ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1

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Generally Accepted Accounting Principles (GAAP). It refers to a common set of accounting

principles, standards, and procedures which aims to improve the clarity, consistency and
comparability of the communication of financial information. The accounting profession has
developed standards that are generally accepted and universally practiced. These standards
indicate how to report economic events.

Standard Setting Bodies:

Financial Accounting Standards Board (FASB)
Securities and Exchange Commission (SEC)
International Accounting Standards Board (IASB)

Selection of which principles to follow generally relates to trade-offs between relevance

and faithful representation. These are two primary qualities that make accounting information
useful for decision-making. This was clearly discussed in Module 1. The accounting process will
be discussed step by step in this module using accrual accounting.

ACCRUAL ACCOUNTING VERSUS CASH BASIS ACCOUNTING

Accrual Accounting.
• Means revenue and expenses are recognized and recorded when they occur, paid or
unpaid.
• It focuses on anticipated revenue and expenses.
• Revenue is accounted for when it is earned such that when a product or service is
delivered to a customer with future expectation that it will be paid.
• Expenses are recorded despite no cash is being paid out yet for those expenses.
• The accrual method is the most commonly used method of recognizing revenue and
expenses as it portrays a more accurate picture of a company’s health, particularly in the
long term by including accounts payable and accounts receivable.

Cash Basis Accounting.

• Revenue is reported on the income statement only when cash is received, and expenses
are only recorded when cash is paid out.
• Cash method is a more immediate recognition of revenue and expenses and is mostly
used by small businesses or for personal finances for its simplicity.
• Tracking the cash flow of a company is also easier, however it might overstate the health
of the company that is cash-rich but has large sums of accounts payable that could exceed
the cash on the books and the company’s current revenue stream.
• An investor might think that the company is making profit but in reality, the company is
losing money.

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STEP 1. IDENTIFICATION OF EVENTS TO BE RECORDED
Aim: To analyze information from the source documents for proper recording and
transfer to their respective accounts.
The analyzing stage follows these four basic steps:
1. identify transactions from source documents
2. indicate the accounts affected by the transaction, either assets, liabilities, equity, income
or expenses.
3. ascertain whether each account is increased or decreased by the transaction.
4. using your knowledge of the rules of debits and credits, determine whether to debit or
credit the account to record the increase or decrease

It is also important to note that companies require that accounting records include only
transactions that can be expressed in terms of money and that activities of the entity be kept
separate and distinct from that of its owners and all other economic entities.

Source documents identify and describe transactions and events entering the accounting
process. It is the starting point in the accounting cycle. These original written evidences contain
information about the nature and the amounts of transactions. Common source documents are
sales invoices, cash register tapes, official receipts, bank deposit slips, bank statements, checks,
purchase orders, timecards and statements of account.

Illustration: Both documents were received by Accounting Department from Human Resource
Department.
Which of the two (2) documents is a valid accountable transaction that will merit a journal entry?

Analysis:

Source document A is not yet a recordable event since the basis is just a memo from HRD
informing the accounting department that three (3) new sales clerks will be working for the
store. There is no proof that the three newly hired people have actually rendered their services
even if their salary amount is clearly stated.

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Source document B is a valid transaction evidenced by the payroll form with names, rate and
period covered of their actual services rendered.
Value received in this transaction is the creation of an expense account, Salaries Expense;
and Value parted with is the obligation of the company to pay the salary, Salaries Payable.
EXPENSE = LIABILITY
The expense account is increased by P7,500 which is a debit and a corresponding increase of
P7,500 also in the liability account which is a credit.

STEP 2. TRANSACTIONS ARE RECORDED IN THE JOURNAL

Aim: To record the economic events that took place within the firm in a journal known as
“general journal” using the rules of debits and credits.

The General Journal. The journal is the simplest form of journal which reflects the
chronological record of the entity’s transaction in terms of debits and credits. Each transaction is
initially recorded in the journal rather than the ledger. The journal is considered the book of
original entry.

Format. The standard contents of the general journal are as follows:

1. Date. The year and month are not rewritten for every entry unless the year or month changes
or a new page of the book is needed.

2. Account titles and explanation. The account to be debited is entered at the extreme left of the
first line while the account to be credited is entered slightly indented on the next line. A brief
description of the transaction or explanation is usually made on the line below the credit entry.
Generally, SKIP a line after each entry.

3. P.R. (posting reference) The column for P.R. will be used when the entries are posted, that is,
until the amounts are transferred to the related leger accounts. The posting process will be
described later.

4. Debit. The debit amount for each account is entered into this column.

5. Credit. The credit amount for each account is entered into this column.

For our illustration in Step 1, the transaction is “to record payroll covering the period July 1-15 for
Salesclerks A, B and C in the amount of P7,500.

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Simple and Compound Entry

The example given above is a simple entry because only two accounts are affected-one account is
debited and one account is credited. However, there are transactions that will require the use of
more than two accounts. This is known as compound entry wherein one or more debit account or
one or more credit account is required.

Example of Compound Entry Transaction

On July 30, 2019, MJ Car Rental Agency, purchased a Machine from Hade Trading for
P150,000 on terms: 25% down payment and the balance payable after 30 days,

It is clearly stated in the example above that the transaction requires more than one
credits, therefore it is a compound entry. The entries follow the basic rule that total Debits =
total Credits. No matter how many debits or how many credits a transaction has the amount of
total debits must always equal to the amount of total credits.

STEP 3. JOURNAL ENTRIES ARE POSTED TO THE LEDGER

Aim: To transfer the information from the journal to the ledger for classification.

The General Ledger. A grouping of accounts with corresponding account codes. It is the
reference book of the accounting system and is used to classify and summarize transactions, and
to prepare data for basic financial statements. All firms have general ledger as shown in the
sample below:

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The accounts in the general ledger are classified into two general groups:
1. Balance Sheet accounts (assets, liabilities and owner’s equity) are classified as
permanent or real accounts.
2. Income Statement accounts (income and expenses) are classified as temporary or
nominal accounts and is used to gather information for a particular accounting
period. At the end of the period, the balances of these accounts are closed to Income Summary
account whose balance is transferred to a permanent owner’s equity, the capital account. Each
account has its own record in the ledger. Compared to a journal, a ledger organizes information
by the account.

Posting. The process of transferring the amounts from the general journal to the appropriate
accounts in the ledger. Debits in the journal are posted as debits in the ledger, and credits in the
journal as credits in the ledger as shown in this figure:

Figure 2.2 Posting Process

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CHART OF ACCOUNTS

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An entity has its own listing of accounts, follows its own format or coding, however they
are the same in respect to the organization of the elements of the financial statements.
• It is an index of all financial accounts in the general ledger of a company.
• It is an organizational tool that provides a listing of the accounts used in business to
define each class of items for which money or its equivalent is spent or received.
• The caption or header are coded by an account type to permit indexing and
crossreferencing.
• The list is typically arranged in the order of the appearance of accounts in the financial
statements: assets, liabilities’ owner’s equity, income and expenses. Figure 2.3

The chart of accounts depends on the nature or type of one’s business. It can differ and be
tailored to reflect a company’s operations however, it must always respect the guidelines set out
by FASB and GAAP. It is of crucial importance that the same chart of accounts are kept year to
year to ensure accurate comparison of the company’s finances.

STEP 4. PREPARATION OF THE TRIAL BALANCE

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Aim: To prove the arithmetical accuracy of bookkeeping and the ledgers.

Trial Balance. Is a type of financial report that is generated at the end of an accounting period
prior to the creation of the company’s financial statements. It shows that the total balances of the
debit column is equal to the total balances of the credit column. It provides a good check on the
accuracy of the work done in preparing the ledger accounts but equality of both debits and
credits is not a guarantee of the absence of errors.

Example: A receipt of P5,000 Cash was erroneously recorded by the bookkeeper as a

debit to Accounts Receivable instead of using Cash account. To this effect, the Trial Balance
would still be equal because both have debit normal balances. This should be corrected since the
Cash account will be understated by such amount and Accounts Receivable will be overstated.

Below is a proper presentation of a Trial Balance done after accomplishing Step 1 to 3.

CONTRA-ACCOUNTS

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An account with a balance that is the opposite of the normal balance for that account
classification. The use of contra account allows an entity to report the original amount and the
reduction to the account to arrive at the carrying value or net realizable value.

Examples of Common Contra Accounts:

1. Allowance for Uncollectible/Bad Debts/Doubtful Accounts- is a contra asset account
related to Accounts Receivable. The receivable is an asset with a debit normal balance, therefore
the contra-asset Allowance has a credit normal balance.

2. Accumulated Depreciation- is a contra account related to any asset under property, plant
and equipment. All assets under this category are subject to depreciation except Land. Since the
normal balance of the related asset is debit, the normal balance of Accumulated Depreciation is
credit.

Depreciation. A reduction in value of an asset with the passage of time, due in particular
to wear and tear.

3. Withdrawal/ or Drawing Account-is a contra-equity account, a reduction in the capital

account. Equity has a normal balance of credit and Withdrawal’s normal balance is the opposite
which is debit.

Other contra-accounts not discussed here are merchandising business accounts.

STEP 5. PREPARATION OF THE WORKSHEET including ADJUSTING ENTRIES

Aim: To verify accuracy of the accounting information and adjust necessary accounts to
provide an up-to-date financial reports.

What is a Worksheet?
It is a multiple-column device or a computer spreadsheet, used for easy preparation of the
financial statements done in a systematic process. All necessary accounting information are
properly presented and structured in the worksheet. Preparation is being done at the end of
accounting period prior to preparation of financial statements. Necessary adjusting entries are
also reflected in the worksheet.

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Figure 2.5 The Worksheet

MJ Car Rental Agency

Worksheet
December 31, 2018

Figure 2.5 is a sample worksheet prepared from the sample Trial Balance of MJ Car Rental
Agency. The columns for Adjustments and Adjusted Trial Balance is not yet filled-up. After
discussion of the topic Adjusting Entries, then students will be familiar with the format and the
extension of the accounts to their respective financial statements. The use of the worksheet
makes the preparation of financial reports easy for accountants as it is prepared in a manner
that all accounts are properly classified.

ADJUSTING ENTRIES
In adjusting the accounts, there are important dates to take into consideration, the date of
the transaction or the journal entry date and the end of accounting period of the business for
accurate computation of the amount to be adjusted.

Why is there a need for adjustments?

• Adjusting entries are adjustments used to bring the assets, liabilities, revenue and
expenses up-to date at the end of accounting period.

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• Adjusting entry can never be equated with correcting entry because the journal entry
made before adjustment is correct, only at end of accounting period the balances may
have been affected because of the happening of some events thus the need for
adjustments. In correcting entry, there is a presumption that error has already been
committed at the time of journalizing.
• The need to provide timely and accurate information, the economic life of the business
are subdivided into artificial time periods known as periodicity concept. Business need
periodic reports to assess the financial condition of the entity and this is the best way to
achieve that without going through the process of liquidation. It interacts with recognition
and derecognition principles to underlie the use of accrual accounting.
• Adjusting entries assigned revenues to the period in which they are earned, and expenses
are assigned to the period in which they are incurred.
• Adjusting entries are needed to measure properly the profit for the period and to bring
related asset and liability accounts to correct balances for an accurate financial reporting
purpose.
• Without adjusting entries, the financial statements may not fairly show the liquidity and
solvency of the business in the statement of financial position, same with its profitability
as reflected in the statement of income.

What are the accounts for adjustments?

DEFERRALS AND ACCRUALS

Adjusting entry is the answer to those transactions that covers more than one accounting
period as a result of the use of accrual accounting. Each adjusting entry either affects a balance
sheet account and an income statement account.

Deferral. Is the postponement of the recognition of an expense already paid but not yet incurred,
or of revenue already collected but not yet earned. Deferrals are needed in two cases:
1. Allocating assets to expense to reflect expenses incurred during the accounting
period.
Example: prepaid insurance expense, rent expense, supplies and depreciation.

2. Allocating revenues received in advance to revenue to reflect revenues earned

during the accounting period.
Example: subscription, unearned revenue

Accrual. Is the recognition of an expense already incurred but not yet paid, or revenue earned
but not yet collected. Accrual will be required in two cases:
1. Expenses to be accrued to reflect expenses incurred during the accounting period that are
unpaid and unrecorded.

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2. Accruing revenues to reflect revenues earned during the accounting period that are
uncollected and unrecorded.

I. ADJUSTMENTS FOR DEFERRALS:

A. PREPAID EXPENSES
This includes expenses that are paid in advance of its use such in the case of prepaid
insurance prepaid supplies, prepaid rent, prepaid advertising, prepaid interest expense. In
adjusting this account two methods can be used, asset method or the expense method.

Illustration: On September 1, 2018, MJ Car Rental Agency paid office rent for one year
amounting to P120,000. The business follows the calendar year as the end of the accounting
period.

Analysis:
The payment of rent will take effect from Sept. 1, 2018 until Sept. 1, 2019 (one year) as shown
in this timeline:

Therefore, the portion of expense that has expired is only for four months (Sept 1 to Dec 1) or a
total amount of P40,000 ( P120,000/12 = 10,000 per mo. x 4 months)

Using Asset Method the adjustments would be:

Dec. 31, 2018 Rent Expense......................................................P40,000

Prepaid Rent Expense............................................P40,000

Using Expense Method, the adjustments would be:

Dec. 31, 2018 Prepaid Rent Expense...........................................80,000
Rent Expense ..........................................................80,000

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At the end of accounting period, the Prepaid Rent account balance have been adjusted to an
amount of P80,000 which represents the unused portion, which is the remaining 8 months (Jan 1
to Aug. 1) and Rent Expense of P40,000 was recognized, representing the used portion of 4
months (Sept 1 to Dec 1).

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To be able to adjust, it is very important to know the original entry of the transaction. Same
adjusting process applies to Prepaid Insurance Expense.

B. SUPPLIES ADJUSTMENT
Analyzing transaction for supplies requires adjustments pertaining to consumption.

Illustration: On July 1, 2018, MJ Car Rental Agency purchased supplies amounting to P5,000
on credit. As of December 31, 2018, the end of accounting period, after actual inventory count of
supplies, it revealed a balance of P2,000.

Analysis:
The book balance of Supplies account decreased by P3,000. The original entry, when the
supplies were purchased was posted to the ledger as follows:

It means there is unrecorded consumption as the physical inventory count done at the
end of accounting period resulted to only P2,000.

Adjusting Entry

12/31/18 Supplies expense P3,000

Supplies P3,000

After posting the adjustment, ledger would now appear like this:

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The asset account Supplies now reflect the adjusted amount of P2,000 which is the amount
derived from the actual count and the amount of supplies consumed during the accounting period
is reflected as P3,000 in the Supplies Expense account..

C. UNEARNED REVENUES
• Unearned revenues are advances made by the customers awaiting future services as in the
case of customers making advance payment for services.
• As of the date of receipt, the amount still remains unearned because the performance of
services have not been rendered yet.
• It is treated as liability account for the reason that the entity still owes from the customer
the services covered by the payment.
• Accounting principles dictates that only income realized during the period shall be
recognized hence unearned revenues is a pre-collected payment subject to realization of
services in the future.
• Two methods can be used to record unearned revenue transactions: Liability method and
Income method

Examples of Unearned Revenues:

Commission income collected in advance
Interest income collected in advance
Rent income collected in advance
Advertising income collected in advance

Illustration: On Oct. 15, 2018 MJ Car Rental Agency received P150,000 from Customer A as
rental payment for five (5) vans to be used by his foreign guests for five months starting next
month. The company uses a calendar period.

Analysis:
The transaction implies that the amount of P150,000 is an advance payment by Customer
A for the use of the MJ vans for a period of five months. This transaction gives rise to a liability
to provide Customer “A” with the needed vans which will take effect on November 1, 2018 and
ends on March 2019.

Nov Dec 2018 Jan 2019 Feb Mar

P30,000 P30,000 P30,000 P30,000 P30,000

Looking at the table, the amount of the contract or agreement is P150,000 for five months so that
means P30,000 per month (150,000/5mos =P30,000 per month). At the end of accounting period
December 31, two months income must already been realized.

For adjustment purposes, a comparative original entry is created:

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Date Liability Method Income Method

2018 Cash P150,000 Cash P150,000
Oct. 15 Unearned Rent Revenue 150,000 Rent Income 150,000

Adjusting Entry using both methods would be:

Date Liability Method Income Method

2018 Unearned Rent Income 60,000 Rent Income 90,000
Dec. 31 Rent Income 60,000 Unearned Rent 90,000

From the ledger, this is how we derived our balance:

After posting the adjusting entries, Rent Income account has a balance of P60,000 and the
Unearned rent Income account has an adjusted balance of P90,000.

D. PROVISION FOR DEPRECIATION

The concept of depreciation applies to assets or resources of the business that are tangible
and its useful life extends beyond one year. Most assets subject to depreciation are those
classified under property, plant and equipment whose value continuously decreases as they are
used in the day-to-day operation of the business. Depreciation does not apply to Land which in
most cases, the value increases as time passed by.

Depreciation. Is a reduction in value of the asset because of the passage of time or due to wear
and tear. It is classified as Expense.
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Example of common depreciable assets: Building, Machinery, Furniture and Fixtures,

Office Equipment and Store Equipment

THREE IMPORTANT ELEMENTS

Acquisition Cost. Refers to the purchase price of the asset or the cash paid to acquire it. It
includes all incidental expenses necessary for the acquisition and in making the asset ready for
use such as cost of test and trial run test, carrying costs, etc. added to the purchase price.

Salvage Value. Refers to the value of the asset at the point of disposal. It is the estimated amount
that the business will receive upon the disposal of the asset. Depreciable assets do not stay in
business forever, so when they are no longer productive, they are usually disposed. It is the
product of estimates based on professional judgement. Other terms used are trade-in value,
residual value, scrap value.

Estimated Useful Life. Refers to the period wherein depreciable assets are productive. The
useful life of depreciable assets is influenced by some factors such as technology, advancement,
obsolescence, number of units produced or number of service hours.

METHODS OF COMPUTING DEPRECIATION

There are various methods to compute depreciation such as:
• Straight-line
• Sum-of-year’s digit
• Declining balance
• Double declining balance
• Output method
• Retirement method
• Replacement method

For this module, we will only consider using the straight-line method. Other methods
will be discussed lengthily in higher accounting. The formula for straight-line is:

Cost – Salvage Value

Annual Depreciation =
Estimated Useful Life

The pro-forma entry to record depreciation is

Depreciation Expense – fixed assets xxxx

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Accumulated Depreciation – fixed assets xxxx

OTHER TERMS RELATED TO DEPRECIATION

Depreciable Cost. Is equal to the difference between cost and salvage value.

Accumulated depreciation.is the sum of depreciation in direct relation with the expired life of
the asset.

Book Value. The difference between cost and accumulated depreciation. It is sometimes called
the carrying value of the asset.

Illustration: Assuming MJ Car Rental Agency purchased set of computers for P95,000 on terms,
with salvage value of P5,000 on November 1, 2018. It is estimated to have a useful life of 6
years. Compute for the depreciation cost of the asset at the end of accounting period and prepare
the entry to adjust the books.

GIVEN: Cost P95,000

Salvage Value 5,000
Estimated useful life 6 years

Annual Depreciation = Cost – Salvage Value

Estimated Useful Life

= P95,000 – 5000
6 years
= P 90,000
6
= P15,000
Analysis

The amount of P15,000 is the annual depreciation rate which will remain the same every
year but the accumulated depreciation increases every time the life of the asset expires. From the
time the computers were purchased in November to the end of accounting period, the asset
already depreciates for two months. This amount will be charged to depreciation expense
computed as :

Annual Depreciation = P15,000/12 months = P1250 per month

Depreciation Expense = P1,250 x 2 months =P2,500

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Adjusting Entry

12/31/18 Depreciation Expense-Computers P2,500

Accumulated Depreciation-Computers P2,500

II. ADJUSTMENTS FOR ACCRUALS

Accruals
Adjustments help the entity avoid the impractical preparation of hourly or daily journal
entries just to accrue expenses. It updates the accounting values by recognizing expired
transactions that remained unrecorded.

A. ACCRUED EXPENSES
Accrued expenses are expenses already incurred before payment is made as of cut-off
date such as salaries, interest, utilities (electricity, water and telecommunications) and taxes.
According to expense recognition principle, expenses must be recognized in the books of
accounts at the time of its incurrence and not at the time of payment.

Pro-forma adjusting entry is

Expenses xxxx
Accrued Expense or Expense Payable xxxx

Illustration: On December 30, 2018, MJ Car Rental Agency hired a daily wage worker for the
maintenance of the office. MJ follows the calendar year as the accounting period. The daily wage
of the worker is P350 or a weekly salary of P2,100 for six days except Sunday. MJ salary scheme
is weekly and pays every Saturday. Assume that December 30, 2018 falls on Monday. This
would imply that December 31, 2018 falls on Tuesday which is the end of accounting period.

Analysis:
Starting December 30, 2018 salaries expense are incurred daily and the cut-off date of
accounting records is December 31, 2018 while payment of salary on a weekly basis is on
January 4, 2019. The unpaid salary expense is for two days as of end of accounting period
equivalent to P700. Though the scheduled payment is on January 4, 2019, the two days salary
expense should be recognized because it has been incurred already.
Adjusting entry

12/31/2018 Salaries Expense P 700

Salaries Payable or Accrued Salaries P700

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B. ACCRUED INCOME
Accrual of income is income already earned but not yet collected or received. The
business already done with services but payment of revenue is received in future date. Similar to
the recognition principle of expenses, income must also be recognized in the period earned and
not at the time of collection.

Pro-forma adjusting entry

Accrued Receivable or Accrued Income xxxx
Service Revenue xxxx

NOTE: The account titles for accrual and income should be clearly identified in the adjusting entry.

Illustration:

On December 20, 2018 MJ Car Rental Agency received a contract for the exclusive use of its two
drivers to assist the foreign guests of a well-respected client for three months. MJ will be paid
P24,000 per month for a period of three months. The payment will be made every 20 th of the
month.

Analysis:
The collection of rental payment of P24,000 will be every 20 th of the month, it means the
first collection will be on January 20, 2019. As of Dec. 31, 2018, the cut-off date, MJ already
realized an income for 10 days. Income must be recognized at the time the income is earned paid
or unpaid, so an adjusting entry is needed to reflect this.

Adjusting entry:

12/31/2018 Accrued Rental Income P8,000

Rental Income P8,000
(P24,000/30 days x 10 days)

C. ACCRUAL FOR UNCOLLECTIBLES ACCOUNTS

Businesses normally have credit policy in order to generate more revenues. This policy
allows customers to purchase goods or services on terms agreed upon. However, not all of the
credit sales are 100% collectibles within the reasonable period. Experience dictates that credits
are not totally collected due to the following reasons:
• Debtor losses his capacity to pay
• Customer is not willing to pay
• Customer cannot be located anymore
• Customer dies

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In this case, the revenue that has been recognized earlier was already lost because of
nonpayment. The service revenue should be adjusted by charging a small portion to doubtful
accounts or uncollectible accounts. Mostly the amount charged against doubtful or uncollectible
account is estimated based on the professional judgement of the management and business
experience.

Pro-forma entry

Doubtful Accounts or Uncollectible accounts xxxx

Allowance for Doubtful or Uncollectible accounts xxxx

Basis of Estimating Doubtful Accounts

Doubtful accounts are computed based on the following:
• Percent of credit sales
• Percent of receivable balance
• Based on aging of receivables

Illustration: Percent of Credit Sales or service income

MJ Car Rental Agency provided the following ledger accounts as of December 31, 2018:
Total Credit Sales or Service Income P3,500,000
Accounts Receivable 2,100,000
Allowance for uncollectible accounts per ledger 50,000

The business estimated that uncollectible accounts at the end of the current year are 5% of credit
service income.

Required: 1. Compute the doubtful account expense

2. Prepare the adjusting entry.

Credit service income P3,500,000

Multiplied by uncollectible accounts rate 5%
Uncollectible account expense 175,000

Adjusting Entry

12/31/2018 Uncollectible Accounts Expense P175,000

Allowance for Uncollectible Accounts P175,000

Illustration: Percent of Accounts Receivable

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The same information will be used to illustrate this concept:

MJ Car Rental Agency revealed the following information from its ledger accounts as at
December 31, 2018 as follows:

Credit sales or Service income P3,500,000

Accounts Receivable 2,100,000
Allowance for Uncollectible Accounts 50,000

The business estimated that uncollectible accounts at the end of the current year are 5% of credit
service income.

Required: 1. Compute the uncollectible accounts expense.

2. Prepare the adjusting entry.

Accounts Receivable P 2,100,000

Multiplied by Uncollectible accounts rate 5%
Required Allowance Uncollectible Account Expense 105,000
Less: Allowance per ledger 50,000
Uncollectible account expense 55,000

Adjusting Entry

12/31/2018 Uncollectible Accounts Expense P 55,000

Allowance for Uncollectible Accounts P55,000

Net Realizable Value. Refers to the value of receivable after deducting the allowance for
uncollectible accounts shown as:

Accounts Receivable P2,100,000

Less: Allowance for doubtful accounts 105,000
Net Realizable value P1,995,000

The most common method to compute for allowance for uncollectible accounts are percent of
credit sales or percent of receivables, aging of receivables will be discussed in higher accounting.

STEP 6. POSTING OF THE ADJUSTING ENTRIES TO THE LEDGER AND TO THE

WORKSHEET
Aim: To communicate to interested parties accounting information for decision-making.

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Financial statements are the final product of the accounting process. It usually follows
after the worksheet process is complete. It is the very purpose of the accounting system.

The complete set of Financial Statements are:

1. Statement of Comprehensive Income
2. Statement of Financial Position
3. Statement of Changes in Equity
4. Statement of Cash Flows

In the preparation of the financial statements, the ultimate guide is the Worksheet. All the
accounting information from the worksheet are merely transferred to the Statement of
Comprehensive Income and Statement of Financial Position. The first three financial reports will
be discussed in this module while the Statement of Cash flows in Module 4.

The same worksheet of MJ Car Rental Agency will be used to produce a complete set of
financial statements. Additional data for adjustments will be provided for presentation purposes
and to complete the columns.

Figure 2.6 Worksheet with Adjustments

MJ Car Rental Agency

Worksheet
December 31, 2018

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As of December 31, 2018, assume the following data for adjustments :

1. The actual count of Supplies on hand is P2,000 only.
2. Additional five (2) months of insurance has already expired.
3. Rent expense will be adjusted to P15,000.
4. Additional 2% will be charged as depreciation expense to Vehicles and Equipment 5. The
estimated allowance for uncollectible accounts will be adjusted to 2% of accounts receivable

Adjusting Entries as of December 31, 2018

1. Supplies Expense P 3,000

Supplies P3,000
To adjust supplies account to correct balance.

2. Insurance Expense 8,000

Prepaid Insurance 8,000
To adjust the insurance expense acct.
(P48,000/12= 4,000 per month)
3. Rent Expense 5,000
Prepaid rent 5,000
To adjust rent expense to P15,000

4. Depreciation Expense-Vehicles 36,000

Accumulated depreciation-Vehicles 36,000
To adjust depreciation expense by 2%

Depreciation Expense -Equipment 1,600

Accumulated depreciation- Equipment 1,600

5. Uncollectible Accounts 1,000

Allowance for uncollectible accounts 1,000
(A/R = 225,000 x 2% = 4,500-3,500)
To adjust allowance for uncollectible
Accounts to 2% of A/R)

After posting the adjusting entries to the Worksheet, the next step is the preparation of Financial
Statements.

STEP 7. PREPARATION OF THE FINANCIAL STATEMENTS

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A. THE STATEMENT OF COMPREHENSIVE INCOME
It is a statement showing the performance of the business for a given period of time. It
summarizes the revenues earned and expenses incurred for that period and communicates to the
users its profitability status for a one-year operation. If the revenue exceeds the expenses of the
business, then it is a Profit, vice-versa, then the result is a Loss for the business. A
comprehensive income statement includes other line items discussed only in higher accounting
subjects. For this module, our discussion will focus mainly on the results of operation of MJ Car
Rental Agency, whose data were taken from the accompanying worksheet.

Figure 2.7 Statement of Comprehensive Income

MJ Car Rental Agency

Income Statement
For the year ended December 31, 2018

Revenues
Rental Revenue P360,000

Less: Operating Expenses P 12,000

Insurance 15,000
Expense 15,000
Gasoline & oil 3,000
Rent Expense 30,000
Repairs & maintenance 2,000
Salaries Expense 96,000
Miscellaneous Expense 11,600
Depreciation Exp- 4,500
Vehicles 18,000
Depreciation Exp-Equipment 3,000
Uncollectible Accounts 210,100
Utilities Expense
Supplies Expense P 149,900
Total Operating Expenses

Net Operating Income

The net operating income of MJ Car Rental Agency of P149,900 is tax inclusive. If the
applicable income tax (NIRC) rate will be deducted, then the next amount derived is the Net
Income.

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B. THE STATEMENT OF FINANCIAL POSITION
It is a statement that measures the financial position of the business in terms of Assets,
Liabilities and Owner’s Equity. It shows the resources(Assets) employed by the business first,
followed by the claim of the creditors (Liabilities) against the assets, and then the claim of the
owner called Capital. The Statement of Financial Position otherwise known as “Balance Sheet”
indicates liquidity and solvency status of the business. The items in this statement are measured
and presented in conformity with the requirements of PAS and PFRS. It is also presented in two
formats: Report Form (vertical) or Account Form (horizontal). For our example we follow the
most commonly used format, the account format.

Liquidity. Refers to the ability of the business to settle its currently maturing obligations.

Solvency. Refers to the ability of the business to pay its non-current liabilities and still remain
stable.

Figure 2.8 The Statement of Financial Position

C. THE STATEMENT OF CHANGES IN EQUITY

It presents the different elements that affect the equity of the owners during a particular
period. It also shows the changes in the equity structure of the entity as it increases when at a
profit and decreases when the business posted a loss, or when additional investments and
temporary withdrawals are made by the owners.

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Figure 2.9 Statement of Changes in Owner’s Equity

MJ Car Rental Agency

Statement of Changes in Owner’s Equity
For the Year Ended December 31, 2018

MJ, Capital Beginning P 1,000,000

Add: Additional Investment 300,000
Net Income 149,900

Total 1,449,900

Less: Withdrawal 30,000

MJ, Capital Ending P 1,419,900

STEP 8. CLOSING JOURNAL ENTRIES

Aim: To describe all the procedures in closing the books, close all temporary accounts
and transfer profit or loss to owner’s capital account.

Closing Entries. Are journal entries that close balances of nominal or temporary accounts using
Income Summary account. The income summary account is ultimately closed to a real account
which is the Capital. Closing entries make the balances of all temporary accounts equal to zero
in preparation for the next accounting period. To close means to debit all credits and credit all
debits. As we go on with the closing procedures, we will be closing the books of MJ Car Rental
Agency.

STEPS TO FOLLOW:

Step 1. Close the revenue or income

Rental Revenue P360,000

Income Summary P360,000
Step 2. Close the cost and expense accounts

Income Summary 210,100

Insurance expense 12,000
Gasoline and Oil 15,000

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Rent Expense 15,000
Repairs and Maintenance 3,000
Salaries Expense 30,000
Miscellaneous Expense 2,000
Depreciation Expense-Vehicles 96,000
Depreciation Expense-Equipment 11,600
Uncollectible Accounts 4,500
Utilities Expense 18,000
Supplies Expense 3,000

Step 3. Close the Income Summary to Capital Account

Income Summary 149,900

MJ, Capital 149,900

Step 4. Close the Drawing account to Capital account

MJ, Capital 30,000

MJ, Withdrawal 30,000

After the closing entries are correctly posted to their respective accounts in the ledger,
these accounts will have zero balances. Before moving on to the next step of the accounting
cycle, important guidelines must be remembered:
• Only temporary or nominal accounts are closed ; permanent or real
accounts are not.
• Closing entries are recorded in the general journal.
• Closing entries are posted to the general ledger.
• Closing entries are made at the end of accounting period only.

STEP 9. PREPARATION OF POST-CLOSING TRIAL BALANCE

Aim: To determine the accuracy of the adjusting and closing entries and to ensure that
the ledger balances for the next accounting period are equal.

Post-closing Trial Balance. Is a trial balance after the preparation of the closing entries. It
contains the ending balances of all real or permanent accounts as reflected in the Statement of
Financial Position. It is also called a balance sheet in a trial balance form.

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These balances will be the beginning balances of the ledger next accounting period.

STEP 10. REVERSING ENTRIES (OPTIONAL)

Aim: To facilitate the normal recording of transactions in the succeeding accounting
period.

Reversing Entries: are entries that reversed the adjusting entries. They are prepared at the
beginning of the next accounting period, the reason why reversing entries sometimes called the
first step in the next accounting cycle. They are the first entries recorded in the general journal of
the next accounting period. Although, reversing entries affect only adjusting entries, but not all
adjusting entries are reversed.

What adjusting entries are reversed?

1. Accrual of income
2. Accrual of expenses
3. prepayment using expense method 4. unearned income using income method.

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All remaining adjusting entries need not be reversed such as: prepayment using asset
method, unearned revenue using liability method, depreciation and uncollectible accounts.

Figure 2.11 Relationship of Adjusting and Reversing Entries

Nature of Adjustment Adjusting Entries Reversing Entries

Accrued Income Accrued Receivable xx Income account xx
Income account xx Accrued
Receivable xx
Accrued Expense Expense account xx Accrued exp./payable xx
Accrued exp or payable xx Expense account
xx
Prepayment-expense Prepaid expense xx Expense account xx
method Expense account xx Prepaid expense
xx
Unearned income-income Income account xx Unearned income xx
method Unearned income xx Income
account xx

All remaining adjusting entries need not be reversed such as: prepayment using asset
method, unearned revenue using liability method, depreciation and uncollectible accounts.

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