ACTBAS 1 Downloaded Lecture Notes

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Unit I
Introduction
Overview

Background The evolution oI accounting is attributed to the social and economic needs oI
society. As business and society become more complex, accounting develops
new concepts, methods and techniques to meet the ever changing and
increasing needs Ior Iinancial inIormation. Without the necessary inIormation
Iurnished by accounting, many complex social programs and economic
development may never have been realized.
InIormation, in any market economy, assists decision-makers in making wise
choices regarding the use oI limited resources under their control. When
decision-makers are able to make well-inIormed decisions, resources are
allocated in a manner that better meets the needs and goals oI companies
within the given market.
The Philippines, being a developing country, would need a great deal oI
reliable and timely inIormation to compete in the global market and
accounting will play an important role in this prevailing competitive global
structure oI the economy. Companies use accounting inIormation to evaluate
the business situations around the world. It is thereIore necessary that Iuture
accountants, businessmen, entrepreneurs and economists must be trained
properly on how to generate and interpret this Iinancial inIormation.

Purpose The purpose oI Unit I 'Introduction to Accounting and Basic Accounting
Principles is to provide students with brieI descriptions oI the nature and
scope oI accounting. This unit also includes simple explanation oI the 13
basic accounting concepts.

In this unit This unit contains the Iollowing topics:

Topics See Page
Nature and Scope oI Accounting 2 oI A
History oI Accounting Thought 5 oI A
Users oI Financial Statements 6 oI A
Forms oI Business Organizations 8 oI A
Basic Accounting Concepts 9 oI A
The Accounting ProIession 17 oI 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 oI thought Iinds support based on the
condition prevailing during the early times when businesses were not as
complex and multiIarious as they are nowadays. However, recognition oI the
importance oI accounting in the development oI modern business methods,
the industrial revolution and the growth oI unlimited companies that provided
the impetus Ior the development oI accounting as a proIession has led to the
distinction in the concepts and eIIects oI bookkeeping as against accounting.

Definition The Iollowing deIinitions diIIerentiates bookkeeping Irom accounting:
! !""##$$%&'( deals primarily with the systematic method oI recording and
classiIying Iinancial transaction oI business. It is considered to be the
procedural element oI accounting as arithmetic is a procedural element oI
mathematics. Normally, books are set up and prepared in a manner that
ensures an orderly recording and classiIication oI business transactions.
However, because oI the rapid economic growth and technological changes,
which necessitate the mechanization oI the bookkeeping job, the demand
Ior bookkeepers has been reduced. The bookkeeping process is now
basically done through the use oI computers and soIt wares designed Ior
such purpose.
! A))"*'+&'( as diIIerentiated Irom bookkeeping has been authoritatively
deIined by the American Institute oI CertiIied Public Accountants (AICPA),
as the art oI recording, classiIying and summarizing in a signiIicant manner
and in terms oI money, transactions and events that are, in part at least, oI a
Iinancial character, and interpreting the results thereoI. Accounting is also
deIined by the Philippine Institute oI CertiIied Public Accountants (PICPA)
as a system that measures business activities, processes given inIormation
into reports, and communicates those Iindings 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 deIinition connotes that accounting is an art oI
communication. Although the primary Iunction oI accounting is to supply oI
Iinancial inIormation, it also provides non-Iinancial inIormation.
Moreover, accounting is reIerred to as a science in the sense that is a
systematized knowledge. A growing body oI accounting theories seeks to
place accounting in the context oI human knowledge and activity in general.
Hence, an accountant is a bookkeeper and more, Ior he must not only be well-
versed with the recording process but must also be concerned with the
Iunctions oI interpretation and analysis oI Iinancial statements which require
the exercise oI reason, judgment and intelligence oI a higher order. It is these
Iunctions that best distinguish accounting Irom bookkeeping.

Language of
Business
Accounting is a special kind oI language. It is oIten described as the
,-.'(*.($ "0 1*2&'$223 because it is the medium of communication between
a business Iirm and the various parties interested in its Iinancial activities. It is
the tool, which enables Iirms to communicate to various interested third
parties certain quantitative inIormation about the Iinancial activities oI a
business.
Accounting is oIten utilized whenever there are business transactions. And
business transactions normally involve people. One cannot engage in business
without involving and aIIecting other persons. The activities oI a business
enterprise involve and aIIect 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 inIormed
about the Iinancial aIIairs oI a business enterprise. Accounting, thereIore,
serves this need oI providing quantitative inIormation, primarily Iinancial in
nature, about economic entities that is useIul in making economic decisions.
The principal accounting reports are the Iinancial statements, i.e., the balance
sheet, income statement and the cash flow statement. As the major end
products oI accounting, these statements convey to management and/or
interested outsider(s) the messages about the Iinancial activities oI the
business.

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Nature and Scope of Accounting, Continued

Language of
Business, con`t.
InIormation needed by diIIerent parties is oI three kinds:
! The financial condition or position oI the business, i.e., the amounts and
kinds oI its assets and liabilities, and the status oI 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 oI time resulted in net
income or a loss.
! The financing and investing activities that are responsible Ior the changes in
the Iinancial resources oI the business, i.e., the sources and applications oI
Iund during a given period oI time.
This inIormation, Iurnished through accounting, are utilized by end-users as
basis Ior reaching important decisions aIIecting 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 inIormation. Account records date back to the
ancient civilizations oI China, Babylonia, Greece and Egypt. The rulers oI
these civilizations used accounting to keep track oI the cost oI labor and
materials used in building structures like the great pyramids.

History Accounting developed as a result oI the inIormation needs oI merchants in the
city-states oI Italy during the 1400s. In that commercial climate a monk, Luca
Pacioli, a mathematician and Iriend oI Leonardo da Vinci, published the Iirst
known description oI 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 oI mathematics and
incidentally set oI accounting procedures. (Horngren, Harison and
Robinson,1995).
The pace oI accounting development increased during the Industrial
Revolution as the economics oI 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 oI corporations, especially those in the
railroad and steel industries, spurred the development oI accounting.
Corporate owners, were no longer necessarily the managers oI 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 Iield oI
accounting when it started using the income tax. Accounting supplied the
concept oI 'income`. Also, government at all levels has assumed expanded
roles in health, education, labor and economics planning. To ensure that the
inIormation that it uses to make decisions is reliable, the government has
required strict accountability in the business community.
At the beginning oI the third millenium, there would still be a lot oI
developments in the Iield oI accounting. The great challenge oI globalization
and the eIIects oI new technologies (e.g. super computers, robotics, inter and
intra-net, etc.) pose a shiIt in the structure and pattern in this Iield. More and
better inIormation are now being required and thereIore, accounting, being the
means used in communicating business and Iinancial inIormation must also
evolve into a more eIIicient level.

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Users of FinanciaI Statements

Overview Today's accountant Iocuses on the ultimate needs oI decision-makers who use
accounting inIormation, whether decision makers are inside or outside the
business. Accounting "is not an end in itselI," but is an inIormation system
that measures, processes, and communicates Iinancial inIormation about an
identiIiable economic entity (Needles, Belverd, et al, 1999). It provides a
vital service by supplying the inIormation decision-makers needs to make
"reasoned choices among alternative uses oI scarce resources in the conduct
oI 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 Iinancial reports, the owner can properly
manage and monitor the business, analyzing whether or not he can expect
reasonable return Irom his investment.
! Management. Managers oI business use accounting inIormation to set
goals Ior the organization, to evaluate the progress made toward those goals,
and to take corrective action iI necessary.

External Users Those who are not directly involved in the operation oI the business such as:
! Potential investors. Investors use Iinancial reports in evaluating what
income they can reasonably expect Irom 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 oI the tax is determined using
accounting inIormation.

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Users of FinanciaI Statements, Continued

External Users,
con`t.
Those who are not directly involved in the operation oI the business such as:
! Government regulation agencies. Most organizations Iace government
regulation. For example, the Securities and Exchange Commission (SEC)
requires businesses to disclose certain Iinancial inIormation to the public.
The SEC, like many government agencies, bases its regulatory activity in
part on the accounting inIormation it receives Irom Iirms.
! Nonprofit organizations. NonproIit organizations, e.g., churches, most
hospitals, government agencies, and colleges, which operates Ior purposes
other than to earn a proIit use accounting inIormation in much the same way
that proIit-oriented businesses do.
! Other users. Employees and labor unions may make wage demands based
on the accounting inIormation that shows their employer`s reported income.
Consumer groups and the general public may also be interested in the
amount oI income that the businesses earned.

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Forms of Business Organization

Based on
Ownership
There are three basic Iorms oI business organization according to
ownership. This classiIication 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 Iorm oI
business are called partners.
! Corporation. A body Iormed 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 Iorm oI business
organization today. Persons who put in capital in a corporation are called
stockholders.

Based on
Operations or
Activity
Business may also be classiIied according to business operations or activity
aIter the necessary capital has been received Irom the owner or owners and
the business starts its operations. The purpose Ior which the business has
been Iormed will determine the nature oI its activities.
! Service concern. Businesses engage in the rendering oI services to others
Ior a Iee, like the beauty parlor, law Iirm, dental clinic, and medical clinic.
! Merchandising or trading concern. Businesses that are into the buying
and selling oI goods or commodities like the grocery store, drug store and
department store.
! Manufacturing concern. Businesses that are engaged in the processing oI
products or the conversion oI raw materials into Iinished goods that are then
sold like the Iurniture Iactory and shoe Iactory. A trading or merchandising
business diIIers Irom a manuIacturing concern in that the Iormer buys
Iinished goods, which are ready Ior sale, while the latter produces or
manuIactured 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 Iinancial inIormation. These
principles have been developed by the accounting proIession over the years to
provide a consistent system oI Iinancial reporting in a constantly changing
business environment (Smith, Keith, et al, 1993).
These concepts assure users oI Iinancial statements that the reports are
prepared in speciIic ways so that they are reliable and comparable Ior the
useIulness oI these reports rests on their reliability and comparability.

Purpose Generally accepted accounting principles serve three basic purposes:
! They help increase the conIidence oI Iinancial statement users that the
Iinancial statements are representationally IaithIul.
! They provide companies and accountants who prepare Iinancial statements
with guidance on how to account Ior and report economic activities.
! And they provide independent auditors oI Iinancial statements with basis Ior
evaluating the Iairness and completeness oI those statements (Chasteen, l.,
Flaherty, R., O'Connor, M., 1998).

Entity Concept For accounting purposes, an $'+&+4 is the organizational unit Ior 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 Irom that oI 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 oI owners must not be combined with transactions oI the
business.
This concept also requires that an accountant record only those Iinancial
activities that occur between the entity being accounted Ior and other parties.
Thus, the accounting entity assumption establishes boundaries or limits as to
what inIormation should be included in the Iinancial statements oI a given
company.

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Basic Accounting Concepts, Continued

Entity Concept,
con`t
Business Transaction. A business event that can be measured in terms oI
money that aIIects 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 oI measure that we can use to record economic
transactions and prepare Iinancial statements. Under this concept, money is
used as the unit oI measure in preparing the various Iinancial reports oI the
company (example oI these would be in terms oI Peso ( P ), Dollar ( $ ), etc.).
It is a common belieI that everybody understands moneyit's universally
available, its certainly relevant to Iinancial transactions and its easy to use.
But money, the "peso" in our case, as a measure oI economic activity does not
have a constant value especially in recent years. It is not time in itselI that
causes the change in the value oI money but economic events, e.g., change in
government leadership, chaos in the stocks markets, etc. The stable monev
concept assumes that, monetary unit oI measure does not change value
overtime, even iI in Iact it does. The assumption is made in order to ensure
objectivity in reporting data on the Iinancial statements.

Time Period
Concept
It is also known as periodicity concept. It divides the liIe oI the business into
regular intervals (usually one year) at the end oI which Iinancial statements
are prepared. This means that the economic activities undertaken during the
liIe oI an accounting entity are assumed to be divisible into various artiIicial
time periods Ior Iinancial reporting purposes. For example, it is assumed that
a reasonable report oI income earned can be made annually or quarterly, even
though the revenue generating activities oI a business are continuous.

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Time Period
Concept, con`t.
This is the assumption that implies that it is necessary to measure accounting
income Ior periods oI time less than the liIe oI a Iirm and that measurement
will not be precise but will be timely and thereIore useIul (Smith, Keith, et al,
1993).
! In choosing one year, the business has two options:
! 5.-$'6.7 8$.7. A twelve-month period beginning with January 1 and
ending December 31.
! 9&2).- 8$.7. The length oI the Iiscal period is determined by the nature oI
the business and the Irequency oI the need Ior data regarding the Iinancial
condition and progress oI the business. A yearly Iiscal period does not
start with January 1 and end on December 31. (e.g., educational
institutions normally Iollows a Iiscal year beginning May 1 and ending
April 30).

Revenue
Realization
Concept
Revenue or income is the inIlow oI assets that results Irom producing goods
or rendering services. Revenue is not earned all at one point in time. Instead,
the earning process extends over a considerable length oI time.
The revenue reali:ation concept provides that income is recognized when
earned regardless whether cash is received. This means that both oI the
Iollowing conditions are met:
! The earning process is essentially complete;
! An exchange has taken place (Smith, Keith, et al, 1993).
These two conditions Ior most oI the companies are met at the time goods are
sold or services rendered. To wit:
! Two points oI income recognition:
! Income is considered earned when services are Iully rendered.
! Income is considered earned when goods or merchandise are Iully
delivered.

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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 beneIits have already been received) regardless whether
payment is made.
To apply the accrual concept, accountants have developed the accrual
accounting. The accrual method oI accounting attempts to record the Iinancial
eIIects on a company oI 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 Iirm. This
means that accrual accounting consists oI 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 oI 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 oI accounting, which generally records a journal
entry upon exchange oI 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 oI the period. There is a cause-and-eIIect
relationship between revenue and expense recognition implicit in this
deIinition
Revenues are inIlows oI resources resulting Irom providing goods or services
to customers. For merchandising companies like Shoe Mart, the main source
oI income is sales revenue derived Irom selling merchandise. Service Iirms
such as SGV and Company generate revenue by providing services.

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Matching
Concept, con`t
Expenses on the other hand are outIlows oI resources incurred in generating
revenue. They represent the costs oI 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. II
causality can be determined, expenses are reported in the same period that the
revenue is recognized. II 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 oI the period
to total revenue oI the same period. II total revenue is greater than total
expenses, the company`s result oI business operation is a net income. But iI
total expense is greater, the result is a net loss.
Net Income Ior 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 Iree Irom personal biases and independent experts (e.g., CPA) can
veriIy reports.
Example: OIIicial receipts, invoices, vouchers, etc.

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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 Ior an ownership
oI 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 arms length transactions, i.e., transactions between a buver 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 oI the resources given up in the transaction provides reliable
evidence Ior the valuation oI 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 oI some assets is then subjected to
depreciation, depletion, amortization, etc. over time to reIlect the said assets
in the balance sheet in a more realistic valuation.

Going Concern
Concept
In the absence oI inIormation to the contrary, this concept assumes that the
business is to continue its operations indeIinitely. This means that the
business will stay in operation Ior a period oI time suIIicient to carry out
contemplated operations, contracts, and commitments. This non liquidation
assumption provides a conceptual basis Ior many oI the classiIications used in
accounting. Assets and liabilities, Ior example, are classiIied as either current
or long term on the basis oI this assumption. II continuity is not assumed, the
distinction between current and long term loses its signiIicance; all assets and
liabilities become current. Continuity supports the measurement and recording
oI assets and liabilities at historical costs and not at their liquidation values
(i.e., estimated net reali:able amounts) (Dyckman, t., Dukes, Davis, C.,
1998).

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Conservatism
Concept
This concept has a powerIul inIluence in valuing assets and measuring net
income. When Iaced which uncertainties, the accountant traditionally leans
towards the direction oI caution, choosing the method that would give the
business a less Iavorable Iinancial condition and lowers net income.
The reasoning behind this assumption is that investors preIer inIormation that
does not unnecessary raise expectations. For example:
! In recognizing assets, preIerably the lower oI two alternative valuations
would be recorded.
! In recognizing liabilities, preIerably the higher oI two alternative amounts
would be recorded.
! In recording revenues, expenses, gains, and losses where there is reasonable
doubt as to the appropriateness oI alternative amounts, the one having the
least Iavorable eIIect on net income should be preIerred.
Conservatism assumes that when uncertainty exists, the users oI Iinancial
statements are better served by understatement than by overstatement oI 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
Irom year to year to allow comparability oI Iinancial statements between years
and between businesses.
For example iI the First In First Out (FIFO) method was used by the Iirm in
valuing their inventories, the Iirm should not change the method into Last In
First Out (LIFO) in the Iollowing year and then go back again to FIFO on the
next year.
Consistency in this case means that the reported inIormation conIorms with
procedures that remain unchanged Irom period to period. Comparison
overtime are diIIicult unless there is consistency in the way accounting
principles are applied across accounting year.

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Materiality
concept
This concept reIers to relative importance oI an item or event. An item/event
is considered material iI knowledge oI it would inIluence the decision oI
prudent users oI Iinancial statements.
To illustrate an instance where strict conIormity 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 Iull when purchased rather
than an asset subject to depreciation. The peso amount involved is simply too
small Ior external users oI Iinancial reports to worry about.

Disclosure
concept
All relevant and material events aIIecting the Iinancial condition/position oI a
business and the results oI its operations must be communicated to users oI
Iinancial statements.
We must remember that the purpose oI accounting is to provide inIormation
that is useIul to decision-makers. So, naturally, iI there is accounting
inIormation not included in the primary Iinancial statements that would
beneIit users, that inIormation should be provided to.
Supplemental inIormation is disclosed in a variety oI ways including:
! Parenthetical comments or modifving comments placed on the Iace oI the
Iinancial statements.
! Disclosure notes conveying additional insights about company operations,
accounting principles, contractual agreements, and pending litigation.
! Supplemental financial statements that report more detailed inIormation
than is shown in the primary Iinancial statements. (Spiceland, D., Sepe, J.,
1998)

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The Accounting Profession

Overview The success oI the accountant in the accounting proIession depends on how
well he understands the accounting procedures and principles, and on how
clearly and accurately he can communicate Iinancial inIormation to the users
oI the statements.

Classification The nature oI these works though relies on the position, which the accountant
holds in his Iield. The positions in the Iield oI accounting are generally
classiIied into two, namely, public accounting and private accounting.
! Public Accountants are those who serve the general public and collect
proIessional Iees Ior 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 proIessional
requirements are designated as Certified Public Accountants (CPAs).
! Private Accountants work Ior 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 CertiIied Public Accountant (CPA) is a proIessional accountant who earns
his title through a combination oI education, qualiIying experience, and an
acceptance score in the written national examination given by the Board of
Accountancv.
The Board of Accountancv prepares, grades and gives the results oI the
examination to the Professional Regulation Commission (PRC) who then
issues licenses that allow qualiIying examinees to practice accounting as
CPAs.
CPAs must also be oI good moral character and must carry on their
proIessional practices according to a code oI proIessional conduct.

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The Accounting Profession, Continued

Organizations The Philippine Institute of Certified Public Accountants (PICPA) is the
national proIessional organization oI CPAs in the country.
In order to Iormalize the accounting standard-setting Iunction in the
Philippines, the Philippine Institute oI CertiIied Public Accountants (PICPA)
established the Accounting Standards Council (ASC).
The Accounting Standards Council's main Iunction is to establish and
improve accounting standards that will be generally accepted in the
Philippines (PreIace to Statements oI Financial Accounting Standards oI
ASC, 1999).
The Accounting Standards Council (ASC) is the same body that Iormulates
the Generallv Accepted Accounting Principles (GAAP). These principles are
the most important accounting guidelines that provide the general Iramework
determining what inIormation is included in Iinancial statements and how this
inIormation is to be presented.
The ASC has approved in November 2004 the adoption oI International
Accounting Standards (IAS) 1, Presentation of Financial Statements, issued
by the International Accounting Standards Boars (IASB), as the Philippine
Financial Reporting Standards(PreIace to Philippine Accounting Standard
(PAS) 1 oI ASC, 2005).
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Unit II
BaIance Sheet
Overview

Background As a means oI telling interested people about business operations, accounting
perIorms important tasks oI recording daily transactions, classiIying recorded
data, summarizing recorded and classiIied data and interpreting the
summarized Iacts. In all business enterprises, accounting inIormation is
summarized in at least two basic Iinancial reports.
One oI these Iinancial reports shows what the business is worth in terms oI
the properties it owns (i.e., the assets), the debts it owes (i.e., the liabilities),
and the investment oI its owner/s (i.e., the proprietorship). This report is
called the balance sheet and this statement inIorms the users oI the Iinancial
condition oI the business at a given date, usually at the end oI an accounting
period.

Purpose The purpose oI Unit II 'The Balance Sheet - Assets, Liabilities and Owner`s
Equity (Service Business) is to illustrate diIIerent Iorms oI balance sheet and
how to prepare them. Students will also be introduced in analyzing business
transactions using the accounting equation.


Topics See Page
Forms oI Balance Sheet 2 oI B
Parts oI the Balance Sheet 5 oI B
Accounting Equation 7 oI B
Current Assets 8 oI B
Plant, Property and Equipment 10 oI B
Current Liabilities 12 oI B
Long-Term Liabilities 13 oI B
Owner`s Equity 14 oI B
Debit and Credit oI Balance Sheet Items 15 oI B

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Forms of BaIance 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 Iollowing the new accounting concept oI 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 oI changes in equity be prepared, and thereIore, the owner's
equity section oI the balance sheet would show only the ending balance oI the
capital account as shown in the given illustration.
The Iollowing discussions will provide readers inIormation on how the
account and report Iormat oI balance sheets may be prepared.

Account Form In the account Iorm oI balance sheet, the assets are listed on the leIt side oI
the report and the liabilities and proprietorship on the right side. The example
below illustrate the account Iorm:
1OSEPH 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 oI
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

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Forms of BaIance Sheet, Continued

Report Form A balance sheet prepared in report Iorm shows the assets on the top section oI
the statement and the liabilities and owner`s equity on the bottom section. The
example below illustrate the report Iorm:
1OSEPH 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 oI 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 BaIance 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 Ior DoubtIul 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
OIIice 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
OIIice Equipment 110,000
Furniture & Fixtures 25,000
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 BaIance Sheet

Overview This portion will enumerate the diIIerent parts oI a balance sheet and their
corresponding placement in the Iinancial report being prepared.

Statement
Heading
Includes the name oI the business, tells the kind oI statement it is, and gives
the date Ior which the report is prepared

Asset, Liability,
Proprietorship
Items are grouped and each group oI items is identiIied by special captions.

Captions ClassiIication oI each group oI items appear against the leIt margin oI the
statement.

Account titles Individual account titles in each classiIication are indented.

Current Assets The individual current assets are usually listed in order of their liquiditv, with
the most liquid asset, 'Cash appearing Iirst.

Plant,
Property,
Equipment
The plant assets are oIten listed in order oI their expected useIul liIe with the
assets with the longest expected useIul liIe, 'Land appearing Iirst.

Note (#) The separate schedule attached to the report explaining in detail the
aggregated amount presented on the Iace oI the Iinancial statement.

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Parts of the BaIance Sheet, Continued

Current
Liabilities
The current liabilities are in theory listed in order oI due date, with the debt
with the earliest due date appearing Iirst.

Captions
Indicating
Totals
Each group oI items (i.e., total current assets, total plant, property and
equipment, total current liabilities, etc.) is indented Iurther.

Single Rule
Line
The last Iigure in each group oI items is underlined.

Final Totals The two Iinal 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 Iinal total.

Peso Sign Peso signs are used (a) to the leIt oI the Iirst amount oI a group oI amounts
being combined and (b) to the leIt oI each Iinal total.

Peso Amount The peso amount Ior the detailed items is shown in one column; the total oI
each classiIication is extended into the last column on the right-hand side oI
the statement.

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Accounting Equation

Overview One important Ieature oI the balance sheet relates to a very simple Iact. The
balance sheet oI any business must show total assets exactly equal in amount
to the sum oI the liabilities and the capital. This relationship exists regardless
oI the size oI the enterprise or the variety oI its assets, liabilities and
ownership interest. This identity is called the basic .))"*'+&'( $:*.+&"';
OIten 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
oI being expressed in terms oI money or possessing <"'$+.74 =.-*$2, and
which, consequently, is available Ior the payment oI the debt oI the business.
In short, assets represent the 7$2"*7)$2 oI the business.

Liabilities Economic obligations (i.e., debts) payable to an individual or an organization
outside the business.

Owner`s Equity The claim oI an owner oI a business over the assets oI the business aIter the
claims oI the creditors have been satisIied.

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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 Irom 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 oI bills.

Investments in
Trading
Securities
Short-term investment in stocks oI other business (also known as marketable
securities).

Notes
Receivable
The amount due in the near Iuture Irom persons or companies on the basis oI
their Iormal, written promises to pay cash to the business on the date speciIied
in the promissory note.

Interest
Receivable
The amount oI interest due as oI the balance sheet date on notes received Irom
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 Iorm oI service.

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Current Assets, Continued

Merchandise
inventory
The purchase price oI the particular line oI goods the business expects to sell
to its customers Ior cash or on a charge account basis. This represents goods
on hand as oI the balance sheet date.

Accrued
Income
Income already earned but not yet collected, such as interest earned on
promissory note issued by the customer beIore the maturity date oI the note.

Supplies on
hand
The cost value oI such things as wrapping paper and packaging tape and
twine, (Store Supplies on Hand), computer ribbons, envelopes, stamps, paper
(OIIice Supplies on Hand) , and other assets oI a similar nature that the
business will use up in perIorming its activities.

Prepaid
insurance
That part oI the premium cost oI all kinds oI insurance carried by the business
aIter the balance sheet date. Prepaid insurance is always classiIied as a
current assets even iI the amount oI the unexpired premiums cover a period
longer than one year, the time limit used in deIining current assets.

Prepaid rent Rent paid by the business Ior Iacilities to be used aIter the balance sheet date.
For example, on December 1, 20X1, a business paid P30,000 Ior December,
January, and February rent. On a balance sheet dated December 31, 20X1, the
amount oI Prepaid Rent would be shown as P20,000 the amount paid Ior the
use oI the Iacilities Ior January and February, 20X2.

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PIant, Property and Equipment

Overview Assets are classiIied as plant, property and equipment iI they meet the
Iollowing criteria: (1) they must have physical existence; (2) they must be
more or less permanent in nature; (3) they must not be Ior sale; (4) they must
be used in business operations; and (5) they must undergo depreciation
(except land). (PeIianco, E., Mercado,R., 1983)

Land The cost oI land the business uses to carry on its activities - the lot on which
its Iactory or oIIice building stands.

Building The original cost less accumulated depreciation is shown to give the
depreciated value oI the structures in which the business carries on its
operation. This item could be separated into such things as Factory Building,
OIIice Building, Warehouse, and any other type oI building the business
wishes to show on its statement oI Iinancial position.

Equipment The original cost less accumulated depreciation is shown to give the
depreciated value oI the equipment used in the operations oI the business.
The title equipment may also be separated into whatever special assets oI this
type the business cares to identiIy. The business may use such titles as >00&)$
?:*&%<$'+ Ior the value oI the adding machines, calculators, and typwritters
the oIIice employees use, and @$-&=$74 ?:*&%<$'+, Ior the value oI the trucks
and automobiles the business uses to deliver its merchadise to customers. A
manuIacturing enterprise would probably show the value oI the machines in
its Iactory as 9.)+"74 A.)B&'$74 .'6 ?:*&%<$'+.

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PIant, Property and Equipment, Continued

Furniture and
Fixtures
The original cost less accumulated depreciation is shown to give the
depreciated value oI Iurniture and Iixtures used in the operation oI the
business. The title Furniture and Iixtures almost explains itselI and may also
be subdivided. Desks and chairs and counters used by oIIice employees might
be listed as >00&)$ 9*7'&+*7$ .'6 9&C+*7$2. Display cases, chairs used by
customers, and merchandise counters in a department store could be entitled
D+"7$ 9*7'&+*7$ .'6 9&C+*7$2.

Accumulated
Depreciation
All property and equipment accounts except land are subject to depreciation.
Depreciation is the allocation oI the cost oI a property account to its period oI
useIulness in order to recognize a decline in its value because oI wear and
tear, obsolescence or inadequacy. The total amount oI depreciation
accumulated over a number oI years is called accumulated depreciation.

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Current LiabiIities

Overview Current liabilities are debts or obligations oI a business that are expected to be
liquidated by the use oI assets classiIied as current or by the creation oI
another current liability.

Accounts
payable
The total amount owed by the business as oI balance sheet date Ior purchases
oI merchandise, supplies, and services made on a charge account basis and
due within one year Irom the balance sheet date.

Notes Payable The amounts owed by the business on the basis oI Iormal, signed notes such
as the thirty-day or six-month notes signed when borrowing Irom a bank. II
merchandise is bought and the creditor requires the business to sign a note Ior
the amount oI the purchase, the title Notes Pavable is used. II the same
business borrowed Irom a bank, the liability may be shown also as Notes
Payable. This is classiIied as current liability iI the note is due within one
year.

Interest
Payable
The amount oI interest owed by the business as oI balance sheet date Ior
money borrowed on interest bearing promissory notes issued by the Iirm.
This interest debt builds up each day. The loan is outstanding-the interest
accrues-and it is shown as a separate liability apart Irom the Iace value oI the
note, which appears in the Notes Payable account.

Deferred
Income
Income already collected but not yet earned. Rental payment received by the
lessor Irom the lessee may be treated as unearned rent income by the Iormer.

Taxes Payable The amount oI taxes owed by the business as oI balance sheet date.

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Long-Term LiabiIities

Overview Long-term liabilities are debts or obligations that will become due and
payable aIter one year Irom balance sheet date.

Notes Payable
Long Term
Amounts on signed Iormal notes due aIter one-year Irom the date oI the
balance sheet.

Installment
Contracts
Payable
Amounts payable aIter one year Irom 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 Irom
the balance sheet date are listed as current liabilities.

Mortgage
Payable
A debt due aIter one year Irom the balance sheet date that has some oI the
business property, such as land, buildings, or equipment-pledged as security.

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Owner's Equity

Overview Owner`s equity or sometimes called capital or proprietorship is the excess oI
assets over liabilities oI a business.

Capital The amount invested in the business by the owner as oI the balance sheet date.

Withdrawal When the owner withdraws cash or other assets Irom the business Ior personal
use, its assets and its owner`s equity both decrease. The amounts taken out oI
the business appear in a separate account entitled Withdrawals, or Drawing.
II withdrawals were recorded directly in the capital account, the amount oI
owner withdrawals would be merged with owner investments. To separate
these two amounts Ior decision-making, businesses used a separate account
Ior Withdrawals. This account shows a decrease in owner`s equity.

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Debit and Credit of BaIance Sheet Items

Overview Analyzing business transactions would involve a dual eIIect in any oI the
elements oI the accounting equation. These dual eIIects would be analyzed
and recorded in terms oI debit and credit. This part oI the study guide will
introduce the readers on the basic understanding oI the rules oI debit and
credit aIIecting balance sheet items.

Account The basic summary device oI accounting is the .))"*'+; This is a detailed
record oI the changes that have occurred in a particular asset, liability or
owner`s equity during a period oI time.

T-Account For the purpose oI analyzing the balance items into debit and credit, we will
be using in our illustrations the T-account. It takes the Iorm oI the capital
letter 'T. The vertical line in the letter divides the account into its leIt and
right sides. The account title rests on the horizontal line.
For example, the cash account oI a business appears in the Iollowing T-
account Iormat:
CASH

LeIt side
Debit
Right side
Credit

The leIt side oI the account is called the 6$1&+ 2&6$, and the right side is
called the )7$6&+ 2&6$. OIten beginners in the study oI accounting are
conIused by the words debit and credit. To become comIortable using
them, simply remember
debit leIt side
credit right side

The type oI an account determines how increases and decreases in it are
recorded. Increases in assets are recorded in the leIt (the debit) side oI
the account. Decreases in the assets are recorded in the right (the
credit) side oI the account. Conversely, increases in liabilities and
owner`s equity are recorded by credits. Decreases are recorded by
debits.
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Debit and Credit of BaIance Sheet Items, Continued

Accounting
Equation
This pattern oI recording debits and credits is based on the accounting
equations:
ASSETS LIABILITIES OWNER`S EQUITY
Rules oI Debit Credit Debit Credit Debit Credit
Debit and Ior Ior Ior Ior Ior Ior
Credit Increase Decrease Decrease Increase Decrease Increase

Illustration The Iollowing examples illustrate the accounting equations:
Joseph Labrador invested P100,000 cash to begin his accounting
business.


Cash Labrador, Capital
Debit
Ior increase
Php 100,000
Credit
Ior increase
Php 100,000

The business purchased oIIice supplies on account Ior P5,000.


OIIice Supplies Accounts Payable
Debit
Ior increase
Php 5,000
Credit
Ior increase
Php 5,000

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Debit and Credit of BaIance Sheet Items, Continued

Illustration,
con`t.
The Iollowing examples illustrate the continuation oI the accounting
equations:
The business paid one year rental Ior its oIIice space, P24,000.


Prepaid Rent Cash
Debit
Ior increase
Php 24,000
Credit
Ior increase
Php 24,000

The business paid oI the amount owed in buying oIIice supplies.


Accounts Payable Cash
Debit
Ior increase
Php 2,500
Credit
Ior increase
Php 2,500
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Unit III and IV
Income Statement and Statement of Equity
Overview

Background Owners, management and other stakeholders oI the business would want to
know whether the business is earning Irom its operations. The results oI
business operations are summarized and reported in the Iinancial statement
called income statement.
The interval covered by the income statement is known as the .))"*'+&'(
%$7&"6, i.e., any period usually oI 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 oI Unit III 'Income Statement is to illustrate how an income
statement may be prepared and the nature oI the diIIerent accounts included in
the said statement.
Income Statement provides Iinancial inIormation regarding the results oI
business operations Ior a given period oI time. It is a report that shows
whether or not the business achieved its primary objective oI earning a %7"0&+
or '$+ &')"<$.
An income statement is prepared by listing
! the revenues earned during the period;
! the expenses incurred in earning the revenue;
! and subtracting the expenses Irom the revenue to determine iI a net income
or a net loss was incurred.

The purpose oI Unit IV 'Statement oI Owner`s Equity is to show how the
capital statement may be prepared and how withdrawals oI proprietor and the
Iirm`s Iinancial perIormance may eIIect the balance oI capital at the end oI
every accounting period.

Topics See Page
Forms oI Income Statement 2 oI C
Income Accounts 7 oI C
Expense Accounts 8 oI C
Debit and Credit oI Income Statement
Accounts
10 oI C
Statement oI Equity or Capital Statement 12 oI C

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Forms of Income Statement

Overview The Iorms oI income statement that a business prepares depend on the nature
oI the business activity undertaken by the Iirm. As provided in the revised
Philippine Accounting Standard (PAS). 1, service oriented businesses
normally prepare the natural Iorm, Iormerly known as the single step income
statement and trading and manuIacturing Iirms normally use the Iunctional
Iorm, Iormerly known as the multiple-step income statement Iormat.

Natural Form The income statement presentation under this Iorm arranges all income
accounts in one group, all expense accounts in another group and then deducts
the total expenses Irom the total income in a single-step operation oI
subtraction to arrive at the Iinal result oI net income or net loss.

Illustration Below is an illustration oI a natural Iorm income statement:
1OSEPH LABRADOR CONSULTANCY
Income Statement
For the year ended December 31, 20X1
Revenues: Note
Service ncome P 650,000
Other ncome (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
nsurance 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 ncome P 27,500

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Forms of Income Statement, Continued

Notes to the
Natural Form
The Iollowing are the notes to the natural Iorm income statement:

Note 1 - Other ncome
nterest 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

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Functional
Form
The income statement presentation under this Iorm clearly shows speciIic sections
oI income, costs and expenses in a series oI arithmetic operations. This Iorm
requires that cost oI goods sold and the expenses be subtracted in steps to arrive at
the net income. Merchandising businesses uses this Iormat.

Illustration Below is an illustration oI a Iunctional Iorm income statement:
213,45 6"7#"81# 91-3/+:"-&;
<-&1=, >:":,=,-:
"#$ %&' (')$ '*+'+ ,'-'./'$ 012 3451

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
nterest expense 1,000 (40,000)
Net income P 11,000

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Notes to the
Functional
Form
The Iollowing are the notes to the Iunctional Iorm income statement:

Note 1 - Net saIes revenue
Gross saIes P 200,000
Less: SaIes Returns & AIIowances P 5,000
SaIes Discount 2,000 7,000
Net saIes revenue P 193,000

Note 2 - Cost of saIes
Merchandise Inventory, Jan. 1 P 5,000
Add: Net cost of purchases
Purchases P 175,000
Less: Purchase Returns & AIIowances P 3,000
Purchase Discounts 2,000 5,000
Net purchase P 170,000
Add: Freight-in 1,000 171,000
Cost of goods avaiIabIe for saIe P 176,000
Less: Merchandise Inventory, Dec. 31 31,000
Cost of saIes P 145,000

Note 3 - Other operating income
Rent Income P 1,500
Dividend Income 800
Interest Income 500
Gain on SaIe of Furniture & Fixtures 200
TotaI other income P 3,000

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Notes to the Functional Form (continued)

Note 4 - SeIIing expenses
SaIesmen's SaIaries and Commissions P 9,000
Representation and Entertainment 1,200
Depreciation - Store Equipment 1,000
SSS & PhiIheaIth Premiums 900
Freight-out 800
MisceIIaneous SeIIing Expense 1,100
TotaI seIIing expenses P 14,000

Note 5 - Administrative expenses
SaIaries Expense P 15,000
Light, Water and TeIephone 3,500
UncoIIectibIe Accounts 2,000
Depreciation Expense 1,500
SSS & PhiIheaIth Premiums 1,300
MisceIIaneous GeneraI Expense 700
TotaI administrative expenses P 24,000

Note 6 - Other operating expenses
Loss on SaIe of Equipment P 800
Discount Lost 200
TotaI other operating expenses P 1,000

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Income Accounts

Overview The Iollowing are the usual income statement account Iound in a single-step
income statement

Service Income DiIIerent businesses have diIIerent ways oI earning income. The term that is
generally used to reIer to any kind oI income Irom services rendered is 2$7=&)$
&')"<$. This represents the inIlow oI cash or non-cash assets arising Irom
services rendered. Other account names that may be used to reIer to income
Irom services describes the speciIic nature oI the service rendered: (PeIianco,
E., Mercado, R., 1983)
! Professional Fees. These indicate income Irom rendering proIessional
services without speciIying the particular nature oI proIessional service
rendered.
! Medical Fees. This reIers to income received Irom rendering medical
services.
! Legal Fees. This reIers to income received Irom rendering legal services.
! Dental Fees. This reIers to income received Irom rendering dental services.
! Accounting Fees. This reIers to income received Irom rendering
accounting services.
! Management Fees. This reIers to income received Irom rendering various
management consultancy services.

Other Income This reIer to income Irom sources other than the principal line oI activity oI
the business.
The examples oI other income are:
! Interest Income. The revenue to the payee Ior loaning out a principal
amount to a borrower. This may also reIer to income earned Irom money
deposited in a bank.
! Dividend Income. Income earned in investing cash in stocks oI other
businesses.

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Expense Accounts

Overview Expenses are the cost oI goods or services that are used or consumed in the
operations oI a particular business activity. In service businesses, the
Iollowing are the common expenses

Salaries This is the cost oI services rendered by the employees and/or laborers oI a
business Iirm. This account may be used to include the cost oI all emergency
allowances, 13
th
month pay, and other employee Iringe beneIits.

Rent The rental cost oI oIIice space, equipment, etc.

Office Supplies This reIers to the cost oI oIIice stationery; coupon bond, carbon paper,
typewriter or computer ribbons, envelopes, pencils, ball pens, and oIIice
supply items that are consumed in business operations.

Utilities This reIers to the cost oI light and water consumed as well as the cost oI using
telephone Iacilities.

Taxes and
Licenses
This reIers to all payments required to be made to the Bureau oI Internal
Revenue and the Municipal Treasurer Ior privilege taxes, mayor`s permits,
municipal taxes and licenses, business taxes and others.

Transportation This is the cost incurred by oIIice employees when commuting Irom the oIIice
to the place oI business oI clients, e.g., jeepney Iares, taxi Iares, and bus Iares.
Also included are transportation Iares Irom the oIIice to any place on oIIicial
business. E7.=$--&'( ?C%$'2$ is used when business trips are made out oI
town, the cost oI transportation Iares by plane, by boat, or by bus.

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Expense Accounts, Continued

Gas and oil This reIers to the cost oI gas and oil consumed whenever transportation
vehicles or company cars are used in oIIicial business trips.

Representation The cost incurred when entertaining clients or prospective clients. Included
are the costs incurred when oIIice employees represent the Iirm in some
oIIicial Iunctions.

Depreciation This reIers to the expense associated with the use oI the company`s plant
assets, i.e., spreading (allocating) the cost oI a plant asset over its useIul liIe.

Bad Debts Selling or rendering services on credit create both a beneIit and a cost. Credit
customers who Iail to pay their liabilities will create an expense in the
company. The allocation or provision Ior this Iuture uncollectibility oI some
oI the accounts oI credit customers is called bad debts expense or doubtIul
accounts expense or uncollectible account expense.

Donations and
Contributions
This reIers to contributions made to charitable institutions or any other
worthwhile projects.

Miscellaneous Any other costs oI operations that may not be suIIiciently big in amount to be
classiIied 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 oI 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 oI these
activities which bring about changes in the income statement.

Revenues The purpose oI a business, other than to render service to the community, is to
increase assets and owner`s equity through 7$=$'*$2, 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 oI the business
increases.

! ?C.<%-$F Jose Labrador earns service income by providing proIessional
accounting service Ior his clients. Assume he earns P10,000 and collects
this amount in cash. The eIIect 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. ?C%$'2$2 are decreases in
owner`s equity that occur in the course oI delivering goods and service to
clients. Expenses decrease owner`s equity because they use up the business
assets.
! ?C.<%-$F During the month, Labrador paid the salary oI the company
secretary Ior P5,000. The eIIect 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

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Debit and Credit of Income Statement Accounts, Continued

Normal
Balance
Upon analyzing the eIIects oI income and expense accounts in the owner`s
equity, one may conclude that, since owner`s equity or capital has a '"7<.-
)7$6&+ 1.-.')$, it must Iollow that all income accounts will also have '"7<.-
)7$6&+ 1.-.')$2 since they cause an increase in the capital account. On the
contrary, since expenses have a decreasing eIIect in the capital account, the
normal balance oI all expense accounts would be debit.
The illustration presents two main sources oI 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
Irom the business
Owner investments
in the business
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Statement of Equity or CapitaI Statement

Overview 5.%&+.- D+.+$<$'+ or D+.+$<$'+ "0 >G'$7H2 ?:*&+4 presents a summary oI
the changes that occurred in the owner`s equity oI the entity during a speciIic
time period, e.g., month or a year. Increases in owner`s equity arise Irom
investments by the owner and net income earned. Net loss Ior the period
causes the owner`s equity to decrease. Net Income or net loss comes directly
Irom the income statement. Investments and withdrawals by the owner are
capital transactions between the business and its owner, so they do not aIIect
the income statement.

Withdrawals The owner oI the Iirm would at times withdraw assets Irom the business Ior
personal use. These personal withdrawals would be treated diIIerently
depending on the intention oI the owner in withdrawing such assets

Types of
Withdrawals
! Temporary Withdrawal. The owner withdraws business assets (e.g. cash)
Ior personal use in anticipation oI proIits derived Irom the operations oI the
business. This type oI withdrawal uses the 67.G&'( .))"*'+ when recorded
in the books oI the company.
The pro-Iorma entry to record this type oI withdrawal is:
Joseph Labrador, Drawing xxx
Cash or Other Assets xxx
To record withdrawal oI owner Ior personal use
! Permanent Withdrawal. Capital withdrawal that is substantial in amount.
The owner in this type oI withdrawal oI the assets has the intentions oI
removing the asset permanently Irom the business operations. This type oI
drawing uses the capital account.
The pro-Iorma entry to record this type oI withdrawal is:
Joseph Labrador, Capital xxx
Cash or Other Assets xxx
To record permanent withdrawal oI asset oI owner Irom the business.

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Statement of Equity or CapitaI Statement, Continued

Statement of
Owner`s Equity
The statement oI owner`s equity opens with the owner`s capital balance at the
beginning oI the period. Add net income, (deduct in the case oI net loss)
which directly comes Irom the income statement. Subtract withdrawals by the
owner and the statement ends with owner`s capital balance at the end oI the
period.

Illustration Below is the illustration oI the statement oI the owner`s equity.

1OSEPH LABRADOR, CPA
Statement oI 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 FIows

The basic Iinancial statements we have presented so Iar provide only limited inIormation 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 oI cash generated by
operating activities, or Iinancing activities. The income statement may show expenses and
revenues that may have an eIIect to cash but will not provide reader oI this report how these
income and expenses aIIected 'Cash account. The capital statement shows what happened to
the capital balance oI the owner during the year. None oI these statements presents a detailed
summary oI where cash came Irom and how it was used.

Statement of Cash Flows Defined

The statement oI cash Ilows reports the cash receipts, cash payments, and net change in cash
resulting Irom operating, investing, and Iinancing activities during a period.

Usefulness of the Statement of Cash Flows

The inIormation in a statement oI cash Ilows 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 oI cash Ilows, investors and others can make predictions oI the
amounts, timing, and uncertainty oI Iuture cash Ilows better than they can Irom accrual
basis data.

2. The entity`s ability to pay dividends and meet obligations. II 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 Ilows oI cash in a business.

3. The reasons for the difference between net income and net cash provided (used) by
operating activities. Net income provides inIormation on the success or Iailure oI a
business enterprise. However, some are critical oI accrual basis net income because it
requires many estimates. As a result, the reliability oI number is oIten challenged. Such
is not the cash with cash. Many readers oI statement oI cash Ilows want to know the
reasons Ior the diIIerence between net income and net cash provided by operating
activities. Then they can assess Ior themselves the reliability oI the income number.

4. The cash investing and financing transactions during the period. By examining a
company`s investing and Iinancing transactions, a Iinancial statement reader can better
understand why assets and liabilities changed during the period.

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Classification of Cash Flows

The cash Ilows shown in the statement are grouped into three major categories: (1) operating
activities. (2) investing activities, and (3) financing activities. We will now look brieIly at the
way cash Ilows are classiIied among these three categories.

Operating Activities. The operating activities section shows the cash eIIects oI revenue and
expense transactions. Stated another way, the operating activities section oI the statement oI cash
Ilows includes the cash eIIects oI those transactions reported in the income statement. To
illustrate this concept, consider the eIIects oI credit sales. Credit sales are reported in the income
statement in the period when the sales occur. But the cash eIIects occur later when the
receivables are collected in cash. II these events occur in diIIerent accounting periods, the
income statement and the operating activities section oI the statement oI cash Ilows will diIIer.
Similar diIIerences may exist between the recognition oI an expense and the related cash
payment. Consider, Ior example, the expense oI postretirement beneIits earned by employees
during the current period. II this expense is not Iunded with a trustee, the cash payments may not
occur Ior many years aIter today`s employees have retired.

Cash Ilows Irom operating activities include:

Notice that receipts and payments oI interest are classiIied as operating activities, not as investing
or Iinancing activities because these are shown in the income statement.

Investing Activities. Cash Ilows relating to investing activities present the cash eIIects oI
transactions involving plant assets, intangible assets, and investments. They include:

Cash Receipts Cash Payments
------------------------------------------------------ --------------------------------------------------
Collections Irom customers Ior sales oI Payment to suppliers oI merchandise
goods and services and services, including payments to
Interest and dividends received Payments oI interest
Other receipts Irom operations; Ior Payments oI income taxes
example, proceeds Irom settlement oI Other expenditures relating to operations;
litigation Ior example, payments in settlement oI
litigation
----------------------------------------------------- --------------------------------------------------
Cash proceeds Irom selling investments and Payments to acquire investments and plant
plant assets assets
Cash proceeds Irom collecting principal Amounts advanced to borrowers
Amounts on loans
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Financing Activities. Cash Ilows classiIied as Iinancing activities include the Iollowing items
that result Irom debt and equity Iinancing transactions:

Repayment oI amounts borrowed reIers to repayment oI loans, not to payments made on
accounts payable or accrued liabilities. Payments oI accounts payable and oI accrued liabilities
are considered payments to suppliers oI merchandise and services and are classiIied as cash
outIlows Irom operating activities. Also, remember that all interest payments are classiIied as
operating activities.

The Iollowing illustration lists typical cash receipts and cash payments within each oI the
three classiIications. Study the list careIully. It will prove very useIul in solving homework
exercises and problems.
------------------------------------------------------- --------------------------------------------------
Proceeds Irom both short-term and long-term Repayment oI amounts borrowed (excluding
borrowing interest payments)
Cash received Irom owners (Ior example, Payments to owners, such as cash withdrawals
From investment)
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Note the Iollowing general guidelines: (1) Operating activities involve income statement
items. (2) Investing activities involve cash Ilows resulting Irom changes in investment and long-
term asset items. (3) Financing activities involve cash Ilows resulting Irom changes in long-term
liability and owner`s equity items.

Some cash Ilows related to investing or Iinancing activities are classiIied as operating
activities. For example, receipts oI investment revenue (interest and dividends) are classiIied as
operating activities. So are payments oI 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 inIlows:
From sale oI goods or services.
From returns on loans (interest received) and on equity securities (dividends received).
Cash outIlows:
To suppliers Ior inventory.
To employees Ior services.
To government Ior taxes.
To lenders Ior interest.
To lenders Ior interest.
To others Ior expenses.
Investing activities - Changes in investments and long-term assets
Cash inIlows:
From sale oI property, plant, and equipment.
From sale oI debt or equity securities oI other entities.
From collection oI principal on loans to other entities.
Cash outIlows:
To purchase property, plant, and equipment.
To purchase debt or equity securities oI other entities.
To make loans to other entities.
Financing activities Changes in long-term liabilities and stockholders` equity
Cash inIlows:
From owner`s investments
From issuance oI debt (bonds and notes).
Cash outIlows:
Withdrawal oI cash by the owner
To redeem long-term debt
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Unit VI - Part 1
GeneraI JournaI, GeneraI Ledger, TriaI BaIance
Overview

Background The work Ior each accounting period Iollows a cycle, which is called the
.))"*'+&'( )4)-$. This reIers to a series oI sequential steps or procedures
perIormed 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 oI Unit IV 'General Journal, General Ledger, Trial Balance is
to introduce the student on the use oI a general journal, general ledger and the
preparation oI the trial balance.


Topics See Page
Journalizing (Step 1) 2 oI D
Journal Rules 4 oI D
Journal Entries 6 oI D
The General Ledger 9 oI D
The Chart oI Accounts 11 oI D
Posting to the General Ledger (Step 2) 13 oI D
Balancing Accounts 16 oI D
Trial Balance 17 oI D
Limitations oI the Trial Balance 19 oI D

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JournaIizing (Step 1)

Overview Bookkeeping is the systematic and chronological recording oI transactions in
books oI accounts Iollowing a series oI steps and procedures commonly
reIerred to as the accounting cycle. This bookkeeping procedure begins with
journalizing which is the Iirst part oI this unit.

1ournal 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 I"*7'.-. A
journal is a daily record oI 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
1""# "0 "7&(&'.- $'+7&$2.

1ournalizing The chronological recording oI the business transactions in the book oI
original entry.

Illustration Below is an example oI a typical journal.
JOURNAL
PAGE
Date P A R T C U L A R S P/R DEBT CREDT

!"#$%$& () *"+,-./,+"0!"-"+1 Page 3oI D

JournaIizing (Step 1), Continued

Legend The deIinitions below illustrate the legend:
! Date, is used to show the day oI 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 aIIected by each transaction and
to give some explanation or justiIication oI the debits and credits being
made to the accounts.
! P/R (Posting Reference) column is important because it indicates the
numbers oI the accounts in the ledger to which the debits and credits
recorded in the journal have been transIerred. In manual systems, these
account numbers are inserted at the proper time in the P/R column oI the
journal.
! Debit and credit columns indicate the amounts to be debited or credited to
the account titles written in the particulars column.

!"#$%$& () *"+,-./,+"0!"-"+1 Page 4oI D

JournaI RuIes

Overview The Iollowing guidelines will be useIul when recording transactions in a
general journal.

1ournal Rules The recording process Iollows these Iive steps:
! 1. Transactions are Iirst analyzed, identiIying the transaction Irom business
source documents, e.g., oIIicial receipts, cash vouchers, etc. All
transactions recorded in journals must be based upon some obfective
verifiable evidence. Business documents are Iormal written records that
provide inIormation to everyone with an understanding oI accounting to
measure the amount oI the transaction and to analyze it in the same way.
The data used Ior the journal entry are veriIiable iI it is possible to trace the
transaction to its point oI origin.
! 2. The day on which the transaction took place is written in the Date
column.
! 3. The account titles aIIected by the transactions are put into the particulars
column. It is an accepted practice to list Iirst in each transaction the account
title/s being debited, Iollowed by the account title/s being credited. The
debited account titles are written against the leIt margin oI the particulars
column. The accounts being credited are indented Irom the leIt margin oI
the particulars column. II any single transaction requires several debits and
credits, all account titles receiving the debits will be listed Iirst, Iollowed 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.

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JournaI RuIes, Continued

1ournal Rules,
con`t.
Continuation oI the steps:
! 4. A brieI explanation is written immediately below the last account title
credited. This gives the reason why the accounts are being debited or
credited and veriIies the amounts used. The explanations Iollow 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 Iollowing the explanation to help
distinguish one journal entry Irom the next. Thus, each journal entry
consists basically oI Iour parts:
! Transaction date
! Debit entry
! Credit entry
! Explanation

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JournaI Entries

1ournal Entries The Iollowing transactions oI 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 Iirst and the proper method oI
recording the transactions Iollows in the illustrative journal Iorm.
Transaction
Date Description of Transaction
September 1 Mr. Joseph Labrador began his accounting Iirm by
investing cash oI P300,000 and Iurniture oI
P50,000.
2 Paid the business tax to the City Treasurer, P5,000.
3 Purchased a computer Irom CompuCenter Ior
P40,000 on account
4 Purchased various oIIice supplies Irom National
Bookstore, P7,000.
5 Sent charge bills to ABC Co. Ior accounting
services rendered, P10,000.
6 Made a partial payment oI P10,000 to
CompuCenter
7 Received P5,000 in cash Ior services rendered to
XYZ Co.
8 Mr. Labrador withdrew P8,000 cash Ior personal
use.
9 Paid repairman Ior repair service on the oIIice
Iurniture, P500.
10 Paid in cash the Iollowing:
Secretary`s salary P3,500
PLDT & MWSS Bills 1,500

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JournaI Entries, Continued

Example of
1ournal entries
Below is a typical journal with journal entries:
P a g e 1
DATE P A R T C U L A R S P/R D E B T C R E D 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
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 ncome 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 ncome 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

!"#$%$& () *"+,-./,+"0!"-"+1 Page 8oI D

JournaI Entries, Continued

Compound
1ournal Entry
A )"<%"*'6 $'+74 (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 oI
the recorder. Compounding an entry, however, is not to be used to serve
laziness at the sacriIice oI clarity. Compound entries should be used only Ior
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 Iollows:
Sept. 1 Cash 300,000
OIIice Iurniture & Iixture 50,000
Joseph, Capital 350,000

Sept. 10 Salaries & wages expense 3,500
Utilities expense 1,500
Cash 5,000
Paid salary oI secretary & PLDT
& MWSS bill

!"#$%$& () *"+,-./,+"0!"-"+1 Page 9oI D

The GeneraI Ledger

Overview Since transactions are recorded in the journal according to their dates oI
occurrences, items oI similar nature are not grouped together. InIormation in
the general journal is spread among the various transactions recorded. II
inIormation regarding an item is desired, say, cash, Ior example, it is still
necessary to gather the inIormation Irom the scattered pages oI the journal.
Due to this inconvenience, there is a need Ior another record in which data
appearing in the journal may be summarized to show the status oI each item.
Each item is represented by an account. A group oI accounts constitutes a
ledger. The general ledger is also known as the 1""# "0 0&'.- $'+74
(Punzalan, J., Santos, M., 1969).

Forms of
General Ledger
There are two possible Iorms oI general ledger account. These are:
! Standard Form
The standard form of the account looks like this:
ACCOUNT NO.
Date T E M S P/R DEBT Date T E M S P/R CREDT

The headings in each column oI this Iorm indicate the type oI
inIormation that is recorded. There is a complete set oI columns,
Date, Items or Explanation, P/R, Amount, Ior each side (debit and
credit oI the account). The Date column shows the day each
transaction aIIecting the account took place. The Item column,
which is rarely used, gives inIormation about unusual transactions
recorded in the account. The P/R column is called a posting
reIerence column and tells the source oI the debit or the credit being
entered in the account. The debit and credit columns show the peso
amount Ior each transaction recorded in the account.

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The GeneraI Ledger, Continued

Forms of a
ledger
The other account Iorm is
! Running Balance Form
ACCOUNT NO.
Date T E M S P/R DEBT CREDT BALANCE

This type oI account permits an analysis oI transactions in terms oI
debits and credits, but the arrangement oI the columns is diIIerent
Irom the standard account Iorm. The sample shows this running
balance Iorm oI account; its use will be deIerred until you have
become more Iamiliar with recording transactions in the standard
account Iormat.

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The Chart of Accounts

Overview An accountant usually prepares a )B.7+ "0 .))"*'+2, which is the listing oI 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 oI the business, the kinds oI transactions, which
are likely, and the names oI the accounts needed to record the inIormation.
He prepares the chart oI accounts in a ledger order, which is also the Iinancial
statement order. Whenever necessary, the accountant or a newly trained
employee may reIer to the chart Ior speciIic account titles and Ior the position
oI such accounts in the ledger or in the statements.

Illustration The chart oI accounts prepared Ior Joseph Labrador, CPA Iollows:
Account No. Account Title
ASSETS
101 Cash
102 Marketable Securities
103 Notes Receivable
104 Accounts Receivable
104-A Allowance For DoubtIul Accounts
105 Interest Receivable
106 Advances To Employees
107 OIIice Supplies
108 Prepaid Rent
109 Prepaid Insurance
201 Land
202 Building
202-A Accumulated Depreciation-Building
203 OIIice Equipment
203-A Accumulated Depreciation-OIIice Equipment
204 OIIice Furniture And Fixture
204-A Accumulated Depreciation-OIIice Furniture &
Fixture

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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 DoubtIul Accounts Expense
604 Gas & Oil Expense
605 Insurance Expense
606 Interest Expense
607 Miscellaneous Expense
608 OIIice 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 GeneraI Ledger (Step 2)

Overview Journals are called books oI original entry because the inIormation Irom the
underlying business papers, i.e., receipts, invoices, etc., is recorded here Iirst.
In most businesses, accounting transactions seldom go to the ledger accounts
without Iirst having been recorded in a journal. The journalized transactions
must, however, be transIerred to the ledger accounts so that the changes in
individual asset, liability, proprietorship, revenue and expense items may be
accumulated. The process oI transIerring the data Irom journal entries to the
individual account in the ledger is called %"2+&'(. Posting simply involves
transIerring the journalized debit and credit data to each account name in the
journal entry. The amounts are written on the side oI the accounts as
speciIied in the journal entry.

1ournal Entry The journal entry and the procedure Ior posting the debit portion oI this
transaction to the proper account are illustrated below:
PAGE 1
20X1
Sept. 1 Cash 101 1 5 0 0 0 0
Labrador , Capital 1 5 0 0 0 0
nitial nvestment

Debit Posting
procedure
On the debit side oI the account, in the ledger:
1. Enter the year (where needed), the month (where needed), and the day in
the Date column oI the account aIIected.
2. Enter the amount in the debit column oI the amount aIIected.
3. Enter the journal posting reIerence (journal symbol, e.g., GJ Ior general
journal and page number) in the P/R column to show the source oI the
data posted.
4. In the journal, enter the ledger posting reIerence (account number) in the
P/R column Ior the debit part oI the transaction, indicating the completion
oI the posting.

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Posting to the GeneraI Ledger (Step 2), Continued

Illustration Below is the illustration oI the debit posting procedure.
Debit Posting Illustrated

CASH ACCOUNT NO. 101
20X1
Sept. 1 GJ1 1 5 0 0 0 0

1ournal Entry The journal entry and the procedure Ior posting the credit portion oI the given
transaction Iollow:
PAGE 1
20X1
Sept. 1 Cash 101 1 5 0 0 0 0
Labrador , Capital 401 1 5 0 0 0 0
nitial nvestment

Credit Posting
Procedure
On the credit side oI the account in the ledger:
1. Enter the year (where needed), the month (where needed), and the day in
the Date column oI the account aIIected.
2. Enter the amount in the credit column oI the account aIIected.
3. Enter the journal posting reIerence (journal symbol and page number) in
the P/R column to show the source oI the data posted.
4. In the journal, enter the ledger posting reIerence (account number) in the
P/R column Ior the credit part oI the transaction, indicating the completion
oI the posting.

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Posting to the GeneraI Ledger (Step 2), Continued

Illustration Below is the illustration oI the credit posting procedure.
Credit Posting Illustrated
Labrador, Capital ACCOUNT NO. 401
20X1
Sept. 1 GJ1 1 5 0 0 0 0

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BaIancing Accounts

Overview The general ledger accounts provide a means Ior determining the amount Ior
each oI these items that exist at the end oI each accounting period or at any
other time. This inIormation is obtained by balancing the accounts.
Balancing accounts in the general ledger is a simple procedure. First, the debit
and credit sides oI each account are Iooted (totaled) whenever more than one
Iigure appears in a column, and the totals are inserted in small penciled
figures immediately below the last entry on each side oI the account. Second,
the total oI the debits in each account is compared with the total oI the credits.
Third, when the total oI the debits is greater than the total oI the credits, the
diIIerence between the two totals is inserted in pencil on the debit side oI the
account Iollowing the line with the penciled Iooting. II the total oI the credits
is more than the total oI the debits, the diIIerence is inserted in pencil on the
credit side next to the penciled Iooting. Asset and expense accounts will
normally have debit balances. Liability capital and revenue accounts will
normally have credit balances.

Illustration Below is an illustration oI Posting the Cash Account transactions oI J.
Labrador Irom September 1 to 10:
CASH ACCOUNT NO. 101
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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TriaI BaIance

Overview The trial balance is a list oI schedule oI open accounts in the general ledger
with their corresponding account balances, i.e., the diIIerence between the
total debits and total credits oI an account in the ledger. It is prepared to
veriIy the equalitv of debits and credits in the ledger at the end oI each
accounting period or at any time the postings are updated.
The previous section has shown the procedure Ior entering transactions
directly in the ledger accounts and the way to determine the balances oI
accounts aIter the transactions Ior an accounting period has been recorded. At
this point in the sequence, it is advisable to check the work Ior 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 oI the debits and credit entries in the ledger. This schedule has the
Iollowing characteristics:
! It is a list oI accounts.
! The list oI accounts is unclassiIied; 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.
II the accounts have been debited and credited with equal amounts Ior each
transaction during the accounting period, and iI the balances oI all accounts
have been accurately calculated, the sum oI the debit balance accounts (the
assets and the expenses) will equal the sum oI the credit balance accounts (the
liabilities, proprietor`s capital and revenues).
It is important to note that the trial balance is a list prepared Ior all accounts
with open (debit or credit) balances. Accounts with zero balances are
excluded.

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TriaI BaIance, Continued

Reminder The trial balance is not a complete prooI oI the correctness oI the accounting
entries recorded. It is possible to debit on asset account instead oI an expense
account, credit a revenue account instead oI a liability account, make
compensating arithmetic errors (errors that oIIset each other), or debit and
credit the appropriate accounts but Ior 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 oI the limitations oI the trial
balance, it is nevertheless an important tool in checking the equality oI the
debit and credit balances in the general ledger. In addition to providing a kind
oI prooI oI work done the trial balance may also be used as a source oI
inIormation Ior the preparation oI balance sheet and income statement.

Illustration Below is the trial balance oI Joseph Labrador, CPA:
Joseph Labrador, CPA
Trial Balance
September 10, 20X1

ACCOUNT TITLES

DEBIT

CREDIT

Cash 269,500
Accounts Receivable 10,000
OIIice Supplies 7,000
OIIice Equipment 40,000
OIIice 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

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Limitations of the TriaI BaIance

Overview The Trial Balance provides prooI that the ledger is in balance. The agreement
oI the debit and credit totals oI the trial balance gives assurance that
! Equal debits and credits have been recorded Ior all transactions.
! The debit or credit balance oI each account has been correctly computed.
! The addition oI the account balances in the trial balance has been correctly
perIormed.

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 oI the credit
total. The Iollowing are the steps in locating errors in the trial balance:
! Prove the addition oI the trial balance by adding columns in the opposite
direction Irom that previously Iollowed.
! II the error does not lie in the addition, determine the exact amount by
which the trial balance is out oI balance. The amount oI the discrepancy is
oIten a clue to the source oI the error.
! II the diIIerence is divisible by 9, this suggests either a:
! Transposition Error. An interchange in the order oI the digits oI a
number, e.g., 87 Ior 78; 453 Ior 354; 1234 Ior 4231; etc. The Iirst 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.

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Limitations of the TriaI BaIance, Continued

Limitations,
cont.
Below is the continuation oI steps in locating errors in the trial balance:
! Transplacement Error. Also known as sliding error, occurs when some or
all the digits oI a number are moved one or more places to the leIt or right,
e.g., 450.00 written as 45.00 or as 4.50 or as 4005.00. The Iirst 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. AIter the division is perIormed, the quotient always
indicates the Iigure transplaced.
! II the diIIerence is an even number, divide it by 2. The quotient could be
the balance oI an account that is erroneously copied to the trial balance on
the wrong side or the amount oI a journal entry that is posted on the wrong
side oI 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 oI each ledger account.
Trace all postings Irom the journal to the ledger accounts. As this is done,
place a check mark in the journal and in the ledger aIter each Iigure is
veriIied. When the operation is completed, look through the journal and the
ledger Ior unchecked amounts. In tracing postings, be alert not only Ior errors
in amount but also Ior debits entered as credits, or vice versa.

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Unit VI - Part 2
Accounting for SaIaries
Overview

Background Every business that has employees is required to keep some kind oI record oI
wages and salaries paid. A business must have correct inIormation about the
reported earnings oI 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 Ior each employee
and must be able to prove the correctness oI 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 rightIully entitled.
The summary oI the employees` salary is prepared in a report called pavroll
register. This is accomplished depending on the payroll period being
Iollowed by the company either in a weekly, semi-monthly or monthly basis.

Purpose The purpose oI 'Accounting Ior 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 oI
those deductions made to proper government agencies.


Topics See Page
Recording Salary Expenses 2 oI E

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Recording SaIary Expenses

Overview All business entities normally hire employees to perIorm its various
operations. Salaries oI these employees must be properly computed and paid
at a speciIied time (e.g. weekly, bi-monthly, monthly).
In this section, readers will be introduced on how to journalize transactions
aIIecting payment oI employees` salaries with corresponding deductions as
required by law or due to some other reasons such as loans made by
employees Irom the company.

Social Security
System
Under PD No. 24, 'no person shall be employed unless he has a social
security number. It is thereIore a requirement that all employees in the
private sector be members oI the Social Security System (SSS). The system
provides beneIits and services to its members which include the Iollowing:
salary loans, educational loans, housing loans, sickness and death beneIits,
unemployment beneIits, disability beneIits, pension beneIits and
reimbursement oI Iuneral expenses Ior deceased members. In consideration
Ior all these beneIits, the employee is required to make a monthly contribution
in accordance with a contribution table provided by the SSS. This
contribution oI the employee is deducted Irom his salary. The corresponding
contribution oI the employer is an "%$7.+&'( $C%$'2$, i.e., DDD 5"'+7&1*+&"'
?C%$'2$.

Philhealth The Philippine Medical Care Commission (PMCC) was established to
provide hospitalization and other medical beneIits 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 oI the employee is deducted Irom his salary. The contribution oI
the employer is an "%$7.+&'( $C%$'2$, i.e., JB&-B$.-+B 5"'+7&1*+&"' ?C%$'2$.

Pag-ibig Fund The Pag-ibig Fund is a provident savings and housing Iund Ior employees
established under P.D. No. 1752. It aims to generate mass savings geared
towards Iinancing homes Ior its members. All private employees who are
members oI the SSS and their employers are covered by the Iund
compulsorily. The employer and its employees in accordance with the pag-
ibig contribution table make contributions to the Pag-ibig Fund.

!"#$%$& () *"+,-./,+"0!"-"+1 Page 3oI E

Recording SaIary Expenses, Continued

Witholding
Income Tax
Under the Bureau oI Internal Revenue regulations, every employer is required
to deduct and withhold income tax Irom the salary oI its employees in
accordance with a withholding tax table. The amount oI income tax to be
withheld Irom the employees will depend on whether the employee is single,
married, a head oI the Iamily, a married woman whose husband is also
working, and on the number oI his qualiIied dependents.

Illustration
No. 1
The Iollowing is an illustration oI how to record salary expense with various
deductions:
September 30, 20X1 transaction:
J. Labrador, CPA paid salaries to employees, P32,500. Deductions were made
Ior the Iollowing: 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 oI salaries Ior the
period Sept. 1-30

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Recording SaIary Expenses, Continued

Illustration
No. 2
The Iollowing are illustrations oI how to record remittances made to diIIerent
government agencies:
October 10, 20X1 transaction:
Remitted to Bureau oI Internal Revenue (BIR) the tax withheld Irom
employees` salaries Ior 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
Iollows:
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.

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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 oI money at a Iixed determinable Iuture time which may or
may not include interest.

Purpose The purpose oI Unit VIII 'Accounting Ior Promissory Note is to illustrate
how an issued promissory note would be recorded in the books oI both the
maker and the payee. A lengthy discussion oI discounting customers`
promissory note is also included in this unit.


Topics See Page
Promissory Note 2 oI F
Typical Transactions 4 oI F
Interest on Notes 5 oI F
Discounting a Note Receivable 6 oI F
Endorsement or Discounting with Recourse 7 oI F
Notes Receivable Discounted in the Balance
Sheet
12 oI F
Discounting Own Note Issued 13 oI F
Review Questions 14 oI F
Exercises 15 oI F

!"#$%$& () *"+,-./,+"0!"-"+1 Page 2oI F

Promissory Note

Overview A promissorv note is an unconditional promise to pay a deIinite sum oI
money on demand or at a Iuture 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 Iixed or determinable Iuture 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 oI the balance sheet. The
maker regards them as Notes Pavable in the current liabilities section oI the
balance sheet (Needles, Belverd, et al, 1999). The Iollowing is an example oI
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
oI Ten Thousand Pesos (P10,000.00) on August 30, 20X1 plus interest at the
annual rate oI 12 percent.

(Signed) Mary de Jesus

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Promissory Note, Continued

Components The components oI a promissory note are as Iollows:
! 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 Iuture
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 oI the note. In the illustration
P10,000.00.
! Interest. The revenue to the payee Ior loaning out principal and the
expense to the maker Ior borrowing the principal.
! Interest period or term of the note. The period oI time during which
interest is to be computed. It extends Irom the date oI the note to
maturity date.
! Interest rate. The percentage rate that is multiplied to the principal
amount and the term oI the note in computing Ior the interest.
! Maturity date or due date. The date on which Iinal payment oI the
note is due.
! Maturity value. The sum oI principal and interest due at the maturity
date oI note.
! Place of issue. The locality where the maker executed the note. In the
illustration Quezon City.

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TypicaI Transactions

Overview A promissory note may arise Irom any oI the Iollowing transactions:
1. A client receives services on goods Ior which he issues a promissory note
in Iavor oI the company. The client is a debtor and is the maker oI the
note. The company to whom the note was issued is a creditor and is the
payee oI the note.
2. The client has an outstanding account with the company, which will
become due. II the client is not in a position to pay, he could oIIer a
promissory note to extend time Ior the payment oI 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 Irom services rendered or goods sold. When a company renders
services or sells merchandise to a customer and receives a promissory note in
consideration Ior such goods or services, the transaction is recorded as:

Notes Receivable
Service Income or Sales
Received note Ior services rendered or goods sold.
xxx
xxx

Illustration
No. 2
Note arising to extend an account. II the sample promissory note illustrated is
given to extend payment oI an account, the transaction will be recorded as:

Notes Receivable
Account Receivable
Received note to extend payment oI an account.
xxx
xxx

Illustration
No. 3
Note arising Irom a loan transaction. II the note was received in consideration
oI a loan, the transaction will be recorded as:

Notes Receivable
Cash
Received note Ior a loan granted.
xxx
xxx

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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 Ior interest so that the amount to be paid at maturity is equal to the
Iace value oI the note. An interest-bearing note, on the other hand, is a note
which provides Ior payment oI the interest so that the amount to be paid at
maturity is equal to the maturity value, i.e., sum oI the principal and interest

Illustration The sample promissory note illustrated above issued by Mary de Jesus in
Iavor oI Joseph Labrador Ior P10,000 is an interest-bearing note. The note
will become due on August 30, 20X1. On this date Labrador will receive Iull
payment on the note.
Interest is computed using the Iormula: Principal x Rate x Time.
ThereIore:
Interest (P10,000 x 12 x 60/360) P 200
Principal 10,000
Maturity Value P 10,200

The entry to record collection oI the note at maturity is:

Cash
Notes Receivable
Interest Income
Collected note on the date oI maturity
10,200
10,000
200

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Discounting a Note ReceivabIe

Overview A promissory note is a negotiable instrument. This means that a note is readily
transIerable Irom one business or person to another and may be sold Ior cash.
To obtain quick cash, payees sometimes sell or endorse a note received Irom
another party beIore it matures. The payee normally endorses the note to a
bank, which in turn collects the maturity value Irom the maker at maturity
date.

Note
Receivable
Discounting
Endorsing a note receivable beIore maturity is called 6&2)"*'+&'( . '"+$
7$)$&=.1-$ because the payee oI the note receives less than its maturity value.
This lower amount decreases the amount oI interest income the payee earns
on the note. Giving up some oI this interest is the price the payee is willing to
pay Ior the convenience oI receiving cash early.

Endorsement When a note is discounted at the bank beIore maturity, the bank advances the
money equal to its value on the date oI discounting computed on the bank rate
oI discount. The endorsement to the bank may either be
! with recourse or
! without recourse.

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Endorsement or Discounting with Recourse

Overview The holder oI 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 oI the note). The bank expects to collect the maturity value
oI the note on the maturity date but also has recourse against the endorser or
seller oI the note. II the maker Iails to pay on maturity date, the endorser is
liable to the bank Ior payment (Needles, Belverd, et al, 1999). The endorser
has a contingent liabilitv in the amount equal to the maturity value oI the note
plus any protest Iee that may be charged by the bank Ior the dishonoring oI
the note by the maker.

Illustration Endorsement or discounting with recourse, thereIore, has the eIIect oI
guaranteeing the payment oI the note at maturity by the maker. II 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 Ior discounting. On Aug. 30, 20X1, the maker de Jesus,
should pay the bank. II he Iails to do so, Cocobank can collect Irom 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 Iailure oI the maker, i.e., Joseph de Jesus, to pay the note at
maturity. Not until aIter this event may the endorser be held liable Ior
payment by the bank. This is known in accounting as a )"'+&'($'+ -&.1&-&+4.

!"#$%$& () *"+,-./,+"0!"-"+1 Page 8oI F

Endorsement or Discounting with Recourse, Continued

Without
Recourse
?'6"72$<$'+ "7 6&2)"*'+&'( G&+B"*+ 7$)"*72$ is done by writing the words
without recourse in the endorsement. Example oI such endorsement is:

The eIIect oI an endorsement without recourse is to exempt the endorser Irom
any liability, iI the maker does not pay at maturity with certain exceptions.
Generally, thereIore, the endorser in this case does not incur any liability, even
iI only a contingent one. This type oI discounting (without recourse) has the
eIIect oI collecting the note Irom a party (the bank), which assumes the role oI
the creditor. As such the credit entry is to Notes Receivable (Pasion, D.,
Pasion, W., Pasion, E., 1990).

Illustration of
discounting
with recourse
The Iollowing discussions will pertain only to discounting oI notes with recourse.
There are three dates encountered in the computation oI the amount to be received
Irom the bank Ior a note receivable discounted.
To Illustrate, assume the Iollowing transactions:
July 1, 20X1 - For merchandise sold, Mary de la Cruz received Irom 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 oI Joseph de Jesus at BPI. Bank
discount rate is 14.
The above may be diagrammed as Iollows:
60 days
Date oI 26 days Date oI 34 days Date oI
note Discounting Maturity
July 1 July 27 Aug. 30
The diagram illustrates that the entire term oI the note is Ior 60 days. The start
oI 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 oI the note oI 60
days less the expired days oI 26 is equal to 34 days, which in turn represent the
discount period (i.e., the period Irom the date the note was discounted up to
maturity date).

Without recourse

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Computing for
the Net
Proceeds
Steps in computing Ior the net proceeds, i.e., the amount to be paid by the
bank to the endorser oI 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 oI days Irom the date oI discounting to the date oI
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 Ior the discount, the bank
normally gives a higher discount rate but iI no rate was given, use the
interest rate oI the note.

Discount Maturity Value x Discount Rate x Discount Period
10,200 x 14 x 34/360 134.87

IV. Compute Ior 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.

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1ournal Entries The Iollowing are the journal entries:

Date 1oseph de 1esus` 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 1oseph'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 1oseph 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 1oseph 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 Iee.
Dishonored note at maturity.
Notes Receivable Discounted 10,000
Notes Receivable 10,000
To close contingent liability

``` In theory, this entry must be eIIected, but actual experience shows
that a maker does not ordinarily prepare this entry but instead prepares
an entry only when the note is Iinally paid.

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Discussion The Iollowing are the explanations Ior the diIIerent parts oI the discounting
process:

I - As per computations, the net proceeds oI the note is P10,065.13.
The interest Ior 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,
K"+$2 L$)$&=.1-$ @&2)"*'+$6. 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 eIIects: (1) it
discharges Mary Irom the guarantee Joseph has made to the bank and
(b) Mary has no more claim Irom Joseph. These two eIIects are
shown in the entry above.

III - Non-payment by Joseph to the bank has two eIIects: (1) it makes
Mary a guarantor/endorser liable to the bank and thus, making her
pay the maturity value oI the note plus any protest Iee that may be
charged by the bank. (2) Payment by Mary to the bank does not
release Joseph Irom his liability. Although the note is no longer
binding, he is still liable to Mary to an amount equal to maturity
value plus protest Iee.

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Notes ReceivabIe Discounted in the BaIance 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 oI
a contingent liability in the books oI the endorser. How do we present this in
the balance sheet would be the Iocus oI the Iollowing discussions.

Four Methods There are Iour methods oI presenting the contingent liability on notes
discounted in the balance sheet. They are the Iollowing:
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 Iorm 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 Iootnote 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

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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 oI interest is usually made on
maturity date oI the note.
There is another method oI 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 Ior the note
issued is called 6&2)"*'+&'( "'$H2 "G' '"+$. In this case, there are two
alternative methods oI recording such transactions, either the expense, Interest
Expense account or the asset, Prepaid Interest account may be debited. Notes
Pavable account is credited at Iace value oI the note and Cash account is
debited Ior the net amount, i.e., Iace value oI the note minus the interest.

Illustration On July 1, Ior money borrowed, Joseph de Jesus discounted its own 30-day,
12 P10,000 note with Mary de la Cruz.
The Iollowing will be the possible entries to record the July 1 transaction:
de 1esus` Book
July 1 Cash 9,900
Interest Expense 100
Discounted own note.
or
Cash 9,900
Prepaid Interest 100
Discounted own note.

When the maker pays the discounted note on the date oI maturity, he will
pay only an amount equal to the Iace value oI the note issued. Since the
payee deducted already Irom the amount loaned to the maker the interest
that the Iormer will be earning Irom the note on maturity date, the maker
will no longer pay the interest. Thus, iI de Jesus pays the note on July
31, he would be paying only P10,000, the principal amount oI the note.
de 1esus` Book
July 31 Notes Payable 10,000
Cash 10,000
Settled discounted note.

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