FINANCIAL ACCOUNTING
&
REPORTING
(Fundamentals)
ZEUS VERNON B. MILLAN
Chapter 1: Introduction to Accounting
(FAR by: Millan)
Chapter 1
Introduction to Accounting
Learning Objectives
1. Define accounting.
2. Describe the nature and purpose of accounting.
3. Give examples of branches of accounting.
4. State the function of accounting in a business.
5. Differentiate between external and internal users of
accounting information.
6. Narrate the history/origin of accounting.
7. State the forms of business organization.
8. State the types of business according to their
activities.
Chapter 1: Introduction to Accounting
(FAR by: Millan)
Definition of accounting
• Accounting is a process of identifying,
recording and communicating economic
information that is useful in making
economic decisions.
Chapter 1: Introduction to Accounting
(FAR by: Millan)
Essential elements of the definition
of accounting
1.
2.
3.
Identifying – The accountant analyzes each business transaction
and identifies whether the transaction is an “accountable event”
or “non-accountable event.” This is because only “accountable
events” are recorded in the books of accounts. “Non-accountable
events” are not recorded in the books of accounts.
Recording – The accountant recognizes (i.e., records) the
“accountable events” he has identified. This process is called
“journalizing.” After journalizing, the accountant then classifies the
effects of the event on the “accounts.” This process is called
“posting.”
Communicating – At the end of each accounting period, the
accountant summarizes the information processed in the
accounting system in order to produce meaningful reports.
Accounting information is communicated to interested users
through accounting reports, the most common form of which is
the financial statements.
Chapter 1: Introduction to Accounting
(FAR by: Millan)
Nature of accounting
• Accounting is a process with the basic
purpose of providing information about
economic activities intended to be useful in
making economic decisions.
Chapter 1: Introduction to Accounting
(FAR by: Millan)
Types of information provided by
accounting
1. Quantitative information
2. Qualitative information
3. Financial information
Chapter 1: Introduction to Accounting
(FAR by: Millan)
Functions of Accounting in Business
1. To provide external users with information
that is useful in making investment and
credit decisions; and
2. To provide internal users with information
that is useful in managing the business.
Chapter 1: Introduction to Accounting
(FAR by: Millan)
Brief history of accounting
• Accounting can be traced as far back as the prehistoric times, perhaps
more than 10,000 years ago.
• Archaeologists have found clay tokens as old as 8500 B.C. in
Mesopotamia which were usually cones, disks, spheres and pellets.
These tokens correspond to commodities like sheep, clothing or bread.
They were used in the Middle West in keeping records. After some
time, the tokens were replaced by wet clay tablets. During such time,
experts concluded this to be the start of the art of writing. (Source:
http://EzineArticles.com/456988)
• Double entry records first came out during 1340 A.D. in Genoa.
• In 1494, the first systematic record keeping dealing with the “double
entry recording system” was formulated by Fra Luca Pacioli, a
Franciscan monk and mathematician. The “double entry recording
system” was included in Pacioli’s book titled “Summa di Arithmetica
Geometria Proportioni and Proportionista,” published on November 10,
1494 in Venice.
• The concept of “double entry recording” is being used to this day. Thus,
Fra Luca Pacioli is considered as the father of modern accounting.
Chapter 1: Introduction to Accounting
(FAR by: Millan)
Common Branches of Accounting
Chapter 1: Introduction to Accounting
(FAR by: Millan)
Common Branches of Accounting
Chapter 1: Introduction to Accounting
(FAR by: Millan)
Common Branches of Accounting
Chapter 1: Introduction to Accounting
(FAR by: Millan)
Common Branches of Accounting
Chapter 1: Introduction to Accounting
(FAR by: Millan)
Users of Accounting Information
1.
Internal users – those who are directly involved in managing the
business. Examples:
• Business owners who are directly involved in managing the
business
• Board of directors
• Managerial personnel
2.
External users – those who are not directly involved in managing
the business. Examples:
• Existing and potential investors (e.g., stockholders who are not
directly involved in managing the business)
• Lenders (e.g., banks) and Creditors (e.g., suppliers)
• Non-managerial employees
• Public
Chapter 1: Introduction to Accounting (FAR by: Millan)
Forms of Business Organizations
Chapter 1: Introduction to Accounting (FAR by: Millan)
Advantages and Disadvantages
Chapter 1: Introduction to Accounting (FAR by: Millan)
Advantages and Disadvantages
Chapter 1: Introduction to Accounting (FAR by: Millan)
Advantages and Disadvantages
Chapter 1: Introduction to Accounting (FAR by: Millan)
Advantages and Disadvantages
Chapter 1: Introduction to Accounting (FAR by: Millan)
Advantages and Disadvantages
Chapter 1: Introduction to Accounting (FAR by: Millan)
Advantages and Disadvantages
Chapter 1: Introduction to Accounting (FAR by: Millan)
Advantages and Disadvantages
Chapter 1: Introduction to Accounting (FAR by: Millan)
Types of Business According to
Activities
1. Service business
2. Merchandising (Trading)
3. Manufacturing
Chapter 1: Introduction to Accounting (FAR by: Millan)
Advantages and Disadvantages
Chapter 1: Introduction to Accounting (FAR by: Millan)
Advantages and Disadvantages
Chapter 1: Introduction to Accounting (FAR by: Millan)
Advantages and Disadvantages
Chapter 1: Introduction to Accounting (FAR by: Millan)
Chapter 2
Accounting Concepts and Principles
Learning Objectives
1. Give examples of accounting concepts and
principles.
2. Apply the concepts in solving accounting
problems.
Chapter 2: Accounting Concepts and
Principles (FAR by: Millan)
Basic Accounting Concepts
1. Separate entity concept
2. Historical cost concept
3. Going concern assumption
4. Matching
5. Accrual Basis
6. Prudence (or Conservatism)
7. Time Period
8. Stable monetary unit
9. Materiality concept
10. Cost-benefit
11. Full disclosure principle
12. Consistency concept
Chapter 2: Accounting Concepts and Principles (FAR by: Millan)
Basic Accounting Concepts – (cont’n)
• Separate entity concept – The business is viewed as
a separate entity, distinct from its owner(s). Only the
transactions of the business are recorded in the
books of accounts. The personal transactions of the
business owner(s) are not recorded.
• Historical cost concept (Cost principle) – assets are
initially recorded at their acquisition cost.
• Going concern assumption – The business is
assumed to continue to exist for an indefinite period
of time.
• Matching – Some costs are initially recognized as
assets and charged as expenses only when the
related revenue is recognized.
Chapter 2: Accounting Concepts and Principles (FAR by: Millan)
Basic Accounting Concepts – (cont’n)
• Accrual Basis of accounting – income is recorded in
the period when it is earned rather than when it is
collected, while expense is recorded in the period
when it is incurred rather than when it is paid.
• Prudence – The observance of some degree of
caution when exercising judgments under conditions
of uncertainty. Such that, if there is a choice between
a potentially unfavorable outcome and a potentially
favorable outcome, the unfavorable one is chosen.
This is necessary so that assets or income are not
overstated and liabilities or expenses are not
understated.
Chapter 2: Accounting Concepts and Principles (FAR by: Millan)
Basic Accounting Concepts – (cont’n)
• Reporting Period – The life of the business is
divided into series of reporting periods.
• Stable monetary unit – Assets, liabilities,
equity, income and expenses are stated in
terms of a common unit of measure, which
is the peso in the Philippines. Moreover, the
purchasing power of the peso is regarded as
stable. Therefore, changes in the purchasing
power of the peso due to inflation are
ignored.
Chapter 2: Accounting Concepts and Principles (FAR by: Millan)
Basic Accounting Concepts – (cont’n)
• Materiality concept – An item is considered
material if its omission or misstatement
could influence economic decisions.
Materiality is a matter of professional
judgment and is based on the size and
nature of an item being judged.
• Cost-benefit – The costs of processing and
communicating information should not
exceed the benefits to be derived from the
information’s use.
Chapter 2: Accounting Concepts and Principles (FAR by: Millan)
Basic Accounting Concepts – (cont’n)
• Full disclosure principle – Information
communicated to users reflect a balance
between detail and conciseness, keeping in
mind the cost-benefit principle.
• Consistency concept – Like transactions are
accounted for in like manner from period to
period.
Chapter 2: Accounting Concepts and Principles (FAR by: Millan)
Philippine Financial Reporting
Standards (PFRSs)
The PFRSs are Standards and Interpretations
adopted by the FRSC. They consist of the
following:
1. Philippine Financial Reporting Standards
(PFRSs);
2. Philippine Accounting Standards (PASs);
and
3. Interpretations
Chapter 2: Accounting Concepts and Principles (FAR by: Millan)
Qualitative Characteristics
I. Fundamental Qualitative Characteristics
i. Relevance (Predictive Value, Confirmatory Value, Materiality)
ii. Faithful Representation (Completeness, Neutrality,
Free from error)
II. Enhancing Qualitative Characteristics
i. Comparability
ii. Verifiability
iii. Timeliness
iv. Understandability
Chapter 2: Accounting Concepts and Principles (FAR by: Millan)
Fundamental vs. Enhancing
• The fundamental qualitative characteristics
are the characteristics that make
information useful to users.
• The enhancing qualitative characteristics
are the characteristics that enhance the
usefulness of information
Chapter 2: Accounting Concepts and Principles (FAR by: Millan)
Relevance
• Information is relevant if it can affect the
decisions of users.
• Relevant information has the following:
a. Predictive value – the information can be used
in making predictions
b. Confirmatory value – the information can be
used in confirming past predictions
Materiality – is an ‘entity-specific’ aspect of
relevance.
Chapter 2: Accounting Concepts and Principles (FAR by: Millan)
Faithful representation
• Faithful representation means the information provides a true,
correct and complete depiction of what it purports to represent.
• Faithfully represented information has the following:
a. Completeness – all information necessary for users to
understand the phenomenon being depicted is provided.
b. Neutrality – information is selected or presented without
bias.
c. Free from error – there are no errors in the description and in
the process by which the information is selected and applied.
Chapter 2: Accounting Concepts and Principles (FAR by: Millan)
Enhancing Qualitative Characteristics
1. Comparability – the information helps users in
identifying similarities and differences between
different sets of information.
2. Verifiability – different users could reach consensus as
to what the information purports to represent.
3. Timeliness – the information is available to users in
time to be able to influence their decisions.
4. Understandability – users are expected to have:
a. reasonable knowledge of business activities;
and
b. willingness to analyze the information diligently.
Chapter 2: Accounting Concepts and Principles (FAR by: Millan)
Chapter 3
The Accounting Equation
Learning Objectives
1. Illustrate the accounting equation.
2. Perform operations involving simple cases
with the use of accounting equation.
Chapter 3: The Accounting Equation (FAR
by: Millan)
The Accounting Equation
Assets =
Liabilities
+
Chapter 3: The Accounting Equation (FAR by: Millan)
Equity
Definitions
• ASSETS – are the economic resources you
control that have resulted from past events
and can provide you with economic benefits.
• LIABILITIES – are your present obligations
that have resulted from past events and can
require you to give up economic resources
when settling them.
• EQUITY – is assets minus liabilities.
Chapter 3: The Accounting Equation (FAR by: Millan)
The Expanded Accounting Equation
Assets = Liabilities + Equity + Income - Expenses
Chapter 3: The Accounting Equation (FAR by: Millan)
Definitions
• INCOME – is increases in economic benefits during the
period in the form of increases in assets, or decreases in
liabilities, that result in increases in equity, excluding
those relating to investments by the business owner.
• EXPENSES – are decreases in economic benefits during
the period in the form of decreases in assets, or
increases in liabilities, that result in decreases in equity,
excluding those relating to distributions to the business
owner.
• The difference between income and expenses represents
profit or loss.
Chapter 3: The Accounting Equation (FAR by: Millan)
Applications of the accounting
equation
1. If total assets is ₱10,000 and total liabilities is
₱6,000, how much is the total equity?
2. If total liabilities is ₱5,000 and total equity is
₱4,000, how much is the total assets?
3. If total assets is ₱10,000 and total equity is
₱3,000, how much is the total liabilities?
4. If total income is ₱10,000 and total expenses
are ₱3,000, how much is the profit or loss?
5. If total income is ₱10,000, total expenses are
₱8,000, total liabilities is ₱7,000, and total
equity (before profit or loss) is ₱6,000, how
much is the total assets?
Chapter 3: The Accounting Equation (FAR by: Millan)
Chapter 4
Types of Major Accounts
Learning Competencies
1. Discuss the five major accounts.
2. Cite examples of each type of account.
3. Prepare a Chart of Accounts.
Chapter 4: Types of Major Accounts (FAR
by: Millan)
The Account
• An account is the basic storage of
information in accounting. It is a record of
the increases and decreases in a specific
item of asset, liability, equity, income or
expense.
Chapter 4: Types of Major Accounts (FAR by: Millan)
The T-Account
Chapter 4: Types of Major Accounts (FAR by: Millan)
The Five Major Accounts
1.
2.
3.
4.
5.
ASSETS – are the resources you control that have resulted from
past events and can provide you with economic benefits.
LIABILITIES – are your present obligations that have resulted
from past events and can require you to give up economic
resources when settling them.
EQUITY – is assets minus liabilities.
INCOME – are increases in economic benefits during the period
in the form of inflows or enhancements of assets or decreases
of liabilities that result in increases in equity, other than those
relating to investments by the business owners.
EXPENSES – are decreases in economic benefits during the
period in the form of outflows or depletions of assets or
increases of liabilities that result in decreases in equity, other
than those relating to distributions to the business owners.
Chapter 4: Types of Major Accounts (FAR by: Millan)
Classification of the Five Major
Accounts
Chapter 4: Types of Major Accounts (FAR by: Millan)
Chart of Accounts
A chart of accounts is a list of all the accounts
used by a business.
Chapter 4: Types of Major Accounts (FAR by: Millan)
Common Account Titles
• BALANCE SHEET ACCOUNTS
ASSETS
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
Cash
Accounts receivable
Allowance for bad debts
Notes receivable
Prepaid supplies
Prepaid rent
Prepaid insurance
Land
Building
Accumulated depreciation - Building
Equipment
Accumulated depreciation - equipment
Chapter 4: Types of Major Accounts (FAR
by: Millan)
Common Account Titles - Continuation
• BALANCE SHEET ACCOUNTS
LIABILITIES
a.
b.
c.
d.
e.
f.
Accounts payable
Notes payable
Interest payable
Salaries payable
Utilities payable
Unearned
Chapter 4: Types of Major Accounts (FAR
by: Millan)
Common Account Titles - Continuation
• BALANCE SHEET ACCOUNTS
EQUITY
a. Owner’s capital (or Owner’s equity)
b. Owner’s drawings
Chapter 4: Types of Major Accounts (FAR
by: Millan)
Common Account Titles - Continuation
• INCOME STATEMENT ACCOUNTS
INCOME
a.
b.
c.
d.
Service fees
Sales
Interest income
Gains
Chapter 4: Types of Major Accounts (FAR
by: Millan)
Common Account Titles - Continuation
•
INCOME STATEMENT ACCOUNTS
EXPENSES
a.
Cost of sales (or Cost of goods sold)
b. Freight-out
c.
Salaries expense
d. Rent expense
e. Utilities expense
f.
Supplies expense
g.
Bad debt expense
h. Depreciation expense
i.
Advertising expense
j.
Insurance expense
k.
Taxes and licenses
l.
Transportation and travel expense
m. Interest expense
n. Miscellaneous expense
o. Losses
Chapter 4: Types of Major Accounts (FAR
by: Millan)
Chapter 5
Books of Accounts and Double-entry
System
Learning Ojectives
1. Identify the uses of the two books of
accounts.
2. Illustrate the format of general and special
journals.
3. Illustrate the format of general and
subsidiary ledgers.
Chapter 5: Books of Accounts & Doubleentry System (FAR by: Millan)
The Books of Accounts
1. Journal (General and Special)
2. Ledger (General and Subsidiary)
Chapter 5: Books of Accounts & Double-entry System (FAR by: Millan)
Journal
The journal, also called the “book of original
entries,” is the accounting record where business
transactions are first recorded.
1. Special Journal – is used to record transactions
with similar nature (e.g., Sales journal,
Purchases journal, Cash receipts journal, and
Cash disbursements journal)
2. General Journal – All other transactions that
cannot be recorded in the special journals are
recorded in the general journal.
Chapter 5: Books of Accounts & Double-entry System (FAR by: Millan)
Ledger
• The ledger is used to classify the effects of
business transactions on the accounts. It is
also called the “book of final entries.”
1. General ledger – contains all the accounts
appearing in the trial balance.
2. Subsidiary ledger – provides a breakdown
of the balances of controlling accounts.
Chapter 5: Books of Accounts & Double-entry System (FAR by: Millan)
Chapter 5: Books of Accounts & Double-entry System (FAR by: Millan)
Format of the General Journal
Chapter 5: Books of Accounts & Double-entry System (FAR by: Millan)
Formats of the Ledgers
Chapter 5: Books of Accounts & Double-entry System (FAR by: Millan)
Double-entry System
• Concept of duality – each transaction is
recorded in two parts – debit and credit
• Concept of equilibrium – each transaction is
recorded in terms of equal debits and
credits.
Chapter 5: Books of Accounts & Double-entry System (FAR by: Millan)
Normal balances of accounts
Chapter 5: Books of Accounts & Double-entry System (FAR by: Millan)
Rules of Debits and Credits
Chapter 5: Books of Accounts & Double-entry System (FAR by: Millan)
Chapter 5: Books of Accounts & Double-entry System (FAR by: Millan)
Contra and Adjunct accounts
• Contra accounts are presented in the
financial statements as deduction to their
related accounts.
• Adjunct accounts are presented in the
financial statements as addition to their
related accounts.
Chapter 5: Books of Accounts & Double-entry System (FAR by: Millan)
Chapter 6
Business Transactions & Their Analysis
Learning Objectives
1. Describe the nature and give examples of
business transactions.
2. Identify the different types of business
documents.
3. Analyze common business transactions using
the rules of debit and credit.
Chapter 6: Business Transcations & Their
Analysis (FAR by: Millan)
Steps in the Accounting cycle
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Identifying and analyzing
Journalizing
Posting
Unadjusted trial balance
Adjusting entries
Adjusted trial balance (and/or Worksheet)
Financial statements
Closing entries
Post-closing trial balance
Reversing entries
Chapter 6: Business Transcations & Their Analysis (FAR by: Millan)
Identifying and analyzing
transactions and events
• Only accountable events are recorded.
Accountable events are those that affect the
assets, liabilities, equity, income or expenses
of the business.
• Accountable events are normally identified
from source documents, such as sales
invoice, official receipts, delivery receipts,
and the like.
Chapter 6: Business Transcations & Their Analysis (FAR by: Millan)
Types of Events
1. External events – are transactions that
involve the business and another external
party.
2. Internal events – are events that do not
involve an external party.
Chapter 6: Business Transcations & Their Analysis (FAR by: Millan)
Journalizing
Journalizing refers to recording an identified
accountable event in the journal by means of a
journal entry.
Chapter 6: Business Transcations & Their Analysis (FAR by: Millan)
Simple and Compound journal entries
• Simple journal entry – contains a single
debit and a single credit element.
• Compound journal entry – contains two or
more debits or credits.
Chapter 6: Business Transcations & Their Analysis (FAR by: Millan)
Chapter 7
Posting to the Ledger
Learning Objectives
1. Post transactions in the ledger.
2. Prepare the unadjusted trial balance.
Chapter 7: Posting to the Ledger (FAR by:
Millan)
Posting
Posting, the third step in the accounting cycle,
is the process of transferring data from the
journal to the appropriate accounts in the
ledger.
Chapter 7: Posting to the Ledger (FAR by: Millan)
Example of posting:
Transaction: Jan. 8 - Services worth ₱30,000
were rendered for cash.
Journalizing:
Chapter 7: Posting to the Ledger (FAR by: Millan)
Example of posting (continuation)
Posting
Chapter 7: Posting to the Ledger (FAR by: Millan)
Trial balance
• A trial balance is a list of general ledger
accounts and their balances. It is prepared
to check the equality of total debits and
total credits in the ledger.
Chapter 7: Posting to the Ledger (FAR by: Millan)
Types of Trial balance
a. Unadjusted trial balance – this is prepared
before adjusting entries are made.
b. Adjusted trial balance – this is prepared
after adjusting entries but before the
financial statements are prepared.
c. Post-closing trial balance – this is prepared
after the closing process.
Chapter 7: Posting to the Ledger (FAR by: Millan)
Errors revealed by a trial balance
1. Journalizing or posting one-half of an entry,
i.e., a debit without a credit, or vice versa.
2. Recording one part of an entry for a
different amount than the other part.
3. Errors of Transplacement (Slide error) on
one side of an entry.
4. Error of Transposition on one side of an
entry.
Chapter 7: Posting to the Ledger (FAR by: Millan)
Errors not revealed by a trial
balance
1. Omitting entirely the entry for a transaction
2. Journalizing or posting an entry twice
3. Using wrong account with the same normal
balance as the correct account
4. Wrong computation with the same
erroneous amounts posted to debit and
credit sides
Chapter 7: Posting to the Ledger (FAR by: Millan)
Chapter 8
Adjusting Entries
Learning Objectives
1. Enumerate the common end-of-period
adjustments.
2. Prepare adjusting entries.
Chapter 8: Adjusting Entries (FAR by:
Millan)
Adjusting entries
• Adjusting entries are entries made prior to
the preparation of financial statements to
update certain accounts so that they reflect
correct balances as of the designated time.
Chapter 8: Adjusting Entries (FAR by: Millan)
Purpose of adjusting entries
a. To take up unrecorded income and expense
of the period.
b. To split mixed accounts into their real and
nominal elements.
Chapter 8: Adjusting Entries (FAR by: Millan)
Real, Nominal and Mixed Accounts
a. Real Accounts (Permanent accounts) – accounts
that are not closed at the end of the accounting
period. These accounts include all balance sheet
accounts, except the “Owner’s drawings” account.
b. Nominal Accounts (Temporary accounts) – accounts
that are closed at the end of the accounting period.
These accounts include all income statement
accounts, drawings account, clearing accounts and
suspense accounts.
c. Mixed accounts – accounts that have both real and
nominal account components. These accounts are
subject to adjustment.
Chapter 8: Adjusting Entries (FAR by: Millan)
Chapter 8: Adjusting Entries (FAR by: Millan)
Methods of Initial Recording of
Income
1. Liability method – under this method, cash receipts
from items of income are initially credited to a
liability account. At the end of the period, the
earned portion is recognized as income while the
unearned portion remains as liability.
2. Income method – under this method cash receipts
from items of income are initially credited to an
income account. At the end of the period, the
unearned portion is recognized as liability while the
earned portion remains as income.
Chapter 8: Adjusting Entries (FAR by: Millan)
Methods of Initial Recording of
Expenses
1. Asset method – under this method cash
disbursements for items of expenses are initially
debited to an asset account. At the end of the
period, the incurred portion (‘used up’ or ‘expired’)
is recognized as expense while the unused portion
remains as asset.
2. Expense method – under this method, cash
disbursements for items of expenses are initially
debited to an expense account. At the end of the
period, the unused portion (‘not yet incurred’ or
‘unexpired’) is recognized as asset while the
incurred portion remains as expense.
Chapter 8: Adjusting Entries (FAR by: Millan)
Chapter 9
Accounting Cycle of a Service Business
Learning Objectives
1. Prepare a worksheet.
2. Prepare closing entries.
3. Prepare a balance sheet and income
statement of a service business.
4. Prepare reversing entries.
Chapter 9: Accounting Cycle of a Service
Business (FAR by: Millan)
Worksheet
A worksheet is an analytical device used to
facilitate the gathering of data for
adjustments, the preparation of financial
statements, and closing entries.
Chapter 9: Accounting Cycle of a Service Business (FAR by: Millan)
Chapter 9: Accounting Cycle of a Service Business (FAR by: Millan)
Financial statements
• The financial statements are the end
product of the accounting process.
Information from the journal and the ledger
are meaningless to most users unless they
are summarized and communicated through
the financial statements.
Chapter 9: Accounting Cycle of a Service Business (FAR by: Millan)
The major processes in accounting are
summarized below:
Chapter 9: Accounting Cycle of a Service Business (FAR by: Millan)
Financial Statements
• Statement of financial position (or Balance
sheet) – shows information on assets,
liabilities and equity.
• Statement of profit or loss (or Income
statement) – shows information on income
and expenses, and consequently, the profit
or loss for the period.
Chapter 9: Accounting Cycle of a Service Business (FAR by: Millan)
Closing entries
• Closing entries are entries prepared at the
end of the accounting period to “zero out”
all nominal accounts in the ledger. This is
done so that the transactions during the
period will not commingle with the
transactions in the next period.
Chapter 9: Accounting Cycle of a Service Business (FAR by: Millan)
Closing entries
• Closing entries are prepared as follows:
a. All income accounts are debited and all
expense accounts are credited. The resulting
balance is recorded in a clearing account
called the “Income summary.”
b. The balance of “Income summary” is closed to
the “Owner’s capital” account.
c. Any balance in the “Owner’s drawings”
account is closed to the “Owner’s capital”
account.
Chapter 9: Accounting Cycle of a Service Business (FAR by: Millan)
Chapter 9: Accounting Cycle of a Service Business (FAR by: Millan)
Reversing Entries
• Reversing entries are entries usually made
on the first day of the next accounting
period to reverse certain adjusting entries
made in the immediately preceding period.
Chapter 9: Accounting Cycle of a Service Business (FAR by: Millan)
Adjusting entries that may be
reversed
1. Accruals for income or expense
2. Prepayments initially recorded using the
expense method
3. Advanced collections initially recorded
using the income method
Chapter 9: Accounting Cycle of a Service Business (FAR by: Millan)
Chapter 10
Accounting Cycle of a Merchandising
Business
Learning Objectives
1. Prepare the Statement of Cost of Goods Sold
and Gross Profit.
2. Complete the accounting cycle of a
merchandising business
Chapter 10: Accounting Cycle of a
Merchandising Business (FAR by: Millan)
Merchandising Business
• A merchandising business is one that buys
and sells goods in their original form and
without any further processing. Those goods
are referred to as merchandise inventory (or
simply, inventory).
Chapter 10: Accounting Cycle of a Merchandising Business (FAR by: Millan)
Inventory Systems
a. Perpetual inventory system – under this
system, the “Inventory” account is updated
each time a purchase or sale is made. Thus,
the “Inventory” account shows a continuing or
running balance of the goods on hand.
b. Periodic inventory system – under this system,
the “Inventory” account is updated only when
a physical count is performed. Thus, the
amounts of inventory and cost of goods sold
are determined only periodically.
Chapter 10: Accounting Cycle of a Merchandising Business (FAR by: Millan)
Chapter 10: Accounting Cycle of a Merchandising Business (FAR by: Millan)
Accounts used under Periodic
System
• Purchases – the account used to record purchases of
inventory under the periodic system.
• Freight-in (Transportation-in) – the account used to
record the shipping costs incurred on purchases of
inventory under the periodic system.
• Purchase returns – the account used to record
returns of purchased goods to the supplier.
• Purchase discounts – the account used to record
cash discounts availed of on the purchased goods.
Chapter 10: Accounting Cycle of a Merchandising Business (FAR by: Millan)
Chapter 10: Accounting Cycle of a Merchandising Business (FAR by: Millan)
Chapter 10: Accounting Cycle of a Merchandising Business (FAR by: Millan)
Gross Profit
Chapter 10: Accounting Cycle of a Merchandising Business (FAR by: Millan)
Chapter 10: Accounting Cycle of a Merchandising Business (FAR by: Millan)
Chapter 10: Accounting Cycle of a Merchandising Business (FAR by: Millan)
• Sales – include both cash sales and credit
sales.
• Sales returns – the account used to goods
sold but were returned by customers.
• Sales discounts – the account used to record
cash discounts given to and taken by
customers.
Chapter 10: Accounting Cycle of a Merchandising Business (FAR by: Millan)
Statement of Cost of Goods Sold and
Gross Profit
Chapter 10: Accounting Cycle of a Merchandising Business (FAR by: Millan)
END
Chapter 10: Accounting Cycle of a
Merchandising Business (FAR by: Millan)