
• Economic Benefit - ability of the
asset to produce future cash
flows for the business entity
whether directly or indirectly.
• LIABILITIES
• an obligation to pay.
• debts of the business owing to
outside parties.
• As per Framework, liability
defines as a present obligation
arising from a past event, the
settlement of which is expected
as a result in an outflow of
resources from an enterprise.
• usually paid in cash but may
also be paid in the form of
property or service.
• EQUITY
• also called Net Worth or Net
Assets
• claimable by the owner is called
owner's equity.
• As per Framework, Equity
defines as the residual right or
interest of the owner(s) in the
entity's net assets.
 • It is a device used to record the changes • Transaction is defined as an exchange
(increases or decreases) in the of values between two parties
accounting elements. expressed in monetary values.

ASSETS • It must always have dual effect - “for

every value received there is an equal
Cash
value parted”. - Double Enty
Accounts Receivable Bookkeeping or Venetian Model.

Notes Receivable • A transaction either increases or

decreases the assets, liabilities or
Merchandise owner's equity but the equation or
Supplies fundamental identity of three elements
should always be maintained.
Land
STATEMENT OF FINANCIAL POSITION (BALANCE
Furniture SHEET)
Equipment • It is a list of assets, liabilities, and
Building owner's equity of a business.

Machinery • This statement informs users of the

wealth and obligations accumulated by
LIABILITIES the business, and is used to determine
liquidity and solvency of the business.
Accounts Payable

Notes Payable • Under the principle of period of time,

this is usually prepared yearly with
Loans Payable balances shown only at the end of the
particular year.
Mortgage due to bank
STATEMENT OF FINANCIAL POSITION (BALANCE
EQUITY
SHEET)
Owner's Capital

Owner's Drawing

(Sole Proprietorship)

Partner's Capital

(Partnership)

Share Capital

Retained Earnings

(Corporation)

BUSINESS TRANSACTIONS AND THE

ACCOUNTING ELEMENTS
SUMMARY OF TRANSACTION AND EFFECTS ON influence a statement user to make a
ACCOUNTING ELEMENTS meaningful decision.

• The information must give the past

performance of business (feedback
value) which is useful in projecting what
might take place in the future
(predictive value).

• It is also affected by the materiality.

QUALITATIVE ATTRIBUTES
• The Framework identifies four principal
attributes:
– Understandability
– Relevance
RELIABILITY
– Reliability
– Comparability
• These attributes must be present for
the financial statements be trustworthy
and useful in making informed
judgment and decision.
UNDERSTANDABILITY
• This requires that:
1. Users have a reasonable
knowledge of finance,
accounting and economics to
come up with a good
assessment and sound
judgment.
2. Terminologies used must be
clear
3. Presentation of reports must be
orderly.
RELEVANCE
• It prescribes the quality of information
that will make a difference and
Materiality will depend on whether an
item (by its nature and size) will
influence user's decision or not.
• Timeliness - Reports must be given
promptly or within the period it is
needed to form judgment.
• FOUR INGREDIENTS:
1. Faithful Representation -
information represent faithfully
what they purport to be, that
the information should not
mislead users to think that it is
when it is not.
2. Substance over Form - if the
substance or economic reality
(intention) of the transaction is
not consistent with the legal
form, the economic reality
should prevail.
3. Neutrality - requires that the
information should not show
any bias for a particular user.
4. Prudence - requires the
accountant to exercise caution
when using estimates or
information that is marked by
uncertainty.
• Completeness is another component of
reliability. This enhances the value of
information in which helping the users
 to make informed judgment when all
information are taken into
consideration.
COMPARABILITY
• A user can identify changes between:
– two or more periods (Trending
analysis); or
– two or more entities
(Competitive analysis)
• Comparability also requires uniformity
of accounting treatment from one
period to another period or from one
entity to another entity. – Consistency
ACCOUNTING PRINICPLES (GAAP)
• These are man-made laws that usually
results of long-used accounting
practice, norm of conduct of a place or
standards promulgated by an
authoritative body.
• These have been revised from time to
time to ensure its appropriateness to
the changes taking place in the business
environment.
• The following are the accounting
principle used in the preparation and
presentation of the Financial
Statement:
• Measurements in Terms of
Money
• Business Entity Concept
• Exchange Price or Cost Principle
• Cost is the amount
agreed upon in an arm's
length transaction.
• Going Concern Assumption
• Accrual Assumption
• Objectivity
• Verifiable and
Substantiated by
supporting documents
• Reporting Period (Calendar or
Fiscal Year)
EXPANDING THE EQUATION TO SHOW
OPERATIONS `
ACCRUAL CONCEPT OF RECOGNIZING
REVENUES AND EXPENSES
• REALIZATION OF REVENUE PRINICIPLE –
recognizes revenue when it is earned
regardless of collection.
• The Framework states further
that recognition of income or
revenue brings about an
increase in owner’s equity with
either an increase in assets or a
decrease in liabilities
• RECOGNITION OF EXPENSE PRINCIPLE –
recognizes expenses when it is incurred
regardless of payment.
• The Framework states further
that recognition of expense
brings about an decrease in
owner’s equity with either a
decrease in assets or a increase
in liabilities
THREE WAYS OF RECOGNIZING EXPENSES IN
GENERATING INCOME
a) Expense is recognized when revenue is
recognized because it is not possible to
earn revenue without incurring
expenses. – MATCHING PRINCIPLE
b) Resources or assets that will benefit the
business over a number of years should
be allocated or spread out as
 Depreciation Expense over the years
the asset will be used.
c) There are expenses that are regularly
incurred such as salaries for services
rendered from employees, rent for the
use of office space, utilities for
telephone, light and water services
used. A measurement is needed for
these expenses which are computed
based on consumption made by the
business.
ACCRUAL CONCEPT VS. CASH CONCEPT
• ACCRUAL ASSUMPTION/CONCEPT –
requires that revenues and expenses be
recognized based on the time period
they relate or based on the occurrence
of the revenue and expense rather
than on whether cash is received or
paid.
• CASH CONCEPT – recognizes revenue
only when cash is collected and
expenses only when cash is paid.
• Applicable to small businesses
which has short operating cycle
and where the focus of
attention may be more on the
liquidity or short term cash
position of the firm.
ASSETS = LIABILITIES + EQUITY
Equity:
INCREASES DUE TO:
1) CONTRIBUTIONS
2) REVENUES
DECREASES DUE TO:
1) WITHDRAWALS
2) EXPENSE
INCOME
• This represents inflow of cash or other
assets coming from a client or customer
for service rendered or for merchandise
sold.
• PAS 1 defines income as an increase in
economic benefits during the period
that results in increase in equity, other
than those resulting from contributions
of equity participants.
• There are 2 types of income:
• Revenue – is income coming
from the normal course of
business.
• Gain – is an income which may
arise but not really from its
normal course of operation.
• Two account titles used for revenue:
• Service Income or Professional
Income – used to describe
revenue common to all service
providers.
• Sales – used by merchandisers
and manufacturers.
EXPENSES
• This defines as the consumption of
asset or using up a service to generate
revenue.
• PAS 1 defines expense as an decrease in
economic benefits during the
accounting period that results in
decrease in equity, other than those
relating to distributions to equity
participants.
PROFIT OR LOSS
• The difference between the total
income earned and the total expense
incurred spells success or failure of an
organization.
 • INCOME > EXPENSES = PROFIT

• INCOME < EXPENSES = LOSS

CLASSIFICATION OF ASSETS AND LIABILITIES

• Current Assets

• Non-current Assets

• Current Liabilities

• Non-current Liabilities

ACCOUNTING PERIOD
Accounting for Merchandising Businesses
• CALENDAR YEAR
Nature of Merchandising Businesses
• FISCAL YEAR
Service Business
• REAL ACCOUNTS – accounts in the
Statement of Financial Position Fees earned $XXX
• NOMINCAL ACCOUNTS – accounts in Operating expenses –XXX
the Income Statement
Net income $XXX
• “As of XXX XX,XXXX” – reports real
accounts at a point of time Sales $XXX

• “For the month/year ended XXX XX, Merchandising Business

XXXX” – reports nominal accounts for a Cost of Merchandise Sold –XXX
certain period of time.
Gross Profit $XXX
OPERATING CYCLE
Operating Expenses –XXX
• This represent the period of time it
takes for cash to be converted into Net Income $XXX
cash.
 When merchandise is sold, the revenue
• PAS 1.68 defines it as a time between is reported as sales, and its cost is
acquisition of assets, their processing recognized as an expense called cost of
and realization in cash or cash merchandise sold.
equivalent.

• It depends on type of business

operation.

 The cost of merchandise sold is
subtracted from sales to arrive at gross
profit. It is the profit before deducting
operating expenses.
Cost of Merchandise Sold
 Merchandise on hand (not sold) at the
end of an accounting period is called
merchandise inventory.
Multiple-Step Income Statement
 The multiple-step income statement
contains several sections, subsections,
and subtotals.
Revenue from Sales
 Sales is the total amount charged
customers for merchandise sold,
including cash sales and sales on
account.
 Sales discounts are granted by the seller
to customers for early payment of
amounts owed.
 Net sales is determined by subtracting
sales returns and allowances and sales
discounts from sales.
 The cost of merchandise sold is the cost
of the merchandise sold to customers.
Merchandise costs consist of all the
costs of acquiring the merchandise and
readying it for sale, such as purchase
and freight costs.
 The buyer may return merchandise to
the seller (purchase return), or the
buyer may receive a reduction in the
initial price at which the merchandise
was purchased (purchase
allowance).
 You have seen that sellers may offer
customers sales discounts for early
payment of their bills. From the buyer’s
perspective, such discounts are referred
to as purchase discounts.
 If merchandise inventory at the end of
the period is determined by taking a
physical count of inventory on hand, a
periodic inventory system is being used.
 Under the perpetual inventory system,
the amounts of inventory purchased,
available for sale, and sold are
continuously (perpetually) updated in
the inventory records.
Gross Profit
 Gross profit is computed by subtracting
the cost of merchandise sold from net
sales.
Income from Operations
 Selling expenses are incurred directly
in the selling of merchandise.
 Sales salaries
 Store supplies used
 Depreciation of store
equipment
 Delivery expense
 Advertising expense
 Administrative expenses, sometimes
called general expenses, are incurred in
the administration or general
operations of the business.
 Office salaries
 Depreciation of office
equipment
 Office supplies used
 Multiple-Step Income Statement
 Income from operations, sometimes
called operating income, is determined
by subtracting operating expenses from
gross profit.
Other Income and Expense
 Other income is revenue from sources
other than the primary operating
activity of a business.
 Other expense is an expense that
cannot be traced directly to the normal
operations of the business.
Single-Step Income Statement
 An alternative form of income
statement is the single-step income
statement. As shown in the next slide,
the income statement for NetSolutions
deducts the total of all expenses in one
step from the total of all revenues.
Purchase Discounts
 A buyer may receive a discount from
the seller (sales discount) for early
payment of the amount owed. From the
buyer’s perspective, such discounts are
called purchases discounts.
Purchases Returns and Allowances
 A purchases return involves actually
returning merchandise that is damaged
or does not meet the specifications of
the order. From a buyer’s perspective,
such returns are called purchases
returns and allowances.
Debit Memo
 A debit memorandum, often called a
debit memo, informs the seller of the
amount the buyer proposes to debit to
the account payable due the seller.
Freight
 If ownership of the merchandise passes
to the buyer when the seller delivers
the merchandise to the freight carrier,
the terms are said to be FOB (free on
board) shipping point.
Trade Discounts
  When wholesalers offer special
discounts to certain classes of buyers
who order large quantities, these
discounts are called trade discounts.
Dual Nature of Merchandise Transactions
 Each merchandising transaction affects
a buyer and a seller. In the following
illustrations, we show how the same
transactions would be recorded by both
the seller and the buyer.
Adjusting Entry for Inventory Shrinkage
 Merchandising businesses may
experience some loss of inventory due
to shoplifting, employee theft, or errors
in recording or counting inventory.
Step 2: Closing Entries
Credit each temporary account with a debit
balance, such as an expense, for its balance and
debit Income Summary.
Step 3: Closing Entries
Debit Income Summary for the amount of its
balance (net income) and credit the owner’s
capital account.
Step 4: Closing Entries
Debit the owner’s capital account for the
balance of the drawing account and credit the
drawing account.
Closing Entries NetSolutions’ Income Summary
account after the closing entries have been
posted is as follows:

 If the balance of the Merchandise

Inventory account is larger than the
total amount of the merchandise count,
the difference is often called inventory
shrinkage or inventory shortage.

Step 1: Closing Entries

Debit each temporary account with a credit

balance, such as Sales, for its balance and credit
Income Summary.
 The Accounting Cycle

Overview of the Accounting Cycle

1. Identify and analyze transactions

2. Record in journal
3. Post to general ledger and sub-ledgers
4. Prepare unadjusted trial balance
5. Reconcile and prepare worksheets
6. Prepare and post adjusting entries
7. Prepare adjusted trial balance
8. Prepare financial statements
** The next two steps are completed at the end of the fiscal period.

9. Close nominal accounts

10. Prepare post closing trial balance

1. Identify and analyze transactions.

Main Categories of Source Documents

a) Sales invoices
b) Purchase invoices
c) Cash disbursements (cheques)
d) Cash receipts (deposits)
e) Other miscellaneous documents

These sources documents contain all the necessary information to record the transaction and also
provide an audit trail.

2. Record in Journal

Once the transaction is identified, it must be recorded in the journal(s). The journal entry shows
which accounts have been debited or credited and always balances. There is also a description
providing more information as well as a reference to the appropriate ledger page.

GENERAL JOURNAL:
 DEBIT CREDIT
Cash xxx
Owner’s Capital xxx
INITIAL INVESTMENT
Prepaid Rent xxx
Cash xxx
PAYMENT IN ADVANCE
Cash xxx
Notes Payable xxx
NET ISSUED FOR CASH
Service Vehicle xxx
Cash xxx
SERVICE VEHICLE ACQUIRED FOR CASH
Prepaid Insurance xxx
Cash xxx
INSURANCE PREMIUM PAID
Office Equipment xxx
Cash xxx
Accounts Payable xxx
OFFICE EQUIPMENT ACQUIRED ON ACCOUNT
Supplies xxx
Accounts Payable xxx
SUPPLIES PURCHASED ON ACCOUNT
Accounts Payable xxx
Cash xxx
ACCOUNTS PAYABLE SETTLED PARTIALLY
Cash xxx
Consulting Revenue xxx
REVENUE EARNED AND CASH COLLECTED
Salaries Expense xxx
Cash xxx
SALARIES PAID
Utilities Expense xxx
Utilities Payable xxx
EXPENSES INCURED BUT UNPAID
Cash xxx
Accounts Recievable xxx
ACCOUNTS RECEIVABLE PARTIALLY COLLECTED
Utilities Expense xxx
Cash xxx
EXPENSES INCURRED AND PAID
Cash xxx
Unearned Revenue xxx
UNEARNED REVENUES COLLECTED
Accounts Receivable xxx
 Consulting Revenue xxx
REVENUES EARNED ON ACCOUNT
Owner’s Withdrawal xxx
Cash xxx
WITHDRAWAL CASH BY OWNER

MERCHANDISE JOURNALS:

GROSS SALES
Debit Credit
Cash xxx
Sales xxx
TO RECORD SALE OF MERCHANDISE FOR CASH
Accounts Receivable xxx
Sales xxx
TO RECORD SALE OF MERCHANDISE ON CREDIT
SALES DISCOUNTS
Cash xxx
Sales Discount xxx
Accounts Receivable xxx
TO RECORD COLLECTION ON --, DISCOUNTS
TAKEN
SALES RETURNS AND ALLOWANCES
Sales Returns and Allowances xxx
Accounts Receivable/Cash xxx
TO RECORD RETURNS ON UNSATISFACTORY
MERCH.
PURCHASES
Purchases
Accounts Payable
TO RECORD PERCHUSE OF MERCHANDISE
PURCHASE RETURNS AND ALLOWANCES
Accounts Payable
Purchase Returns and Allowances
RETURN OF DAMAGE MERCHANDISE
PURCHASE DISCOUNTS
Accounts Payable
Purchase Discounts
Cash

3. Post to the General Ledger

Once a journal entry is complete, the information must be copied to the appropriate ledger pages.
This updates the balances of all the affected accounts. The journal page number is recorded in the
ledger to provide a circular audit trail and to ensure the transaction is not posted twice.

4. Prepare Unadjusted Trial Balance

Once all journal entries have been posted, a trial balance is prepared to determine the numerical
accuracy of the general ledger. This TB is called an unadjusted TB because period-end adjusting
entries have not been prepared yet.

5. Reconcile and Prepare Worksheets

Before financial statements can be prepared, the accounts must be adjusted for unrecorded
changes that have occurred during the accounting period. The worksheet is used to display the
adjustments before they are recorded in the journal. The worksheet will also show the net income
or loss for the period.

Categories of Adjustments:

 Unearned revenues
 Prepaid expenses
 Accrued revenues
 Accrued expenses
 Amortization

6. Prepare and Post Adjusting Entries

Once the adjustments have been documented on the worksheet, they must be journalized and
posted to the ledger. The account balances now correctly include the adjustments.

ADJUSTING ENTRIES:

ADJUSTMENTS FOR DEFFERALS

Debit Credit
Rent Expense xxx
Prepaid Rent xxx
EXPIRATION OF NTH MONTH’S RENT
Insurance Expense xxx
Prepaid Insurance xxx
 EXPIRATION OF NTH MONTH’S INSURANCE
Supplies Expense xxx
Supplies xxx
CONSUMPTION OF SUPPLIES EXPENSE
DEPPRECIATION OF PROPERTY EQUIPMENT
Depreciation Expense-Service Vehicle xxx
Accumulated Depreciation-Service Vehicle xxx
Depreciation Expense-Office Equipment xxx
Accumulated Depreciation- Office Equipment xxx
RECORDING DEPRECIATION EXPENSE
UNEARNED REVENUES
Unearned Revenue xxx
Service Revenue xxx
RECOGNITION OF INCOME WHERE CASH IS
RECEIVED IN ADVANCE
ADJUSTMENT FOR ACCRUALS
Salaries Expense xxx
Salaries Payable xxx
ACCRUAL FOR UNRECORDED EXPENSE
Interest Expense xxx
Interest Payable xxx
ACCRUAL FOR UNRECORDED EXPENSE
ACCRUED REVENUES
Accounts Receivable xxx
Service Revenue xxx
ACCRUAL FOR UNCOLLECTIBLE ACCOUNTS
Uncollectible Accounts Expenses
Allowance for uncollectible Accounts

7. Prepare Adjusted Trial Balance

After the adjustments have been posted to the ledger, another trial balance is prepared to ensure
the numerical accuracy of the accounts. If the adjusted trial balance does not work, only the
adjusting entries need to be checked.

8. Prepare Financial Statements

The final step in a regular accounting cycle is to communicate the accounting information to the
users. The income statement will show how much profit was earned (or lost) over a certain period
of time and the balance sheet will show the financial position of a company as of a particular day.
9. Closing Entries

To prepare the accounts for a new accounting period, some account balances need to be set to zero.
“Nominal” accounts start with a balance of zero at the beginning of each accounting cycle and
consist of all revenue, expense, and drawings accounts. “Real” accounts carryover their balance
from one period to the next and consist of asset, liability, and equity accounts.

To close the nominal accounts, three reversing entries must be made. The first two transactions use
a temporary account called “income summary”.

 Closing entry #1 – Debit all revenue accounts and credit income summary.
 Closing entry #2 – Debit income summary and credit all expense accounts.
 Closing entry #3 – Debit capital and credit owner withdrawals (Drawings).
 Closing entry #4 - A final transaction is required to remove the balance from the income
summary account. This journal entry moves the net income (or loss) from the income
summary account to the capital account.

CLOSE THE REVENUE

Debit Credit
Service Revenue xxx
Income Summary xxx
CLOSE THE EXPENSE ACCOUNTS
Income Summary xxx
Expenses xxx
CLOSE THE INCOME SUMMARY AMOUNTS
Income Summary xxx
Owner’s Capital xxx
CLOSE THE WITHDRAWAL
Owner’s Capital xxx
Owner’s Withdrawal xxx

MERCHANDISING CLOSING ENTRIES:

CLOSE THE REVENUE

Debit Credit
Sales xxx
Purchase Discounts xxx
Purchase Returns and Allowances xxx
Other Income xxx
 Income Summary xxx
CLOSE THE EXPENSE ACCOUNTS
Income Summary xxx
Expenses xxx
CLOSE THE INCOME SUMMARY AMOUNTS
Income Summary xxx
Owner’s Capital xxx
CLOSE THE WITHDRAWAL
Owner’s Capital xxx
Owner’s Withdrawal xxx

10. Post Closing Trial Balance

This trial balance includes only real accounts that have a balance transferring to the new accounting
period. The capital account is now updated to reflect the net income/loss and owner withdrawals
from the previous period.

MERCHANDISING

Freight Terms

1. FOB Shipping point (Buyer)

2. FOB Destination (Seller)

Payment terms or freight

1. Freight Prepaid
2. Freight collect

Freight Terms Who should shoulder Who should pay the shipper?
the transportation?

1. FOB Destination, Freight Prepaid Seller Seller

2. FOB Shipping point, Freight collect Buyer Buyer
3. FOB Destination, Freight collect Seller Buyer
4. FOB Shipping point Freight Prepaid Buyer Seller
 ₱200,000

2/n n/30
Seller Buyer
n/3
Seller 0 Buyer

July
1, 2018 Accounts Receivable 160K Purchases 160K
Sales 160K Accounts Payable 160K
July
2, 2018 Freight out 5,000 NoEntry
Cash 5,000

FOB Destination, Freight Prepaid

July
9, 2018 Cash 156,500 Accounts Payable 160K
Sales Discount 3,200 Purchased Discount 3200
Account Receivable 160K Cash 156,800

FOB Shipping Point, Freight Collect

July
1, 2018 Accounts Receivable 160K Purchases 160K
Sales 160K Accounts Payable 160K
July
2, 2018 No Entry Freight in 5,000
Cash 5,000
July
9, 2018 Cash 156,500 Accounts Payable 160K
Sales Discount 3,200 Purchased Discount 3200
Account Receivable 160K Cash 156,800

FOB Destination, Freight Collect

July
1, 2018 Accounts Receivable 160K Purchases 160K
Sales 160K Accounts Payable 160K
July
2, 2018 Freight out 5,000 Accounts Payable 5,000
Accounts Receivable 5,000 Cash 5,000
July
9, 2018 Cash 151,800 Accounts Payable 155,000
Sales Discount 3,200 Purchased Discount 3200
Account Receivable 155,000 Cash 151,800
FOB Shipping, Point, Freight Prepaid

July
1, 2018 Accounts Receivable 160K Purchases 160K
Sales 160K Accounts Payable 160K
July
2, 2018 Freight out 5,000 Accounts Payable 5,000
Accounts Receivable 5,000 Cash 5,000
July
9, 2018 Cash 161,800 Accounts Payable 165,000
Sales Discount 3,200 Purchased Discount 3200
Account Receivable 165,000 Cash 161,800

A= L + OE
Sales NE NE Increase
Sales Discount NE NE Decrease
Sales Returns NE NE Decrease
Purchase NE NE Increase
Purchase Discount NE NE Increase
Purchase Returns NE NE Increase
Freight in (COGS) NE NE Decrease
Freight out (Expense) NE NE Decrease