FINANCIAL

ACCOUNTING AND
REPORTING

Melvin S. Sarsale
FINANCIAL ACCOUNTING
AND REPORTING
Learning Modules

MELVIN S. SARSALE

SOUTHERN LEYTE STATE UNIVERSITY

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COURSE OVERVIEW
Course Number SA-1-A-5 / SA-1-B-3 / MA-1-A-8
Course Code AE 101
Descriptive Title Financial Accounting and Reporting
Credit Units 6
School Year/Term 2020-2021 / 1st Semester
Mode of Delivery Modular Distance Learning
Name of Instructor Melvin S. Sarsale, CPA, DBA
Course Description This course focuses on the basic concepts, principles, and
conventions of accounting. This will help the students to develop a
strong foundation for the accounting subject. It includes the basic
application of those principles in the accounting cycle involving
different types of business organizations and the different nature
of business operations. It also includes discussions on partnership
formation, operation, dissolution, and liquidation. It also involves
accounting for corporations as well as the issuance of dividends.
Course Outcomes 1. Explain the different accounting concepts and principles.
2. Illustrate the steps in the accounting cycle.
3. Complete the accounting cycle of a servicing business.
4. Apply the steps in the accounting cycle to a merchandising
business.
5. Practice the procedures in partnership accounting.
6. Illustrate the procedures in corporate accounting.
SLSU Vision A high quality corporate University of Science, Technology, and
Innovation.
SLSU Mission SLSU will (i) develop science, technology, and innovative leaders
and professionals; (ii) produce high impact technologies from
research and innovations; (iii) contribute to sustainable
development through responsive community engagement
programs; and (iv) generate revenues to be self-sufficient and
financially viable.

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MODULE GUIDE
This learning material in financial accounting and reporting is designed to provide the
accountancy and management accounting students with the basic concepts, principles, and
conventions of accounting. This will help the students to develop a strong foundation of the
accounting cycle as applied in different forms of business organizations and different types
of business activities.

The contents of this material are divided into six modules. Module 1 presents the accounting
concepts and principles which are further subdivided into three lessons. Lesson 1 talks about
the introduction to accounting. Lesson 2 discusses the accounting concepts and principles.
Lesson 3 explores on the accounting equation. Module 2 discusses the accounting cycle and
is sectioned into ten lessons. Lesson 4 explains how to analyze business transactions. Lesson
5 illustrates how to make journal entries. Lesson 6 explains the posting process. Lesson 7
presents the preparation of an unadjusted trial balance. Lesson 8 talks on how to make
adjusting entries. Lesson 9 illustrates how to prepare an adjusted trial balance. Lesson 10
demonstrates how to make financial statements. Lesson 11 provides procedures in making
closing entries. Lesson 12 presents the guide in making the post-closing trial balance. Lesson
13 gives you instructions on how to prepare reversing entries. Module 3 illustrates only
Lesson 14 on how to complete the accounting cycle of a service business.

Module 4 also provides only Lesson 15 on how to complete the accounting cycle of a
merchandising business. Module 5 discusses accounting for partnerships and is composed of
four lessons. Lesson 16 presents the procedures in accounting partnership formation. Lesson
17 guides in accounting partnership operations. Lesson 18 illustrates accounting procedures
for partnership dissolutions. Lesson 19 discusses accounting for partnership liquidation.
Module 6 explains the accounting procedures for basic corporate equity transactions. Lesson
20 provides accounting entries for basic shareholder’s equity transactions. Lesson 21
illustrates on how to account dividends.

This material includes a pre-test comprising of 40 questions. You need to accomplish the pre-
test first before navigating the rest of the modules. Each lesson contains review questions,
exercises and CPALE simulations for you to answer and to be submitted on or before the
deadline. Each lesson also contains suggested readings and exercises for you to practice. This
module promotes self-paced learning which means you can access this module at your own
pace, convenience, and time. If you think you have encountered things to clarify while
exploring this material, you are encouraged to address your concern to your instructor
immediately. Lastly, please be always reminded that diligence and self-discipline are the keys
to becoming a Certified Public Accountant.

“You say: You can’t do it, but God says: You can do everything.”

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PRE-TEST
Instruction: Read the questions carefully. Write your answer in a ½ lengthwise sheet of paper. Choose
the best answer only!
1. What is the primary purpose of accounting?
a. to count money
b. to provide accounts
c. to provide information that is intended to be useful in making economic decisions
d. to produce accountants
2. The following are decisions made by internal users except ________.
a. to analyze the profitability of product lines
b. to impose taxes
c. to decide whether to continue or discontinue product lines
d. to decide whether to build new production facilities
3. The branch of accounting that deals with providing financial information to external decision-
makers is _______.
a. public accounting b. government accounting
c. financial accounting d. managerial accounting
4. When uncertainty exists, the convention of conservatism or prudence uses estimates of a
conservative nature in an attempt to ensure which of the following?
a. Assets, income, liabilities, and expenses are not overstated.
b. Assets, income, liabilities, and expenses are not understated.
c. Assets and income are not understated; liabilities and expenses are not overstated.
d. Assets and income are not overstated; liabilities and expenses are not understated.
5. The information has this qualitative characteristic if two different users could reach a general
agreement as to what the information intends to represent.
a. relevance b. comparability c. faithful representation d. verifiability
6. While making a delivery, the driver of Speedy Courier collided with another vehicle causing both
property damage and personal injury. The party sued Speedy for damages that could exceed
Speedy's insurance coverage. The existence of the lawsuit was reported in the notes to Speedy's
financial statements. What accounting principle, assumption, or constraint is being applied in this
situation?
a. full-disclosure b. conservatism c. matching principle d. unit-of-measure
7. A business has total assets of P640,000 and total equity of P360,000 at the beginning of the
period. The business earns an income of P220,000 during the period and reports a profit of
P80,000. There were no transactions with the owner during the period. Total liabilities increased
by P40,000 by the end of the period. How much are the total assets at the end of the period?
a. P560,000 b. P440,000 c. P860,000 d. P760,000
8. Accounts are listed in the trial balance in this sequence.
a. asset, liabilities, equity, expense, and income
b. asset, equity, liabilities, expense, and income
c. asset, liabilities, equity, income, and expense
d. asset, expense, liabilities, equity, and income
9. The first step in the accounting cycle is ______.
a. posting to the ledger b. journalizing
c. preparing the adjusting entries d. analyzing events

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10. At the beginning of the period, Sean had a cash balance of P20,000 and notes payable of P15,000.
During the period, Sean collected P11,000 accounts receivable, paid P8,000 notes payable, and
issued additional notes payable of P5,000 in exchange for cash. How much are the ending
balances of cash and notes payable, respectively?
Cash Notes payable
a. P17,000 P20,000
b. P20,000 P12,000
c. P28,000 P12,000
d. P36,000 P20,000
11. If a resource has been consumed but a bill has not been received at the end of the accounting
period, then _______.
a. an expense should be recorded when the bill is received
b. an expense should be recorded when the cash is paid out
c. an adjusting entry should be made recognizing the expense
d. it is optional whether to record the expense before the bill is received
12. The term posting as used in accounting means _______.
a. recording an accountable event in debit-credit format
b. transferring the debits and credits of journal entries from the journal to the affected accounts in
the ledger
c. checking the equality of the monetary totals of debits and credits of accounts in the ledger
d. uploading photographs to the internet
13. When preparing closing entries, which of the following accounts is debited when closing to the
income summary account?
a. depreciation expense b. owner’s drawings
c. sales d. salaries payable
14. Which of the following would result in an income of P320,000?
a. total expenses of p280,000 and loss of p40,000
b. total expenses of p360,000 and profit of p40,000
c. total expenses of p220,000 and loss of p100,000
d. total expenses of p360,000 and loss of p40,000
15. Revenues earned from rendering services are recorded in this account.
a. sales b. service fees c. interest income d. gains
16. In a service-type of business, revenue is considered earned _________.
a. at the end of the month b. at the end of the year
c. when the service is performed d. when cash is received
17. Ricci Company purchased office supplies costing P6,000 and debited office supplies for the full
amount. At the end of the accounting period, a physical count of office supplies revealed P2,400
still on hand. The appropriate adjusting journal entry to be made at the end of the period would
be _______.
a. debit office supplies expense, P2,400; credit office supplies, P2,400
b. debit office supplies expense, P3,600; credit office supplies expense, P3,600
c. debit office supplies expense, P3,600; credit office supplies, P3,600
d. debit office supplies, P2,400; credit office supplies expense, P2,400
18. A law firm received P2,000 cash for legal services to be rendered in the future. The full amount
was credited to unearned legal fees. If the legal services have been rendered at the end of the
accounting period and no adjusting entry is made, this would cause ______.
a. expenses to be overstated b. net income to be overstated
c. liabilities to be understated d. revenues to be understated
19. At the beginning of the period, a business has a cash balance of P20,000. During the period, total
cash collections and total cash payments amounted to P100,000 and P70,000, respectively. How
much is the ending balance of cash?
a. P10,000 b. P30,000 c. P50,000 d. P70,000

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20. The financial statement that shows the information on assets, liabilities, and equity is the ___.
a. balance statement b. income sheet c. balance sheet d. income statement
21. The accounts debited when recording purchases of inventory under the perpetual inventory
system and periodic inventory system, respectively, are ______.
Perpetual Periodic
a. inventory purchases
b. purchases inventory
c. inventory merchandise inventory
d. purchases purchases
22. The account to be used under the periodic inventory system to record the transportation costs
incurred on purchases.
a. freight-out b. transportation out c. freight-in d. purchases-in
23. Inventory, beg. P50,000; net purchases, p120,000; cost of goods sold, P80,000. How much is the
ending inventory?
a. P90,000 b. P120,000 c. P70,000 d. P80,000
24. MSS Corp. has a beginning inventory of P340,000. During the period MSS Corp. purchased
inventories costing P990,000. Freight paid on the purchase totaled P40,000. The ending inventory
was P360,000. If the net sales were P1,200,000, how much is the gross profit?
a. P1,010,000 b. P1,200,000 c. P190,000 d. P260,000
25. If gross sales are P40,000, sales returns and allowances P1,000, sales discounts P400, and delivery
expenses P100, the net sales of the business will total _____.
a. P38,500 b. P38,600 c. P40,000 d. P39,000
26. Y and Z formed a partnership. Y contributed cash of P500,000 while Z contributed land with a
carrying amount of P400,000 and a fair value of P800,000. The land has an unpaid mortgage of
P200,000 which is assumed by the partnership. How much is the correct valuation of Z’s capital
immediately after the partnership formation?
a. P400,000 b. P500,000 c. P600,000 d. P800,000
27. Mr. Y and Ms. Z formed a partnership and agreed to divide the initial capital equally even though
Mr. Y contributed P100,000 and Ms. Z contributed P84,000 in identifiable assets. The partners
agree that the difference in the amount of contribution and the amount of credit to the partner’s
capital shall be treated as compensation for the expertise that the partner will be bringing to the
partnership. How much is the correct valuation of Y’s capital immediately after the partnership
formation?
a. P84,000 b. P92,000 c. P100,000 d. P108,000
28. Which of the following best describes the nature of salary and interest allowance in a partnership
profit and loss sharing agreement?
a. expenses of the business that should be deducted from revenue in determining the income
b. the amount upon which each partner will have to pay personal income tax
c. a means of distributing net income to services rendered and capital invested by partners
d. a means of determining reasonable monthly withdrawals by each partner
29. Y and Z share in partnership profits and losses on a 40:60 ratio. During the year, Y’s capital
account has a net increase of P50,000. Partner Y made contributions of P10,000 and capital
withdrawals of P60,000 during the year. How much was the share of Z in the partnership profit
for the year?
a. P100,000 b. P150,000 c. P200,000 d. P180,000
30. At the time of dissolution, _________.
a. all assets and liabilities are restated at their fair values
b. only current assets are restated at their fair values
c. non-cash assets are restated at their fair values
d. only non-current assets are restated at their fair values

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31. Y and Z are partners who share profits and losses in the ratio of 6:4, respectively. On May 1, 2016,
their respective capital accounts were P60,000 and P50,000 respectively. On that date, Z was
admitted as a partner with a one-third interest in capital and profits for an investment of P40,000.
The new partnership began with total capital of P150,000. X’s capital account was credited equally
to her proportionate share in the partnership net assets. Immediately after X’s admission, Y’s
capital should be ________.
a. P50,000 b. P54,000 c. P56,667 d. P60,000
32. A partner’s loss absorption balance is calculated by _______.
a. dividing the partner’s capital balance by his percentage interest in the capital
b. dividing the partner’s total interest by his profit and loss sharing percentage
c. multiplying the partner’s total interests by his profit and loss sharing percentage
d. multiplying distributable assets by the partner’s profit-sharing percentage
33. As of December 31, 2016, the books of CDE Partnership showed capital balances of Camado,
P40,000; Denteng, P25,000; Emando, P5,000. The partner’s profit and loss ratio were 3:2:1,
respectively. The partners decided to liquidate and they sold all non-cash assets for P37,000. After
the settlement of all liabilities amounting to P12,000, they still have cash of P28,000 left for
distribution. Assuming that any capital deficiency is uncollectible, the share of Camado in the
distribution of cash would be ________.
a. P17,000 b. P17,800 c. P18,000 d. P19,000
34. At the time of admission of a new partner, the firm is _____.
a. dissolved b. continued c. not affected d. either a or b
35. Legal capital is the portion of contributed capital that cannot be distributed to the owners during
the lifetime of the corporation unless the corporation is dissolved and all of its liabilities are
settled first. For no-par value shares, legal capital is ______.
a. the aggregate par value of shares issued and subscribed
b. the total consideration received or receivable from shares issued or subscribed
c. the aggregate stated value of shares issued and subscribed
d. the aggregate market value of shares issued and subscribed
36. Which of the following is not one of the basic shareholder’s rights?
a. the right to participate in earnings
b. the right to maintain one's proportional interest in the corporation
c. the right to participate in the proceeds of the sale of corporate assets upon liquidation
d. the right to inspect the accounting records of the corporation
37. A year ago, Y Corp. reacquired 2,000 of its own shares with a par value of P100 per share for
P240,000. Today, Y Corp. reissues half of the treasury shares at P160 per share. The journal entry
to record the re-issuance includes which of the following?
a. credit to retained earnings for P240,000
b. debit to treasury shares for P120,000
c. credit to share premium-treasury shares for P80,000
d. credit to share premium-treasury shares for P40,000
38. Y Corp. reacquires 10,000 of its own shares for P50. The shares have a par value of P10 and were
originally issued at P15 per share. Subsequently, Y Corp. reissues the 10,000 shares at P48 per
share. The journal entry to record the re-issuance involves which of the following?
a. debit to retained earnings for P20,000
b. credit to cash for P480,000
c. debit to share premium for P50,000
d. debit to treasury shares for P500,000
39. Cash dividends payable or stocks dividends payable is credited on the _____.
a. date of dividend declaration b. date of dividend subscription
c. date of record d. any of these
40. An example of a nominal contra account is _____.
a. accumulated depreciation b. freight-in
c. premium on bond liability d. sales return

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BRIEF CONTENTS
MODULE 1 Accounting Concepts and Principles 1
Lesson 1 Introduction to Accounting 2
Lesson 2 Accounting Concepts and Principles 8
Lesson 3 Accounting Equation 13
MODULE 2 Accounting Cycle 17
Lesson 4 Analyzing Transactions 18
Lesson 5 Journalizing 22
Lesson 6 Posting 26
Lesson 7 Unadjusted Trial Balance 31
Lesson 8 Adjusting Entries 35
Lesson 9 Adjusted Trial Balance 41
Lesson 10 Financial Statements 44
Lesson 11 Closing Entries 49
Lesson 12 Post-Closing Trial Balance 53
Lesson 13 Reversing Entries 56
MODULE 3 Accounting for Service Business 59
Lesson 14 Accounting for Service Business 60
MODULE 4 Accounting for Merchandising Business 64
Lesson 15 Accounting for Merchandising Business 65
MODULE 5 Accounting for Partnership 77
Lesson 16 Partnership Formation 78
Lesson 17 Partnership Operations 83
Lesson 18 Partnership Dissolution 88
Lesson 19 Partnership Liquidation 93
MODULE 6 Accounting for Corporation 100
Lesson 20 Accounting for Shareholder’s Equity 101
Lesson 21 Accounting for Dividends 107

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 FINANCIAL ACCOUNTING AND REPORTING
LEARNING MODULES

MODULE

1
Accounting Concepts and Principles
Students take down notes some important lessons in their class. Secretaries record the
proceedings of the meetings. Doctors write their medical prescriptions to their patients in a
prescription form. Registrars require students to fill up enrollment forms before admitted to
schools. These activities simply describe the importance of records. The evidence of records
in itself depicts that the human brain cannot remember everything such that important
events have to be written to serve as a reference for future recall. This idea is very much true
to business organizations especially that important economic decision solely relies on the
information at hand. Without these records, several parties will face difficulty in drawing
sound financial decisions. The recording is just the starting point of the accounting process.
Accounting involves several activities that link between the day-to-day business transactions
and the decisions made by various stakeholders.

This module consists of three essential lessons which include an introduction to accounting,
accounting concepts and principles and the accounting equation. The first lesson shall bring
us an understanding of basic accounting including its definition, nature, fields, history,
different forms of business organizations, and different users of accounting information so
that we can appreciate its importance as well its existence in every organization. The second
lesson imparts significant accounting concepts and principles to guide various users of
accounting information in preparing and interpreting financial statements which are the
ultimate product of the whole accounting process. The third lesson discusses the effects of
business transactions on the accounting equation.

LESSON
1 Introduction to Accounting
2 Accounting Concepts and Principles
3 Accounting Equation

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 FINANCIAL ACCOUNTING AND REPORTING
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Lesson 1 INTRODUCTION TO ACCOUNTING

Did you know that?

LEARNING OBJECTIVES Vicente F. Fabella became the first Filipino certified
public accountant in 1915 at the state of Wisconsin,
1. Explain the definition, nature, fields, USA.
and history of accounting; Source: www.manilatimes.net

2. Describe the users of accounting

information; and
Accounting is a process of identifying, recording,
3. Classify business organizations as to
and communicating economic information that is
their form and activities.
useful in making economic decisions.

The accountant identifies whether the

transaction is an accountable or non-accountable event because only accountable events are
recorded in the books of accounts which this process is known as journalizing. The
accountant classifies the effects of the event on the accounts and this process is called
posting. At the end of the accounting period, the accountant summarizes the information
processed in the accounting system to produce meaningful reports. Accounting information
is communicated to interested users through accounting reports, the most common form of
which is the financial statements.

The nature of accounting is to provide information about economic activities intended to be

useful in making economic decisions. The types of information provided by accounting can be
quantitative, qualitative, and financial information. The functions of accounting in business
are to provide external users with information that is useful in making investment and credit
decisions and to provide internal users with information that is useful in managing the
business. Internal users are those who are directly involved in managing the business. External
users are those who are not directly involved in managing the business.

Internal Users
 Owner  They are interested to know whether the business should be maintained, increased,
decreased, or disposed of completely. They also want to know whether they are getting
a fair return for his/her investment.
 Management  Financial information serves a measure for making future financial decisions and a
measure of its effectiveness.

External Users
 Investors (Potential Investors)  They are interested in the financial statement to determine whether
to acquire ownership in the firm.
 Creditors (Potential Creditors)  They are interested to investigate whether the firm can meet its
obligations before granting loans or credits.
 Employees  They are interested in accounting information to enable them to
assess the ability of the firm to provide remuneration and other
benefits.
 Government  The government needs accounting information to regulate the firm’s
activities and determine the basis for taxation policies.

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 FINANCIAL ACCOUNTING AND REPORTING
LEARNING MODULES

Accounting can be traced as far back as prehistoric times, perhaps more than 10,000 years
ago. Archeologists found writings in cones, disks, spheres, and pellets which serve as
records.

“In 1494, the first book on double-entry accounting was

published by a Franciscan monk, Luca Pacioli. While Friar
Luca is regarded as the “Father of Accounting”, he did not
invent the system. Instead, he simply described a method
used by merchants in Venice during the Italian
Renaissance period. His system included most of the
accounting cycle as we know it today. The first accounting
book was one of five sections in Pacioli's mathematics
book, titled “Summa de Arithmetica, Geometria,
Proportioni et Proportionalita”. This section on accounting
served as the world’s only accounting textbook until into
the 16th century.” (Smith, 2018).
Exhibit 1. Fr. Luca Pacioli is the author of the
book on double-entry bookkeeping.
Fields of Accounting Source: Smith (2018)

Public accounting is a professional service rendered by a CPA to the public for a fee.
1. Auditing  It primarily centers on the critical examination of financial statements by an
independent CPA to express an opinion regarding the fairness of the
contents of the financial statements.
2. Management Advisory  It assists the management through industrial advice regarding accounting,
Services finance, budgeting, business policies, and organization procedures.
3. Tax Services  It deals with the preparation of income tax returns, business, and transfer
taxes. The accountant represents the client in tax assessment and
investigations conducted by the BIR.

Private accounting is an accounting job done by accountants in private business enterprises.

1. General Accounting  It includes the recording of transactions and preparing financial reports for
the use of management, owners, creditors, governmental units, and other
interested parties.
2. Cost Accounting  It has to do with the determining and controlling costs especially in
producing products or services.
3. Budgeting  It provides management a plan for future operations that will be compared
eventually to actual results.
4. Internal Auditing  It deals with determining the operational efficiency of the company
regarding the protection of the company’s assets, accuracy, and reliability of
the accounting data, and adherence to prescribed managerial policies.
5. International  It encompasses specialized accounting for international transactions,
Accounting comparisons of accounting principles in different countries, and
harmonization of diverse accounting standards worldwide and tax
requirements of each country in which the company does business.
6. Social Accounting  It concerns the measurement of the impact of business or government
agency’s decision on the public sector.
7. Not-for-Profit  It deals with specialized accounting for charitable organizations,
Accounting philanthropic foundations, religious groups, governmental agencies,
schools, and cooperatives.

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 FINANCIAL ACCOUNTING AND REPORTING
LEARNING MODULES

Government accounting mainly focuses on the custody of government funds and their purposes and is
generally used in accounting for the national government and its political instrumentalities.

Accounting education refers to CPAs teaching accounting in various colleges and universities.

Forms of Business Organizations

A sole proprietorship is a business entity owned by one person and registered with DTI.
Advantages Disadvantages
 Easy to start; only a few legal requirements.  The owner bears all the losses.
 Only the owner decides for the business.  The owner bears all responsibility and decision-
making.
 All profits are for the owner.  Limited resources, e.g. capital and managerial
skills.
 Lower extent of government regulation and  Unlimited liability. The owner is legally liable for
relatively lower taxes. all business debts.

A partnership is a business entity owned by two or more persons called partners and registered with the SEC.
Advantages Disadvantages
 Partners are sharing ideas towards a better  Joint decision making may give rise to conflict
business decision. among partners.
 Partners share the business risk and the  Profits are divided among partners.
responsibility of running the business.
 Easy to form – Mere agreement organizes a  Limited life, since a partnership can be easily
partnership. dissolved by the withdrawal, retirement, death, or
insanity of one of the partners.
 Joint resources, e.g. capital and skills.  Lesser capital compared to a corporation.
 Relatively lower extent of government regulation  A partnership other than a general professional
compared to corporations. partnership is taxed like a corporation.
 Unlimited liability - The partners can be held liable
for partnership debts up to their personal assets.

A corporation is an artificial person under the operation of the law and its existence as evidenced by its
registered Articles of Incorporation and Corporation By-Laws with the SEC.
Advantages Disadvantages
 Limited liability because shareholders are liable for  Shareholders have limited access and control over
corporate debts only up to they have invested. management and operations.
 Greater source of resources, e.g. capital and skills.  Costly and difficult to organize.
 Unrestricted transfer of ownership.  Greater government regulation and higher taxes.
 Renewable and perpetual life.  Profits are only shared through dividends when
declared by the board of directors.

Types of Business According to Activities

Service business deals with the rendering of services to customers such as tailoring shops, beauty shops, and
professional firms.
Advantages Disadvantages
 No or minimal inventory costs.  Demand more personal time from the owner.
 Minimal capital is needed.  A service business is usually affected the most
during economic recession especially when it does
not cater to the basic needs.
 Promote expertise.  Largely depends on the owner’s credibility and
more costly to commit an error.

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 FINANCIAL ACCOUNTING AND REPORTING
LEARNING MODULES

Merchandising business deals with the buying and selling of goods for profit.
Advantages Disadvantages
 Lower start-up capital than a manufacturing  Requires retail stores in a strategic location.
business.
 More opportunities for lesser purchase prices  Lesser control on the purchase price of goods.
during sale offering more discounts.
 Easy to start since it is only buying and selling.  Higher inventory costs.

Manufacturing business involves the purchase of raw materials and converting these raw materials into
finished products.
Advantages Disadvantages
 Potential for high growth.  High start-up capital.
 Opportunity to establish a brand that could last  Conceptualizing a viable manufacturing business is
longer than your lifetime. difficult.
 Do not need a retail store.  Need to be always updated and innovative.
 Better pricing policies due to economies of scale.  Warehousing and logistics costs can be high.
 Greater flexibility in controlling costs.  Too much reliance on raw materials.
 Manufacturing processes are too complicated and
difficult to manage.

Review Questions
1. Define accounting.
2. Differentiate partnership from corporations.
3. What are the advantages and disadvantages of single proprietorship?
4. What type of business do “sari-sari stores” belongs to?
5. If you have only a limited amount of capital, what type of business activity will you
undertake?
6. Why does the government need accounting information from the firms?
7. As an owner of a business, is it necessary to know the financial health of your company?
8. If you are the manager, how does accounting information helps you in making decisions?
9. Why is the Bureau of Internal Revenue interested in the annual financial statements of
every business?
10. Supposing you are planning to invest in a company, how does accounting information
from your prospect company where you want to invest help you in your decision?
11. What accounting information do you want to know from your clients before granting
their loans?

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 FINANCIAL ACCOUNTING AND REPORTING
LEARNING MODULES

CPALE Simulation Level 1

1. What is the major objective of financial 2. Financial accounting can be broadly defined
reporting? as the area of accounting that prepares __.
a. to provide information that excludes claims a. financial statements to be used by
to the resources investors only
b. to provide information that portrays b. financial statements to be used primarily by
nonfinancial transactions management
c. to provide information that is useful to c. general purpose financial statements to be
management in making decisions used by parties internal to the business
d. to provide information that is useful to enterprise only
assess the amounts, timing, and d. general purpose financial statements to be
uncertainty of prospective cash receipts used by parties both internal and external
to the business enterprise
3. One element of the objective of financial 4. The objective of general-purpose financial
reporting is to provide information _____. statements shall be to provide financial
a. that will attract new investors information about the reporting entity that
b. about the investors in the entity is useful to all of the following, except ___.
c. that is useful in assessing cash flow a. existing shareholder
prospects b. lenders
d. about the liquidation value of the resources c. potential investors
held by the entity d. prospective customers
5. The objectives of financial reporting for 6. Which of the following best states the
business enterprises are based on the need purpose of general-purpose financial
______. statements?
a. for conservative information a. to identify shareholders
b. of the users of the information b. to help users make decisions
c. to report on management’s stewardship c. to determine compliance with tax laws
d. to comply with financial accounting d. to disclose the market value of the firm
standards
7. A primary objective of financial reporting is 8. Services performed by a public accountant
to assist ______. include ______.
a. investors in analyzing the company a. auditing, taxation, and management
b. investors in predicting prospective cash consulting
flows b. auditing, budgeting, and management
c. banks to determine an appropriate interest consulting
rate for their commercials loans c. auditing, budgeting, and cost accounting
d. suppliers to find a suitable discount to offer d. auditing, budgeting, and management
a particular company consulting
9. Which of the following is not a step in the 10. The three types of business entities are __.
accounting process? a. proprietorships, small businesses, and
a. identification partnerships
b. recording b. proprietorships, partnerships, and
c. economic entity corporations
d. communication c. proprietorships, partnerships, and large
businesses
d. financial, manufacturing, and service
companies

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Suggested Readings

1. Basic Financial Accounting and Reporting (2019) by Ballada & Ballada, pp. 1-1 to 1-48.
2. Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp. 1-25.
3. Accounting Principles 13th Edition (2018) by Weygandt, Kimmel, & Kieso, pp. 1-1 to 1-25.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition.
Manila, Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio
City, Philippines: Bandolin Enterprise.
3. Smith, M. (2018). Luca Pacioli: The father of accounting (2018). Available at SSRN:
https://ssrn.com/abstract=2320658 or http://dx.doi.org/10.2139/ssrn.2320658
4. Philippine Institute of Certified Public Accountants - Northern Metro Manila Chapter.
(2018). PFRS.
5. Torres, J. (2018). 95 years of invaluable service. https://www.manilatimes.net/2018/03/08/
opinion/analysis/95-years-of-invaluable-service/384747/
6. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition.
Asia: John Wiley & Sons (Asia) Pte Ltd.

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LEARNING MODULES

Lesson 2 ACCOUNTING CONCEPTS AND PRINCIPLES

Did you know that?

LEARNING OBJECTIVE Washington Z. Sycip became the first Asian and the
only Filipino president of the International Federation
1. Apply the accounting concepts and of Accountants in 1982 until 1985.
principles in real-life situations. Source: www.ifac.org

Accounting concepts and principles guide accountants in

recording and communicating economic information. These concepts and principles are either explicit or implicit.
Those that are specifically mentioned in the Conceptual Framework for Financial Reporting and the Philippine
Financial Reporting Standards (PFRS) are called explicit concepts and principles while those that are not mentioned
are called implicit concepts and principles. Accounting standards refer to the PFRS and previously called generally
accepted accounting principles (GAAP). Technically, the standards and interpretations adopted by the Financial
Reporting Standard Council, the official accounting standard-setting body in the Philippines, include the (1)
Philippine Financial Reporting Standards, (2) Philippine Accounting Standards, and (3) Interpretations.

Basic Assumptions and Principles in Financial Reporting

Monetary Unit Economic Entity Time Period Going Concern
The monetary unit The economic entity The time period The going concern
assumption requires that assumption states that assumption states that assumption states that
only those things that can every economic entity can the life of a business can the business will remain in
be expressed in money be separately identified be divided into artificial operation for the
are included in the and accounted for. It is time periods and that foreseeable future. It is
accounting records. It is also called separate entity useful reports covering also called continuity
also called monetary unit concept, accounting entity those periods can be assumption.
concept and stable concept, entity concept, prepared for the business.
monetary unit concept. It and business entity It is also called periodicity This assumption underlies
follows the quantifiability concept. concept, accounting the historical cost
assumption (common unit period concept, and principle that dictates
of measurement) and reporting period concept. that companies record
peso stability assumption assets at their cost in
(stable value of money). This assumption supports adherence to the
the accrual-basis objectivity principle in
A reporting period or accounting period is usually 12 accounting in which which the purchase price
months, although it can be longer or shorter income is recorded in the as indicated in the
depending on the normal accounting cycle of the period when it is earned document must be used
business. It can be a calendar year period (January 1 rather than when it is as the value of the asset.
to December 31 of the same year) or a fiscal year collected (revenue
period (12 months and may start other than January
recognition principle) If the business intends to
1). An accounting period that is shorter than 12
while expense is recorded liquidate, it becomes a
months is called an interim period that can be a
month, a quarter (3 months), or semi-annual (6 in the period when it is liquidating concern. Then,
months). incurred upon which the it follows the fair value
related revenue is principle in which assets
generated rather than and liabilities should be
An economic entity can be any organization or unit when it is paid (expense reported at fair value (the
in society. It may be a company, a government recognition principle, also price received to sell an
agency, a municipality, a school district, or a church. known, as matching asset or settle a liability).
principle)

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Companies should consider the cost constraint or cost-benefit principle in which the benefit must outweigh the
cost in providing information to the users. Moreover, when a company needs to choose between a potentially
favorable from the unfavorable outcome, the unfavorable one should be chosen. This is in adherence to the
principle of prudence or conservatism which prescribes the observance of some degree of caution when
exercising judgments under conditions of uncertainty. In this manner, assets or income are not overstated and
liabilities or expenses are not understated.

These are called fundamental qualities because it makes the information useful to users.
Relevance Faithful Representation
Accounting information has relevance if it would make Faithful representation means that information
a difference in a business decision. The relevant accurately depicts what happened. Faithfully
information has the following aspects: represented information has the following aspects:
a. It has predictive value if it helps in making a. Information is complete if all necessary information is
predictions. provided. It supports the full-disclosure principle that
b. It has confirmatory value if it confirms or corrects requires companies to disclose all circumstances and
past predictions. events that would make a difference to financial
c. Materiality is a company-specific aspect of relevance. statement users.
An item is material when its size makes it likely to b. Information is neutral if it is not biased toward one
influence the decision of an investor or creditor. position or another.
c. The information must be free from error particularly
in describing and processing accounting information.

These are called enhancing qualities because it enhances the usefulness of the information.
Comparability Verifiability Timeliness Understandability
Different companies use Information is verifiable if The information must be The information must be
the same accounting independent observers, timely available to clear and concise so that
principles. using the same methods, decision-makers before it users who have
obtain similar results. This loses its capacity to reasonable knowledge
The company uses the supports the objectivity influence decisions. and willingness to analyze
same accounting principle. can interpret it and
principles and methods comprehend its meaning.
from year to year which is
known as the consistency
principle.

Let us consider what accounting assumption, concept, or principle that relates to the story.
1
In the time of the opening of the school, you started an Economic entity assumption. The business must be separated
internet café business and invested P100,000 as initial capital from the owner.
and deposited in a bank account named after the business1.
2
The business acquired computers amounting to P50,000 of Historical cost principle. The computer should be recorded at
which P1,000 was deducted as a trade discount and recorded acquisition cost.
P49,0002 as evidenced in the official receipt 3 provided by the 3
Objectivity principle. Each transaction should have a source
supplier. document as evidence.
4
The business acquired supplies amounting to P3,000 and was Matching principle. Expense is recognized when the related
recorded as prepaid supplies4 instead of supplies expense. revenue is generated.
5
The business rendered services to various clients on credit Accrual-basis accounting. Income is recognized when earned
amounting to P5,000 and recorded as accounts receivable5. regardless of when received.
6
The owner estimated that P100 will not be collected because Prudence or Conservatism. Expense should be overstated
the debtor is nowhere to be found and immediately recorded rather than understated.
as bad debts expense6.
7
The owner withdrew cash from the business amounting to Economic entity assumption. Personal withdrawal should be a
P2,000 and recorded as drawings7. withdrawal of investment.
When the year ended8, the business prepares the financial 8
Time period assumption. The life of the business is divided
statements to determine the profit of the business. into reporting periods to determine the profit of the business.
9
The business discovered that there is a $20 US dollars paid by Monetary unit assumption. Financial statements should be
a client. The accountant translated9 the dollar into the presented using a common unit of measurement.
Philippine peso using the current exchange rate.
10
Despite the COVID-19 pandemic which is mostly affected Going concern assumption. Businesses are expected to
across all business sectors, the owner still expects that the operate indefinitely.
internet café business will continue to operate indefinitely 10.

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11
The owner bought broomsticks for the café amounting to P50 Materiality concept. The business can decide when a
which will be expected to be used for less than a year. So, the transaction is considered to be material or not depending on the
owner recorded such as an expense instead of an asset 11. company’s policy.
12
However, the accountant describes other expenses with Full disclosure principle. The financial statements should
complete details in the notes to financial statements 12. disclose all the necessary information to make it more
understandable to the users.
13
The business recorded all immaterial expenses as other Cost-benefit constraint. The user should gain more benefit
expenses since the business considered this policy as more than its cost in providing accounting information.
beneficial to the user than recording each separately13.
This particular policy was consistently 14 applied yearly by the 14
Consistency principle. The same accounting policy was
company. applied from year to year.
15
During the following year, the business rendered internet Revenue recognition principle. Revenue is recognized on the
services on January 16 and received payment on January 18. date when it is earned.
The business recorded an income on January 1615.
16
The business requested for repair services from an IT Expense recognition principle. Expense is recognized on the
technician and rendered the service on February 1 16. The date when it is incurred.
business paid the technician on February 15. However, the
business recorded the expense on February 1.

This time, let us check the following transactions in which accounting assumption, concept, or principle has been
violated.

1. The accountant included sales of the subsequent period Revenue recognition principle. Sales should be recognized
as sales of the current period. during the period when it was earned.
2. The owner bought a new computer for personal use and Economic entity assumption. Personal transactions must be
was charged to the business as expenses. distinct from the business.
3. Equipment costing P50,000 was reported at P30,000 in its Historical cost principle. Assets should be recorded at its
current market value. acquisition cost.
4. The owner did not report the portion of receivables Full disclosure principle. Financial statements should disclose
pledged to obtain a bank loan. all the necessary information to the users.
5. The owner decided not to report depreciation incurred Expense recognition principle. Expenses should be recognized
this year because it can lower the net income. when the related income is earned.
6. The accountant records transactions as desired by the Objectivity principle. Transactions must be supported with
owner without proper supporting documents. proper documents.
7. The accounting methods and procedures used are Consistency principle. Accounting methods and procedures
changed regularly every six months. must be consistently applied from year to year.
8. The financial reports are always delayed. Timeliness. Financial statements should be made timely to
ensure its relevance.
9. The company depreciated a calculator costing P60 Materiality concept. When things are immaterial, it should be
because it is estimated to be used for five years. expensed outright rather than recording it as an asset and
depreciate it eventually.
10. A company believes that it will close its operations in the Going concern assumption. Businesses are expected to operate
next five years. indefinitely.

Review Questions
1. Differentiate calendar year from fiscal year and interim period.
2. What accounting concept assumes that a business entity will operate in an unforeseeable future?
3. Contrast fundamental from enhancing qualities of useful information.
4. Explain the cost-benefit principle.
5. What are the fundamental and enhancing qualities of useful information?
6. Discuss the principle of prudence.
7. Explain the basic accounting assumptions in financial reporting.
8. What is going concern assumption?
9. You are the loan officer of a bank. A businessperson submits a loan proposal and brings two sets
of financial information: A financial statement ending December 31, 2018, duly audited by an
external auditor and a financial statement for the 6 months ending June 30, 2019, prepared by an
employee of the firm. (i) Which statement do you think is more relevant and why? (ii) Which
statement do you think is more comparable to industry information and why?

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CPALE Simulation Level 2

1. Which of the following basic accounting 2. Which of the following is not considered a
assumptions is threatened by the existence primary characteristic of financial
of severe inflation in the economy? information?
a. economic entity assumption a. comparability
b. going concern assumption b. completeness
c. monetary unit assumption c. neutrality
d. periodicity assumption d. timeliness
3. Generally accepted accounting principles 4. To achieve faithful representation, the
___. financial statements ____.
a. derive their authority from legal court a. must have predictive and confirmatory
procedures value
b. have been specified in detail in the FRSC b. are comparable, understandable, verifiable,
Conceptual Framework and timely
c. are fundamentally truths or axioms that can c. must be complete, neutral, and reasonably
be derived from laws of nature free from error
d. derived their credibility and authority from d. All of these would achieve faithful
general recognition and acceptance by the representation.
accounting profession
5. The usefulness of providing information in 6. What links the decision-makers and the
financial statements is not subject to the decisions they make so that financial
constraint of _____. information would be useful?
a. timeliness a. materiality
b. consistency b. relevance
c. a balance between benefit and cost c. reliability
d. a balance between qualitative d. understandability
characteristics
7. What is the concept that supports the 8. Which of the following is not a qualitative
issuance of interim reports? characteristic of financial statements?
a. consistency a. comparability
b. faithful representation b. materiality
c. relevance c. relevance
d. materiality d. understandability
9. Which of the following is a fundamental 10. Which term best describes the information
quality of useful accounting information? that influences the economic decisions of
a. comparability users?
b. consistency a. prospective
c. materiality b. relevant
d. relevance c. reliable
d. understandable
11.The economic entity assumption ______. 12. Preparation of consolidated FS when a
a. requires periodic income measurement parent-subsidiary relationship exists is an
b. applies to unincorporated businesses example of the ______.
c. recognizes the legal aspects of business a. comparability characteristic
entities b. economic entity assumption
d. applies to all forms of business organization c. neutrality characteristic
d. relevance characteristics

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13. Which of the following is not an ingredient 14. All of the following represent costs of
of faithful representation? providing information, except _____.
a. completeness a. accessing capital
b. confirmatory value b. auditing
c. freedom from error c. disseminating
d. neutrality d. preparing
15. Which of the following terms best 16. During the lifetime of an entity,
describes financial statements whose basis accountants produce financial statements
of accounting recognizes transactions and at arbitrary points in time by what basic
other events when they occur? accounting concept?
a. accrual basis of accounting a. cost and benefit constraint
b. cash basis of accounting b. expense recognition principle
c. going concern basis of accounting c. materiality constraint
d. invoice basis of accounting d. periodicity assumption
17. Which of the following is not an economic 18. If financial information that is presented in
entity? a balance sheet or income statement is
a. SM Group of Companies misstated, and it influences the economic
b. Lions Club International, a civic decisions of the user, that information is
organization described as ______.
c. ABS-CBN Foundation, a charitable a. faithful
institution b. material
d. Chris James, a Quezon City resident who c. prudent
owns a chain of beauty salons d. reliable
19. Freedom from error relates to which 20. Which of the following terms describing
qualitative characteristic of the Conceptual information in the financial statements are
Framework? properly matched?
a. faithful representation a. prudent and relevant
b. relevance b. reliable and verifiable
c. understandability c. unbiased and neutral
d. verifiability d. understandable and comparable

Suggested Readings

1. Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp. 43-58.
2. Conceptual Framework and Accounting Standards (2019) by Millan, pp. 37-52.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition.
Manila, Philippines: DomDane Publishers.
2. International Federation of Accountants. (2007). IFAC: 30 Years of Progress Encouraging
Quality and Building Trust https://www.ifac.org/system/files/downloads/IFAC_History_-_
Nov_2007.pdf.
3. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio
City, Philippines: Bandolin Enterprise.
4. Philippine Institute of Certified Public Accountants - Northern Metro Manila Chapter.
(2018). PFRS.
5. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition.
Asia: John Wiley & Sons (Asia) Pte Ltd.

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LEARNING MODULES

Lesson 3 ACCOUNTING EQUATION

Did you know that?

LEARNING OBJECTIVES The Philippine Institute of Certified Public
1. Distinguish the elements of financial Accountants is the national accredited professional
statements; organization for CPAs in the Philippines. It has four
sub-organizations representing each sector namely,
2. Prepare a chart of accounts; and ACPACI for commerce and industry, GACPA for
3. Illustrate the effects of simple cases government, ACPAPP for public practice, and
NACPAE for education.
to the elements in the accounting
equation.

An account is the basic storage of information in accounting. It is a record of the increases and decreases in a
specific item of an asset, liability, equity, income, or expense, also known as the elements of financial statements.
Assets are the controlled economic resources that have resulted from past events and provide economic benefits.
Liabilities are present obligations that have resulted from past events and require giving up economic resources
when settling them. Equity is assets minus liabilities. Income is the increases in economic benefits during the
period in the form of increases in assets or decreases in liabilities, which 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.

A chart of accounts is a list of all the accounts used by a business and the account numbers that identify their
location in the ledger. These are grouped into balance sheet accounts (assets, liabilities, and equity) and income
statement accounts (income and expenses). Balance sheet accounts are permanent accounts or real accounts
because they are carried forward to the next accounting period. Income statement accounts are temporary
accounts or nominal accounts because they are closed at the end of the accounting period. The numbering system
of accounts usually starts from the balance sheet accounts and is followed by the income statement accounts.

Contra accounts are presented in the These are the common account titles used by economic entities.
financial statements as a deduction to Assets Income
their related accounts (e.g. Cash Service fees
Accounts receivable Sales
accumulated depreciation, allowance Allowance for bad debts Interest income
for bad debts). Notes receivable Gains
Prepaid supplies Expenses
Adjunct accounts are presented in the Prepaid rent Cost of sales (or Cost of goods sold)
financial statements as an addition to Prepaid insurance Freight-out
their related accounts (e.g. freight in). Land Salaries expense
Building Rent expense
Accumulated depreciation - building Utility expense
Accounts are also called account Equipment Supplies expense
titles and account names. Accumulated depreciation - equipment Bad debt expense
Liabilities Depreciation expense
Accounts payable Advertising expense
Notes payable Insurance expense
Interest payable Taxes and licenses
Please bear in mind that all the Salaries payable Transportation and travel expense
processes in the accounting Utilities payable Interest expense
Unearned income Miscellaneous expense
system must observe the equality
Owner’s Equity Losses
of the accounting equation. Owner’s capital
Owner’s drawings

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This accounting equation simply depicts that for every asset,

Assets = Equities there is corresponding equity. Equity is defined as the right,
claim, or interest of a person over the assets of the business.

Assets can be sourced through debt equity (borrowings) or

Assets = Debt Equity + Owner’s Equity
owner’s equity (owner’s contribution).

Debt equity is popularly known as liabilities. The owner’s equity

fits for sole proprietorship while owners’ equity fits for
Assets = Liabilities + Owner’s Equity partnerships and corporations. However, for partnerships, it is
also termed as partners’ equity and shareholders’ equity for
corporations.

This is an expanded equation which incorporates the income

Assets = Liabilities + Owner’s Equity + Income - Expenses
and expenses as an adjustment of owner’s equity.

Let us consider the following illustrations to analyze the relationship of the five elements in the accounting
equation. Let us denote A for assets, L for liabilities, OE for owner’s equity, I for income, and E for expenses.

1. If total assets are P20,000 and total liabilities are P5,000, how OE=A-L=P20,000-P5,000=P15,000
much is the total equity?
2. If total liabilities are P10,000 and total equity is P5,000, how A=L+OE=P10,000+P5,000=P15,000
much are the total assets?
3. If total assets are P20,000 and total equity is P5,000, how L=A-OE=P20,000-P5,000=P15,000
much are the total liabilities?
4. If total income is P20,000 and total expenses are P10,000, P/L=I-E=P20,000-P10,000=P10,000
how much is the profit or loss?
5. If total income is P30,000, total expenses are P20,000, total A=L+OE+I-E=P20,000+P15,000+P30,000-
liabilities are P20,000, and total equity (before profit or loss) is P20,000=P45,000
P15,000, how much are the total assets?

You can try the following exercise to further test your knowledge about the accounting equation. Find the
missing value.

2017 2018 2019 2020

Assets 200,000 (3) (6) 350,000
Liabilities (1) 120,000 110,000 100,000
Owner’s Equity (after profit & loss) (2) 140,000 (7) (9)
Owner’s Equity (before profit & loss) 80,000 (4) 140,000 (10)
Income 50,000 (5) 90,000 120,000
Expenses 30,000 40,000 (8) 50,000

Review Questions
1. What are the elements of financial statements and give at least 2 account titles on each element?
2. What is the basic accounting equation?
3. What is the expanded accounting equation?
4. What is the effect of an increase in assets to the owner’s equity assuming there is no change in
total liabilities?
5. Differentiate real accounts from nominal accounts.
6. Differentiate contra accounts from adjunct accounts.
7. How to compute the profit or loss?
8. Describe how account titles are arranged in the chart of accounts.

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CPALE Simulation Level 3

1. Which of the following is not a correct 2. Which one of the following is an essential
expanded accounting equation? characteristic of an asset?
a. Assets = Liabilities + Equity + Income - a. The cost of the asset can be measured
Expenses accurately.
b. Assets + Expenses = Liabilities + Equity + b. It is a result of either past or predictable
Income transactions.
c. Assets – Liabilities = Equity + Income - c. It must be exclusively owned and must be
Expenses exchangeable.
d. Assets = Liabilities + Equity + Income + d. The inflow of future economic benefits is
Expenses controlled by the enterprise.
3. Which of the following is not considered a 4. Which of the following is an essential
characteristic of a liability? characteristic of a liability?
a. present obligation a. The exact amount due must be known.
b. arises from a past event b. It may be the result of future transactions.
c. results in an outflow of resources c. The identity of the creditor must be known.
d. liquidation is reasonably expected to d. It must be an obligation to transfer assets
require the use of current assets or provide services in the future.
5. Liabilities are _____. 6. It is an accounting device for accumulating
a. deferred credits increases and decreases relating to a
b. any accounts with credit balances particular accounting value such as an asset
c. obligations to transfer ownership shares to or a liability.
other entities in the future a. account
d. present obligations arising from past b. journal
events and result in an outflow of c. trial balance
resources d. worksheet
7. Which of the following is not an essential 8. How is profit or loss calculated?
characteristic for an item to be reported as a. It is the difference between net assets at
a liability on the balance sheet? the beginning and end of the accounting
a. The liability arises from past transactions or period irrespective of transactions with
events. owners.
b. The liability is payable to a specifically b. It is the difference between net liabilities at
identified payee. the beginning and end of the accounting
c. The liability is the present obligation of a period.
particular entity. c. It is the difference between assets and
d. The settlement of the liability requires an liabilities.
outflow of resources embodying economic d. It is the difference between income and
benefits. expenses.
9. The beginning equity is P5,000. If total 10. The ending equity is P9,000. If total income
income for the period is P8,000 while total for the period is P5,000 while total
expenses are P6,000, how much is the expenses are P8,000, how much is the
ending balance of equity? beginning balance of equity?
a. P7,000 a. P12,000
b. P5,000 b. P9,000
c. P3,000 c. P6,000
d. P1,000 d. P0

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11. At the start of the period, a business has 12. A business has total assets of P640,000 and
total assets of P500,000 and total liabilities total equity of P360,000 at the beginning of
of P300,000. During the period, the the period. The business earns an income of
business earned a total income of P220,000 during the period and reports a
P1,000,000 and total expenses of profit of P80,000. There were no
P640,000. No additional investments or transactions with the owner during the
withdrawals were made by the owner. period. Total liabilities increased by
Total assets at the end of the period were P40,000 by the end of the period. How
P830,000. How much are the total liabilities much are the total assets at the end of the
at the end of the period? period?
a. P280,000 a. P560,000
b. P270,000 b. P440,000
c. P260,000 c. P860,000
d. P240,000 d. P760,000
13. Which of the following is not a basic 14. A chart of accounts is a _____.
element of financial statements? a. listing of all accounts and their balances
a. asset b. subsidiary ledger
b. equity c. special journal
c. income d. listing of all account titles
d. revenue
15. It is defined as an increase in economic
benefits during the accounting period in
the form of inflows or enhancements of
assets or decreases in liabilities that result
in increases in equity, other than those
relating to contributions from equity
participants.
a. gain
b. income
c. profit
d. revenue

Suggested Readings

1. Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp. 68-84,
104-125.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition.
Manila, Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio
City, Philippines: Bandolin Enterprise.
3. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition.
Asia: John Wiley & Sons (Asia) Pte Ltd.

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MODULE

2
Accounting Cycle
Financial statements are the end product of the accounting process which is also known as
the accounting cycle. It is a cycle because it is a continuous process as long as the existence
of the business organization continues. This cycle starts from the analysis of business
transactions and ended in the post-closing trial balance which will be reversed at the
beginning of the succeeding year. This accounting cycle will provide you the real picture of
how accounting works in every organization. You will be exposed first to the rules of debit
and credit to prepare you for the complexity of the accounting cycle.

In this module, you will be exposed to various examples of the different steps of the
accounting cycle. You are encouraged to take extra hard work in answering various problems
and extra patience to come up with the correct solutions. Although it will take time to
completely understand the whole process, eventually your efforts will be paid off in every
correct balance you get from every problem in this module. This module is specially crafted
for you in a very user-friendly way for your learning experience in accounting would be as
easy as counting numbers.

LESSON
4 Analyzing Transactions
5 Journalizing
6 Posting
7 Unadjusted Trial Balance
8 Adjusting Entries
9 Adjusted Trial Balance
10 Financial Statements
11 Closing Entries
12 Post-Closing Trial Balance
13 Reversing Entries

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Lesson 4 ANALYZING TRANSACTIONS

Did you know that?

LEARNING OBJECTIVE Certified Public Accountant Licensure Examination,
popularly known as CPALE, is conducted yearly during
1. Illustrate the debit and credit in each May and October. The examinee must have at least
transaction. 75% general average across six board subjects, in no
case that the rating of any subject is below 65%,
otherwise, the examinee becomes a conditional
examinee and needs to retake and pass the failed
subjects within two years to pass the entire
Accountable events are those that affect the examination.
elements of financial statements namely, assets,
liabilities, equity, income, and expenses. These
events are usually evidenced with supporting
documents such as sales invoices, official receipts, delivery receipts, etc. External events are transactions involving
the business and an external party while internal events are those that do not involve an external party. Let us
consider the following transactions if it is accountable events or not and if accountable, is it an external event or
an internal event.

Transactions Does it affect the elements of financial Should it be

statements (assets, liabilities, equity, recorded or
income, and expenses) not?
1. Received cash from clients for services rendered. Yes (assets, income) Yes
2. Paid suppliers the amount owed. Yes (assets, liabilities) Yes
3. Purchased supplies on account. Yes (assets, liabilities) Yes
4. Hired employees. No No
5. Paid electricity bill of the house. No No
6. Paid electricity of the business. Yes (assets, expenses) Yes
7. Collected cash from clients on account. Yes (assets, assets) Yes
8. Withdrew cash from the business. Yes (assets, equity) Yes
9. Billed clients for services rendered. Yes (assets, income) Yes
10. Paid advertising expenses. Yes (assets, expenses) Yes

Let us apply those transactions in the expanded accounting equation to explore its effects on the elements.

Transactions Assets = Liabilities + Equity + Income - Expenses

1. Received cash from clients for Increase = Increase
services rendered.
2. Paid suppliers the amount owed. Decrease = Decrease
3. Purchased supplies on credit. Increase = Increase
4. Hired employees. No effect
5. Paid electricity bill of the house. No effect
6. Paid electricity of the business. Decrease = Increase
7. Collected cash from clients on Increase =
credit. Decrease
8. Withdrew cash from the business. Decrease = Decrease
9. Billed clients for services Increase = Increase
rendered.
10. Paid advertising expenses. Decrease = Increase

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Let us apply the concept of debit and credit in the transaction analysis. In simple language, debit means the value
of the things received while credit refers to the value of the things parted with. Debit refers to inflows and credit
refers to outflows. Applying the separate entity concept, debit means all the values received by the business and
credit means all the values parted by the business. The debit indicates the left side of an account, and credit
indicates the right side. They are commonly abbreviated as Dr. for debit and Cr. for credit. When comparing the
totals of the two sides, an account shows a debit balance if the total of the debit amounts exceeds the credits. An
account shows a credit balance if the credit amounts exceed the debits. Normally, assets and expenses have debit
balances while liabilities, equity, and income have credit balances.

Let us take the below illustration as a tool in recording the debit and the credit for every transaction. Using the
previous transactions, let us make use of the elements affected by the transactions instead of the correct account
titles and provide some hypothetical amounts.

DEBIT CREDIT
Accounts Amount Accounts Amount
1. 1Asset 20,000 1. 1Income 20,000
2. 2Liability 10,000 2. 2Asset 10,000
3. 3Asset 2,000 3. 3Liability 2,000
4. No effect - 4. No effect -
5. No effect - 5. No effect -
6. Expense 1,000 6. Asset 1,000
7. Asset 5,000 7. Asset 5,000
8. Equity 3,000 8. Asset 3,000
9. Asset 10,000 9. Income 10,000
10. Expense 1,000 10. Asset 1,000
This time, let us consider the following transactions in applying the debit and credit sides of a transaction.

MSS Internet Café is engaged in internet services and computer rentals for various clients. The following
account titles are used in the business.
Assets Liabilities Income
Cash Accounts Payable Service Revenue
Accounts Receivable Equity Expenses
Prepaid Supplies MSS, Capital Electricity Expenses
ICT Equipment MSS, Drawings Rent Expenses
The following transactions occurred during September 2020.
September 1 Invested cash in the business amounting to P100,000.
September 3 Purchased computers and printers for the business for P60,000 in cash.
September 6 Paid rent, P2,000.
September 10 Received cash from clients for services rendered, P2,000.
September 17 Billed clients for services rendered, P5,000.
September 19 Purchased supplies on account, P1,000. The concept of duality in
September 22 Paid the supplies owed, P1,000. accounting suggests that for
September 25 Paid electricity, P 1,000. every debit, there is a
September 28 Collected cash from clients on account, P5,000 corresponding credit while the
September 30 Withdrew cash from the business, P2,000. concept of equality suggests
that the value of the debit must
equal the value of the credit.
Let us make a debit and credit analysis for each transaction.

DEBIT CREDIT
Explanation
Accounts Amount Accounts Amount
1 Cash 100,000 1 MSS, Capital 100,000 The business received cash from the
owner representing his initial capital.
3 ICT 60,000 3 Cash 60,000 The business received equipment and
Equipment parted cash in exchange.
6 Rent 2,000 6 Cash 2,000 The business used the building through
Expenses rent and parted cash in exchange.

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10 Cash 2,000 10 Service 2,000 The business received cash in exchange

Revenue for the services.
17 Accounts 5,000 17 Service 5,000 The business received the right to collect
Receivable Revenue from the client for the rendered services.
19 Prepaid 1,000 19 Accounts 1,000 The business received supplies in
Supplies Payable exchange for a promise to pay.
22 Accounts 1,000 22 Cash 1,000 The business paid the payable in
Payable exchange for cash.
25 Electricity 1,000 25 Cash 1,000 The business used electricity and paid
Expenses cash in exchange.
28 Cash 5,000 28 Accounts 5,000 The business received cash in exchange
Receivable for collectibles.
30 MSS, 2,000 30 Cash 2,000 The business gave cash to the owner
Drawings withdrawing his investment.

Review Exercises
You are required to make a debit and credit analysis using the preceding format in both problems.

JSS is engaged in sound system rental services. The following account titles are used in the business.
Assets Liabilities Income
Cash Accounts Payable Service Revenue
Accounts Receivable Equity Expenses
Sound Equipment JSS, Capital Utilities Expenses
Transportation Equipment JSS, Drawings Salaries Expenses
The following transactions occurred during August 2020.
August 2 Invested cash in the business amounting to P500,000.
August 4 Purchased sound equipment for the business for P200,000 in cash.
August 7 Purchased transportation equipment for the business for P100,000 on account.
August 11 Received cash from clients for services rendered, P50,000.
August 18 Billed clients for services rendered, P25,000.
August 19 Paid utilities expenses, P5,000.
August 22 Paid salaries, P10,000.
August 25 Withdrew cash from the business, P10,000.

PSS Laundry Shop provides laundry services. The following account titles are used in the business.
Assets Liabilities Income
Cash Accounts Payable Service Revenue
Accounts Receivable Equity Expenses
Prepaid Supplies PSS, Capital Electricity Expenses
Laundry Equipment PSS, Drawings Rent Expenses
The following transactions occurred during June 2020.
June 2 Invested cash, P100,000, and laundry equipment, P50,000 totaling to P150,000.
June 3 Purchased additional laundry equipment for the business for P30,000 on account.
June 7 Purchased supplies on account, P5,000.
June 8 Received cash from clients for services rendered, P10,000.
June 10 Billed clients for services rendered, P15,000.
June 11 Paid 50% of the laundry equipment owed.
June 13 Paid the supplies owed.
June 15 Paid electricity, P2,000.
June 17 Collected cash from clients on account, P15,000
June 18 Withdrew cash from the business, P10,000.
June 20 Paid rent for the space occupied, P5,000.

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CPALE Simulation Level 4

1. The first step in the accounting cycle is __. 2. Credit is on which side of an account?
a. posting to the ledger a. right
b. journalizing b. left
c. preparing the adjusting entries c. top
d. analyzing events d. bottom
3. Owner’s cash investment to the business 4. Acquisition of equipment on credit
Debit Credit Debit Credit
a. cash owner’s capital a. equipment accounts payable
b. cash owner’s drawings b. accounts payable equipment
c. owner’s capital cash c. accounts payable cash
d. cash sales d. cost of sales accounts payable
5. Payment of advertising expense 6. Collection of accounts receivable
Debit Credit Debit Credit
a. advertising expense cash a. cost of sales sales
b. cash advertising expense b. cash accounts receivable
c. cash advertisement payable c. cash sales
d. advertising expense accounts payable d. accounts receivable sales
7. Owner’s drawings (owner’s withdrawal of 8. Which accounting process is the
cash from the business) recognition or non-recognition of business
Debit Credit activities as accountable events?
a. drawings expense cash a. communicating
b. cash owner’s drawings b. identifying
c. owner’s drawings cash c. measuring
d. cash owner’s capital d. recording
9. Which is not among the criteria to consider 10. Payment (settlement) of accounts payable
an event as accountable? Debit Credit
a. It must have already happened. a. inventory accounts payable
b. Its amount can be measured reliably. b. cash accounts payable
c. It must increase or decrease an element of c. accounts payable cash
the financial statements. d. cost of sales inventory
d. It must be classified as an external event
rather than an internal event.

Suggested Exercises

1. Problems 1-6, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp.
204-209.
2. Problems 1-21, Basic Financial Accounting and Reporting 22nd Edition (2019) by Ballada & Ballada,
pp. 2-38 to 2-58.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition. Manila,
Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City,
Philippines: Bandolin Enterprise.
3. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John
Wiley & Sons (Asia) Pte Ltd.

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Lesson 5 JOURNALIZING

Did you know that?

LEARNING OBJECTIVE The highest passing rate in the history of CPALE was
61% (20/33) in 1942 and the lowest passing rate was 6%
1. Prepare journal entries. (152/2,345) in 1954.
Source: www.businessmirror.com.ph

Journalizing refers to recording an accountable

event in the journal using a journal entry. Journal is also defined as the book of original entry. The transactions are
recorded in the journal chronologically. An illustrative journal entry is shown below.

GENERAL JOURNAL J1
Date Account Titles & Explanation Ref. Debit Credit
2020
1 2 3
September 1 Cash 100,000
4 5
MSS, Capital 100,000
6
To record initial investment.
1
The date when the transaction occurred.
2
The account title to be debited.
3
The corresponding amount of the account to be debited.
4
The account title to be credited.
5
The corresponding amount of the account to be credited.
6
A short explanation of the transaction.

A simple journal entry contains a single debit and a single credit element. A compound journal entry contains two
or more debits or credits. Using the previous lesson’s transaction analysis, let us transform each analysis into a
journal entry.

MSS Internet Café is engaged in internet services and computer rentals for various clients. The following
account titles are used in the business.
Assets Liabilities Income
Cash Accounts Payable Service Revenue
Accounts Receivable Equity Expenses
Prepaid Supplies MSS, Capital Electricity Expenses
ICT Equipment MSS, Drawings Rent Expenses
The following transactions occurred during September 2020.
September 1 Invested cash in the business amounting to P100,000.
September 3 Purchased computers and printers for the business for P60,000 in cash.
September 6 Paid rent, P2,000.
September 10 Received cash from clients for services rendered, P2,000.
September 17 Billed clients for services rendered, P5,000.
September 19 Purchased supplies on account, P1,000.
September 22 Paid the supplies owed, P1,000.
September 25 Paid electricity, P1,000.
September 28 Collected cash from clients on account, P5,000
September 30 Withdrew cash from the business, P2,000.
September 30 Bought additional computers amounting to P50,000 of which 50% was paid in cash and the
rest was on account.
September 30 Paid electricity expenses, P2,000, and rent expenses, P2,000.

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DEBIT CREDIT
Accounts Amount Accounts Amount
1 Cash 100,000 1 MSS, Capital 100,000
3 ICT Equipment 60,000 3 Cash 60,000
6 Rent Expenses 2,000 6 Cash 2,000
10 Cash 2,000 10 Service Revenue 2,000
17 Accounts Receivable 5,000 17 Service Revenue 5,000
19 Prepaid Supplies 1,000 19 Accounts Payable 1,000
22 Accounts Payable 1,000 22 Cash 1,000
25 Electricity Expenses 1,000 25 Cash 1,000
28 Cash 5,000 28 Accounts Receivable 5,000
30 MSS, Drawings 2,000 30 Cash 2,000
30 ICT Equipment 50,000 30 Cash 25,000
Accounts Payable 25,000
30 Electricity Expenses 2,000 30 Cash 4,000
Rent Expenses 2,000

This transaction analysis is provided for accounting beginners only. When you master already the debits and
credits for each transaction, you can make the journal entries without doing the debit and credit analysis.

September 1 Cash 100,000

MSS, Capital 100,000
To record initial investment.
September 3 ICT Equipment 60,000
Cash 60,000
To record the purchase of ICT equipment.
September 6 Rent Expenses 2,000
Cash 2,000
To record the rental payment.
September 10 Cash 2,000
Service Revenue 2,000
To record service revenue paid in cash.
September 17 Accounts Receivable 5,000
Service Revenue 5,000
To record service revenue on account.
September 19 Prepaid Supplies 1,000
Accounts Payable 1,000
To record the purchase of supplies on account.
September 22 Accounts Payable 1,000
Cash 1,000
To record payment of supplies owed.
September 25 Electricity Expenses 1,000
Cash 1,000
To record payment of electricity expenses.
September 28 Cash 5,000
Accounts Receivable 5,000
To record the collection of collectibles.
September 30 MSS, Drawings 2,000
Cash 2,000
To record the owner’s cash withdrawal.
September 30 ICT Equipment 50,000
Cash 25,000
Accounts Payable 25,000
To record the purchase of ICT equipment.
September 30 Electricity Expenses 2,000
Rent Expenses 2,000
Cash 4,000
To record payment of various expenses.

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Review Exercises
The following problems are the same problems from the preceding lesson. This time, you are tasked to
prepare journal entries. You can make use of the debit and credit analysis you had in the preceding
lesson. However, if you think you had master already the debits and credits for each transaction, then
you can proceed with the preparation of journal entries as required without looking at the debit and
credit analysis you had already made.

JSS is engaged in sound system rental services. The following account titles are used in the
business.
Assets Liabilities Income
Cash Accounts Payable Service Revenue
Accounts Receivable Equity Expenses
Sound Equipment JSS, Capital Utilities Expenses
Transportation Equipment JSS, Drawings Salaries Expenses
The following transactions occurred during August 2020.
August 2 Invested cash in the business amounting to P500,000.
August 4 Purchased sound equipment for the business for P200,000 in cash.
August 7 Purchased transportation equipment for the business for P100,000 on account.
August 11 Received cash from clients for services rendered, P50,000.
August 18 Billed clients for services rendered, P25,000.
August 19 Paid utilities expenses, P5,000.
August 22 Paid salaries, P10,000.
August 25 Withdrew cash from the business, P10,000.

PSS Laundry Shop provides laundry services. The following account titles are used in the business.
Assets Liabilities Income
Cash Accounts Payable Service Revenue
Accounts Receivable Equity Expenses
Prepaid Supplies PSS, Capital Electricity Expenses
Laundry Equipment PSS, Drawings Rent Expenses
The following transactions occurred during June 2020.
June 2 Invested cash, P100,000, and laundry equipment, P50,000 totaling to P150,000.
June 3 Purchased additional laundry equipment for the business for P30,000 on account.
June 7 Purchased supplies on account, P5,000.
June 8 Received cash from clients for services rendered, P10,000.
June 10 Billed clients for services rendered, P15,000.
June 11 Paid 50% of the laundry equipment owed.
June 13 Paid the supplies owed.
June 15 Paid electricity, P2,000.
June 17 Collected cash from clients on account, P15,000
June 18 Withdrew cash from the business, P10,000.
June 20 Paid rent for the space occupied, P5,000.

“Please be reminded that when you got a wrong journal entry, you will end up wrong financial statements. Thus, you must put
extra care in doing the debit and credit analysis and in preparing journal entries.”

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CPALE Simulation Level 5

1. Which of the following is the effect of 2. Which of the following is the effect of
rendering services on account? purchasing equipment on account?
a. Accounts receivable increases and cash a. Equipment increases and cash decreases.
decreases. b. Equipment increases and accounts payable
b. Accounts receivable increases and accounts also increases.
payable increases. c. Equipment increases and accounts payable
c. Accounts receivable increases and sales decreases.
increases. d. Equipment decreases and accounts payable
d. Accounts receivable decreases and sales increases.
decreases.
3. Obtaining a loan results in ____. 4. Liabilities, owners' equity, and income are
a. an increase in asset but a decrease in ____.
liability a. decreased by credits and increased by
b. a decrease in asset but an increase in debits
liability b. decreased by debits and increased by
c. an increase in both asset and liability credits
d. a decrease in both asset and liability c. decreased by both debits and credits
d. it depends on the situation
5. Which of the following represents an
abnormal balance?
a. accounts receivable, P10 (Dr.)
b. inventory, P10 (Dr.)
c. accounts payable, P10 (Dr.)
d. notes Payable, P10 (Cr.)

Suggested Exercises

1. Problems 7-12, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp.
209-213.
2. Problems 11-17, Basic Financial Accounting and Reporting 22nd Edition (2019) by Ballada & Ballada,
pp. 3-54 to 3-61.
3. Exercises E2.8-E2.9, Accounting Principles 13th Edition (2018) by Weygandt, Kimmel & Kieso, pp. 2-
36.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition. Manila,
Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City,
Philippines: Bandolin Enterprise.
3. Valcarcel, L. (2018). CPA Examination in the Philippines. https://businessmirror.com.ph/
2018/10/01/cpa-examination-in-the-philippines/
4. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John
Wiley & Sons (Asia) Pte Ltd.

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Lesson 6 POSTING

Did you know that?

LEARNING OBJECTIVE The Professional Regulatory Board of Accountancy is
composed of seven members and is currently chaired
1. Post journal entries to the ledger. by Dr. Noe G. Quiňanola.

Posting is the process of transferring data from the

journal to the ledger. The ledger contains the balance and the changes in each account. A general ledger includes
all the elements of the financial statements. The ledgers are arranged according to the elements. Ledger is also
known as the book of final entry. Below is a typical three-column form of account or the standard form of account
as it shows the three money columns, debit, credit, and balance. It is widely practiced among companies.

CASH No. 101

Date Explanation Ref. Debit Credit Balance
2020
July 1 100,000 100,000
4 20,000 80,000
15 20,000 60,000

For illustration purposes, the T-account as shown below has been mostly used as a representation of a ledger.

Cash
Debit Credit
7/1 100,000 7/4 20,000
7/15 20,000
Bal. 60,000

Let us make use of the journal entry below to illustrate how the data therein were transferred to the ledger. The
illustration below also shows the forms of ledgers, 3-Column Form of Account, and the T-account.

GENERAL JOURNAL J1
Date Account Titles & Explanation Ref. Debit Credit
2020
July 1 Cash 100,000
MSS, Capital 100,000
To record initial investment.

3-Column Form of Account T-account

CASH No. 101 CASH
Date Explanation Ref. Debit Credit Balance 7/1 100,000
2020
July 1 J1 100,000 100,000

MSS, CAPITAL No. 301 MSS, CAPITAL

Date Explanation Ref. Debit Credit Balance 7/1 100,000
2020
July 1 J1 100,000 100,000

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Let us try the following journal entries on how should it be posted in the ledger. But this time, we will make use of
the T-account for illustration purposes only.

September 1 Cash 100,000

MSS, Capital 100,000
To record initial investment.
September 3 ICT Equipment 60,000
Cash 60,000
To record the purchase of ICT equipment.
September 6 Rent Expenses 2,000
Cash 2,000
To record the rental payment.
September 10 Cash 2,000
Service Revenue P2,000
To record service revenue paid in cash.
September 17 Accounts Receivable P5,000
Service Revenue 5,000
To record service revenue on account.
September 19 Prepaid Supplies 1,000
Accounts Payable 1,000
To record the purchase of supplies on account.
September 22 Accounts Payable 1,000
Cash 1,000
To record payment of supplies owed.
September 25 Electricity Expenses 1,000
Cash 1,000
To record payment of electricity expenses.
September 28 Cash 5,000
Accounts Receivable 5,000
To record the collection of collectibles.
September 30 MSS, Drawings 2,000
Cash 2,000
To record the owner’s cash withdrawal.

Cash Accounts Receivable Prepaid Supplies

9/1 100,000 9/3 60,000 9/17 5,000 9/28 5,000 9/19 1,000
9/10 2,000 9/6 2,000 Bal. -
9/28 5,000 9/22 1,000
9/25 1,000
9/30 2,000 Please put extra care in posting the journal entries to its appropriate
Bal. 41,000 account since it is prone to errors. You can put a checkmark on each
entry in the journal as a hint that it was already posted. Lastly, always
ICT Equipment double-check.
9/3 60,000

Accounts Payable MSS, Capital MSS, Drawings

9/22 1,000 9/19 1,000 9/1 100,000 9/30 2,000
Bal. -

Service Revenue Electricity Expenses Rent Expenses

9/10 2,000 9/25 1,000 9/6 2,000
9/17 5,000
Bal. 7,000

“No matter how good you are in posting, you must always ensure that you have a correct entry in each transaction.”

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Review Exercises
The following problems are the same problems from the preceding lesson. This time, you are tasked to
post the entries in the ledger. You can make use of the journal entries you made in the preceding
lesson, provided, those are correct journal entries. If you think you are not confident with your entries,
you can ask your classmates to check your work. You can use T-account as a ledger.

JSS is engaged in sound system rental services. The following account titles are used in the business.
Assets Liabilities Income
Cash Accounts Payable Service Revenue
Accounts Receivable Equity Expenses
Sound Equipment JSS, Capital Utilities Expenses
Transportation Equipment JSS, Drawings Salaries Expenses
The following transactions occurred during August 2020.
August 2 Invested cash in the business amounting to P500,000.
August 4 Purchased sound equipment for the business for P200,000 in cash.
August 7 Purchased transportation equipment for the business for P100,000 on account.
August 11 Received cash from clients for services rendered, P50,000.
August 18 Billed clients for services rendered, P25,000.
August 19 Paid utilities expenses, P5,000.
August 22 Paid salaries, P10,000.
August 25 Withdrew cash from the business, P10,000.

PSS Laundry Shop provides laundry services. The following account titles are used in the business.
Assets Liabilities Income
Cash Accounts Payable Service Revenue
Accounts Receivable Equity Expenses
Prepaid Supplies PSS, Capital Electricity Expenses
Laundry Equipment PSS, Drawings Rent Expenses
The following transactions occurred during June 2020.
June 2 Invested cash, P100,000, and laundry equipment, P50,000 totaling to P150,000.
June 3 Purchased additional laundry equipment for the business for P30,000 on account.
June 7 Purchased supplies on account, P5,000.
June 8 Received cash from clients for services rendered, P10,000.
June 10 Billed clients for services rendered, P15,000.
June 11 Paid 50% of the laundry equipment owed.
June 13 Paid the supplies owed.
June 15 Paid electricity, P2,000.
June 17 Collected cash from clients on account, P15,000
June 18 Withdrew cash from the business, P10,000.
June 20 Paid rent for the space occupied, P5,000.

“Journalizing and posting are two critical tasks in the accounting cycle. Speed and accuracy are the keys so you can finish these
tasks effectively and efficiently.”

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CPALE Simulation Level 6

1. Which of the following accounts is 2. Which of the following accounts is
increased by a credit? increased by debiting it?
a. cash a. accounts payable
b. accounts receivable b. equipment
c. accounts payable c. sales
d. owner’s drawings d. accumulated depreciation
3. At the beginning of the period, a business 4. At the beginning of the period, the owner’s
has accounts payable of P200,000. During capital account of a business has a balance
the period, the total debits and credits to of P220,000. During the period, the total
the accounts payable account were debits and credits to that account were
P100,000 and P70,000, respectively. How P60,000 and P70,000, respectively. How
much is the ending balance of accounts much is the ending balance of the owner’s
payable? capital account?
a. P230,000 a. P230,000
b. P170,000 b. P210,000
c. P370,000 c. P350,000
d. P30,000 d. P90,000
5. At the beginning of the period, Entity Z’s 6. At the beginning of the period, a business
notes payable had a balance of P1,200. has a cash balance of P20,000. During the
During the period, Entity Z obtained an period, total cash collections and total cash
additional loan of P800 and made total payments amounted to P100,000 and
payments of P500. How much is the ending P70,000, respectively. How much is the
balance of Entity Z’s notes payable? ending balance of cash?
a. P1,800 a. P10,000
b. P1,500 b. P30,000
c. P1,200 c. P50,000
d. P900 d. P70,000
7. If the ending balance of accounts 8. If the ending balance of accounts payable is
receivable is P100,000 and its total debits P100,000 and the total debits and credits to
and credits during the period were P60,000 that account during the period were
and P40,000, respectively, the beginning P60,000 and P40,000, respectively, the
balance must be ____. beginning balance must be ____.
a. P0 a. P0
b. P20,000 b. P20,000
c. P80,000 c. P80,000
d. P120,000 d. P120,000
9. At the start of the period, Amy had a cash 10. To post in accounting means to copy the
balance of P20,000 and notes payable of information about accounting changes
P15,000. During the period, Amy collected from the _____.
P11,000 accounts receivable, paid P8,000 a. ledger, and place it into the journal
notes payable, and issued additional notes b. journal, and place it into the ledger
payable of P5,000 in exchange for cash. c. source, documents and record it in the
How much are the ending balances of cash ledger
and notes payable, respectively? d. journal, place it into the ledger, and then
Cash Notes payable delete it from the journal
a. P17,000 P20,000
b. P20,000 P12,000
c. P28,000 P12,000
d. P36,000 P20,000

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Suggested Exercises

1. Problems 1-3, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp.
232-233.
2. Problems 11-17, Basic Financial Accounting and Reporting 22nd Edition (2019) by Ballada & Ballada,
pp. 3-54 to 3-61.
3. Exercises E2.8-E2.9 & E2.11, Accounting Principles 13th Edition (2018) by Weygandt, Kimmel &
Kieso, pp. 2-36 & 2-38.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition. Manila,
Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City,
Philippines: Bandolin Enterprise.
3. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John
Wiley & Sons (Asia) Pte Ltd.

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Lesson 7 UNADJUSTED TRIAL BALANCE

Did you know that?

LEARNING OBJECTIVE Since 2019, only the basic calculators are allowed to
be used during CPALE. Previously, some scientific
1. Prepare an unadjusted trial balance. calculators are allowed but this time, they are
restricted.

A trial balance is a list of accounts and their balances

usually at the end of the accounting period. It checks the equality of debits and credits in the ledger after posting.
This procedure uncovers errors arising from journalizing and posting especially when total debit does not equal
total credit. Accounts are listed in the order they appear in the ledger and their corresponding balances are
posted to the appropriate debit and credit columns.

There are three types of trial balance prepared by accountants in an accounting cycle, namely, unadjusted trial
balance, adjusted trial balance, and post-closing trial balance. Unadjusted trial balance is prepared before
adjusting entries are made. Adjusted trial balance is prepared after adjusting entries but before the financial
statements are prepared. Post-closing trial balance is prepared after the closing process.

This time we will prepare the unadjusted trial balance. Below is a sample unadjusted trial balance.

Zachary Dominic Company

Unadjusted Trial Balance
August 31, 2020

Debit Credit
Cash P 52,950
Notes Receivable 35,000
Accounts Receivable 55,880
Office Supplies 1,090
Prepaid Insurance 4,560
Land 20,000
Store Equipment 27,100
Accumulated Depreciation – Store Equipment P 2,600
Office Equipment 15,570
Accumulated Depreciation – Office Equipment 2,230
Accounts Payable 22,420
Unearned Rent 2,400
Notes Payable 25,000
JSS, Capital 153,800
JSS, Drawing 18,000
Sales Revenue 60,790
Interest Income 3,600
Advertising Expense 10,860
Miscellaneous Expense 630
Salaries Expense 20,660
Rent Expense 8,100
Interest Expense 2,440
P 272,840 P 272,840

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Let us make use of the ledgers we had made in the previous lesson as shown below and prepare its
corresponding trial balance.

Cash Accounts Receivable Prepaid Supplies

9/1 100,000 9/3 60,000 9/17 5,000 9/28 5,000 9/19 1,000
9/10 2,000 9/6 2,000 Bal. -
9/28 5,000 9/22 1,000
9/25 1,000
9/30 2,000 The accounts are already arranged according to the elements of the
Bal. 41,000 financial statements. All you have to do is to list all the accounts on the
left portion of the trial balance and put in the appropriate columns the
ICT Equipment corresponding balances.
9/3 60,000

Accounts Payable MSS, Capital MSS, Drawings

9/22 1,000 9/19 1,000 9/1 100,000 9/30 2,000
Bal. -

Service Revenue Electricity Expenses Rent Expenses

9/10 2,000 9/25 1,000 9/6 2,000
9/17 5,000
Bal. 7,000

MSS Company
Unadjusted Trial Balance
August 31, 2020

Debit Credit
Cash P 41,000
Accounts Receivable -
Prepaid Supplies 1,000
ICT Equipment 60,000
Accounts Payable P -
MSS, Capital 100,000
MSS, Drawings 2,000
Service Revenue 7,000
Electricity Expense 1,000
Rent Expense 2,000
P 107,000 P 107,000

The trial balance can reveal certain errors such as journalizing or posting one-half of an entry, recording one part of
an entry for a different amount than the other part, errors of transplacement on one side of an entry, and error of
transposition on one side of an entry. However, there are also certain errors that the trial balance cannot reveal
such as omitting entirely the entry for a transaction, journalizing or posting an entry twice, using the wrong account
with the same normal balance as the correct account, and wrong computation with the same erroneous amounts
posted to debit and credit sides. Meanwhile, the following tips are suggested to easily locate if errors occurred.

1. If the error is 1, 10, 100, or 1,000, add again the trial balance or compute again the account balances.
2. If the error is divisible by 2, check the trial balance if there is an account balance equal to half the error has
been entered in the wrong column.
3. If the error is divisible by 9, check the account balances if they are correctly copied from the ledger.
4. If the error is not divisible by 2 or 9, check the ledger if there is an account balance in the amount of the error
that has been omitted from the trial balance, or check the journal if the posting of that amount has been
omitted.

The amounts in journals and ledgers need not have peso signs. Peso signs are used in the trial balance and
financial statements. Usually, they are put only on the first amount of each column, and the column totals. A
single rule indicates that the figures are to be added or subtracted. A double rule shows final sums or totals.

“Make sure that you already master the normal balances of each account so you can easily prepare a trial balance .”

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Review Exercises
The following problems are the same problems from the preceding lesson. This time, you are tasked to
prepare an unadjusted trial balance. You can make use of the T-accounts you made in the preceding
lesson, provided, they have correct balances. If you think you are not confident with the balances, you
can ask your classmates to check your work.

JSS is engaged in sound system rental services. The following account titles are used in the business.
Assets Liabilities Income
Cash Accounts Payable Service Revenue
Accounts Receivable Equity Expenses
Sound Equipment JSS, Capital Utilities Expenses
Transportation Equipment JSS, Drawings Salaries Expenses
The following transactions occurred during August 2020.
August 2 Invested cash in the business amounting to P500,000.
August 4 Purchased sound equipment for the business for P200,000 in cash.
August 7 Purchased transportation equipment for the business for P100,000 on account.
August 11 Received cash from clients for services rendered, P50,000.
August 18 Billed clients for services rendered, P25,000.
August 19 Paid utilities expenses, P5,000.
August 22 Paid salaries, P10,000.
August 25 Withdrew cash from the business, P10,000.

PSS Laundry Shop provides laundry services. The following account titles are used in the business.
Assets Liabilities Income
Cash Accounts Payable Service Revenue
Accounts Receivable Equity Expenses
Prepaid Supplies PSS, Capital Electricity Expenses
Laundry Equipment PSS, Drawings Rent Expenses
The following transactions occurred during June 2020.
June 2 Invested cash, P100,000, and laundry equipment, P50,000 totaling to P150,000.
June 3 Purchased additional laundry equipment for the business for P30,000 on account.
June 7 Purchased supplies on account, P5,000.
June 8 Received cash from clients for services rendered, P10,000.
June 10 Billed clients for services rendered, P15,000.
June 11 Paid 50% of the laundry equipment owed.
June 13 Paid the supplies owed.
June 15 Paid electricity, P2,000.
June 17 Collected cash from clients on account, P15,000
June 18 Withdrew cash from the business, P10,000.
June 20 Paid rent for the space occupied, P5,000.

“Please refrain to be always confident every time you equal debits and credits in the trial balance. Correct balances are still
dependent on accurate journal entries and ledgers.”

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CPALE Simulation Level 7

1. The trial balance ______. 2. D equals the sum of the debit column of a
a. can be used to uncover errors in firm’s unadjusted trial balances, and C
journalizing and posting equals the sum of the credit column. Which
b. has as its primary purpose to prove that all of the following statements is correct?
journal entries were made for the period a. If D does not equal C, it is possible that no
c. is a listing of all the accounts and their errors were committed.
balances in the order the accounts appear b. D does not equal the sum of all accounts
in the statement of financial position increases during the period.
d. is used to prepare the statement of c. If D equals C, there is no chance that the
financial position while the general ledger is company committed a recording error.
used to prepare the income statement D typically does not equal C because the
adjusting entries have not yet been
recorded.
3. What is the normal order of accounts in the 4. Which of the following errors will probably
unadjusted trial balance? be disclosed by the preparation of a trial
a. assets, liabilities, equity balance?
b. assets, equity, income expense, and finally a. failure to post part of a journal
liabilities b. failure to post an entire journal
c. assets, liabilities, equity, income, and finally c. failure to record an entity in the journal
expenses d. posting the debit of a journal entry as a
d. all accounts with debit balances, then all credit, and the credit as a debit
accounts with credit balances
5. A control device that helps minimize and
localize accounting errors is known as ___.
a. a chart of accounts
b. subsidiary ledger
c. trial balance
d. worksheet

Suggested Exercises

1. Problems 4-9, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp.
233-237.
2. Problems 11-21, Basic Financial Accounting and Reporting 22nd Edition (2019) by Ballada & Ballada,
pp. 3-54 to 3-64.
3. Exercises E2.12-E2.13 & E2.15, Accounting Principles 13th Edition (2018) by Weygandt, Kimmel &
Kieso, pp. 2-37 & 2-38.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition. Manila,
Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City,
Philippines: Bandolin Enterprise.
3. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John
Wiley & Sons (Asia) Pte Ltd.

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Lesson 8 ADJUSTING ENTRIES

Did you know that?

LEARNING OBJECTIVE The Professional Regulatory Board of Accountancy
has issued a new syllabus and table of specifications
1. Prepare the adjusting entries. for the six board subjects effective this October 2022
CPALE.

Adjusting entries are made to ensure that income is

recorded in the period in which they are earned and expenses are recognized in the period in which they are
incurred, in adherence to the revenue and expense recognition principles. These are required every time a
company prepares financial statements to ensure that the accounts in the trial balance are complete and
updated. Every adjusting entry will include one income statement account and one balance sheet account.
Adjusting entries are classified as either deferrals or accruals. Deferrals include prepaid expenses and unearned
revenues. Accruals include accrued revenues and accrued expenses.

Prepaid expenses, also known as prepayments, are expenses paid in cash before they are consumed through use
(e.g. supplies) or expired over time (e.g. insurance, rent, and advertising). These prepayments provide benefits to
the company for more than one accounting period, thus, it is usually recorded as an asset, which is why it is called
an asset method. However, some companies also recorded these prepayments initially as an expense, which is
why it is called as expense method. When companies prepare financial statements, these accounts become a
mixed account (a mix of real and nominal accounts) and so, the asset portion must be separated from the expense
portion.

Illustration 8.1: MSS Company bought supplies in cash to be used for the business on March 1, 2019, amounting to
P5,000. At the end of the year, the supplies on hand are valued at P1,000.

Asset Method Expense Method

Mar. 1 Prepaid Supplies 5,000 Mar. 1 Supplies Expenses 5,000
Cash 5,000 Cash 5,000
To record the purchase of To record the purchase of
supplies. supplies.
Adjusting Entry Adjusting Entry
Dec. 31 Supplies Expenses 4,000 Dec. 31 Prepaid Supplies 1,000
Prepaid Supplies 4,000 Supplies Expenses 1,000
To record adjustment on To record adjustment on
supplies. supplies.

Illustration 8.2: MSS Company bought a one-year insurance policy for its building on June 1, 2019, amounting to
P12,000.

Asset Method Expense Method

Jun. 1 Prepaid Insurance 12,000 Jun. 1 Insurance Expenses 12,000
Cash 12,000 Cash 12,000
To record the purchase of To record the purchase of
insurance. insurance.
Adjusting Entry Adjusting Entry
Dec. 31 Insurance Expenses 7,000 Dec. 31 Prepaid Insurance 5,000
Prepaid Insurance 7,000 Insurance Expenses 5,000
To record adjustment on To record adjustment on
insurance. insurance.

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Illustration 8.3: MSS Company paid one-year advertising for its new services on August 1, 2019, amounting to
P12,000.

Asset Method Expense Method

Aug. 1 Prepaid Advertising 12,000 Aug. 1 Advertising Expenses 12,000
Cash 12,000 Cash 12,000
To record payment of To record payment of
advertising. advertising.
Adjusting Entry Adjusting Entry
Dec. 31 Advertising Expenses 5,000 Dec. 31 Prepaid Advertising 7,000
Prepaid Advertising 5,000 Advertising Expenses 7,000
To record adjustment on To record adjustment on
advertising. advertising.

Illustration 8.4: MSS Company paid rent in advance for 12 months on October 1, 2019, amounting to P12,000.

Asset Method Expense Method

Oct. 1 Prepaid Rent 12,000 Oct. 1 Rent Expenses 12,000
Cash 12,000 Cash 12,000
To record payment of rent. To record payment of rent.
Adjusting Entry Adjusting Entry
Dec. 31 Rent Expenses 3,000 Dec. 31 Prepaid Rent 9,000
Prepaid Rent 3,000 Rent Expenses 9,000
To record adjustment on To record adjustment on
rent. rent.

If we are going to analyze the preceding illustrations, regardless of methods, adjustments are done to reflect the
used and unused or expired and unexpired portions of prepayments. Please take note of the period covered by
the prepayments as this would be critical in determining the expired and unexpired portions.

Technically, companies are also doing prepayments when they acquire buildings and equipment since it can
benefit the company for more than one accounting period. The cost of the asset is spread over the useful life of
the asset. This process is called systematic and rational allocation of costs. Thus, it is considered as an allocation
concept rather than a valuation concept. The expense recognized in this concept is called depreciation expense.
Depreciation represents the declining value of the asset due to wear and tear from operations or due to
inadequacy and obsolescence. Using the straight-line method, the depreciation is computed by dividing the cost
of the asset less its salvage or scrap value over the useful life of the asset.

Acquisition Cost – Scrap Value

Annual Depreciation =
Useful Life

Illustration 8.5: MSS Company bought equipment amounting to P100,000 on January 1, 2019. The equipment is
expected to have a useful life of 5 years and a scrap value of P5,000.

100,000 – 5,000
Annual Depreciation =
5
= 19,000

Dec. 31 Depreciation Expense 19,000

Accumulated Depreciation 19,000
To record the adjustment on depreciation expenses.

Accumulated depreciation is a contra account which means that it is presented in the financial statements as a
deduction of the related asset account.

Unearned income is recognized when cash is received before services are performed e.g. rent. When the company
records advance payment from customers for future services as unearned income, then the company is using the
liability method. When the company records the advance payment directly as income, then the company is using
the income method. This scenario is the exact opposite of prepayments where the company is considered as the
customer, but this time, the company is the provider of services or the supplier. These accounts are mixed and
need to separate the earned portion (income) and the unearned portion (liability).

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Illustration 8.6: MSS Company received a one-year rental payment from a customer on August 1, 2019, amounting
to P12,000.

Liability Method Income Method

Aug. 1 Cash 12,000 Aug. 1 Cash 12,000
Unearned Rent 12,000 Rent Income 12,000
To record advance rent from To record advance rent from
a customer. a customer.
Adjusting Entry Adjusting Entry
Dec. 31 Unearned Rent 5,000 Dec. 31 Rent Income 7,000
Rent Income 5,000 Unearned Rent 7,000
To record adjustment on To record adjustment on
rent. rent.

If we are going to analyze the preceding illustration, regardless of methods, adjustments are done to reflect the
earned and unearned portions. Please take note of the period covered by the advance payment of the customer
as this would be critical in determining the earned and unearned portions.

Accrued income is recognized when already earned but not yet collected, e.g. interest and rent.

Illustration 8.7: MSS Company received a 12%, P10,000, one-year, note receivable on March 1, 2020. The principal
and interest on the note are due on March 1, 2021. The company uses a calendar year period.

Interest = Principal x rate x time

= 10,000 x 12% x 10/12
= 1,000

Dec. 31 Interest Receivable 1,000

Interest Income 1,000
To record accrued interest income.

Illustration 8.8: MSS Company rents out commercial space to a tenant for a monthly rent of P5,000. As of
December 31, 2019, the tenant has not yet paid the rent for October to December.

Dec. 31 Rent Receivable 15,000

Rent Income 15,000
To record accrued rent income.

Please be reminded to observe the period covered of the uncollected income especially that it is critical in
determining the amount to be adjusted.

Accrued expenses are expenses incurred but not yet paid e.g. interest, utilities, and salaries.

Illustration 8.9: MSS Company issued a 12%, P10,000, one-year, note receivable on April 1, 2020. The principal and
interest on the note are due on March 1, 2021. The company uses a calendar year period.

Interest = Principal x rate x time

= 10,000 x 12% x 9/12
= 900

Dec. 31 Interest Expense 900

Interest Payable 900
To record accrued interest expense.

Illustration 8.10: MSS Company did not pay the electricity expenses for December amounting to P3,000. The bill
was paid in January of the following year. Electricity and water expenses are collectively termed as utilities.

Dec. 31 Utility Expense 3,000

Utilities Payable 3,000
To record unpaid utilities.

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Illustration 8.11: MSS Company incurred salary expenses for its employees for December amounting to P10,000.
This was paid in the following month of the following year.

Dec. 31 Salaries Expense 10,000

Salaries Payable 10,000
To record unpaid salaries.

Again, please be reminded to observe the period covered of the unpaid expense especially that it is critical in
determining the amount to be adjusted.

When companies found out that a portion of the accounts receivable becomes uncollectible, it ceases to provide
future economic benefits and thus, should be immediately treated as an expense. It is usually termed as bad
debts expense, uncollectible accounts expense, or doubtful accounts expense. Companies usually provide a policy
on how to determine the provision for bad debts which can be % of sales, % of accounts receivable, or aging the
accounts receivable. This will be explained further in your intermediate accounting subject.

Illustration 8.12: MSS Company has outstanding accounts receivable of P10,000 of which P400 was found to be
doubtful to collect.

Dec. 31 Bad Debts Expense 400

Allowance for Bad Debts 400
To record adjustment on bad debts expenses.

Allowance for bad debts is a contra account which means that it is presented in the financial statements as a
deduction of the account receivable.

Review Exercises
JSS Company has the following transactions that occurred during the calendar year.
1. JSS Company issued a 15%, P200,000, one-year, note payable on March 1, 2019. The principal and interest are
due at the maturity date. What is the adjusting entry on December 31, 2019?
2. The business received billing for utilities used for December and only paid in January of the following year.
What is the adjusting entry on December 31, 2019?
3. JSS Company is renting a space at a monthly rate of P10,000. As of December 31, 2019, the company has not
yet paid the rent for November and December. What is the adjusting entry on December 31, 2o19?
4. JSS Company has a commercial building in the nearby town and rented out to a certain businessman at a
monthly rate of P100,000. As of December 31, 2019, the tenant did not pay the rent for September up to
December. What is the adjusting entry on December 31, 2019?
5. The company has an outstanding receivable of P500,000 of which 2% found to be uncollectible. What is the
adjusting entry on December 31, 2019?
6. The company bought a commercial building on April 1, 2019, at P500,000. The company estimated that the
said building has a scrap value of P20,000 and would last for 10 years. What is the adjusting entry on
December 31, 2019?
7. The company has rented out the newly bought commercial building to a certain businesswoman at a monthly
rate of P20,000. On September 1, 2019, the businesswoman paid in advance a one-year rent totaling
P240,000.
a. What is the journal entry during the receipt of payment in both liability and income methods?
b. What is the adjusting entry on December 31, 2019, under each method?
8. The business paid a one-year insurance policy for its commercial buildings on November 1, 2019.
a. What is the journal entry during the prepayment in both asset and expense methods?
b. What is the adjusting entry on December 31, 2019, under each method?

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CPALE Simulation Level 8

1. Which of the following statements is false 2. As prepaid expenses expire over time, the
regarding adjusting entries? correct adjusting entry will be a _____.
a. Adjusting entries involve accruals or a. debit to an asset account and a credit to an
deferrals. expense account
b. Cash is neither debited nor credited as a b. debit to an expense account and a credit to
result of adjusting entries. an asset account
c. Each adjusting entry affects one revenue c. debit to an asset account and a credit to an
account and one expense account. asset account
d. Each adjusting entry affects one statement d. debit to an expense account and a credit to
of financial position and one income an expense account
statement account.
3. The failure to properly record an adjusting 4. The failure to properly record an adjusting
entry to accrue revenue results in ____. entry to accrue an expense results in ___.
a. overstatement of revenue and an a. overstatement of expense and an
overstatement of asset understatement of asset
b. overstatement of revenue and an b. understatement of expense and an
overstatement of liability overstatement of asset
c. understatement of revenue and an c. understatement of expense and an
understatement of asset overstatement of liability
d. understatement of revenue and an d. understatement of expense and an
understatement of liability understatement of liability
5. Adjusting entries are needed because an 6. An entity must make adjusting entries ___.
entity ______. a. to account for accruals or deferrals
a. has expenses b. each time it prepares an income statement
b. uses the accrual basis of accounting and a statement of financial position
c. uses the cash basis of accounting rate than c. to ensure that the revenue recognition and
the accrual basis expense recognition principles are followed
d. has earned revenue during the period by d. All of the choices are correct regarding
selling products from its central operations adjusting entries.
7. Which one of the following concepts is 8. Adjusting entries are primarily based on
least related to adjusting entries? the accounting principles of _____.
a. Accrual a. matching and historical cost
b. Approximation b. matching and monetary unit
c. Matching of cost against revenue c. revenue realization and matching
d. Materiality d. revenue realization and materiality
9. The adjusting entry at the end of the 10. Recording the adjusting entry for
accounting year to reflect revenues earned depreciation has the same effect as
but not yet collected or recorded will ___. recording the adjusting entry for _____.
a. increase assets a. a prepaid expense
b. not affect assets b. an accrued expense
c. decrease liabilities c. an accrued income
d. not affect income for the current period d. an unearned revenue

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11. Adjusting entries are needed because in 12. Accounts often need to be adjusted
reporting financial data, an entity because _____.
I. Adopts the accrual assumption a. there are never enough accounts to record
II. Reports on transactions that overlap all the transactions
accounting periods and records b. many transactions affect more than one
III. Accepts the going concern assumption time period
a. I only c. there are always errors made in recording
b. I and II only transactions
c. II and III only d. management cannot decide what they
d. I, II, and III want to report
13. Which of the following is an example of 14. Adjusting entries are needed _____.
deferral? a. whenever expenses are not paid in cash
a. recognizing prepaid rent b. whenever revenues are not received in cash
b. accruing year-end wages c. primarily to correct errors in the initial
c. recognizing revenues earned but not yet recording of business transactions
recorded d. whenever transactions affect the revenues
d. recognizing expenses incurred but not yet or expenses of more than one accounting
recorded period

15. Which one of the following items least

resembles a typical adjusting entry?
a. debit an asset and credit liability
b. debit an asset and credit revenue
c. debit an expense and credit liability
d. debit revenue and credit liability

Suggested Exercises

1. Problems 1-7, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp.
264-276.
2. Problems 1-19, Basic Financial Accounting and Reporting 22nd Edition (2019) by Ballada & Ballada,
pp. 4-54 to 4-70.
3. Exercises E3.1-E3.21, Accounting Principles 13th Edition (2018) by Weygandt, Kimmel & Kieso, pp. 3-
42 & 3-48.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition. Manila,
Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City,
Philippines: Bandolin Enterprise.
3. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John
Wiley & Sons (Asia) Pte Ltd.

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 FINANCIAL ACCOUNTING AND REPORTING
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Lesson 9 ADJUSTED TRIAL BALANCE

Did you know that?

LEARNING OBJECTIVE Taxation has been known as the killer subject in both
CPALE and the bar exam. Many examinees failed in
1. Prepare an adjusted trial balance. this subject.

Adjusted trial balance can be made after effecting

the adjustments in the ledger. The adjusted balances in the ledger become the basis in making the adjusted trial
balance. This is done to prove the equality of debits and credits and to detect errors from the postings to the
ledger. The use of worksheet facilitates the preparation of adjusting entries, financial statements, and closing
entries. Technically, the worksheet is prepared before posting adjusting entries in the journal and ledger. In this
lesson, we will use the worksheet to have a better picture of the effects of adjusting entries in preparing the
adjusted trial balance. The adjusted trial balance is very critical in making financial statements. To better
understand how worksheet helps accountants in preparing an adjusted trial balance, let us make use of the
following worksheet and discuss how it works.

MSS REPAIR SERVICES

Worksheet
December 31, 2019
Unadjusted Trial Balance Adjustments Adjusted Trial Balance
Account Titles
Dr Cr Dr Cr Dr Cr
Cash 60,000 60,000
Accounts Receivables 12,000 6,000 18,000
Supplies 9,000 2,000 7,000
Prepaid Insurance 19,000 5,000 14,000
Land 480,000 480,000
Buildings 700,000 700,000
Accumulated Depreciation-Buildings 200,000 4,000 204,000
Equipment 500,000 500,000
Accumulated Depreciation-Equipment 180,000 10,000 190,000
Accounts Payable 20,000 20,000
Unearned Service Revenue 21,000 10,000 11,000
Mortgage Payable 400,000 400,000
MSS, Capital 715,000 715,000
Service Revenue 335,000 16,000 351,000
Salary Expense 85,000 2,000 87,000
Telephone Expense 3,000 3,000
Utility Expense 2,000 2,000
Miscellaneous Expense 1,000 1,000
1,871,000 1,871,000

Supplies Expense 2,000 2,000

Insurance Expense 5,000 5,000
Depreciation Expense-Building 4,000 4,000
Depreciation Expense-Equipment 10,000 10,000
Salaries Payable 2,000 2,000
Interest Expense 1,000 1,000
Interest Payable 1,000 1,000
40,000 40,000 1,894,000 1,894,000

Adjusted trial balance is done by adding or subtracting horizontally the adjustments to the unadjusted trial
balance on a per-account basis, this process is also known as cross-footing. If the account has no adjustment, then
simply copy the amount to the appropriate column in the adjusted trial balance. The following scenarios are
observed whenever there are adjustments.

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1. If the account has a debit balance and a debit adjustment, just add and put the sum in the debit column
of the adjusted trial balance.
2. If the account has a credit balance and a credit adjustment, just add and put the sum in the credit
column of the adjusted trial balance.
3. If the account has a debit balance and a credit adjustment, then the debit balance is deducted by the
credit adjustment. If the difference is positive, place the amount in the debit column of the adjusted trial
balance. If the difference is negative, place the amount in the credit column of the adjusted trial balance.
4. If the account has a credit balance and a debit adjustment, the credit balance is deducted by the debit
adjustment. If the difference is positive, place the amount in the credit column of the adjusted trial
balance. If the difference is negative, place the amount in the debit column of the adjusted trial balance.

Review Exercises
1. This is a worksheet of JSS Company prepared on December 31, 2019. You are tasked to prepare an adjusted
trial balance after some adjustments are effected. You can use a 14-column worksheet.

JSS COMPANY
Worksheet
December 31, 2019

Unadjusted Trial Balance Adjustments Adjusted Trial Balance

Account Titles
Dr Cr Dr Cr Dr Cr
Cash 6,000
Accounts Receivables 1,200 600
Supplies 900 200
Prepaid Insurance 1,900 500
Land 48,000
Buildings 70,000
Accumulated Depreciation-Buildings 20,000 400
Equipment 50,000
Accumulated Depreciation-Equipment 18,000 1,000
Accounts Payable 2,000
Unearned Service Revenue 2,100 1,000
Mortgage Payable 40,000
JSS, Capital 71,500
Service Revenue 33,500 1,600
Salary Expense 8,500 200
Telephone Expense 300
Utility Expense 200
Miscellaneous Expense 100
187,100 187,100

Supplies Expense 200

Insurance Expense 500
Depreciation Expense-Building 400
Depreciation Expense-Equipment 1,000
Salaries Payable 200
Interest Expense 100
Interest Payable 100
4,000 4,000

2. This exercise will examine you on how to prepare an adjusted trial balance for PDSS Hatod Services as of
December 31, 2019, using the ledgers only. Please take note that these accounts were not arranged according
to the elements of the financial statements. You can use a 14-column worksheet.

Motor Vehicle 70,000 Accounts Payable 10,000 Service Revenue 60,000

Accounts Receivable 18,000 Prepaid Insurance 5,000 Dep. Expense-Office Equipment 1,000
Rent Expense 5,000 PDSS, Capital 160,000 Utility Expense 3,000
Insurance Expense 6,000 Dep. Expense-Motor Vehicle 2,000 Salaries Expense 12,000
Accum. Dep. –Office Equipment 5,000 Supplies 4,000 Salaries Payable 6,000
Notes Payable 5,000 Accum. Dep. -Motor Vehicle 10,000 Miscellaneous Expense 1,000
Interest Payable 6,000 Office Equipment 50,000 Cash 80,000
PDSS, Drawings 2,000 Utilities Payable 3,000 Unearned Service Revenue 10,000
Prepaid Rent 5,000 Supplies Expense 5,000 Interest Expense 6,000

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CPALE Simulation Level 9

1. In a worksheet, which of the following is 2. Adding amounts horizontally in a
prepared after the unadjusted trial balance? worksheet is called _____.
a. adjusted trial balance columns a. footing
b. income statement columns b. cross-footing
c. adjusting entries columns c. cross-legging
d. balance sheet columns d. horizontaling
3. A document prepared to prove the equality 4. In the accounting cycle, a worksheet is
of debits and credits after all adjustments is prepared _____.
the _____. a. as a substitute for financial statements.
a. adjusted financial statements b. only to prepare reversing entries
b. adjusted statement of financial position c. after adjusting entries are entered in the
c. adjusted trial balance journal and posted to the ledger
d. post-closing trial balance d. before adjusting entries are entered in the
journal and posted to the ledger
5. Debit and debit result in _____.
a. addition
b. deduction
c. multiplication
d. two debits

Suggested Exercises

1. Exercises E4.5-E4.6, Accounting Principles 13th Edition (2018) by Weygandt, Kimmel & Kieso, pp. 4-
43 & 4-44.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition. Manila,
Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City,
Philippines: Bandolin Enterprise.
3. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John
Wiley & Sons (Asia) Pte Ltd.

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Lesson 10 FINANCIAL STATEMENTS

Did you know that?

LEARNING OBJECTIVE A CPA faculty handling accounting education subjects
1. Prepare financial statements. must be an accredited accounting teacher from the
Professional Regulatory Board of Accountancy.

Financial statements are considered as the ultimate

product of the accounting process. A complete set of
financial statements include the statement of financial position (balance sheet), statement of financial
performance (income statement), statement of changes in equity, statement of cash flows, and notes to financial
statements. These financial statements can be briefly explained in the following manner:
1. The statement of financial position provides information about all the assets, liabilities, and owner’s equity of
an entity as at a specific date.
2. The statement of financial performance shows a summary of the income and expenses of an entity for a
specific period.
3. The statement of changes in equity presents the changes in the capital which include investments, profit or
loss, and withdrawals during a specific period.
4. The statement of cash flows shows the amount of cash received and disbursed during the period.
5. Notes to financial statements provide information about the entity’s accounting policies adopted and other
explanations about the financial statements.
In preparing the financial statements, completing the worksheet is necessary. In our previous lesson, we only did
the unadjusted trial balance, adjustments, and adjusted trial balance. This time, we will extend the worksheet to
the income statement and balance sheet columns as shown below.
MSS REPAIR SERVICES
Worksheet
December 31, 2019

Unadjusted Trial Adjustments Adjusted Trial Balance Income Statement Balance Sheet
Account Titles Balance
Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr
Cash 60,000 60,000 60,000
Accounts Receivables 12,000 6,000 18,000 18,000
Supplies 9,000 2,000 7,000 7,000
Prepaid Insurance 19,000 5,000 14,000 14,000
Land 480,000 480,000 480,000
Buildings 700,000 700,000 700,000
Accumulated Depreciation-Buildings 200,000 4,000 204,000 204,000
Equipment 500,000 500,000 500,000
Accumulated Depreciation-Equipment 180,000 10,000 190,000 190,000
Accounts Payable 20,000 20,000 20,000
Unearned Service Revenue 21,000 10,000 11,000 11,000
Mortgage Payable 400,000 400,000 400,000
MSS, Capital 715,000 715,000 715,000
Service Revenue 335,000 16,000 351,000 351,000
Salary Expense 85,000 2,000 87,000 87,000
Telephone Expense 3,000 3,000 3,000
Utility Expense 2,000 2,000 2,000
Miscellaneous Expense 1,000 1,000 1,000
1,871,000 1,871,000
Supplies Expense 2,000 2,000 2,000
Insurance Expense 5,000 5,000 5,000
Depreciation Expense-Building 4,000 4,000 4,000
Depreciation Expense-Equipment 10,000 10,000 10,000
Salaries Payable 2,000 2,000 2,000
Interest Expense 1,000 1,000 1,000
Interest Payable 1,000 1,000 1,000
40,000 40,000 1,894,000 1,894,000 115,000 351,000 1,779,000 1,543,000
Net Income 236,000 236,000
351,000 351,000 1,779,000 1,779,000

Income and expenses accounts are extended to the income statement columns. Assets, liabilities, and owner’s
equity accounts are extended to the balance sheet columns. Under the income statement columns, the difference
between the debit and credit totals represents the net income and usually placed in the debit column, if it is a

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LEARNING MODULES

profit, and in the credit column, if it is a loss. Under the balance sheet columns, the difference between the debit
and credit totals represents the net income and usually placed in the credit column, if it is a profit and in the credit
column, if it is a loss. Net income in both income statement and balance sheet must be equal.

After getting done with the income statement and balance sheet in the worksheet, this time, we start making the
financial statements. First, we will prepare the income statement. The left illustration below is the income
statement columns in the worksheet. The right illustration is the formal income statement.
MSS REPAIR SERVICES
MSS REPAIR SERVICES
Worksheet
Income Statement
December 31, 2019
For the Year Ended December 31, 2019
Income Statement
Account Titles Revenue
Dr Cr Service Revenue P351,000
Cash Expenses
Accounts Receivables Salary Expense P87,000
Supplies Telephone Expense 3,000
Prepaid Insurance Utility Expense 2,000
Land Miscellaneous Expense 1,000
Buildings Supplies Expense 2,000
Accumulated Depreciation-Buildings Insurance Expense 5,000
Equipment Depreciation Expense-Building 4,000
Accumulated Depreciation-Equipment Depreciation Expense-Equipment 10,000
Accounts Payable Interest Expense 1,000
Unearned Service Revenue Total 115,000
Mortgage Payable Net Income P236,000
MSS, Capital
Service Revenue 351,000
Salary Expense 87,000
Telephone Expense 3,000
In preparing the income statement,
Utility Expense 2,000
Miscellaneous Expense 1,000 simply list all the income and expenses,
Supplies Expense 2,000 then the difference is the net income or
Insurance Expense 5,000
loss. Just copy all the income and
Depreciation Expense-Building 4,000
Depreciation Expense-Equipment 10,000 expenses accounts in the income
Salaries Payable statement columns in the worksheet. To
Interest Expense 1,000
Interest Payable
check the net income, the net income in
115,000 351,000 the formal statement must be equal with
Net Income 236,000 the net income in the worksheet.
351,000 351,000

Next, we will prepare the statement of changes in equity. Below is the formal statement of changes in equity.

MSS REPAIR SERVICES

In our illustration, we assume that the Statement of Changes in Equity
beginning balance of the MSS, Capital is For the Year Ended December 31, 2019
the same as the ending balance in the
MSS, Capital, 1/1/2019 P715,000
adjusted trial balance. The net income we Add: Additional Investments P 0
get in the income statement is added to Net Income 236,000 236,000
the beginning capital balance along with Total
Less: Withdrawals 0
any additional investments. Withdrawals MSS, Capital, 12/31/2019 P951,000
during the year will be deducted to arrive
at the ending capital balance.

Next, we will prepare the balance sheet. This time, we will discuss first the classification of assets and liabilities
since it is being discussed in our previous lessons. Assets are classified as current and non-current assets. This
classification is according to the liquidity principle. This principle describes the convertibility of assets into cash to
pay maturing obligations. Thus, assets are presented in the decreasing order of liquidity. Current assets are assets
that a company expects to convert to cash or use up within one year or its operating cycle, whichever is longer,
otherwise, it is non-current assets. Current assets usually include cash, accounts receivables, inventories, and
prepaid expenses while non-current assets usually include land, building, and equipment. Liabilities are classified as
current and non-current liabilities. Current liabilities are obligations that the company is to pay within the coming

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LEARNING MODULES

year or its operating cycle, whichever is longer, otherwise, these are non-current liabilities. Current liabilities
usually include accounts payable, notes payable, salaries payable, utilities payable, interest payable, and unearned
revenues while non-current liabilities normally include loans payable, bonds payable, and mortgage payable. The
left illustration below is the balance sheet columns in the worksheet. The right illustration is the formal balance
sheet.
MSS REPAIR SERVICES MSS REPAIR SERVICES
Worksheet Balance Sheet
December 31, 2019 As of December 31, 2019

Assets
Balance Sheet
Account Titles Current Assets
Dr Cr Cash P 60,000
Cash 60,000 Accounts Receivables 18,000
Accounts Receivables 18,000 Supplies 7,000
Supplies 7,000 Prepaid Insurance 14,000
Prepaid Insurance 14,000 Total Current Assets P 99,000
Non-Current Assets
Land 480,000 Land P480,000
Buildings 700,000 Buildings P700,000
Accumulated Depreciation-Buildings 204,000 Less: Accumulated Depreciation-Buildings 204,000 496,000
Equipment 500,000 Equipment 500,000
Accumulated Depreciation-Equipment 190,000 Accumulated Depreciation-Equipment 190,000 310,000
Accounts Payable 20,000 Total Non-Current Assets 1,286,000
Total Assets P1,385,00
Unearned Service Revenue 11,000
Liabilities
Mortgage Payable 400,000
Current Liabilities
MSS, Capital 715,000 Accounts Payable 20,000
Service Revenue Salaries Payable 2,000
Salary Expense Interest Payable 1,000
Telephone Expense Unearned Service Revenue 11,000
Utility Expense Total Current Liabilities P 34,000
Non-Current Liabilities
Miscellaneous Expense Mortgage Payable 400,000
Supplies Expense Owner’s Equity
Insurance Expense MSS, Capital, 12/31/19 951,000
Depreciation Expense-Building Total Liabilities and Owner’s Equity P1,385,000
Depreciation Expense-Equipment
Salaries Payable 2,000
Interest Expense Please ensure that you master the classification of
Interest Payable 1,000 accounts particularly the current and non-current
1,779,000 1,543,000
Net Income 236,000 assets and liabilities for you to complete the
1,779,000 1,779,000 balance sheet easily.

Next, we will prepare the statement of cash flow. We will make use of the cash ledger in making the cash flow
statement. Below is a sample cash ledger and the next illustration is the sample cash flow statement.
CASH No. 101
Date
2020
Explanation Ref. Debit Credit Balance
Please take note that the
Jan.
Feb.
1
2
Investments by owner
Proceeds from borrowings through mortgage
1,095,000
400,000
1,095,000
1,495,000 statement of cash flows can
Mar. 3 Payment for land 469,000 1,026,000
Mar. 3 Payment for building 700,000 326,000 be done by classifying each
Mar. 3 Payments from clients 344,000 670,000
Apr. 4 Payment for equipment 500,000 170,000 transaction in the cash
May 5 Payment for insurance 19,000 151,000
Jun. 6 Payment for salaries 85,000 66,000 ledger into operating,
Jul. 7 Payment for telephone 3,000 63,000
Aug.
Dec.
8
9
Payment for utilities
Payment of miscellaneous
2,000
1,000
61,000
60,000
investing, and financing
activities.
MSS REPAIR SERVICES
Statement of Cash Flows
For the Year Ended December 31, 2019
Operating activities are cash
Cash Flows from Operating Activities transactions used in determining profit
Cash received from clients P 344,000
Payment for insurance (19,000) and loss. Investing activities include
Payment for salaries (85,000) acquiring and disposing of long-term
Payment for telephone (3,000)
Payment for utilities (2,000) assets, and lending money and
Payment of miscellaneous (1,000)
Net cash provided by (used in) operating activities P 234,000
collecting the loans. Financing
Cash Flows from Investing Activities activities include obtaining and settling
Payment for land (469,000)
Payment for building (700,000) resources from owners and creditors.
Payment for equipment (500,000) The ending balance in the ledger must
Net cash provided by (used in) investing activities (1,669,000)
Cash Flows from Financing Activities equal in the ending balance in the cash
Cash received as investments by owner 1,095,000 flow statement. This topic will be
Cash received from borrowing 400,000
Net cash provided by (used in) financing activities 1,495,000 discussed thoroughly in your
Net Increase (Decrease) in Cash P 60,000 intermediate accounting.
Cash balance at the beginning of the period 0
Cash balance at the end of the period P 60,000

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Review Exercises
In our previous review exercise, you are tasked to prepare an adjusted trial balance, this time, you need to
complete the worksheet and prepare the income statement, balance sheet, and statement of changes in equity. If
you think you are not confident with your answers on the adjusted trial balance, you can ask your classmates to
check your work. The problems are provided again hereunder for your convenience.

1. This is a worksheet of JSS Company prepared on December 31, 2019. You are tasked to extend the worksheet
to the income statement and balance sheet columns and prepare the required financial statements. You can
use the 14-column worksheet you used before.

JSS COMPANY
Worksheet
December 31, 2019

Unadjusted Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet
Account Titles
Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr
Cash 6,000
Accounts Receivables 1,200 600
Supplies 900 200
Prepaid Insurance 1,900 500
Land 48,000
Buildings 70,000
Accumulated Depreciation-
Buildings 20,000 400
Equipment 50,000
Accumulated Depreciation-
Equipment 18,000 1,000
Accounts Payable 2,000
Unearned Service Income 2,100 1,000
Mortgage Payable 40,000
JSS, Capital 71,500
Service Income 33,500 1,600
Salary Expense 8,500 200
Telephone Expense 300
Utility Expense 200
Miscellaneous Expense 100
187,100 187,100

Supplies Expense 200

Insurance Expense 500
Depreciation Expense-
Building 400
Depreciation Expense-
Equipment 1,000
Salaries Payable 200
Interest Expense 100
Interest Payable 100
4,000 4,000

2. Please take note that these accounts were not arranged according to the elements of the financial
statements. You are tasked to prepare an extended worksheet up to income statement and balance sheet
columns and prepare the required financial statements for PDSS Hatod Services as of December 31, 2019. You
can use the 14-column worksheet you used before.

Motor Vehicle 70,000 Accounts Payable 10,000 Service Income 60,000

Accounts Receivable 18,000 Prepaid Insurance 5,000 Dep. Expense-Office Equipment 1,000
Rent Expense 5,000 PDSS, Capital 160,000 Utility Expense 3,000
Insurance Expense 6,000 Dep. Expense-Motor Vehicle 2,000 Salaries Expense 12,000
Accum. Dep. –Office Equipment 5,000 Supplies 4,000 Salaries Payable 6,000
Notes Payable 5,000 Accum. Dep. -Motor Vehicle 10,000 Miscellaneous Expense 1,000
Interest Payable 6,000 Office Equipment 50,000 Cash 80,000
PDSS, Drawings 2,000 Utilities Payable 3,000 Unearned Service Income 10,000
Prepaid Rent 5,000 Supplies Expense 5,000 Interest Expense 6,000

In completing the worksheet, please make use of a pencil so you can erase immediately it if you have made
mistakes. Please ensure neatness in your work, so you can recheck your work easily. During actual examinations in
this particular subject which only gives you 2-3 hours to finish, you need speed and accuracy so you can complete
the requirements on time.

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CPALE Simulation Level 10

1. Which of the following would result in an 2. The basis for classifying assets as current or
income of P32,000? noncurrent is conversion to cash within the
a. total expenses of p28,000 and loss of ______.
p4,000 a. operating cycle or one year, whichever is
b. total expenses of p36,000 and profit of longer
p4,000 b. operating cycle or one year, whichever is
c. total expenses of p22,000 and loss of shorter
p10,000 c. accounting cycle or one year, whichever is
d. total expenses of p36,000 and loss of longer
p4,000 d. accounting cycle or one year, whichever is
shorter
3. In the unadjusted trial balance of its 4. What financial statements do not involve a
worksheet for the year ended December 31, distinct period of time?
2020, J Company reported Equipment of a. statement of cash flows
P120,000. The year-end adjusting entries b. statement of financial position
require an adjustment P15,000 for c. statement of changes in equity
depreciation expense for the equipment. d. statement of comprehensive income
After the adjusted trial balance is
completed, what amount should be shown 5. Current assets are listed ______.
in the financial statement columns? a. by expected conversion to cash
a. a debit of P105,000 for equipment in the b. by importance
balance sheet column c. by longevity
b. a credit of P15,000 for depreciation d. alphabetically
expense in the income statement column
c. a debit of P120,000 for equipment in the
balance sheet column
d. a debit of P15,000 for accum. dep.-
equipment in the balance sheet column

Suggested Exercises

1. Problems 1-4, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp.
316-319.
2. Problems 4-7, 9-13, 15, Basic Financial Accounting and Reporting 22nd Edition (2019) by Ballada &
Ballada, pp. 5-29 to 5-33, 5-35 to 5-40.
3. Exercises E4.1, E4.2, E4.9 & E4.14-E.4.17 Accounting Principles 13th Edition (2018) by Weygandt,
Kimmel & Kieso, pp. 4-42, 4-43, 4-45 to 4-47.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition. Manila,
Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City,
Philippines: Bandolin Enterprise.
3. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John
Wiley & Sons (Asia) Pte Ltd.

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Lesson 11 CLOSING ENTRIES

Did you know that?

LEARNING OBJECTIVE The accountancy programs of Southern Leyte State
1. Prepare closing entries. University, the BS Accountancy, and BS Management
Accounting have already been granted the Certificate
of Program Compliance by CHED Region 8.
Closing entries are prepared at the end of the
accounting period to close all the nominal accounts
in the ledger. This process is popularly known as closing the books. Typically, this process involves the following:

1. All credit accounts in the income statement are debited and all debits accounts are credited. The balancing
figure representing the net income is recorded in a temporary account, usually called an income summary.
2. The income summary account is closed to the owner’s capital account. If the income summary account has a
debit balance (net loss), then it is credited to zero-out. If the income summary account has a credit balance
(net profit), then it is debited to zero-out.
3. The owner’s drawings account will be closed to the owner’s capital account. Usually, the owner’s drawings
account has a normal debit balance, so to zero out, it must be credited and the debit entry is the owner’s
capital.

Let us make use of the worksheet below in which the closing entries columns are created for a better illustration
of how closing entries using the worksheet are done. Please take note that the income summary account as an
additional account was created.

MSS REPAIR SERVICES

Worksheet
December 31, 2019

Income Statement Balance Sheet Closing Entries

Account Titles
Dr Cr Dr Cr Dr Cr
Cash 60,000
Accounts Receivables 18,000
Supplies 7,000
Prepaid Insurance 14,000
Land 480,000
Buildings 700,000
Accumulated Depreciation-Buildings 204,000
Equipment 500,000
Accumulated Depreciation-Equipment 190,000
Accounts Payable 20,000
Unearned Service Revenue 11,000
Mortgage Payable 400,000
MSS, Capital 715,000 236,000
Service Revenue 351,000 351,000
Salary Expense 87,000 87,000
Telephone Expense 3,000 3,000
Utility Expense 2,000 2,000
Miscellaneous Expense 1,000 1,000
Supplies Expense 2,000 2,000
Insurance Expense 5,000 5,000
Depreciation Expense-Building 4,000 4,000
Depreciation Expense-Equipment 10,000 10,000
Salaries Payable 2,000
Interest Expense 1,000 1,000
Interest Payable 1,000
Income Summary 236,000 236,000
115,000 351,000 1,779,000 1,543,000
Net Income 236,000 236,000
351,000 351,000 1,779,000 1,779,000 587,000 587,000

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This time, we will make use of the formal format of a closing entry. Please take note that an illustrative entry was
made for the drawing account since in our previous illustration, there was no drawing account.

December 31 Service Revenue 351,000

Salary Expense 87,000
Telephone Expense 3,000
Utility Expense 2,000
Miscellaneous Expense 1,000
Supplies Expense 2,000
Insurance Expense 5,000
Depreciation Expense-Building 4,000
Depreciation Expense-Equipment 10,000
Interest Expense 1,000
Income Summary 236,000
To close the income and expenses accounts.
December 31 Income Summary 236,000
MSS, Capital 236,000
To close income summary account to the owner’s capital.
December 31 MSS Capital 0
MSS, Drawings 0
To close the drawing account to the owner’s capital.

Review Exercises
In our previous review exercise, you are tasked to extend the worksheet up to income statement and balance
sheet columns and prepare the income statement, balance sheet, and statement of changes in equity. This time,
you are tasked to extend the worksheet to the closing entries columns. If you think you are not confident with
your answers, you can ask your classmates to check your work. The problems are provided again hereunder for
your convenience.
1. This is a worksheet of JSS Company prepared on December 31, 2019. You are tasked to extend the worksheet
up to the closing entries columns and prepare the closing entries. You can use the 14-column worksheet you
used before.
JSS COMPANY
Worksheet
December 31, 2019

Unadjusted Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet Closing Entries
Account Titles
Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr
Cash 6,000
Accounts Receivables 1,200 600
Supplies 900 200
Prepaid Insurance 1,900 500
Land 48,000
Buildings 70,000
Accumulated Depreciation-
Buildings 20,000 400
Equipment 50,000
Accumulated Depreciation-
Equipment 18,000 1,000
Accounts Payable 2,000
Unearned Service Revenue 2,100 1,000
Mortgage Payable 40,000
JSS, Capital 71,500
Service Revenue 33,500 1,600
Salary Expense 8,500 200
Telephone Expense 300
Utility Expense 200
Miscellaneous Expense 100
187,100 187,100

Supplies Expense 200

Insurance Expense 500
Depreciation Expense-
Building 400
Depreciation Expense-
Equipment 1,000
Salaries Payable 200
Interest Expense 100
Interest Payable 100
4,000 4,000

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2. Please take note that these accounts were not arranged according to the elements of the financial
statements. You are tasked to prepare an extended worksheet up to the closing entries column for PDSS
Hatod Services as of December 31, 2019. You are also tasked to prepare the closing entries. You can use the
14-column worksheet you used before.

Motor Vehicle 70,000 Accounts Payable 10,000 Service Income 60,000

Accounts Receivable 18,000 Prepaid Insurance 5,000 Dep. Expense-Office Equipment 1,000
Rent Expense 5,000 PDSS, Capital 160,000 Utility Expense 3,000
Insurance Expense 6,000 Dep. Expense-Motor Vehicle 2,000 Salaries Expense 12,000
Accum. Dep. –Office Equipment 5,000 Supplies 4,000 Salaries Payable 6,000
Notes Payable 5,000 Accum. Dep. -Motor Vehicle 10,000 Miscellaneous Expense 1,000
Interest Payable 6,000 Office Equipment 50,000 Cash 80,000
PDSS, Drawings 2,000 Utilities Payable 3,000 Unearned Service Income 10,000
Prepaid Rent 5,000 Supplies Expense 5,000 Interest Expense 6,000

PDSS HATOD SERVICES

Worksheet
December 31, 2019

Adjusted Trial Balance Income Statement Balance Sheet Closing Entries

Account Titles
Dr Cr Dr Cr Dr Cr Dr Cr

In completing the worksheet, please make use of a pencil so you can erase immediately it if you have made
mistakes. Please ensure neatness in your work, so you can recheck your work easily. During actual examinations in
this particular subject which only gives you 2-3 hours to finish, you need speed and accuracy so you can complete
the requirements on time.

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CPALE Simulation Level 11

1. The closing process ______. 2. Which of the following is an example of a
a. is done each time a transaction takes place closing entry?
and is journalized a. transferring the balance in a temporary
b. posts all closing entries to the appropriate account to a contra account
general ledger account b. posting the ending inventory balance in a
c. transfers all income statement items to perpetual inventory system
their related statement of financial position c. transferring an amount entered in a wrong
account account to the appropriate account
d. All of the choices are correct regarding the d. transferring the balance in the bad debt
closing process expense account to the income summary
account
3. If the income summary account has a credit 4. When preparing closing entries, which of
balance after all income and expense the following accounts is debited when
accounts are closed, there is ____. closing to the income summary account?
a. profit a. depreciation expense
b. loss b. owner’s drawings
c. owner’s drawings c. sales
d. an error d. salaries payable
5. The effect of closing entries is to ______.
a. change assets
b. change liabilities
c. change retained earnings
d. change debit balances of all accounts into
credits and vice-versa

Suggested Exercises

1. Problems 1-4, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp.
316-319.
2. Problems 3-5,9-13,15, Basic Financial Accounting and Reporting 22nd Edition (2019) by Ballada &
Ballada, pp. 6-18 to 6-20, 5-35 to 5-40.
3. Exercises E4.11 & E4.19, Accounting Principles 13th Edition (2018) by Weygandt, Kimmel & Kieso,
pp. 4-45 & 4-47.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition. Manila,
Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City,
Philippines: Bandolin Enterprise.
3. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John
Wiley & Sons (Asia) Pte Ltd.

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Lesson 12 POST-CLOSING TRIAL BALANCE

Did you know that?

LEARNING OBJECTIVE The inventor of the calculator is Blaise Pascal. The
1. Prepare a post-closing trial balance. training of accountancy students includes the use of a
calculator in solving simple and complex problems.

The post-closing trial balance lists permanent

accounts and their balances after the journalizing and posting of closing entries. This is done by cross-footing the
amounts in the closing entries columns and the balance sheet columns. It is assumed that all the accounts in the
income statement columns are zero-out or closed already. All the real accounts are forwarded to the next
accounting period.

Let us make use of the worksheet below in which the post-closing trial balance columns are created for a better
illustration of how post-closing trial balance using worksheet is done. Just copy the balances of the balance sheet
accounts to the post-closing trial balance columns except for the capital account in which you need to horizontally
add or subtract the entries in the closing entries columns first before putting the resulting amount to the
appropriate column in the post-closing trial balance.

MSS REPAIR SERVICES

Worksheet
December 31, 2019

Income Statement Balance Sheet Closing Entries Post-closing Trial Balance

Account Titles
Dr Cr Dr Cr Dr Cr Dr Cr
Cash 60,000 60,000
Accounts Receivables 18,000 18,000
Supplies 7,000 7,000
Prepaid Insurance 14,000 14,000
Land 480,000 480,000
Buildings 700,000 700,000
Accumulated Depreciation-Buildings 204,000 204,000
Equipment 500,000 500,000
Accumulated Depreciation-Equipment 190,000 190,000
Accounts Payable 20,000 20,000
Unearned Service Revenue 11,000 11,000
Mortgage Payable 400,000 400,000
MSS, Capital 715,000 236,000 951,000
Service Revenue 351,000 351,000
Salary Expense 87,000 87,000
Telephone Expense 3,000 3,000
Utility Expense 2,000 2,000
Miscellaneous Expense 1,000 1,000
Supplies Expense 2,000 2,000
Insurance Expense 5,000 5,000
Depreciation Expense-Building 4,000 4,000
Depreciation Expense-Equipment 10,000 10,000
Salaries Payable 2,000 2,000
Interest Expense 1,000 1,000
Interest Payable 1,000 1,000
Income Summary 236,000 236,000
115,000 351,000 1,779,000 1,543,000
Net Income 236,000 236,000
351,000 351,000 1,779,000 1,779,000 587,000 587,000 1,779,000 1,779,000

Review Exercises
In our previous review exercise, you are tasked to extend the worksheet up to the closing entries columns. This
time, you are tasked to extend the worksheet up to the post-closing trial balance columns. If you think you are

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not confident with your answers, you can ask your classmates to check your work. The problems are provided
again hereunder for your convenience.

1. This is a worksheet of JSS Company prepared on December 31, 2019. You are tasked to extend the worksheet
up to the post-closing trial balance columns. You can use the 14-column worksheet you used before.

JSS COMPANY
Worksheet
December 31, 2019

Income Statement Balance Sheet Closing Entries Post-closing Trial Balance

Account Titles
Dr Cr Dr Cr Dr Cr Dr Cr
Cash
Accounts Receivables
Supplies
Prepaid Insurance
Land
Buildings
Accumulated Depreciation-Buildings
Equipment
Accumulated Depreciation-Equipment
Accounts Payable
Unearned Service Revenue
Mortgage Payable
JSS, Capital
Service Revenue
Salary Expense
Telephone Expense
Utility Expense
Miscellaneous Expense
Supplies Expense
Insurance Expense
Depreciation Expense-Building
Depreciation Expense-Equipment
Salaries Payable
Interest Expense
Interest Payable
Income Summary

Net Income

2. Please take note that these accounts were not arranged according to the elements of the financial
statements. You are tasked to prepare an extended worksheet up to the post-closing trial balance columns
for PDSS Hatod Services as of December 31, 2019. You can use the 14-column worksheet you used before.

Motor Vehicle 70,000 Accounts Payable 10,000 Service Income 60,000

Accounts Receivable 18,000 Prepaid Insurance 5,000 Dep. Expense-Office Equipment 1,000
Rent Expense 5,000 PDSS, Capital 160,000 Utility Expense 3,000
Insurance Expense 6,000 Dep. Expense-Motor Vehicle 2,000 Salaries Expense 12,000
Accum. Dep. –Office Equipment 5,000 Supplies 4,000 Salaries Payable 6,000
Notes Payable 5,000 Accum. Dep. -Motor Vehicle 10,000 Miscellaneous Expense 1,000
Interest Payable 6,000 Office Equipment 50,000 Cash 80,000
PDSS, Drawings 2,000 Utilities Payable 3,000 Unearned Service Income 10,000
Prepaid Rent 5,000 Supplies Expense 5,000 Interest Expense 6,000

PDSS HATOD SERVICES

Worksheet
December 31, 2019

Income Statement Balance Sheet Closing Entries Post-closing Trial Balance

Account Titles
Dr Cr Dr Cr Dr Cr Dr Cr

Income Summary

Net Income

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CPALE Simulation Level 12

1. The amounts shown on this trial balance 2. This trial balance contains only real
represent the beginning balances of accounts.
accounts in the next accounting period. a. unadjusted trial balance
a. unadjusted trial balance b. adjusted trial balance
b. adjusted trial balance c. post-closing trial balance
c. post-closing trial balance d. permanent trial balance
d. carry-over trial balance
3. A document prepared to prove the equality 4. An account that will have a zero balance
of debits and credits after posting the after closing entries have been journalized
closing entries to the ledger is the ____. and posted is _____.
a. adjusted financial statements a. service revenue
b. adjusted statement of financial position b. supplies
c. adjusted trial balance c. prepaid insurance
d. post-closing trial balance d. accumulated depreciation-equipment
5. Which types of accounts will appear in the
post-closing trial balance?
a. permanent (real) accounts
b. temporary (nominal) accounts
c. accounts shown in the income statement
columns of a worksheet
d. None of these answer choices is correct.

Suggested Exercises

1. Problems 1-4, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp.
316-319.
2. Exercises E4.7 & E4.8, Accounting Principles 13th Edition (2018) by Weygandt, Kimmel & Kieso, pp.
4-44 & 4-45.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition. Manila,
Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City,
Philippines: Bandolin Enterprise.
3. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John
Wiley & Sons (Asia) Pte Ltd.

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Lesson 13 REVERSING ENTRIES

Did you know that?

LEARNING OBJECTIVE There are four accountancy programs in the
1. Prepare reversing entries. Philippines which include BS Accountancy, BS
Management Accounting, BS Accounting Information
System, and BS Internal Auditing. However, only a BS
Accountancy graduate is allowed to take the CPALE.
Reversing entries are is an optional procedure in
the accounting cycle in which a reversing entry is
made on the first day of the next accounting period
to reverse certain adjusting entries that increased an asset or liability of the preceding period (e.g. accruals,
prepaid expenses using expense method, and unearned revenue using income method). This is the exact opposite
of the adjusting entry made in the previous period. Companies use reversing entries to simplify the recording of a
subsequent transaction related to an adjusting entry, to facilitate the recording of cash receipts and disbursements
in the next accounting period, to promote convenience in recording accrual adjustments in the next accounting
period, and to promote consistency in the accounting procedure. The use of reversing entries does not change the
amounts reported in the financial statements. In most cases, only adjusting entries on accruals are reversed.

Let us assume that these are the adjusting entries of the preceding period and the next entry is the reversing
entry.

Accrued Expense

December 31 Salaries Expense 1,000

Salaries Payable 1,000
To record adjustment on unpaid salaries.

January 1 Salaries Payable 1,000

Salaries Expense 1,000
To reverse entry made on unpaid salaries.

Accrued Income

December 31 Interest Receivable 4,000

Interest Income 4,000
To record adjustment on uncollected interest.

January 1 Interest Income 4,000

Interest Receivable 4,000
To reverse entry made on uncollected interest.

Prepaid Expense using Expense Method

December 31 Prepaid Rent 3,000

Rent Expense 3,000
To record adjustment on the unexpired portion of rent.

January 1 Rent Expense 3,000

Prepaid Rent 3,000
To reverse entry made on the unexpired portion of rent.

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Unearned Revenue using Income Method

December 31 Service Revenue 6,000

Unearned Service Revenue 6,000
To record adjustment on the unearned portion of service
revenue.

January 1 Unearned Service Revenue 3,000

Service Revenue 3,000
To reverse entry made on the unearned portion of service
revenue.

Review Exercises
1. This is a worksheet of JSS Company prepared on December 31, 2019. You are tasked to analyze the
adjustments if certain adjusted entries are to be reversed in the next accounting period and prepare
reversing entries if any.

JSS COMPANY
Worksheet
December 31, 2019

Unadjusted Trial Balance Adjustments Adjusted Trial Balance

Account Titles
Dr Cr Dr Cr Dr Cr
Cash 6,000
Accounts Receivables 1,200 600
Supplies 900 200
Prepaid Insurance 1,900 500
Land 48,000
Buildings 70,000
Accumulated Depreciation-Buildings 20,000 400
Equipment 50,000
Accumulated Depreciation-Equipment 18,000 1,000
Accounts Payable 2,000
Unearned Service Revenue 2,100 1,000
Mortgage Payable 40,000
JSS, Capital 71,500
Service Revenue 33,500 1,600
Salary Expense 8,500 200
Telephone Expense 300
Utility Expense 200
Miscellaneous Expense 100
187,100 187,100

Supplies Expense 200

Insurance Expense 500
Depreciation Expense-Building 400
Depreciation Expense-Equipment 1,000
Salaries Payable 200
Interest Expense 100
Interest Payable 100
4,000 4,000

2. Please refer to the review exercise in Lesson 8 on adjusting entries. This time, you are tasked to analyze
which adjusting entry needs to be reversed and prepare the corresponding reversing entry if any. For number
7, use the income method, and for number 8, use the expense method. You can let your classmates check
your previous work if you think you are not confident with your answers on adjusting entries.

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CPALE Simulation Level 13

1. As a general rule, which of the following is 2. Which of the following adjusting entries
not subject to reversal? cannot be subject to reversing entries?
a. accrued expenses a. accrual of income
b. accrued revenues b. accrual of expense
c. prepaid expenses recorded as assets upon c. deferral of an expense under the asset
payment method
d. deferred revenues recorded as revenue d. deferral of income under the income
upon receipt method
3. An appropriate reversing entry _____. 4. Which of the following statements
a. is dated the first day of the next accounting regarding reversing entries is incorrect?
period a. All accruals should be reversed.
b. is usually made for adjusting entries that b. Adjusting entries for depreciation and bad
affect deferred items only debts are never reversed.
c. must be made because they are required by c. Deferrals entered in the statement of
accounting standards financial position accounts make reversing
d. is often used to correct entries that were entries unnecessary.
initially based on estimates d. Reversing entries change amounts
reported in the statement of financial
position for the previous period.
5. Reversing entries ________.
a. impact the income statement only
b. are not allowed under Philippine financial
reporting standards
c. impact the statement of financial position
and the income statement
d. change amounts reported in the financial
statements of the preceding period

Suggested Exercises

1. Problem 6, Basic Financial Accounting and Reporting 22nd Edition (2019) by Ballada & Ballada, pp.
6-21.
2. Problem 6, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp. 328-
330.
3. Exercises E4.18 & E4.19, Accounting Principles 13th Edition (2018) by Weygandt, Kimmel & Kieso,
pp. 4-47.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition. Manila,
Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City,
Philippines: Bandolin Enterprise.
3. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John
Wiley & Sons (Asia) Pte Ltd.

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MODULE

3
Accounting for Service Business
The previous module gave you the different steps of the accounting cycle. Each lesson
contained a step in the accounting cycle. This time, you will be exposed to comprehensive
problems on service-oriented businesses for you to master the accounting cycle. In this
module, you will be examined if you learned the procedures of the accounting cycle. This
module is dedicated solely to the mastery of the accounting cycle through practice sets
involving service businesses.

In comprehensive accounting cases, you need to exercise diligence, extra care, and patience.
These attributes will help you go through this module.

LESSON
14 Accounting for Service Business

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Lesson 14 ACCOUNTING FOR SERVICE BUSINESS

Did you know that?

LEARNING OBJECTIVE The practice of accountancy in the Philippines is
1. Complete the accounting cycle of a governed by the Republic Act No. 9298 which is
service business. known as the Philippine Accountancy Act of 2004.
This repealed the Presidential Decree No. 692, also
known as the Revised Accountancy Law of 1975.

The accounting cycle starts from identifying and

analyzing transactions, journalizing, posting, unadjusted trial balance, adjusting entries, adjusted trial balance,
financial statements, closing entries, post-closing trial balance, and reversing entries. To illustrate the accounting
cycle of a service business, let us make use of this illustration below.

1. Identifying and anaylzing transactions 10. Reversing Entries

DEBIT CREDIT
Accounts Amount Accounts Amount December 31 Salaries Expense 1,000.00
1 Cash 100,000.00 1 MSS, Capital 100,000.00 Salaries Payable 1,000.00
3 ICT Equipment 60,000.00 3 Cash 60,000.00
6 Rent Expenses 2,000.00 6 Cash 2,000.00
To record adjustment on unpaid salaries.
10 Cash 2,000.00 10 Service Revenue 2,000.00
17 Accounts Receivable 5,000.00 17 Service Revenue 5,000.00 January 1 Salaries Payable 1,000.00
19 Prepaid Supplies 1,000.00 19 Accounts Payable 1,000.00
22 Accounts Payable 1,000.00 22 Cash 1,000.00 Salaries Expense 1,000.00
25 Electricity Expenses 1,000.00 25 Cash 1,000.00 To reverse entry made on unpaid salaries.
28 Cash 5,000.00 28 Accounts Receivable 5,000.00
30 MSS, Drawings 2,000.00 30 Cash 2,000.00
30 ICT Equipment 50,000.00 30 Cash 25,000.00
Accounts Payable 25,000.00
30 Electricity Expenses 2,000.00 30 Cash 4,000.00
Rent Expenses 2,000.00

2. Journalizing 9. Post-closing Trial Balance

MSS REPAIR SERVICES
GENERAL JOURNAL J1 Post-closing Trial Balance
December 31, 2019

Date Account Titles & Explanation Ref. Debit Credit Cash

Dr
60,000.00
Cr

Accounts Receivables 18,000.00

2020 Supplies 7,000.00
Prepaid Insurance 14,000.00
1 2 3
September 1 Cash 100,000.00 Land
Buildings
480,000.00
700,000.00
4 5
MSS, Capital 100,000.00 Accumulated Depreciation-Buildings
Equipment 500,000.00
204,000.00

6 Accumulated Depreciation-Equipment 190,000.00

To record initial investment. Accounts Payable
Salaries Payable
20,000.00
2,000.00
Interest Payable 1,000.00
Unearned Service Revenue 11,000.00
Mortgage Payable 400,000.00
MSS, Capital 951,000.00
1,779,000.00 1,779,000.00

3. Posting 8. Closing Entries

December 31 Service Revenue 351,000.00
3-Column Form of Account Salary Expense 87,000.00

CASH No. 101 T-account Telephone Expense

Utilities Expense
Miscellaneous Expense
3,000.00
2,000.00
1,000.00

Date Explanation Ref. Debit Credit Balance CASH Supplies Expense

Insurance Expense
Depreciation Expense-Building
2,000.00
5,000.00
4,000.00

2020 7/1 100,000.00 Depreciation Expense-Equipment

Interest Expense
Income Summary
10,000.00
1,000.00
236,000.00
July 1 J1 100,000.00 100,000.00 December 31
To close income and expenses accounts.
Income Summary 236,000.00
MSS, Capital 236,000.00
To close income summary account to owner’s capital.
December 31 MSS Capital 0
MSS, Drawings 0
To close drawing account to the owner’s capital.

4. Unadjusted Trial Balance 7. Financial Statements MSS REPAIR SERVICES

Statement of Cash Flows
For the Year Ended December 31, 2019
MSS REPAIR SERVICES
MSS Company MSS REPAIR SERVICES
Income Statement
Balance Sheet
As of December 31, 2019
Cash Flows from Operating Activities
Cash received from clients P 344,000.00
Payment for insurance (19,000.00)
Unadjusted Trial Balance For the Year Ended December 31, 2019
Current Assets
Assets Payment for salaries
Payment for telephone
(85,000.00)
(3,000.00)

August 31, 2020 Revenue

Cash
Accounts Receivables
P 60,000.00
18,000.00
Payment for utilities
Payment of miscellaneous
(2,000.00)
(1,000.00)
Supplies 7,000.00 Net cash provided by (used in) operating activities P 234,000.00
Service Revenue 351,000.00 Prepaid Insurance 14,000.00 Cash Flows from Investing Activities
Total Current Assets P 99,000.00 Payment for land (469,000.00)
Expenses Non-Current Assets Payment for building (700,000.00)
Debit Credit Salary Expense 87,000.00 Land
Buildings P700,000.00
P480,000.00 Payment for equipment
Net cash provided by (used in) investing activities
(500,000.00)
(1,669,000.00)
Telephone Expense 3,000.00 Less: Accumulated Depreciation-Buildings 204,000.00 496,000.00
Cash P 41,000.00 Utilities Expense 2,000.00
Equipment
Accumulated Depreciation-Equipment
500,000.00
190,000.00 310,000.00
Cash Flows from Financing Activities
Cash received as investments by owner 1,095,000.00
Cash received from borrowing 400,000.00
Accounts Receivable - Miscellaneous Expense
Supplies Expense
1,000.00
2,000.00
Total Assets
Total Non-Current Assets 1,286,000.00
P1,385,00.00
Net cash provided by (used in) financing activities
Net Increase (Decrease) in Cash P
1,495,000.00
60,000.00
Liabilities
Prepaid Supplies 1,000.00 Insurance Expense 5,000.00 Current Liabilities
Accounts Payable 20,000.00
Cash balance at the beginning of the period
Cash balance at the end of the period P
0
60,000.00
Depreciation Expense-Building 4,000.00 Salaries Payable 2,000.00
ICT Equipment 60,000.00 Depreciation Expense-Equipment 10,000.00
Interest Payable
Unearned Service Revenue
1,000.00
11,000.00
Total Current Liabilities P 34,000.00
Accounts Payable P - Interest Expense 1,000.00 Non-Current Liabilities
Total 115,000.00 Mortgage Payable 400,000.00
MSS REPAIR SERVICES
MSS, Capital 100,000.00 Net Income 236,000.00 MSS, Capital, 12/31/19
Total Liabilities and Owner’s Equity
Owner’s Equity
951,000.00
P1,385,000.00
Statement of Changes in Equity
For the Year Ended December 31, 2019
MSS, Drawings 2,000.00
MSS, Capital, 1/1/2019 P715,000.00
Service Revenue 7,000.00 Add: Additional Investments P 0
Electricity Expense 1,000.00 Total
Net Income 236,000.00 236,000.00

Rent Expense 2,000.00 Less: Withdrawals

MSS, Capital, 12/31/2019
0
P951,000.00
P 107,000.00 P 107,000.00

5. Adjusting Entries 6. Adjusted Trial Balance

MSS REPAIR SERVICES
Asset Method Adjusted Trial Balance
December 31, 2019
Mar. 1 Prepaid Supplies 5,000.00 Dr Cr
Cash 60,000.00
Cash 5,000.00 Accounts Receivables 18,000.00
Supplies 7,000.00
To record purchase of Prepaid Insurance 14,000.00
Land 480,000.00
supplies. Buildings 700,000.00
Accumulated Depreciation-Buildings 204,000.00
Adjusting Entry Equipment
Accumulated Depreciation-Equipment
500,000.00
190,000.00
Dec. 31 Supplies Expenses 4,000.00 Accounts Payable
Salaries Payable
20,000.00
2,000.00
Prepaid Supplies 4,000.00 Interest Payable
Unearned Service Revenue
1,000.00
11,000.00
To record adjustments on Mortgage Payable
MSS, Capital
400,000.00
715,000.00
supplies. Service Revenue
Salary Expense 87,000.00
351,000.00

Telephone Expense 3,000.00

Utilities Expense 2,000.00
Miscellaneous Expense 1,000.00
Supplies Expense 2,000.00
Insurance Expense 5,000.00
Depreciation Expense-Building 4,000.00
Depreciation Expense-Equipment 10,000.00
Interest Expense 1,000.00
1,894,000.00 1,894,000.00

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Review Exercises
Comprehensive Problem No. 1

Below is the unadjusted trial balance of Zachary Company as of December 31, 2019.

Zachary Company
Unadjusted Trial Balance
December 31, 2019

Debit Credit
Cash 52,950
Notes Receivable 35,000
Accounts Receivable 55,880
Office Supplies 1,090
Prepaid Insurance 4,560
Land 20,000
Store Equipment 27,100
Accumulated Depreciation – Store Equipment 2,600
Office Equipment 15,570
Accumulated Depreciation – Office Equipment 2,230
Accounts Payable 22,420
Unearned Rent Income 2,400
Notes Payable 25,000
ZDSS, Capital 153,800
ZDSS, Drawing 18,000
Sales Revenue 60,790
Interest Income 3,600
Advertising Expense 10,860
Miscellaneous Expense 630
Salaries Expense 20,660
Rent Expense 8,100
Interest Expense 2,440
Total 272,840 272,840

Additional information:
1. Interest earned but not received on notes receivable, P200
2. Office supplies used, P610
3. Required allowance for bad debts, P2,000
4. Insurance expired, P1,910
5. Depreciation of store equipment, P3,100
6. Depreciation of office equipment, P2,490
7. Salaries accrued but not paid, P1,140
8. Rent earned from the amount received in advance, P600

Additional accounts:
Interest Receivable, Office Supplies Expense, Insurance Expense, Depreciation Expense – Store Equipment,
Depreciation Expense – Office Equipment, Salaries Payable, Rent Income, Allowance for Bad Debts, Bad Debts
Expense

Requirements:
1. Complete Worksheet (Unadjusted Trial Balance up to Post-closing Trial Balance)
2. Income Statement
3. Statement of Changes in Equity
4. Balance Sheet
5. Reversing Entries

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Comprehensive Problem No. 2

J and M got married on December 31, 2018. The day after their marriage, they built up a computer shop for their
source of living. The business was called JM Computer Shop. The subsequent transactions occurred during 2019
are as follows:

Jan. 1 JM invested P300,000 cash in the business.

Jan. 3 JM purchased computers amounting to P100,000 in cash.
Feb. 3 Purchased office supplies from Capon, Inc. on credit amounting to P2,000.
Mar. 4 Paid the internet subscription for the month amounting to P2,000.
Mar. 31 Paid the amount owed for office supplies.
Apr. 5 Received P8,000 cash from clients.
May 7 Paid the monthly rent P2,000.
Jun. 10 Paid electricity for the month worth at P1,000.
Jul. 11 Received P15,000 from cash customers.
Aug. 15 Paid salaries of the employees, P5,000.
Nov. 21 Rendered services to clients for credit amounting to P30,000.
Dec. 23 Withdrew P10,000 cash for personal use.

JM Computer Shop used the following chart of accounts in recording transactions:

110 Cash
120 Accounts Receivable
121 Allowance for Bad Debts
130 Office Supplies
140 Computer Equipment
141 Accumulated Depreciation-Computer Equipment
210 Accounts Payable
220 Salaries Payable
310 JM, Capital
320 JM, Drawing
410 Service Revenue
510 Internet Expense
520 Salaries Expense
530 Electricity Expense
540 Supplies Expense
550 Rent Expense
560 Depreciation Expense-Computer Equipment
570 Bad Debts Expense

Additional information:
1. Office supplies used, P1,000
2. Required allowance for bad debts, P500
3. Depreciation of computer equipment, P20,000
4. Salaries accrued but not paid, P2,000

Requirements:
1. Journal Entries
2. T-accounts
3. Complete Worksheet (Unadjusted Trial Balance up to Post-closing Trial Balance)
4. Income Statement
5. Statement of Changes in Equity
6. Balance Sheet
7. Reversing Entries

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CPALE Simulation Level 14

1. Which is the correct order of the following 2. The proper order of the following steps in
steps in the accounting cycle? the accounting cycle is ______.
Step 1. Preparation of financial statements a. prepare an unadjusted trial balance,
Step 2. Making closing entries in the journalize transactions, post to ledger
general journal accounts, journalize, and post adjusting
Step 3. Posting transaction entries in the entries
general ledger b. journalize transactions, prepare an
Step 4. Making reversing entries in the unadjusted trial balance, post to ledger
general journal accounts, journalize and post adjusting
a. 2,3,4,1 entries
b. 2,4,3,1 c. journalize transactions, post to ledger
c. 3,1,2,4 accounts, prepare an unadjusted trial
d. 3,1,4,2 balance, journalize and post adjusting
entries
d. prepare an unadjusted trial balance,
journalize and post adjusting entries,
journalize transactions, post to ledger
accounts
3. All of the following are required steps in 4. The recording phase of financial accounting
the accounting cycle except ______. covers the following steps, except ____.
a. journalizing and posting closing entries a. journalizing transactions
b. preparing financial statements b. preparing financial statements
c. journalizing the transactions c. posting transactions to the ledger
d. preparing a worksheet d. analyzing business documents
5. Which of the following accounting cycle
steps comes before the others?
a. preparing financial statements
b. recording and posting closing entries
c. analyzing source documents
d. recording and posting adjusting entries

Suggested Exercises

1. Problem 7 & 8, Basic Financial Accounting and Reporting 22nd Edition (2019) by Ballada & Ballada,
pp. 6-22 to 6-24.
2. Problem 1-4,6-9, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan,
pp. 316-319 & 328-341.
3. Exercises P4.1A to P4.6A, Accounting Principles 13th Edition (2018) by Weygandt, Kimmel & Kieso,
pp. 4-47 to 4-51.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition. Manila,
Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City,
Philippines: Bandolin Enterprise.
3. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John
Wiley & Sons (Asia) Pte Ltd.

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MODULE

Accounting for Merchandising Business

4
Merchandising companies are very rampant around the world. The accounting cycle of a
services business is the same as that of a merchandising business. The difference is more on
the additional account titles that are distinct for a merchandising business as well as in the
preparation of income statements. In this module, you will be exposed to the two inventory
systems that are commonly used among merchandising firms. These inventory systems are
very critical in accounting merchandising transactions.

This module contains only one lesson which talks about the procedures in accounting for the
merchandising operations. Your mastery in the basic accounting cycle is still needed for you
to accomplish this module.

LESSON
15 Accounting for Merchandising Business

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Lesson 15 ACCOUNTING FOR MERCHANDISING BUSINESS

Did you know that?

LEARNING OBJECTIVE The Professional Regulatory Board of Accountancy
1. Complete the accounting cycle of a has revised the 7 board subjects into 6, which include
Financial Accounting and Reporting, Taxation,
merchandising business. Regulatory Framework for Business Transactions,
Advanced Financial Accounting and Reporting,
Management Advisory Services, and Auditing.

A merchandising business involves buying and selling

of goods without changing its form. These goods are also known as merchandise, merchandise inventories, and
inventories. The difference between a merchandising business and a service business is the holding of inventories
for sale. The operating cycle of a merchandising firm is normally longer than a service business because of the
buying and selling of inventories which lengthens the cycle.

Let us first define the terms used in a merchandising business so that you can immediately relate to the
succeeding discussion as these terms are mentioned.

Purchases refer to the merchandise bought, which can be a cash purchase or a credit purchase.
Freight-in refers to the shipping charges in buying the merchandise, which is also known as Transportation In.
Purchase returns refer to the purchased goods found to be damaged upon inspection and need to be returned
to the supplier.
Purchase discounts refer to the discounts availed of the payment made for a credit purchase within the
discount period.
Net purchases refer to the purchases plus freight-in minus purchase returns and purchase discounts.
Sales refer to the merchandise sold, which includes cash sales and credit sales.
Sales returns refer to the sold merchandise returned by customers.
Sales discounts refer to the discounts given to the customers for the payment made within the discount period.
Net sales refer to the sales minus sales returns and sales discounts.
The cost of goods sold refers to the cost of the sold merchandise, which is also known as the cost of sales.
Beginning inventory refers to the inventory on hand at the beginning of the year.
Total goods available for sale refer to the beginning inventory plus net purchases.
Ending inventory refers to the inventory on hand at the end of the year.
Gross profit equals the net sales minus cost of goods sold.

As inventories are very critical in a merchandising business, an inventory system must be in place to control the
inventories. Two inventory systems are widely used among merchandising companies namely, the perpetual
inventory system and periodic inventory system. Perpetual inventory system records every movement in the
inventory which keeps the inventory account always updated. In a perpetual inventory system, the inventory
always shows its continuing or running balance. This is usually used for inventories that are specifically identifiable
and relatively highly valued e.g. cars, machinery, and equipment. In a periodic inventory system, the inventory will
only be updated once there is a physical count of an inventory conducted. In other words, the inventory account
under the periodic inventory system remains the same with the last year’s balance unless another physical count
of inventory is made, such balance will be adjusted as to its actual balance at the end of the current year. This is
commonly used for inventories that are interchangeable, relatively low value, and have a fast turn-over rate e.g.
groceries, medicines, and office supplies.

To illustrate more the difference between these two systems, let us consider the following transactions and
prepare the journal entries for each system.

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PERPETUAL INVENTORY SYSTEM PERIODIC INVENTORY SYSTEM

1. ABC Corp. purchased merchandise from XYZ Corp. amounting to P100,000 on credit.
Merchandise Inventory 100,000 Purchases 100,000
Accounts Payable 100,000 Accounts Payable 100,000
2. ABC Corp. paid transportation charges related to the purchase of merchandise amounting to P500.
Merchandise Inventory 500 Freight-in 500
Cash 500 Cash 500
3. ABC Corp. returned damaged items to XYZ Corp. amounting to P1,000.
Accounts Payable 1,000 Accounts Payable 1,000
Merchandise Inventory 1,000 Purchase Returns 1,000
4. ABC Corp. paid XYZ Corp. the account made in the previous transaction. Assuming ABC Corp. was granted a 2% discount on the
account balance for making the payment within the discount period.
Accounts Payable 99,000 Accounts Payable 99,000
Merchandise Inventory 1,980 Purchase Discounts 1,980
Cash 97,020 Cash 97,020
5. Sold merchandise costing P60,000 for P80,000 on account.
Accounts Receivable 80,000 Accounts Receivable 80,000
Sales 80,000 Sales 80,000
Cost of Goods Sold 60,000
No entry
Merchandise Inventory 60,000
6. A customer returned damaged items to ABC Corp. amounting to P1,000 with a cost value of P800
Sales Returns 1,000 Sales Returns 1,000
Accounts Receivable 1,000 Accounts Receivable 1,000
Merchandise Inventory 800
No entry
Cost of Goods Sold 800
7. A customer paid in full the account made in the previous transaction. Assuming ABC Corp. granted the customer a 2% discount
on the account balance for making the payment within the discount period.
Cash 77,420 Cash 77,420
Sales Discounts 1,580 Sales Discounts 1,580
Accounts Receivable 79,000 Accounts Receivable 79,000

The journal entries under the perpetual inventory system always use the merchandise inventory account every
time there is a movement in the merchandise inventory while the periodic inventory system used other accounts
such as purchases, freight-in, purchase returns, and purchase discounts. Please take note that on the buyer’s side, in
computing the discount, the balance must be net of purchase returns since it is a deduction of the accounts
payable. On the supplier’s side, the balance must be net of sales returns since it is a deduction of the accounts
receivable.

When merchandise is sold and goods are returned from the customers, the perpetual inventory system records
the merchandise inventory and cost of goods sold since this is a movement of the inventory whereas no entries
are made under the periodic inventory system. However, both systems have the same journal entries in
recordings sales, sales returns, and sales discounts. If we are going to post the above transactions in the
merchandise inventory and cost of goods sold account, the following T-accounts are illustrated to demonstrate
the difference between the two systems.
Purchases
PERPETUAL INVENTORY SYSTEM PERIODIC INVENTORY SYSTEM
(1) 100,000
Merchandise Inventory Merchandise Inventory
(1) 100,000 - Freight-in
(2) 500 - (2) 500
(3) 1,000 -
(4) 1,980 - Purchase Returns
(5) 60,000 - (3) 1,000
(6) 800
101,300 62,980 - - Purchase Discounts
38,320 - (4) 1,980

Cost of Goods Sold Cost of Goods Sold

(5) 60,000 -
(6) 800 - Under the periodic inventory system, the
60,000 800 - - ending inventory is determined when there is
a physical count of inventories while the cost
59,200 -
of goods sold is computed using the format
as illustrated on the next page.

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It is clearly illustrated in the ledger that in the perpetual inventory system, the inventory and cost of goods sold
accounts are always updated while in the periodic inventory system, the account balance remains the same with
the beginning balance if it has a beginning balance simply because inventory account was not used in recording
transactions occurred during the year. Thus, a physical count of inventory is needed at the end of the year so the
inventory account will be updated. However, in both inventory systems, the inventory account balance should be
equal. Moreover, the cost of goods sold under the periodic inventory system is not recorded and so, needs to be
computed using the following format. Assuming there is no beginning inventory and the ending inventory during
the physical count is valued at P38,320.

MSS General Merchandise

Statement of Cost of Goods Sold
For the Year Ended December 31, 2019

Beginning Inventory P 0
Add: Net Purchases
Purchases P100,000
Add: Freight-in 500
Total 100,500
Less: Purchase Returns P1,000
Purchase Discounts 1,980 2,980 97,520
Total Goods Available for Sale 97,520
Less: Ending Inventory 38,320
Cost of Goods Sold P59,200

Please take note that under normal circumstances, both the cost of goods sold and ending inventory should be
equal in both perpetual and periodic inventory systems.

One of the complexities in a merchandising operation is the granting of credit terms. This refers to the terms
when a supplier allowed credit sales. This involves a credit period, cash discounts, and transportation costs. The
credit period is denoted as “n/30” which means that the credit period is 30 days. Sometimes, it is also denoted as
“n/10 eom” which means that the credit is due on the 10th day after the end of the month.

A cash discount is designated by this notation, “2/10” which means the buyer may avail a 2% discount if payment is
made within 10 days from the invoice date. Sales invoice refers to the document that evidences the sale. Please
take note that purchase discounts are used on the buyer’s point of view while sales discounts are on the seller’s
point of view.

Illustration 15.1: MSS Company bought merchandise on account from JSS Trading on March 1, 2019, amounting to
P5,000 with credit terms, 2/10, n/30. MSS Company paid in full JSS Trading on March 9, 2019.

Perpetual Inventory Method Periodic Inventory Method

Mar. 1 Merchandise Inventory 5,000 Mar. 1 Purchases 5,000
Accounts Payable 5,000 Accounts Payable 5,000
Mar. 9 Accounts Payable 5,000 Mar. 9 Accounts Payable 5,000
Cash 4,900 Cash 4,900
Merchandise Inventory 100 Purchase Discounts 100

The cash discount is computed by multiplying the gross amount by the discount rate (P5,000 x 2% = P100).

Illustration 15.2: MSS Company bought merchandise on account from JSS Trading on March 1, 2019, amounting to
P5,000 with credit terms, 2/10, n/10 eom. MSS Company paid in full JSS Trading on April 11, 2019.

Perpetual Inventory Method Periodic Inventory Method

Mar. 1 Merchandise Inventory 5,000 Mar. 1 Purchases 5,000
Accounts Payable 5,000 Accounts Payable 5,000
Apr. 11 Accounts Payable 5,000 Apr. 9 Accounts Payable 5,000
Cash 5,000 Cash 5,o00

The cash discount was not availed since the payment was made on the 11th day after the end of March.

In most cases, a trade discount is given at the time of sale to attract more sales. Please take note that a cash
discount is different from a trade discount since a trade discount is not recorded in the books while a cash
discount is recorded in the books. In other words, the value of the merchandise to be recorded at the time of sale

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must be net of trade discount. The amount to be recorded in the books is computed by getting the difference
between the list price and the trade discount. This difference is mostly called as the invoice price, the amount
presented in the sales invoice. List price is called such since this is the price being listed on the price catalog.

Illustration 15.3: MSS Company bought merchandise on account from JSS Trading on March 1, 2019, with a list price
of P5,000, less a trade discount of 20%. The credit terms are 2/10, n/10 eom. MSS Company paid in full JSS Trading
on April 10, 2019.

Perpetual Inventory Method Periodic Inventory Method

Mar. 1 Merchandise Inventory 4,000 Mar. 1 Purchases 4,000
Accounts Payable 4,000 Accounts Payable 4,000
Apr. 10 Accounts Payable 4,000 Apr. 10 Accounts Payable 4,000
Cash 3,920 Cash 3,920
Merchandise Inventory 80 Purchase Discounts 80

The trade discounts computed as follows (P5,000 x 20% = P1,000). The net amount to be recorded in the books
must be net of the trade discount (P5,000 – P1,000 = P4,000).

The cash discount was availed since the payment was made on the 10 th day after the end of the month and was
computed as follows (P4,000 x 2% = P80).

Freight charges refer to the amount of transportation cost or the shipping charges. In principle, the owner of the
merchandise must pay the shipping cost. However, the complexity in the transaction starts when is the ownership
is transferred. There are shipping terms used in practice such as FOB shipping point, FOB destination, freight
collect, and freight prepaid. Let us first define each term for us to understand how it is used in the succeeding
illustrations.

FOB is an abbreviation of free on board.

FOB shipping point means that the ownership is transferred to the buyer at the shipping point (the point when
the goods leave from the seller’s place) and thus, the buyer must bear the shipping charges.
FOB destination means that the ownership is transferred to the buyer at the destination (when the goods arrive
at the buyer’s place) and thus, the seller still owns the goods and must bear the shipping charges.
Freight prepaid means that the shipping costs are paid by the seller.
Freight collect means that the shipping costs are paid by the buyer.

Let us summarize the above information so we can have a full grasp of how each freight term is accounted for by
the buyer and seller.

Freight Terms Who is the owner Who actually Accounting Treatment

who must bear the pays the
shipping cost? shipper?
FOB shipping point, freight collect Buyer Buyer No adjustment.
FOB shipping point, freight prepaid Buyer Seller The buyer has a payable to the seller or the seller has
a collectible from the buyer on the shipping cost.
FOB destination, freight collect Seller Buyer The seller has a payable to the buyer or the buyer has
a receivable from the seller on the shipping cost.
FOB destination, freight prepaid Seller Seller No adjustment.

Illustration 15.4: MSS Company bought merchandise on account from JSS Trading on March 1, 2019, amounting to
P5,000, FOB shipping point, freight collect, 2/10, n/30. MSS Company paid the shipper in the amount of P200. MSS
Company paid in full JSS Trading on March 11, 2019.

Who is the owner who must bear the shipping cost? Buyer
Who pays the shipper? Buyer
Accounting Treatment No adjustment on the part of the seller.

Perpetual Inventory Method Periodic Inventory Method

Mar. 1 Merchandise Inventory 5,000 Mar. 1 Purchases 5,000
Accounts Payable 5,000 Accounts Payable 5,000
Mar. 1 Merchandise Inventory 200 Mar. 1 Freight-in 200
Cash 200 Cash 200
Mar. 11 Accounts Payable 5,000 Mar. 11 Accounts Payable 5,000
Cash 4,900 Cash 4,900
Merchandise Inventory 100 Purchase Discounts 100

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Illustration 15.5: MSS Company bought merchandise on account from JSS Trading on March 1, 2019, amounting to
P5,000, FOB shipping point, freight prepaid, 2/10, n/30. MSS Company paid the shipper in the amount of P200. MSS
Company paid in full JSS Trading on March 11, 2019.

Who is the owner who must bear the shipping cost? Buyer
Who pays the shipper? Seller
Accounting Treatment The buyer has a payable to the seller on the shipping cost.

Perpetual Inventory Method Periodic Inventory Method

Mar. 1 Merchandise Inventory 5,000 Mar. 1 Purchases 5,000
Accounts Payable 5,000 Accounts Payable 5,000
Mar. 1 Merchandise Inventory 200 Mar. 1 Freight-in 200
Accounts Payable 200 Accounts Payable 200
Mar. 11 Accounts Payable 5,000 Mar. 11 Accounts Payable 5,000
Cash 4,900 Cash 4,900
Merchandise Inventory 100 Purchase Discounts 100
Mar. 11 Accounts Payable 200 Mar. 11 Accounts Payable 200
Cash 200 Cash 200

Illustration 15.6: MSS Company bought merchandise on account from JSS Trading on March 1, 2019, amounting to
P5,000, FOB destination, freight collect, 2/10, n/30. MSS Company paid the shipper in the amount of P200. MSS
Company paid in full JSS Trading on March 11, 2019.

Who is the owner who must bear the shipping cost? Seller
Who pays the shipper? Buyer
Accounting Treatment The buyer has a receivable from the seller on the shipping cost.

Perpetual Inventory Method Periodic Inventory Method

Mar. 1 Merchandise Inventory 5,000 Mar. 1 Purchases 5,000
Accounts Payable 5,000 Accounts Payable 5,000
Mar. 1 Accounts Receivable 200 Mar. 1 Accounts Receivable 200
Cash 200 Cash 200
Apr. 10 Accounts Payable 5,000 Apr. 10 Accounts Payable 5,000
Cash 4,900 Cash 4,900
Merchandise Inventory 100 Purchase Discounts 100
Apr. 10 Accounts Receivable 200 Apr. 10 Accounts Receivable 200
Cash 200 Cash 200

On the other hand, the buyer may request the seller to deduct the amount paid for the shipping cost from the
amount to be paid to the seller. If this is the case, the payment is recorded as follows.

Perpetual Inventory Method Periodic Inventory Method

Mar. 1 Merchandise Inventory 5,000 Mar. 1 Purchases 5,000
Accounts Payable 5,000 Accounts Payable 5,000
Mar. 1 Accounts Receivable 200 Mar. 1 Accounts Receivable 200
Cash 200 Cash 200
Mar. 11 Accounts Payable 5,000 Mar. 11 Accounts Payable 5,000
Cash 4,700 Cash 4,900
Accounts Receivable 200 Accounts Receivable 200
Merchandise Inventory 100 Purchase Discounts 100

Illustration 15.7: MSS Company bought merchandise on account from JSS Trading on March 1, 2019, amounting to
P5,000, FOB destination, freight prepaid, 2/10, n/30. MSS Company paid the shipper in the amount of P200. MSS
Company paid in full JSS Trading on March 11, 2019.

Who is the owner who must bear the shipping cost? Seller
Who pays the shipper? Seller
Accounting Treatment No adjustment on the part of the buyer.

Perpetual Inventory Method Periodic Inventory Method

Mar. 1 Merchandise Inventory 5,000 Mar. 1 Purchases 5,000
Accounts Payable 5,000 Accounts Payable 5,000
Mar. 11 Accounts Payable 5,000 Mar. 11 Accounts Payable 5,000
Cash 4,900 Cash 4,900
Merchandise Inventory 100 Purchase Discounts 100

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In a merchandising business, special journals are also maintained to record similar transactions e.g. sales journal,
purchases journal, cash receipts journal, and cash disbursements journal. The general journal is used when the
transactions are not recorded in the special journals. Below are the special journals commonly used in a
merchandising business and their corresponding description.

The sales journal is used to record sales on account or credit sales.

The purchases journal is used to record purchases on account or credit purchases.
The cash receipts journal is used to record all transactions involving cash receipts.
The cash disbursement journal is used to record all transactions involving cash payment.

Moreover, aside from the general ledger which contains all the accounts appearing in the trial balance, a
subsidiary ledger can be maintained to provide a breakdown of a controlling account e.g. a subsidiary for each
customer and supplier.

The income statement of a merchandising business is different from a service business. Below is an illustrative
income statement of a merchandising business under the periodic inventory system.

MSS General Merchandise

Income Statement
For the Year Ended December 31, 2019

Sales P80,000
Less: Sales Discounts P1,000
Sales Returns 1,580 2,580
Net Sales P77,420
Less: Cost of Goods Sold
Beginning Inventory P 0
Add: Net Purchases
Purchases P100,000
Add: Freight-in 500
Total P100,500
Less: Purchase Returns P1,000
Purchase Discounts 1,980 2,980 97,520
Total Goods Available for Sale P97,520
Less: Ending Inventory 38,320
Cost of Goods Sold 59,200
Gross Profit P18,220
Less: Operating Expenses
Rent Expense P1,000
Electricity Expense 2,000
Depreciation Expense 2,000
Bad Debts Expense 500
5,500
Profit P12,720

Below is an illustrative income statement under the perpetual inventory system.

MSS General Merchandise

Income Statement
For the Year Ended December 31, 2019

Sales P80,000
Less: Sales Discounts P1,000
Sales Returns 1,580 2,580
Net Sales P77,420
Less: Cost of Goods Sold 59,200
Gross Profit P18,220
Less: Operating Expenses
Rent Expense P1,000
Electricity Expense 2,000
Depreciation Expense 2,000
Bad Debts Expense 500
5,500
Profit P12,720

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The difference between them is that for illustration purposes, the computation of cost of goods sold under the
periodic inventory system is presented unlike in the perpetual inventory system, there is a running balance for the
cost of goods sold.

Under the perpetual inventory system, the rest of the accounting cycle is the same as that of a service business.
However, under the periodic inventory system, there is a slight difference particularly on the recognition of
ending inventory which can be either using an adjusting entry method or a closing entry method. Under the
adjusting entry method, an adjusting entry is made for the ending inventory as illustrated in the following entry:

Dec. 31 Merchandise Inventory, 12/31/19 38,320

Income Summary 38,320
To record adjustment on ending inventory.

The ending merchandise inventory is extended in the worksheet in the debit column of the balance sheet while its
corresponding income summary account is extended in the credit column of the income statement. Eventually,
only the beginning inventory and related income summary of the ending inventory are closed along with other
income statement accounts.

Dec. 31 Sales 80,000

Purchase Returns 1,000
Purchase Discounts 1,980
Sales Discounts 1,000
Sales Returns 1,580
Purchases 100,000
Freight-in 500
Rent Expense 1,000
Electricity Expense 2,000
Depreciation Expense 2,000
Bad Debts Expense 500
Merchandise Inventory, 1/1/19 0
Income Summary 38,320 12,720
To close the income statement accounts including
the beginning inventory.

Under the closing entry method, the ending inventory is established as part of the closing entry including the
beginning inventory.

Dec. 31 Merchandise Inventory, 12/31/19 38,320

Sales 80,000
Purchase Returns 1,000
Purchase Discounts 1,980
Sales Discounts 1,000
Sales Returns 1,580
Purchases 100,000
Freight-in 500
Rent Expense 1,000
Electricity Expense 2,000
Depreciation Expense 2,000
Bad Debts Expense 500
Merchandise Inventory, 1/1/19 0
Income Summary 12,720
To close the income statement accounts including
the beginning inventory and to record the ending
inventory.

Both methods will arrive at the same profit and inventory balance. However, in most cases, the
adjusting entry method is usually used instead of the closing entry method.

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Let us consider the following problem to illustrate the worksheet under the perpetual inventory
system.

The following are the accounts of merchandising business of Additional information:

JSS Company at their normal balances as of December 31, 2019. 1. The allowance for bad debt is to be increased to
Account Titles Amount P1,850.
Cash 25,000 2. The actual unused supplies at the end of the period
Accounts Receivable 185,000 are P200.
Merchandise Inventory 20,000 3. The correct accumulated depreciation is P21,000.
4. The accrued interest on notes payable is P1,600.
Allowance for Bad Debts 500
5. The physical count of unsold merchandise at the end
Prepaid Supplies 2,000 of the period is valued at P20,000.
Office Equipment 60,000
Accumulated Depreciation – Office Equipment 9,000 Additional accounts:
Accounts Payable 40,000 Bad Debts Expense, Supplies Expense, Depreciation
Notes Payable 80,000 Expense – Office Equipment, Interest Expense, Interest
JSS, Capital 100,000 Payable
JSS, Drawing 5,000
Sales 300,000 Requirements:
1. Worksheet (unadjusted trial balance up to post-
Sales Discounts 2,500
closing trial balance)
Sales Returns 10,000
2. Reversing Entries
Cost of Goods Sold 210,000
Freight Out 10,000

JSS COMPANY
Worksheet
December 31, 2019

Unadjusted Trial Adjustments Adjusted Trial Income Statement Balance Sheet

Account Titles Balance Balance
Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr
Cash 25,000 25,000 25,000
Accounts Receivables 185,000 185,000 185,000
Allowance for Bad Debts 500 1,350 1,850 1,850
Merchandise Inventory 20,000 20,000 20,000
Prepaid Supplies 2,000 1,800 200 200
Office Equipment 60,000 60,000 60,000
Accum. Depreciation-Office Equipment 9,000 12,000 21,000 21,000
Accounts Payable 40,000 40,000 40,000
Notes Payable 80,000 80,000 80,000
JSS, Capital 100,000 100,000 100,000
JSS, Drawing 5,000 5,000 5,000
Sales 300,000 300,000 300,000
Sales Discounts 2,500 2,500 2,500
Sales Returns 10,000 10,000 10,000
Cost of Goods Sold 210,000 210,000 210,000
Freight-out 10,000 10,000 10,000
529,500 529,500
Bad Debts Expense 1,350 1,350 1,350
Supplies Expense 1,800 1,800 1,800
Depreciation Exp.-Office Equipment 12,000 12,000 12,000
Interest Expense 1,600 1,600 1,600
Interest Payable 1,600 1,600 1,600
16,750 16,750 544,450 544,450 249,250 300,000 295,200 244,450
Net Income 50,750 50,750
300,000 300,000 295,200 295,200

Worksheet Continuation (Columns 11 to 14)

JSS COMPANY
Worksheet
Reversing entry
December 31, 2019
Dec. 31 Interest Payable 1,600
Closing Entries Post-closing Trial Balance Interest Expense 1,600
Account Titles
Dr Cr Dr Cr
Cash 25,000
To revere entry on
Accounts Receivables 185,000 unpaid interest.
Allowance for Bad Debts 1,850
Merchandise Inventory 20,000
Prepaid Supplies 200
Office Equipment 60,000
Accum. Depreciation-Office Equipment 21,000
As illustrated in the worksheet, the accounting
Accounts Payable 40,000 cycle of the merchandising business under the
Notes Payable 80,000
JSS, Capital 5,000 50,750 145,750 perpetual inventory method is not so
JSS, Drawing 5,000
Sales 300,000
complicated. It is almost alike with that of a
Sales Discounts 2,500 service business.
Sales Returns 10,000
Cost of Goods Sold 210,000
Freight-out 10,000
Bad Debts Expense 1,350
Supplies Expense 1,800
Depreciation Exp.-Office Equipment 12,000
Interest Expense 1,600
Interest Payable 1,600
Income Summary 50,750 50,750

Net Income
335,750 335,750 290,200 290,200

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This time, let us consider the following problem to illustrate the worksheet under the periodic
inventory system.
The following are the accounts of merchandising business of Additional information:
JSS Company at their normal balances as of December 31, 2019. 1. The allowance for bad debt is to be increased to
Account Titles Amount P1,850.
Cash 25,000 2. The actual unused supplies at the end of the period
are P200.
Accounts Receivable 185,000
3. The correct accumulated depreciation is P21,000.
Allowance for Bad Debts 500
4. The accrued interest on notes payable is P1,600.
Prepaid Supplies 2,000 5. The physical count of unsold merchandise at the end
Office Equipment 60,000 of the period is valued at P20,000.
Accumulated Depreciation – Office Equipment 9,000
Accounts Payable 40,000 Additional accounts:
Notes Payable 80,000 Bad Debts Expense, Supplies Expense, Depreciation
JSS, Capital 100,000 Expense – Office Equipment, Interest Expense, Interest
JSS, Drawing 5,000 Payable, Merchandise Inventory, Income Summary
Sales 300,000
Requirements:
Sales Discounts 2,500
1. Worksheet (unadjusted trial balance up to post-
Sales Returns 10,000 closing trial balance)
Purchases 250,000 2. Reversing Entries
Freight-in 5,000
Purchase Discounts 5,000 Assumption
Purchase Returns 20,000 1. The company is using adjusted balance method in
Freight Out 10,000 treating ending inventory.

JSS COMPANY
Worksheet
December 31, 2019

Unadjusted Trial Adjustments Adjusted Trial Income Statement Balance Sheet

Account Titles Balance Balance
Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr
Cash 25,000 25,000 25,000
Accounts Receivables 185,000 185,000 185,000
Allowance for Bad Debts 500 1,350 1,850 1,850
Prepaid Supplies 2,000 1,800 200 200
Office Equipment 60,000 60,000 60,000
Accum. Depreciation-Office Equipment 9,000 12,000 21,000 21,000
Accounts Payable 40,000 40,000 40,000
Notes Payable 80,000 80,000 80,000
JSS, Capital 100,000 100,000 100,000
JSS, Drawing 5,000 5,000 5,000
Sales 300,000 300,000 300,000
Sales Discounts 2,500 2,500 2,500
Sales Returns 10,000 10,000 10,000
Purchases 250,000 250,000 250,000
Freight-in 5,000 5,000 5,000
Purchase Discounts 5,000 5,000 5,000
Purchase Returns 20,000 20,000 20,000
Freight-out 10,000 10,000 10,000
554,500 554,500
Bad Debts Expense 1,350 1,350 1,350
Supplies Expense 1,800 1,800 1,800
Depreciation Exp.-Office Equipment 12,000 12,000 12,000
Interest Expense 1,600 1,600 1,600
Interest Payable 1,600 1,600 1,600
Merchandise Inventory 20,000 20,000 20,000
Income Summary 20,000 20,000 20,000
36,750 36,750 589,450 589,450 294,250 345,000 295,200 244,450
Net Income 50,750 50,750
345,000 345,000 295,200 295,200

Worksheet Continuation (Columns 11 to 14)

JSS COMPANY
Worksheet
December 31, 2019

Closing Entries Post-closing Trial

Account Titles Balance Reversing entry
Dr Cr Dr Cr
Cash 25,000
Accounts Receivables 185,000 Dec. 31 Interest Payable 1,600
Allowance for Bad Debts 1,850 Interest Expense 1,600
Prepaid Supplies 200
Office Equipment 60,000
To revere entry on
Accum. Depreciation-Office Equipment 21,000 unpaid interest.
Accounts Payable 40,000
Notes Payable 80,000
JSS, Capital
JSS, Drawing
5,000 50,750
5,000
145,750
As illustrated in the worksheet, the accounting cycle of the
Sales 300,000 merchandising business under the periodic inventory method is
Sales Discounts 2,500
Sales Returns 10,000 not so complicated. It is almost alike to the perpetual inventory
Purchases 250,000
Freight-in 5,000 method. The difference is more on the alternate account titles for
Purchase Discounts
Purchase Returns
5,000
20,000
inventory and the presence of adjusting entry for the ending
Freight-out 10,000 inventory. A difference in the preparation of the income
Bad Debts Expense 1,350
Supplies Expense 1,800 statement can also be noticed although the income statement is
Depreciation Exp.-Office Equipment 12,000
Interest Expense 1,600 not presented in this problem. Both inventory systems will arrive
Interest Payable
Merchandise Inventory 0 20,000
1,600
at the same net income, post-closing trial balance, and reversing
Income Summary 70,750 50,750 entries.
Net Income
400,750 400,750 290,200 290,200

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Review Exercises
Comprehensive Problem No. 1

Below is the post-closing trial balance of Portia Company as of January 1, 2019.

Portia Company
Post-closing Trial Balance
January 1, 2019

Debit Credit
Cash 60,000
Merchandise Inventory 10,000
Equipment 300,000
Accumulated Depreciation – 50,000
PDSS, Capital
Equipment 320,000
Total 370,000 370,000

The following transactions occurred during 2019.Portia Company.

1. Purchased merchandise worth P400,000 on account.
2. Sold merchandise costing P300,000 for P600,000, on account.
3. Collected P500,000 of the accounts receivable.
4. Paid P300,000 of the accounts payable.
5. Paid salaries expense, P50,000.

Adjustment
1. The annual depreciation on the equipment is P25,000.
2. The ending inventory is valued at P110,000. The company is using adjusting entry method in
treating ending inventories.

Additional accounts:
Accounts Receivable, Accounts Payable, Sales, Cost of Goods Sold, Salaries Expense, Depreciation
Expense-Equipment, Purchases, Income Summary

You are required to prepare the following for both perpetual and periodic inventory methods.
1. Journal Entries
2. T-accounts
3. Worksheet (unadjusted trial balance up to post-closing trial balance)
4. Income Statement
5. Statement of Changes in Equity
6. Balance Sheet

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Comprehensive Problem No. 2

This illustrative problem is about MSS Enterprises which uses the periodic inventory system. Read the
following transactions carefully and logically. Answer the requirements only.

Nov.
1 The business MSS Enterprises was registered as a single proprietorship with DTI, Max Saralee invested
P40,000.
2 Bought computer equipment for P15,000.
Bought merchandise on account from Jack Corp. P20,000, 2/10, n/30.
3 Bought office supplies on a cash basis for P1,000.
4 Sold merchandise on account for P20,000, FOB destination, 2/10, n/30.
5 Paid P200 freight on November 4 sale.
6 Received credit memo from Jack Corp. for merchandise return P500.
11 Paid Jack Corp.
13 Collected from November 4 customers.
14 Bought merchandise on a cash basis for P16,000.
15 Salaries paid P2,000.
16 Borrowed money from Metrobank, signed a promissory note for P15,000.
17 Received refund from a supplier on cash purchase on November 14, P1,000.
18 Bought merchandise from Zach Corp., P30,000, FOB shipping point, 2/10, n/30.
20 Paid freight on November 18 purchase, P1,000.
23 Sold merchandise for P25,000.
26 Bought merchandise for cash, P14,000.
27 Paid Zach Corp. on November 18 purchase, P15,000. No discount allowed on partial payment.
28 M. Saralee gets cash from the business, P2,500.
29 Made refund to cash customers for defective merchandise, P1,500.
30 Sold merchandise on account, P16,000, 2/30.
Paid the following: advertising P2,000, utilities P1,000, rent P5,000, salaries P3,000.
Inventory, November 30, P31,110.

Below is the chart of accounts used by MSS Enterprises.

Account No. Account Title Account No. Account Title

101 Cash 501 Cost of Goods Sold
102 Accounts Receivable 502 Purchases
103 Supplies 503 Freight-in
104 Equipment 504 Purchase Discount
105 Merchandise Inventory 505 Purchase Returns
201 Accounts Payable 601 Freight-out
202 Notes Payable 602 Salaries Expense
301 M. Saralee, Capital 603 Utility Expense
302 M. Saralee, Drawing 604 Rent Expense
303 Income Summary 605 Advertising Expense
401 Sales
402 Sales Discount
403 Sales Returns

Requirements:
1. Make journal entries of each transaction in the general journal.
2. Post each entry in the general ledger.
3. Prepare an unadjusted trial balance.
4. Make closing entries in the general journal.
5. Prepare the post-closing trial balance.

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CPALE Simulation Level 15

1. In a perpetual inventory system, two 2. The failure to record a purchase of
entries are normally made to record each merchandise on account even though the
sales transaction, _____. goods are properly included in the physical
a. one entry records the purchase of inventory results in an _____.
merchandise, and the other records the a. overstatement of asset and net income
sale b. understatement of asset and net income
b. one entry updated the subsidiary ledger c. understatement of liability and an
and the other updates the general ledger overstatement of equity
c. one entry recognizes sales revenue and the d. understatement of cost of goods sold and
other recognizes the cost of the goods sold liability and an overstatement of assets
d. one entry records the cost of goods and
the other reduces the balance in the
inventory account
3. Which of the following is a characteristic of 4. In a perpetual inventory system, recording
a perpetual inventory system? a sale on account involves debiting which
a. The inventory record is not kept for every of the following accounts?
item. a. only accounts receivable
b. The cost of goods sold is recorded in each b. accounts receivable and inventory
sale. c. accounts receivable and cost of goods sold
c. Inventory purchases are debited to the d. accounts receivable and cost of goods sold,
Purchases account. and inventory
d. The cost of goods sold is determined by the
purchases less the change in inventory.
5. An entity that purchases inventory from
suppliers for resale to customers should
record which inventory?
a. finished goods inventory
b. merchandise inventory
c. work in process inventory
d. All of the choices are correct.

Suggested Exercises

1. Problem 1-23 & 1-11, Basic Financial Accounting and Reporting 22nd Edition (2019) by Ballada &
Ballada, pp. 7-47 to 7-66 & 8-21 to 8-28.
2. Problem 1-14, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp.
401-418.
3. Exercises E5.3 to E5.22, Accounting Principles 13th Edition (2018) by Weygandt, Kimmel & Kieso,
pp. 5-42 to 5-46.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition. Manila,
Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City,
Philippines: Bandolin Enterprise.
3. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John
Wiley & Sons (Asia) Pte Ltd.

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MODULE

5
Accounting for Partnership
Partnerships have been mostly used by professionals such as accounting and law firms. This
business form is grounded on the concept of sharing risks and rewards among partners. The
mere agreement between two or more persons can organize a partnership. In our previous
lessons, you are exposed to sole proprietorship businesses. This time, you will be oriented to
partnership firms and learn how to account for the life cycle of a partnership starting from its
formation, down to its operation, until its dissolution and liquidation.

This module has four lessons that correspond to the major considerations in the life cycle of a
partnership. Your mastery in the basic accounting cycle is still needed for you to accomplish
this module. The concept of accounting partnership is still procedural. You have to master
the procedures so you can solve the problems effectively and efficiently. The topics in this
module will help you get easy points in the Advanced Financial Accounting and Reporting
subject in the CPALE.

LESSON
16 Partnership Formation
17 Partnership Operations
18 Partnership Dissolution
19 Partnership Liquidation

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Lesson 16 PARTNERSHIP FORMATION

Did you know that?

LEARNING OBJECTIVE The old types of partnerships in the Philippines are
1. Practice procedures in accounting commercial and civil partnerships. Commercial or
mercantile partnership is governed by the Code of
partnership formation. Commerce while the civil or non-commercial
partnership is governed by the old Civil Code.

A partnership is a business entity owned by two or

more persons called partners and registered with the SEC. A partnership is commonly characterized by the
following:

1. Ease of formation  The partnership can be easily formed by mere agreement among two or more persons
and requires less formality compared to a corporation.
2. Separate legal personality  The partnership is separate and distinct from the partners.
3. Mutual agency  The partners can be an agent of the partnership in which the partner can enter into a
contract on behalf of the partnership, provided it is part of the partnership’s
operations.
4. Co-ownership of property  Each partner is considered as co-owner of the properties of the partnership.
5. Co-ownership of profits  Each partner is entitled to a share in the partnership.
6. Limited life  The partnership can be dissolved in any of the following:
a. by the express will of any partner;
b. by termination as part of the terms in the contract;
c. when it becomes unlawful to carry out the partnership;
d. when a specific thing, which a partner had promised to contribute to the
partnership perishes before the delivery; or
e. by expulsion, death, insolvency, or civil interdiction of a partner.
7. Transfer of ownership  A partner can transfer his/her ownership in the partnership to a new or existing
partner provided it is approved by the remaining partners.
8. Unlimited liability  A partner can be personally liable for partnership liabilities. When all partners are
personally liable, it is called general partnership. When there is at least one partner
who can be personally liable, who is usually a general partner, then it is called limited
partnership.

The advantages and disadvantages of a partnership are presented in Lesson 1 under the different forms of
business organizations. The accounting of partnerships circulates on the following major considerations which
can be known as the life cycle of a partnership:

1. Formation accounts for the initial investments to the partnership.

2. Operation accounts for the division of profits or losses among partners.
3. Dissolution accounts for the admission of a new partner and withdrawal, retirement, or death of a partner.
4. Liquidation accounts for the winding-up of partnership affairs.

In this lesson, you will be exposed to the procedures in accounting partnership formation particularly in
accounting the initial investments among partners during the formation of their partnership. The valuation of the
partner’s contribution is governed by the fair value principle. Fair value is the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement
date (PFRS 13).

All assets contributed to including the related liabilities assumed by the partnership
shall be measured at fair value.

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However, there are exceptions to that rule which include that cash and cash equivalents must be measured using
its face value (PAS 7) and inventories must be measured using the lower of cost and net realizable value (PAS 2).
Net realizable value is the difference between the estimated selling price less the costs to complete and sell.

Illustration 16.1: J and M formed a partnership on June 1, 2019. J contributed cash in the amount of P150,000 and
an account receivable valued at P100,000 which include P10,000 deemed to be uncollectible. Meanwhile, M
contributed a building with a book value of P400,000 and a fair value of P300,000. The building has an unpaid
mortgage payable amounting to P100,000 which is assumed by the partnership. You are required to determine the
correct valuation of the contribution of partners in the partnership books and to provide the journal entry.

In solving this problem, let us make use of this format to have a better picture of how to account for the
contribution of each partner.

J M Partnership
If we are going to analyze Cash 150,000 150,000
the illustration, partner Accounts Receivable (100,000-10,000) 90,000 90,000
capital balance is Building 390,000 390,000
normally credited for the Total Assets 240,000 390,000 630,000
fair value of his/her Less: Liabilities
contributions to the Mortgage Payable 0 100,000 100,000
partnership. In all cases, Adjusted Capital Balances 240,000 290,000 530,000
the total partnership
capital must be equal to June 1 Cash 150,000
the fair values of the Accounts Receivable 90,000
partner’s net Building 390,000
Mortgage Payable 100,000
contributions to the
J, Capital 240,000
partnership. M, Capital 290,000
To record initial contribution among partners.

Illustration 16.2: Let us use the same contribution in the previous illustration. This time, the partners further agree
that J should have an initial 60% interest and M must have a 40% initial interest of the partnership capital. You are
required to provide the journal entry to record the initial investment of the partners.

In solving this problem, simply multiply the total fair value of partners’ contribution by the agreed capital interest
for each partner. If a partner’s capital balances have been credited for an amount greater than or less than the fair
value of his/her net contribution, then there is a bonus.

June 1 Cash 150,000

Under the bonus method, any
decrease or increase in the Accounts Receivable 90,000
capital of a partner is Building 390,000
Mortgage Payable 100,000
deducted from or added to
J, Capital (60% x P530,000) 318,000
the capital balances of the
other partners. M, Capital (40% x P530,000) 212,000
To record initial contribution among partners.

In some cases, if there is a bonus, the partners may agree to settle the bonus among partners outside of the
partnership.

Illustration 16.3: Let us use the same contribution in the previous illustration. This time, the partners agree to
equalize their initial capital interest. Any difference between the contributed capital and the agreed capital for
each partner, the partners further agree to settle the difference in cash outside of the partnership. You are
required to determine which partner shall receive a cash payment from the other partner and to provide the journal
entry to record the initial investment of the partners.

In solving this problem, we need to make use of the format we had introduced a while to have a better illustration
of the capital of each partner as well as for the whole partnership.

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J M Partnership
Please take note that the Cash 150,000 150,000
cash settlement among Accounts Receivable (100,000-10,000) 90,000 90,000
partners is not recorded Building 390,000 390,000
in the books since it is a Total Assets 240,000 390,000 630,000
transaction among Less: Liabilities
partners and not of the Mortgage Payable 0 100,000 100,000
partnership. In this Net Contributions 240,000 290,000 530,000
problem, J must pay M Equal Interest (P530,000÷ 2) 265,000 265,000 530,000
the amount of Cash Receipt (Payment) (25,000) 25,000 -
P25,000.00 to settle the
difference between the June 1 Cash 150,000
contribution and the Accounts Receivable 90,000
agreed capital balances Building 390,000
among partners. Mortgage Payable 100,000
J, Capital (50% x P530,000) 265,000
M, Capital (50% x P530,000) 265,000
To record initial contribution among partners.

There are also cases in which the difference is settled by putting additional investment or withdrawal of a portion
of the investment. Using the preceding illustration, instead of a cash settlement, the partners agree to put
additional investment or withdraw a portion of the investment to arrive at the agreed capital interest.

J M Partnership
In this problem, J must Cash 150,000 150,000
put additional investment Accounts Receivable (100,000-10,000) 90,000 90,000
P25,000.00 while M must Building 390,000 390,000
withdraw P25,000.00 to Total Assets 240,000 390,000 630,000
equalize the interest. Less: Liabilities
Mortgage Payable 0 100,000 100,000
Net Contributions 240,000 290,000 530,000
Additional (Withdrawal) 25,000 (25,000) -
Equal Interest (P530,000÷ 2) 265,000 265,000 530,000

Please take note that the initial total partnership capital still equals the fair value of the contributed assets and
liabilities among partners. The twist is more on what is the initial capital interest for each partner.

Review Exercises
1. On January 1, 2019, Mr. S and Ms. T formed a partnership. Mr. S contributed cash of P500,000 while Ms. T
contributed a building with a carrying amount of P400,000 and a fair value of P800,000. The building has an
unpaid mortgage of P200,000 which is not assumed by the partnership. You are required to provide the
journal entry to record the contributions of the partners.
2. D and E formed a partnership. D contributed cash, P500,000, accounts receivable, P100,0000 while E
contributed a building valued at P700,000. The accounts receivable includes a P20,000 account that is
deemed uncollectible. The building is over-depreciated by P50,000. The building has an unpaid mortgage
P100,000, which is assumed by the partnership. You are required to provide the journal entry to record the
contributions of the partners in the partnership books.
3. F and G agreed to form a partnership. F contributed P40,000 cash while G contributed equipment with a fair
value of P100,000. However, due to the expertise that F will be bringing to the partnership, the partners
agreed that they should initially have an equal interest in the partnership capital.
4. On June 1, 2018, Maria and Agwanta formed a partnership and agreed to share profits and losses in the ratio
of 3:7, respectively. Maria contributed a parcel of land that costs P10,000 but, according to Maria, has a fair
market value of P20,000. Agwanta contributed P42,000 cash. The land was sold for P18,000 on June 1,
immediately after the formation of the partnership. At what amount should Maria’s capital account be
recorded on the formation of the partnership?

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CPALE Simulation Level 16

1. Cash settlements between and among 2. When property other than cash is invested in
partners to equalize their initial capital a partnership, at what amount should the
credits are _____. non-cash property be credited to the
a. recorded in the partnership books contributing partner’s capital account?
b. not recorded in the partnership books a. fair value at the date of contribution
c. accounted for as an additional investment to b. contributing partner’s original cost
the partnership or as withdrawals or c. assessed valuation for property tax purposes
investments from the partnership d. contributing partner’s tax basis
d. a and c
3. A partner who is entitled to a share of the 4. Which of the following is generally thought
profits from a partnership is known as ____. of as a benefit of partnership?
a. a salaried partner a. limited life
b. a managing partner b. mutual agency
c. an equity partner c. unlimited liability
d. a limited partner d. ease of formation
5. An advantage of the partnership as a form of 6. The legal characteristic of a partnership
business organization would be _____. whereby each partner is an agent of the
a. partners do not pay income taxes on their partnership and can bind the partnership to
share in partnership income contracts within the normal scope of the
b. a partnership is bound by the act of the partnership business is known as ______.
partners a. agreement
c. a partnership is created by mere agreements b. mutual agency
of the partners c. contract
d. a partnership may be terminated by the d. partnership
death or withdrawal of a partner
7. Which of the following is not a characteristic 8. The maximum number of persons who are
of most partnerships? legally allowed to operate in a partnership is
a. limited liability _____.
b. limited life a. 2
c. mutual agency b. 20
d. ease of formation c. no limit
d. 100
9. Mr. P and Ms. Q formed a partnership and 10. Mr. O and Ms. P formed a partnership and
agreed to divide the initial capital equally agreed to divide the initial capital equally
even though Mr. P contributed P100,000 and even though Mr. O contributed P100,000 and
Ms. Q contributed P84,000 in identifiable Ms. P contributed P84,000 in identifiable
assets. The partners agree that the assets. The partners agree that the
difference in the amount of contribution and difference in the amount of contribution and
the amount of credit to the partner’s capital the amount of credit to the partner’s capital
shall be treated as a cash settlement shall be treated as compensation for the
between the partners. The compound entry expertise that the partner will be bringing to
to record the partners’ contributions includes the partnership. How much is the correct
credit to Q’s capital account in the amount of valuation of O’s capital immediately after the
______. partnership formation?
a. P84,000 a. P84,000
b. P92,000 b. P92,000
c. P100,000 c. P100,000
d. P108,000 d. P108,000

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11. Under the bonus method, the asset 12. Q and R formed a partnership. Q contributed
contribution of the partner receiving a bonus cash of P500,000 while R contributed land
is debited at _____. with a carrying amount of P400,000 and a
a. fair value fair value of P800,000. The land has an
b. an increased amount with a corresponding unpaid mortgage of P200,000 which is
decrease to the other partner’s asset assumed by the partnership. How much is the
contributions correct valuation of R’s capital immediately
c. a decreased amount with a corresponding after the partnership formation?
increase to the other partner’s asset a. P400,000
contributions b. P500,000
d. b or c, depending on which partner is c. P600,000
receiving the bonus d. P800,000
13. On July 1, a partnership was formed by W and 14. Tingga contributes equipment to a
B. W contributed the cash. B previously a sole partnership that she purchased 2 years ago
proprietor, contributed property other than for P10,000. The current book value is P7,500
cash including realty subject to a mortgage and the market value is P9,000. At what
which was assumed by the partnership. B’s value should the partnership record the
capital account on July 1, should be recorded equipment?
at _______. a. P10,000
a. B’s book value of the property less the b. P9,000
mortgage payable on July 1 c. P7,500
b. the fair value of the property less the d. P3,500
mortgage payable on July 1
c. the fair value of the property on July 1
d. B’s book value of the property on July 1
15. Any assets invested by a particular partner in
a partnership ______.
a. do not become a partnership asset but
instead, remain with the partner
b. can be used only by the investing partner
c. become the property of all partners
d. are the basis for all profit sharing

Suggested Exercises

1. Problem 1-6, Basic Financial Accounting and Reporting 22nd Edition (2019) by Ballada & Ballada,
pp. 12-28 to 12-34.
2. Problem 1-6, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp.
436-448.
3. Exercises E12.2 to E12.3 & P12.1A, Accounting Principles 13th Edition (2018) by Weygandt, Kimmel &
Kieso, pp. 12-32 to 12-33 & 12-35.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition. Manila,
Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City,
Philippines: Bandolin Enterprise.
3. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John
Wiley & Sons (Asia) Pte Ltd.

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Lesson 17 PARTNERSHIP OPERATIONS

Did you know that?

LEARNING OBJECTIVE W. W. Larkin is the holder of the CPA Certificate No. 1
1. Illustrate procedures in accounting in the Philippines and the first president of the
Philippine Institute of Certified Public Accountants.
partnership operations.
Source: www.picpa.com.ph

The accounting of partnership operations is more on

the division of profits and losses among partners. A capitalist partner is the one who contributes cash or other
non-cash assets to the partnership. An industrial partner is the one who contributes services other than cash or
non-cash assets to the partnership. These types of partners are described in this lesson as they are important in
dividing the profits and losses among partners.

The partners shall share in the profits or losses of a partnership following the partnership agreement. If only the
share of each partner in the profits has been agreed upon, the share of each in the losses shall be in the same
proportion. In the absence of stipulation, the share of each partner in the profits and losses shall be proportionate
to their contributions. However, other stipulations are considered before dividing the profits and losses among
partners such as:

1. Salaries – normally, an industrial partner shall receive a salary, in addition to his share in the
partnership’s profits, as compensation for his services to the partnership.
2. Bonuses – the partnership agreement may stipulate a bonus to be given to a managing partner to
encourage excellent management performance only if the partnership earns a profit.
3. Interest on capital contributions – the partnership agreement may stipulate that each partner may be
entitled to a per annum interest computed on his capital contributions.

Please take note that these items are normally provided first to the respective partners and any remaining
amount of the profit or loss is shared based on the stipulated profit or loss ratio.

Illustration 17.1: J and M formed a partnership on June 1, 2019. The partnership stipulates to provide an annual
salary of P50,000 to J, being the managing partner. A bonus of 10% of the profit will be provided to each partner.
The partners further agree to share the profits and losses equally among the partners. During the year, the
partnership earned a profit of P200,000. You are required to determine the share of each partner and to provide
the journal entry in closing the income summary to the partner’s capital.

J M Total
Let us make use of this
Amount for allocation 200,000
format so we can have a Allocation:
better view of how the Salary for J 50,000 50,000
profits and losses are to Bonus (200,000 x 10%=20,000) 20,000 20,000 40,000
be divided among Allocation of the remaining profit (200,000-
partners. Please observe 50,000-40,000=110,000); 110,000÷2 55,000 55,000 110,000
that this format shall be Amount as allocated 125,000 75,000 200,000
used to determine how
the income summary is Dec. 31 Income Summary 200,000
allocated among the J, Capital 125,000
partners. M, Capital 75,000
To close the income summary among partners.

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Illustration 17.2: J and M formed a partnership on June 1, 2019. The partnership stipulates to provide an annual
salary of P50,000 to J, being the managing partner. A bonus of 10% of the profit will be provided to each partner. J
contributed P200,000 cash while M contributed P50,000 cash. During the year, the partnership earned a profit of
P200,000. You are required to determine the share of each partner and to provide the journal entry in closing the
income summary to the partner’s capital.

J M Total
Since there was no
Amount for allocation 200,000
stipulation in the articles
Allocation:
of partnership on how to Salary for J 50,000 50,000
divide the profit and loss, Bonus (200,000 x 10%=20,000) 20,000 20,000 40,000
the profit/loss ratio will Allocation of the remaining profit (200,000-
be based on their initial 50,000-40,000=110,000); J (110,000 x
contribution and is 80%=88,000); M (110,000 x 20%=22,000) 88,000 22,000 110,000
computed as follows: Amount as allocated 158,000 42,000 200,000
J (200,000/250,000) = 80%
M (50,000/200,000) = 20% Dec. 31 Income Summary 200,000
J, Capital 158,000
M, Capital 42,000
To close the income summary among partners.

Illustration 17.3: J and M formed a partnership on June 1, 2019. The partnership stipulates to provide an annual
salary of P50,000 to J, being the managing partner. A bonus of 10% of the profit will be provided to each partner.
The partners further agree to share the profits and losses equally among the partners. During the year, the
partnership incurred a loss of P10,000. You are required to determine the share of each partner and to provide the
journal entry in closing the income summary to the partner’s capital.

Please take note that the J M Total

bonus was not provided Amount for allocation (10,000)
since the partnership Allocation:
Salary for J 50,000 50,000
incurred a loss. However,
Allocation of the remaining loss (-10,000-
the salary was still 50,000=60,000); 60,000÷2 (30,000) (30,000) (60,000)
provided since it Amount as allocated 20,000 (30,000) (10,000)
represents the
compensation for J in the Dec. 31 M, Capital 30,000
partnership. The J, Capital 20,000
remaining loss shall be Income Summary 10,000
allocated based P/L ratio. To close the income summary among partners.

Illustration 17.4: J and M formed a partnership on June 1, 2019. J, being the managing partner will receive a bonus
of 10% of the profit over P100,000 while M shall receive a bonus of 10% of the remaining profit over P150,000. The
partners further agree to share the profits and losses equally among the partners. During the year, the
partnership earned a profit of P300,000. You are required to determine the share of each partner and to provide
the journal entry in closing the income summary to the partner’s capital.

J M Total
Please understand the
Amount for allocation 300,000
conditions first as stated Allocation:
in the problem before Bonus for J
doing the allocation 200,000: (300,000-100,000=200,000 x 10%) 20,000 20,000
process. In this problem, Bonus for M (300,000-20,000-
a special condition was 150,000=130,000 x 10%=13,000) 13,000 13,000
set in getting the bonus Allocation of the remaining profit (300,000--
for each partner. 20,000-13,000=257,000); 257,000÷2 128,500 128,500 257,000
Amount as allocated 148,500 151,500 300,000

Dec. 31 Income Summary 300,000

J, Capital 148,500
M, Capital 151,500
To close the income summary among partners.

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Illustration 17.5: J and M formed a partnership on June 1, 2019. J, being the managing partner will receive a salary
of P50,000 annually. M will receive a 20% interest based on the weighted average capital balance. The partners
further agree to share the profits and losses in the following manner: 40% for J and 60% for M. During the year,
the partnership earned a profit of P300,000. Below is the T-account for the capital balance of M during the year.

M, Capital
9/1 withdrawal 10,000 100,000 6/1 initial investment
20,000 8/1 additional investment
Bal. 110,000

You are required to determine the share of each partner and to provide the journal entry in closing the income
summary to the partner’s capital.

In computing weighted Balances Months Outstanding÷ Weighted

average capital balance, Total Months in a Year Average
simply get the weighted June 1 initial investment 100,000 7/12 58,333
average for each movement August 1 additional investment 20,000 5/12 8,333
in the capital balance by September 1 withdrawal (10,000) 4/12 3,333
multiplying each movement Weighted average capital balance 69,999
with the months outstanding Multiply by interest rate 20%
in a year over 12 months. Interest on weighted average capital balance 14,000

J M Total
Amount for allocation 300,000
The same process will be Allocation:
observed in the allocation Salary 50,000 50,000
Interest 14,000 14,000
process. Deduct all the
Allocation of the remaining profit (300,000--
special conditions first. It 50,000-14,000=236,000); 236,000 x 40%;
is only then that the 236,000 x 60% 94,400 141,600 236,000
remaining profit/loss will Amount as allocated 144,400 155,600 300,000
be allocated among
partners based on the Dec. 31 Income Summary 300,000
stipulated P/L ratio. J, Capital 144,400
M, Capital 155,600
To close the income summary among partners.

Certain rules will be observed in a partnership as stipulated in the Philippine Civil Code e.g. the industrial partner
shall not be liable for the losses (Art. 1797), the designation of losses and profits cannot be entrusted to one of
the partners (Art. 1798), and a stipulation which excludes one or more partners from any share in the profits or
losses is void (Art. 1799).

Review Exercises
1. The partnership agreement of J and K provides that interest at 10% per year is to be credited to each partner based on
weighted-average capital balances. A summary of K’s capital account for the year ended December 31, 2018, is as follows:
Balance, Jan. 1, 2018 P252,000
Additional investment, July 1 72,000
Withdrawal, August 1 (27,000)
Balance, Dec. 31, 2018 P297,000
Determine the share in profit/loss of each partner and provide the corresponding journal entry.
2. Lara and Jessa formed a partnership in 2018. The partnership agreement provides for annual salary allowances of P55,000
for Lara and P45,000 for Jessa. The partners share profits equally and losses in a 60/40 ratio. The partnership had earnings
of P80,000 for 2018 before any allowance to partners. What amount of these earnings should be credited to each partner’s
capital account?
3. The partnership agreement of K, B & O provides for the year-end allocation of net income in the following order: First, K is
to receive 10% of net income up to P100,000 and 20% over P100,000. Second, B and O each are to receive 5% of the
remaining income over P150,000. The balance of income is to be allocated equally among the three partners. The
partnership’s 2019 net income was P250,000 before any allocations to partners. What amount should be allocated to K?

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CPALE Simulation Level 17

1. H, I, and J are partners. Their contributions 2. J, K, and L are partners. Their contributions
are as follows: H=P600,000; I=P400,000 and are as follows: J=P600,000; K=P400,000 and
J=services. Partners H, I, and J agreed to L=services. The partners did not agree on
divide profits and losses in the ratio of how to divide profits or losses. If there is a
50:40:10, respectively. How should a net loss net loss of P100,000, how should the loss be
of P180,000 be shared by partners? shared by the partners?
a. H=P100,000; I=P80,000; and J=nothing a. J=P35,000; K=P35,000; and L=P30,000
b. H=P100,000; I=P65,000; and J=P15,000 b. J=P60,000; K=P40,000; and L=nothing
c. H=P90,000; I=P72,000; and J=P18,000 c. J=P40,000; K=P60,000; and L=nothing
d. H=P90,000; I=P70,000; and J=P20,000 d. J=P30,000; K=P20,000; and L=P50,000
3. If the partnership agreement does not 4. Which of the following best describes the
specify how income is to be allocated, profits nature of salary and interest allowance in a
and loss should be allocated ______. partnership profit and loss sharing
a. equally agreement?
b. in proportion to the number of hours, they a. expenses of the business that should be
have spent on the business since partnership deducted from revenue in determining the
formation income
c. equitably so that partners are compensated b. the amount upon which each partner will
for the time and effort expended on behalf have to pay personal income tax
of the partnership c. a means of distributing net income to
d. based on their capital contributions services rendered and capital invested by
partners
d. a means of determining reasonable monthly
withdrawals by each partner
5. Which of the following is not considered a 6. Which of the following is not a component of
legitimate expense of a partnership? the formula used to distribute income?
a. interest paid to partners based on the a. salary allowances to the managing partners
amount of their invested capital b. after all other allocations, the remainder
b. depreciation on assets contributed to the divided according to the profit and loss
partnership by the partners sharing ratio
c. salaries for management hired to run the c. interest on the average capital investments
business d. interest on notes to partners
d. supplies used in the partner’s offices
7. Ma, Ris, and Tella are partners with average 8. The partnership agreement of Al and Bert
capital balances during 2017 of P120,000, provides that interest at 10% per year is to be
P60,000, and P40,000, respectively. Partners credited to each partner based on weighted-
receive 10% interest on their average capital average capital balances. A summary of
balances. After deducting salaries of P30,000 Bert’s capital account for the year ended
to Ma and P20,000 to Tella, the residual December 31, 2018, is as follows:
profit or loss is divided equally. In 2017 the
Balance, January 1 P140,000
partnership sustained a P33,000 loss before
Additional investment, July 1 40,000
interest and salaries to partners. By what Withdrawal, August 1 (15,000)
amount should Ma’s capital account change? Balance, December 31 P165,000
a. P7,000 increase What amount of interest should be credited
b. P11,000 decrease to Bert’s capital account for 2018?
c. P35,000 decrease a. P15,250
d. P42,000 increase b. P15,375
c. P16,500
d. P17,250

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9. Segun and Dina, are partners in a fishing 10. Luz, Vi, and Minda are partners. Luz is an
business, who share profits and losses in the industrial partner. During the first year of
ration of 60% and 40%, respectively. Segun’s operation, the firm realized a net income of
salary is P60,000 and while P30,000 for Dina. P60,000. During the second year, the firm
The partners are also paid interest on their sustained a net loss of P30,000. In the
average capital balances in 2016. Segun Articles of Partnership, it was agreed that
received P30,000 interest and Dina received Luz, the industrial partner would get one-
P12,000. The profit and loss allocation is third of the profit but would not share in the
determined after deductions for the salary losses. How much will Luz, the industrial
and interest payments. If Dina’s share in the partner get?
residual income was P60,000 in 2016, what a. Luz will get P20,000 which is 1/3 of the
was the partnership net income? income of the first year of operations and the
a. P192,000 will share in the loss in the second year of
b. P345,000 P10,000.
c. P282,000 b. Luz will get P20,000 in the first year and none
d. P232,000 in the second year.
c. Luz will get P10,000 which is one-third of the
net income for the first year and second year
combine.
d. Luz will share in the net loss in the second
year.

Suggested Exercises

1. Problem 2-9, Basic Financial Accounting and Reporting 22nd Edition (2019) by Ballada & Ballada,
pp. 13-25 to 13-32.
2. Problem 1-4, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp.
463-469.
3. Exercises E12.4 to E12.5, Accounting Principles 13th Edition (2018) by Weygandt, Kimmel & Kieso,
pp. 12-33.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition. Manila,
Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City,
Philippines: Bandolin Enterprise.
3. Philippine Institute of Certified Public Accountants (2016). History of the PICPA.
https://www.picpa.com.ph/content.html?article=History&page=About
4. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John
Wiley & Sons (Asia) Pte Ltd.

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Lesson 18 PARTNERSHIP DISSOLUTION

Did you know that?

LEARNING OBJECTIVE The Philippine Institute of Certified Public
1. Perform procedures in accounting Accountants has a local chapter in the province of
Southern Leyte under the Eastern Visayas Region.
partnership dissolutions.

Dissolution is the change in the relation of the partners

caused by any partner ceasing to be associated in the carrying on of the business. Partnership dissolution can be
caused by the admission of a partner, withdrawal, retirement or death of a partner, and incorporation of a
partnership. When a partnership is dissolved but not liquidated, a new partnership is created. The assets and
liabilities carried over to the new partnership are restated to fair values. Any adjustment to the assets and
liabilities is allocated first to the existing partners before recording the admission of the new partner.

The admission of a new partner may be effected either through the purchase of an interest in the partnership or
investment in the partnership. The former affects only the capital accounts of the partners who are parties to the
transaction. The latter increases both net assets and total capital of the partnership.

Purchase of Interest Investment in the Partnership

• A personal transaction between and among the • The incoming partner invests directly in the
partners partnership instead of purchasing interest from the
• Any consideration paid or received is not recorded existing partners.
in the partnership books • This is a transaction between the new partner and
• Only a transfer within equity is made to establish the partnership. Any consideration paid by the
the capital account of the new partner and incoming partner is recorded in the partnership
decrease the capital account of the selling partner. books.
• No gain or loss shall is recognized in the • No gain or loss shall be recognized
partnership books.

Illustration 18.1: On June 1, 2019, J and M partnership has capital balances of P100,000 for J and P150,000 for M
with a P/L ratio of 40% and 60% respectively.

Illustration 18.1.A: On June 1, 2019, J and M admitted P to the partnership when he purchased a 20% interest of the
net assets and profits of the firm representing 50% of the J’s interest in the partnership for P80,000. The net
assets of the firm as of this date approximate their fair values. You are required to determine the capital balances
of each partner after admission and to provide the journal entry to record the admission of the new partner.

J M P Total
The gain of J (P80,000 - Capital balances before admission 100,000 150,000 250,000
P50,000 = P30,000) is not Purchase of P (P100,000 x 50%) (50,000) 50,000 -
recorded in the Capital balances after admission 50,000 150,000 50,000 250,000
partnership books PL ratio before admission 40% 60% - 100%
because it is a personal Purchase of P (40% x 50%) (20%) 20% -
transaction of J and P. P/L ratio after admission 20% 60% 20% 100%
Only the transfer of
capital is recorded. The June 1 J, Capital 50,000
total partnership capital P, Capital 50,000
remains the same before To record admission of P by purchase.
and after admission.

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Illustration 18.1.B: On June 1, 2019, J and M admitted P to the partnership when he purchased a proportionate
interest from J and M representing 20% of the net assets and profits of the firm for P80,000. The net assets of the
firm as of this date approximate their fair values. You are required to determine the capital balances of each
partner after admission and to provide the journal entry to record the admission of the new partner.

J M P Total
P purchased 20% interest Capital balances before admission 100,000 150,000 250,000
from the partnership or Purchase of P (P100,000 x 20%); -
20% from J and 20% from (P150,000 x 20%) (20,000) (30,000) 50,000
M. Just get the 20% of J Capital balances after admission 80,000 120,000 50,000 250,000
and M and transfer to P. PL ratio before admission 40% 60% - 100%
Again, only the transfer Purchase of P (40% x 20%); (60% x 20%) (8%) (12%) 20% -
of capital from the old P/L ratio after admission 32% 48% 20% 100%
partners to the new
partner will be recorded June 1 J, Capital 20,000
in the partnership books. M, Capital 30,000
P, Capital 50,000
To record admission of P by purchase.

Illustration 18.1.C: On June 1, 2019, J and M admitted P to the partnership when he purchased a proportionate
interest from J and M representing 20% of the net assets and profits of the firm for P80,000. However, the fair
value of the net assets of the partnership as of this date is 100,000 higher than its carrying amount. You are
required to determine the capital balances of each partner after revaluation and after admission and to provide the
journal entry to record the admission of the new partner.

J M P Total
The increase or decrease Capital balances before revaluation 100,000 150,000 250,000
in the fair value of net Share in revaluation (P100,000 x 40%);
assets due to revaluation P100,000 x 60%) 40,000 60,000 100,000
before admission shall be Capital balances after revaluation 140,000 210,000 350,000
allocated to the old Purchase of P (P140,000 x 20%); -
partner based on its P/L (P210,000 x 20%) (28,000) (42,000) 70,000
ratio and shall be Capital balances after admission 112,000 168,000 70,000 350,000
recorded first in the PL ratio before admission 40% 60% - 100%
Purchase of P (40% x 20%); (60% x 20%) (8%) (12%) 20% -
partnership books. The
P/L ratio after admission 32% 48% 20% 100%
adjusted capital balances
will then be the basis for
June 1 Assets 100,000
the transfer of capital
J, Capital 40,000
from the old partners to M, Capital 60,000
the new partner. Again, To record the revaluation of assets.
the gain earned by the
old partners will not be June 1 J, Capital 28,000
recorded in the M, Capital 42,000
partnership books. P, Capital 70,000
To record admission of P by purchase.

Illustration 18.1.D: On June 1, 2019, J and M admitted P to the partnership when he acquired a proportionate
interest from J and M representing 20% of the net assets and profits of the firm for P80,000 investment. The net
assets of the firm as of this date approximate their fair values. You are required to determine the capital balances
of each partner after admission and to provide the journal entry to record the admission of the new partner.
J M P Total
Total capital balances before investment 100,000 150,000 250,000
Add: Investment of P 80,000
Total capital after investment 330,000.00
Capital credit for P (P330,000 x 20%) 66,000
Bonus to old partners (P80,000-P66,000=P14,000) 5,600 8,400
Capital balances after admission 105,600 158,400 66,000 330,000
PL ratio before admission 40% 60% - 100%
Purchase of P (40% x 20%); (60% x 20%) (8%) (12%) 20% -
P/L ratio after admission 32% 48% 20% 100%

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June 1 Cash 80,000

J, Capital 5,600
M, Capital 8,400
P, Capital 66,000
To record admission of P by investment.

The total partnership capital after the investment of P is P330,000 of which 20% of it is for P in the amount of
P66,000. Since his investment of P80,000 is higher than the capital credit, then there is a bonus to the old partner
of P14,000 to be distributed using the old P/L ratio.

Illustration 18.1.E: On June 1, 2019, J and M admitted P to the partnership when he acquired a proportionate
interest from J and M representing 20% of the net assets and profits of the firm for P40,000 investment. The net
assets of the firm as of this date approximate their fair values. You are required to determine the capital balances
of each partner after admission and to provide the journal entry to record the admission of the new partner.

J M P Total
Total capital balances before investment 100,000 150,000 250,000
Add: Investment of P 40,000
Total capital after investment 290,000
Capital credit for P (P290,000 x 20%) 58,000
Bonus to the new partner (P40,000-P58,000=P18,000) (7,200) (10,800)
Capital balances after admission 92,800 139,200 58,000 290,000
PL ratio before admission 40% 60% - 100%
Purchase of P (40% x 20%); (60% x 20%) (8%) (12%) 20% -
P/L ratio after admission 32% 48% 20% 100%

June 1 Cash 40,000

J, Capital 7,200
M, Capital 10,800
P, Capital 58,000
To record admission of P by investment.

The total partnership capital after the investment of P is P290,000 of which 20% of it is for P in the amount of
P58,000. Since his investment of P40,000 is lower than his capital credit, then he has is a bonus as a new partner
of P18,000 of which to be deducted from the old partner using the old P/L ratio.

When a partner withdraws, retires, or dies, his interest may be purchased (a) by one or all of the remaining
partners or (b) by the partnership. The interest of the withdrawing, retiring, or deceased partner shall be adjusted
by his share of any profit or loss during the period up to the date of his withdrawal, retirement, or death; and by
his share of any revaluation gains or losses as at the date of his withdrawal, retirement, or death.

When the remaining partners purchase the interest of the withdrawing partner, this transaction is between and
among the partners. As such, the settlement amount is not recorded in the books. The only entry to be made in
the partnership books is a transfer within equity.

Illustration 18.2.A: On June 1, 2019, J, M, and P partnership have capital balances of P100,000 for J, P200,000 for M,
and P200,000 for P with a P/L ratio of 20%, 40%, and 40% respectively. The partnership profits are P200,000. P
withdraws from the partnership when his partners bought his interests for P400,000. The net assets of the firm as
of this date approximate their fair values. You are required to determine the capital balances of each partner after
profit-sharing and after withdrawal and to provide the journal entry to record the admission of the new partner.

J (20%) M (40%) P (40%) Total

Capital balances before profit 100,000 200,000 200,000 500,000
Share in profit 80,000 160,000 160,000 400,000
Capital balances after profit 180,000 360,000 360,000 900,000
Withdrawal of P (360,000 x 20%/60%); (360,000 x 40%/60%) 120,000 240,000 (360,000) -
Capital balances after withdrawal 300,000 600,000 900,000
PL ratio before the withdrawal 20% 40% 40% 100%
withdrawal of P (40% x 20%/60%); (40% x 40%/60%) 13% 27% (40%) -
P/L ratio after withdrawal 33% 67% - 100%

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June 1 Income Summary 400,000

J, Capital 80,000
M, Capital 160,000
P, Capital 160,000
To close the income summary to the partner’s capital.

June 1 P, Capital 360,000

M, Capital 120,000
P, Capital 240,000
To record the withdrawal of P by purchase.

Illustration 18.2.B: Let us make use of the previous illustration. But this time, P withdraws from the partnership and
the partnership pays his interests for P400,000. The net assets of the firm as of this date approximate their fair
values. You are required to determine the capital balances of each partner after profit-sharing and after withdrawal
and to provide the journal entry to record the admission of the new partner.

J (20%) M (40%) P (40%) Total

Capital balances before profit 100,000 200,000 200,000 500,000
Share in profit 80,000 160,000 160,000 400,000
Capital balances after profit 180,000 360,000 360,000 900,000
Withdrawal of P (360,000 x 20%/60%); (360,000 x 40%/60%) (360,000) (400,000)
Bonus to new partner (400,000-360,000=40,000);40,000 x
20%/40%; 40,000 x 40%/60%) (13,333) (26,667)
Capital balances after withdrawal 166,667 333,333 - 500,000
PL ratio before the withdrawal 20% 40% 40% 100%
Withdrawal of P (40% x 20%/60%); (40% x 40%/60%) 13% 27% (40%) -
P/L ratio after withdrawal 33% 67% - 100%

June 1 Income Summary 400,000

When the partnership J, Capital 80,000
purchases the interest of the M, Capital 160,000
withdrawing partner, this P, Capital 160,000
becomes a transaction To close the income summary to the partner’s capital.
between the retiring or
withdrawing partner and the
June 1 P, Capital 360,000
partnership. As such, the
M, Capital 13,333
settlement amount is
P, Capital 26,667
recorded in the partnership
Cash 400,000
books.
To record the withdrawal of P by paying partnership
assets.

Review Exercises
On June 30, 2017, the condensed balance sheet for the partnership of Maria, Fe, and Novere, together with their
respective profit and loss sharing percentages was as follows:
Assets, net of liabilities P320,000
Marie, capital (50%) 160,000
Fe, capital (30%) 96,000
Novere, capital (20%) 64,000
P320,000

1. Maria decided to retire from the partnership and by mutual agreement is to be paid P180,000 out of
partnership funds for his interest. No goodwill is to be recorded. Determine the capital balances of each
partner after the retirement of Maria and provide journal entry.
2. Assume instead that Maria remains in the partnership and that Sam is admitted as a new partner with a 25%
interest in the capital of the new partnership for a cash payment of P140,000. The bonus method shall be
used to record the admission of Sam. Determine the capital balances after Sam’s admission and provide
journal entry.

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CPALE Simulation Level 18

1. If incoming partner purchases share from an old 2. The total proprietorship of the business is
partner, it _____. increased _____.
a. reduces total ownership a. at the admission of a new partner
b. increases total ownership b. by the purchase of an asset
c. brings no change in ownership c. by admission through investment
d. either a or b d. either a or b
3. During the admission of a new partner, the firm is 4. At the time of dissolution, _____.
____. a. net assets are restated at their fair values
a. dissolved b. only current assets are restated at their fair values
b. continued c. non-cash assets are restated at their fair values
c. not affected d. only non-current assets are restated at their fair
d. either a or b values
5. If all the partners, but one, are insolvent, it ____. 6. If all the partners, but one, are solvent, it ____.
a. is the dissolution of the partnership agreement a. is the dissolution of the partnership agreement
b. is the dissolution of a firm b. is the dissolution of a firm
c. either a or b c. either a or b
d. is the liquidation of a firm d. is the liquidation of a firm
7. K and P are partners with capital balances of 8. B and R are partners who share profits and losses
P60,000 and P20,000, respectively. Profits and in the ratio of 6:4, respectively. On May 1, 2016,
losses are divided in the ratio of 60:40. K and P their capital accounts were P60,000 and P50,000
decided to form a new partnership with G, who respectively. On that date, L was admitted as a
invested land valued at P15,000 for a 20% capital partner with a 1/3 interest in capital and profits for
interest in the new partnership. G’s cost of the an investment of P40,000. The new partnership
land was P12,000. The partnership elected to use began with total capital of P150,000. L’s capital
the bonus method to record the admission of G account was credited equally to her proportionate
into the partnership. G’s capital account should be share in the partnership net assets. Immediately
credited for _____. after L’s admission, B’s capital should be ____.
a. P12,000 a. P50,000
b. P15,000 b. P54,000
c. P16,000 c. P56,667
d. P19,000 d. P60,000
9. Capital balances of STUV partnership are S, Capital 10. Retirement and death of a partner _____.
P50,000; T, Capital P40,000; U, Capital P30,000; a. is the dissolution of the partnership agreement
and V, Capital P20,000, and income ratios are b. is the dissolution of a firm
4:3:2:1, respectively. V withdraws from the firm c. either a or b
following payment of P29,000 in cash from the d. is the liquidation of a firm
partnership. T’s capital balance after recording the
withdrawal of V is _____.
a. P36,000
b. P37,000
c. P38,000
d. P40,000
Suggested Exercises

1. Problem 1-4, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp. 490-496.
2. Exercises E12.11 to E12.15, Accounting Principles 13th Edition (2018) by Weygandt, Kimmel & Kieso, pp. 12-34 to
12-35.

References

1. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City, Philippines:
Bandolin Enterprise.
2. Weygandt, J. J., Kimmel, P. D., and Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John Wiley &
Sons (Asia) Pte Ltd.

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Lesson 19 PARTNERSHIP LIQUIDATION

Did you know that?

LEARNING OBJECTIVE The October 2019 CPALE registered a very low
1. Demonstrate procedures in passing rate of 14.32% which jokingly meant as “I love
you 2”. More than 40% of accountancy schools got
accounting partnership liquidations. zero passing rates.

Liquidation is the termination of business operations or the winding up of affairs. The liquidation process involves
realization and liquidation activities. When the assets of the business are converted into cash, this is known as
realization which may give rise to either gain or loss on realization. When the liabilities of the business are settled
and the remaining amount is distributed to the owners, this process is known as the liquidation. These two
methods of liquidation include the lump-sum liquidation and the installment liquidation. In lump-sum liquidation,
the partners’ claims are settled in a single, lump-sum payment after all non-cash assets are realized and all
liabilities are settled. Under the installment liquidation, the partners’ claims are settled on an installment basis as
non-cash assets are realized and as cash becomes available, but only after all liabilities are fully settled. In
settlement of claims, this order of priority is observed: 1. outside creditors (e.g. accounts payable and notes
payable), 2. inside creditors (e.g. payable to partners), and 3. owners.
Lump-sum Liquidation Installment Liquidation
• All of the non-cash assets are converted to cash. • Some of the non-cash assets are converted to cash.
• The total gain or loss on the sale is allocated to the • The carrying amount of any unsold non-cash asset is
partner’s capital balances based on their P/L ratio. considered as a loss. This is allocated to the partner’s
capital balances based on their P/L ratio.
• Actual liquidation expenses are allocated to the partner’s • Actual and estimated future liquidation expenses are
capital balances based on the P/L ratio. allocated to the partner’s capital balances based on their
profit or loss ratio.
• The liabilities to outside creditors are fully settled. • The liabilities to outside creditors are partially or fully
settled.
• The liabilities to inside creditors are fully settled. • The liabilities to inside creditors are partially or fully
settled but only after full settlement of the liabilities to
outside creditors.
• Any remaining cash is distributed to the owners in full • If both the liabilities to the outside and inside creditors
settlement of their interests. are fully settled, any remaining cash minus cash set aside
for future liquidation expenses are distributed to the
owners as partial settlement of their interests.
Illustration 19.1: On June 1, 2019, J, M, and P decided to liquidate their partnership. The following information was made
available.
Assets Liabilities and Owners’ Equity Illustration 19.1.A: The following information
Cash P 10,000 Accounts Payable P100,000 is provided regarding the conversion of non-
Accounts Receivable 100,000 Payable to J 10,000 cash assets:
Inventory 100,000 J, Capital (20%) 50,000
a. P80,000 was collected on the accounts
Equipment 200,000 M, Capital (40%) 150,000
Building 100,000 P, Capital (40%) 200,000 receivable; the balance is uncollectible.
Total P510,000 Total P510,000 b. P90,000 was received for the entire
inventory.
c. The equipment was sold for P150,000.
In solving this problem, we have to observe the following
d. The building was sold for P40,000.
procedures:
e. P5,000 liquidation expenses were paid.
1. Compute the gain or loss on realization.
Determine the amount of cash distributed to
2. Allocate the gain or loss on realization among partners. Please
the partners in the final settlement of their
take note to include payables to partners as part of the capital
interests and to provide the journal entry to
balances; this is the legal right to offset.
record the liquidation.
3. Pay the partnership liabilities.
4. Distribute remaining cash based on their capital balances.

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Step 1. Compute the gain or loss on realization.

June 1 Cash 355,000
1. Collection of accounts receivable 80,000
Loss on sale 145,000
2. Sale of inventory 90,000
Accounts Receivable 100,000
3. Sale of equipment 150,000
Inventory 100,000
4. Sale of building 40,000
Equipment 200,000 5. Liquidation expenses (5,000)
Building 100,000
Net cash proceeds 355,000
To record the realization of
Less: Carrying amount of the non-cash assets
non-cash assets.
(100,000+100,000+200,000+100,000=500,000) (500,000)
Total loss on sale (145,000)

Step 2. Allocate the gain or loss on realization among partners.

June 1 J, Capital 29,000 J (20%) M (40%) P (40%) Total
M, Capital 58,000
Capital balances 50,000 150,000 200,00 400,000
P, Capital 58,000
Payable to J 10,000 10,000
Loss on sale 145,000
To record allocation of gain or Total 60,000 150,000 200,00 410,000
loss on realization. Allocation of loss
(145,000 x (20%; 40%;
& 40%) (29,000) (58,000) (58,000) (145,000)
Amount distributed to
To check your computation, let us calculate the cash ending partners 31,000 92,000 142,000 265,000
balance before distribution to partners.

Cash beginning balance 10,000 Step 3. Pay partnership liabilities.

Net proceeds from the sale of non-cash assets 355,000 June 1 Accounts Payable 100,000
Less: Payment to creditors (100,000) Cash 100,000
Cash available for distribution to partners 265,000 To record payment of outside creditors.

Step 4. Distribute the remaining cash inside creditors and partners.

A statement of liquidation is a formal financial report June 1 Payable to J 10,000
that highlights the realization (conversion of non- J, Capital 21,000
cash assets) and the liquidation (settlement of M, Capital 92,000
creditors and partners) of a partnership. The P, Capital 142,000
statement below is a sample statement of the Cash 265,000
liquidation of a partnership. The details follow the To record payment of inside creditor
procedures of liquidation. and partner’s capital.

J M P PARTNERSHIP
Statement of Liquidation
June 1, 2019

Assets Liabilities Equity

Cash Non-Cash Accounts Payable to J J, Capital M, Capital P, Capital
Payable (20%) (40%) (40%)
Balances before liquidation 10,000 500,000 100,000 10,000 50,000 150,000 200,000
1. Realization of non-cash assets and allocation of
gain or loss on realization. 355,000 (500,000) (29,000) (58,000) (58,000)
Totals 365,000 - 100,000 10,000 21,000 92,000 142,000
2. Payment to outside creditors. (100,000) (100,000)
Totals 265,000 - - 10,000 21,000 92,000 142,000
3. Payment to partners (265,000) (10,000) (21,000) (92,000) (142,000)
Totals - - - - - - -

Illustration 19.1.B: Using the same information in the previous illustration. This time, the liquidation
process will take time and the distributions of cash to partners will be made as it becomes available. The
information below provides the conversion of non-cash assets on June 1, 2019:
a. 60% of the accounts receivable was collected for only P50,000.
b. 60% of the inventory was sold for P50,000.
c. The equipment was sold for P150,000.
d. The building was sold for P40,000.
e. P5,000 liquidation expenses were paid.
f. The estimated future liquidation expenses are P10,000.
g. An estimated of P10,000 of cash will be retained for potential liabilities and other expenses.
Determine the amount of cash distributed to the partners in the first installment of the settlement of their
interests and to provide the journal entry to record the liquidation.

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Step 1. Compute the gain or loss on realization.

June 1 Cash 285,000
1. Collection of accounts receivable 50,000
Loss on sale 135,000
2. Sale of inventory 50,000
Accounts Receivable 60,000
3. Sale of equipment 150,000
Inventory 60,000
4. Sale of building 40,000
Equipment 200,000 5. Liquidation expenses (5,000)
Building 100,000
Net cash proceeds 285,000
To record the realization of
Less: Carrying amount of sold non-cash assets
non-cash assets.
(60,000+60,000+200,000+100,000=420,000) (420,000)
Please take note that the entries made in here are the first
Actual loss on realization (135,000)
realization of non-cash assets under the installment liquidation.
Less: Carrying amount of the unsold non-cash assets +
Maximum loss possible representing the unsold non-cash assets
Estimated liquidation expenses + Cash retained for (100,000)
and estimated future expenses are not recorded under the
future expenses (40,000+40,000+10,000+10,000
installment liquidation.
=100,000)
Total maximum loss possible (235,000)

June 1 J, Capital 27,000

M, Capital 54,000 Step 2. Allocate the gain or loss on realization among partners and make a safe
P, Capital 54,000 payment schedule.
Loss on sale 135,000 J (20%) M (40%) P (40%) Total
To record the allocation of Capital balances 50,000 150,000 200,00 400,000
actual loss on realization. Payable to J 10,000 10,000
Total 60,000 150,000 200,00 410,000
Allocation of actual loss on
To check your computation, let us calculate the cash ending realization (135,000 x (20%;
balance before distribution to partners. 40%; & 40%) (27,000) (54,000) (54,000) (135,000)
Cash beginning balance 10,000 Totals 33,000 96,000 146,000 275,000
Net proceeds from the sale of non-cash assets 285,000 Less: Allocation of maximum
Less: Payment to creditors (100,000) loss possible (100,000 x
Less: Cash set aside for future expenses (20,000)
(20%; 40%; & 40%) (20,000) (40,000) (40,000) (100,000)
Cash available for distribution to partners 175,000
First installment payment to
partners 13,000 56,000 106,000 175,000

In this problem, we follow the safe payment schedule Step 3. Pay partnership liabilities.
in making the installment liquidation. This schedule June 1 Accounts Payable 100,000
shows how much cash can be safely paid to the Cash 100,000
partner to avoid overpayment. In this process, the To record payment of outside creditors.
unsold non-cash assets and expected future
Step 4. Distribute the remaining cash to inside creditors and partners.
expenses are treated immediately as losses to be
June 1 Payable to J 10,000
part of the maximum loss possible.
J, Capital 3,000
M, Capital 56,000
Illustration 19.1.C: This is a continuation of the previous P, Capital 106,000
illustration. The following transactions occurred on July 1, 2019. Cash 175,000
a. 40% of the accounts receivable were collected for P30,000. To record payment of inside creditor and
b. 40% of the inventory was sold for P10,000. partner’s capital.
c. P10,000 liquidation expenses were paid.
Determine the amount of cash distributed to the partners in the Step 1. Compute the gain or loss on realization.
final settlement of their interests and to provide the journal 1. Collection of accounts receivable 30,000
entry to record the liquidation. 2. Sale of inventory 10,000
3. Liquidation expenses (10,000)
Net cash proceeds 30,000
June 1 Cash 30,000 Less: Carrying amount of sold non-cash assets (40,000 +
Loss on sale 50,000 40,000 = 80,000) (80,000)
Accounts Receivable 40,000 Actual loss on realization (50,000)
Inventory 40,000
To record the realization of Step 2. Allocate the gain or loss on realization among partners and make a safe
non-cash assets. payment schedule.
J (20%) M (40%) P (40%) Total
Capital balances 6/1/19 20,000 40,000 40,00 100,000
June 1 J, Capital 10,000 Allocation of actual loss on
M, Capital 20,000 realization (50,000 x (20%;
P, Capital 20,000 40%; & 40%) (10,000) (20,000) (20,000) (50,000)
Loss on sale 50,000 Final installment 10,000 20,000 20,000 50,000
To record the allocation of
actual loss on realization. Step 4. Distribute the remaining cash to partners.
June 1 J, Capital 10,000
M, Capital 20,000
Let us check the cash balance before distribution to partners. P, Capital 20,000
Cash beginning balance 20,000
Cash 50,000
Net proceeds from the sale of non-cash assets 30,000
Cash available for final distribution to partners 50,000
To record the final payment of the partner’s
capital.

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Let us prepare a statement of liquidation for the preceding problem.

J M P PARTNERSHIP
Statement of Liquidation
June 1, 2019

Assets Liabilities Equity

Cash Non-Cash Accounts Payable to J J, Capital M, Capital P, Capital
Payable (20%) (40%) (40%)
Balances before liquidation 10,000 500,000 100,000 10,000 50,000 150,000 200,000
1. Realization of non-cash assets and allocation of
gain or loss on realization. 285,000 (420,000) (27,000) (54,000) (54,000)
Totals 295,000 80,000 100,000 10,000 23,000 96,000 146,000
2. Payment to outside creditors. (100,000) (100,000)
Totals 195,000 80,000 - 10,000 23,000 96,000 146,000
3. First payment to inside creditors and partners (175,000) (10,000) (3,000) (56,000) (106,000)
Totals 20,000 80,000 - - 20,000 40,000 40,000
4. Realization of non-cash assets and allocation of
gain or loss on realization. 30,000 (80,000) (10,000) (20,000) (20,000)
Totals 50,000 - - - 10,000 20,000 20,000
5. Final payment to partners (50,000) (10,000) (20,000) (20,000)
Totals - - - - - - -

Another method of ensuring no overpayment can be made to partners is the cash priority program. The same concept is applied
in the safe payment schedule in determining the maximum possible loss. However, the ranking of partners is made based on
their maximum loss absorption capacity (MLAC) which is computed by dividing the partner’s capital balance by the partner’s P/L
ratio. The partner with the highest maximum loss absorption capacity shall be paid first while those with the lowest shall be paid
last. Any remaining cash after payment of those in priority will be distributed using the P/L ratio.
Step 1. Determine the maximum loss absorption capacity of each partner.
Using the previous illustration, instead of a safe J (20%) M (40%) P (40%)
payment schedule, we will make a cash priority Capital balances 50,000 150,000 200,00
program. In making this, we will observe the Payable to J 10,000
following procedures: Total 60,000 150,000 200,00
1. Determine the maximum loss absorption Divided by P/L ratio 20% 40% 40%
capacities of the partners. Max. Loss Absorption Capacity 300,000 375,000 500,000
Rank of Payment 3 2 1
2. Equalize the MLAC.
3. Compute cash priorities by multiplying the Step 2. Equalize the MLAC.
differences above by the respective P/L ratios. J (20%) M (40%) P (40%)
4. Distribute cash as prioritized. The remaining cash Rank of Payment 3 2 1
will be distributed using the P/L ratio. Max. Loss Absorption Capacity 300,000 375,000 500,000
Difference between 1 and 2 (125,000)
Balance 300,000 375,000 375,000
There are cases when the partnership and some Difference between 1, 2 and 3 (75,000) (75,000)
of the partners become insolvent. The following Equal balance of MLAC 300,000 300,000 300,000
rules shall be observed. Step 3. Compute cash priorities.
1. First, the assets of the partnership are used to J (20%) M (40%) P (40%)
settle its liabilities. Rank of Payment 3 2 1
2. Second, in case the assets of the partnership 1st Priority (125,000 x 40%) 50,000
are insufficient, the solvent general partners 2nd Priority (75,000 x 40%; 40%) 30,000 30,000
are required to provide additional funds from Totals - 30,000 80,000
personal assets. Claims against personal Step 4. Distribute of cash using the cash priority program.
assets are ranked in the following order: J (20%) M (40%) P (40%) Total
a. Personal creditors of the partner Available cash balance 175,000
b. Partnership creditors Allocation:
c. Partners through contribution 1st Priority 50,000 (50,000)
3. In case some partners are insolvent or 2nd Priority 30,000 30,000 (60,000)
limited, their capital deficiency is offset to the Totals - 30,000 80,000 65,000
Payment after priorities
capital balances of the other partners. If after
(65,000 x 20%; 40%; 40%) 13,000 26,000 26,000 (65,000)
allocating the capital deficiency of an
First installment payment to
insolvent or limited partner, a solvent partners 13,000 56,000 106,000 175,000
partner’s capital balance results in a negative
amount, the solvent partner is required to Journal entry in the distribution of the remaining cash to inside creditors and
provide an additional contribution. partners.
June 1 Payable to J 10,000
These rules are following the legal doctrine of
J, Capital 3,000
marshaling of assets when the partnership and
M, Capital 56,000
some of the partners are insolvent. This follows
P, Capital 106,000
one of the characteristics of a partnership which
Cash 175,000
is unlimited liability.
To record payment of inside creditor and
partner’s capital.

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Illustration 19.2: On June 1, 2019, J, M, and P decided to liquidate their partnership. The following information was made
available.
Assets Liabilities and Owners’ Equity
Cash P 10,000 Accounts Payable P100,000 Illustration 19.2.A: All of the partners are
Accounts Receivable 100,000 Payable to J 10,000 personally solvent. The following information
Inventory 100,000 J, Capital (20%) 50,000 provides regarding the conversion of non-cash
Equipment 200,000 M, Capital (40%) 150,000 assets:
Building 100,000 P, Capital (40%) 200,000
a. P40,000 was collected on the accounts
Total P510,000 Total P510,000
receivable; the balance is uncollectible.
b. P50,000 was received for the entire inventory.
c. The equipment was sold for P70,000.
Step 1. Compute the gain or loss on realization. d. The building was sold for P20,000.
1. Collection of accounts receivable 40,000 e. P5,000 liquidation expenses were paid.
2. Sale of inventory 50,000 Determine the amount of cash distributed to the
3. Sale of equipment 70,000 partners in the final settlement of their interests
4. Sale of building 20,000 and to provide the journal entry to record the
5. Liquidation expenses (5,000) liquidation.
Net cash proceeds 175,000
Less: Carrying amount of the non-cash assets
(100,000+100,000+200,000+100,000=500,000) (500,000)
Total loss on sale (325,000) Since J is a solvent partner, he is
required to provide an additional
Step 2. Allocate the gain or loss on realization among partners. contribution to the partnership to
J (20%) M (40%) P (40%) Total cover his capital deficiency.
Capital balances 50,000 150,000 200,00 400,000
Payable to J 10,000 10,000
Total 60,000 150,000 200,00 410,000
Allocation of loss (325,000 x Let us check the cash balance before
(20%; 40%; & 40%) (65,000) (130,000) (130,000) (325,000) payment to partners.
Total (5,000) 20,000 70,000 85,000
Additional contribution by J 5,000 5,000 Cash beginning balance 10,000
Amount distributed to partners - 20,000 70,000 90,000 Net proceeds from the sale of
non-cash assets 175,000
Additional contribution of J 5,000
What if J is insolvent, how is the capital deficiency is allocated Less: Payment to creditors (100,000)
among partners? Cash available for distribution to
partners 90,000

Step 2. Allocate the gain or loss on realization among partners.

J (20%) M (40%) P (40%) Total
Capital balances 50,000 150,000 200,00 400,000 Let us check the cash balance before
Payable to J 10,000 10,000 payment to partners.
Total 60,000 150,000 200,00 410,000
Allocation of loss (325,000 x Cash beginning balance 10,000
(20%; 40%; & 40%) (65,000) (130,000) (130,000) (325,000) Net proceeds from the sale of
Total (5,000) 20,000 70,000 85,000 non-cash assets 175,000
Allocation of capital deficienty Less: Payment to creditors (100,000)
to the other partners
Cash available for distribution to
(5,000 x 40%/80%; & 40%/80%) 5,000 (2,500) (2,500) -
Amount distributed to partners - 17,500 67,500 85,000
partners 85,000

Review Exercises
1. The following condensed balance sheet is presented for the partnership of Bea and Alonzo, who share
profits and losses in the ratio of 60:40, respectively:

Cash P 45,000 Accounts payable P120,000

Other assets 625,000 Bea, capital 348,000
Alonzo, loan 30,000 Alonzo, capital 232,000
P700,000 P700,000

Instead of admitting a new partner, Bea and Alonzo decide to liquidate the partnership. If the other assets
are sold for P500,000, what amount of the available cash should be distributed to Bea?

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2. The statement of financial position of the partnership of C, T, and O shows the following information:

Cash P 22,400 Liabilities P 38,400

Other assets 212,000 C, capital (50%) 76,000
Total assets P234,400 T, capital (25%) 64,000
O, capital (25%) 56,000
Total liabilities and equity P234,400

The partners realized P56,000 from the first installment sale of non-cash assets with a total carrying amount
of P120,000. How much did T receive from the partial liquidation?

3. The statement of financial position of the partnership of C, O, and A shows the following information:

Cash P 40,000 Liabilities P300,000

Other assets 720,000 O, loan 64,000
Total assets P760,000 A, loan 20,000
C, capital (50%) 250,000
O, capital (30%) 86,000
A, capital (20%) 40,000
Total liabilities and equity P760,000

The non-cash assets are sold for P320,000. Partner A is the only solvent partner. In the settlement of the
partners’ claims, how much additional contribution is required of Partner A?

4. C, S, and B are partners. Their respective personal assets, personal liabilities, and partnership capital balances
are as follows:

C S B
Personal assets P 90,000 P240,000 P180,000
Personal liabilities 75,000 150,000 216,000
Capital balances P150,000 (P96,000) P210,000

Which of the partners is personally insolvent?

5. The equity section of the balance sheet of the partnership of G, S, and C shows the following information:

G, capital (40%) P 64,000

S, capital (40%) 104,000
C, capital (20%) 76,800
Total liabilities and equity P244,800

Non-cash assets are sold in installment. Cash distributions are made to the partners as cash becomes
available. In the second sale of non-cash assets, the partners received the same amount of cash in the
distribution. In the third sale of non-cash assets, the amount of cash available for distribution is P100,000.
The carrying amount of the remaining non-cash assets is P260,000. Under the cash priority program, how
much cash is distributed to S in the third installment payment?

6. A partnership has the following balance sheet just before the final liquidation is to begin:

Cash P 26,000 Liabilities P 50,000

Inventory 31,000 V, capital (40%) 18,000
Other assets 62,000 S, capital (30%) 25,000
Total assets P119,000 U, capital (30%) 26,000
Total liabilities and equity P119,000

Liquidation expenses are estimated to be P12,000. The other assets are sold for P40,000. What distribution
can be made to the partners?

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CPALE Simulation Level 19

1. The loss on realization is _____. 2. In case of liquidation, assets are ______.
a. debited to partner’s capital account a. donated
b. credited to realization account b. distributed
c. credited to partner’s capital account c. sold
d. either a or b d. revalued
3. In partnership liquidation, it is necessary to (1) distribute 4. If a partner is insolvent, his personal properties shall first
cash to the partners, (2) sell non-cash assets, (3) allocate be distributed _____.
any gain or loss on realization to the partners, and (4) a. to partnership creditors
pay liabilities. These steps should be performed in the b. to personal creditors
following order: c. to the partners by way of additional contribution when
a. 2-3-4-1 the assets of the partnership were insufficient to settle
b. 2-3-1-4 all obligations
c. 3-2-1-4 d. to partnership and separate creditors in the ratio of their
d. 3-2-4-1 loan exposures
5. In accounting for liquidation of a partnership, cash 6. A partner’s loss absorption balance is got by ____.
payment s to partners after all outside creditors’ claims a. dividing the partner’s capital balance by his percentage
have been satisfied, but before final cash distribution, interest in the capital
should be according to _____. b. dividing the partner’s total interest by his profit and loss
a. relative profit and loss sharing ratios sharing percentage
b. the final balances in the partner’s capital accounts c. multiplying the partner’s total interests by his profit and
c. the relative share of gain or loss on liquidation loss sharing percentage
d. safe payment computations d. multiplying distributable assets by the partner’s profit-
sharing percentage
7. Which of the following statements is correct regarding a 8. Black and Pearl have shared profits and losses equally.
partner’s capital deficiency? Immediately before final cash disbursement in the
a. The partner should contribute to reducing the debit liquidation of their partnership, the book showed:
balance to the extent possible. Cash = Liabilities + Black, + Pearl,
b. If a contribution is not possible, the other partners with Capital Capital
credit capital balances will be allocated a portion of the P100,000 P0 P60,000 P40,000
debit balances. How much cash should Black receive?
c. Partners who absorb another capital deficiency have a a. P40,000 c. P60,000
legal claim against the deficient partner. b. P50,000 d. P100,000
d. All of these statements are correct.
9. Val, Len, and Tin are partners with capital balances of 10. As of December 31, 2016, the books of JCO Partnership
P350,000, P250,000, and P350,000 and sharing profits showed capital balances of Jamado, P40,000; Centeng,
30%, 20%, and 50%, respectively. Partners agree to P25,000; Oando, P5,000. The partner’s profit and loss
dissolve the business and upon liquidation, all of the ratio were 3:2:1, respectively. The partners decided to
partnership assets are sold and sufficient cash is realized liquidate and they sold all non-cash assets for P37,000.
to pay all the claims except one for P50,000. Tin is After the settlement of all liabilities amounting to
personally insolvent, but the other two partners can P12,000, they still have cash of P28,000 left for
meet any indebtedness to the firm. On the remaining distribution. Assuming that any capital deficiency is
claim or debts against the partnership, Val is to pay __. uncollectible, the share of Jamado in the distribution of
a. P40,000 c. P30,000 cash would be _____.
b. P15,000 d. P25,000 a. P17,000 c. P18,000
b. P17,800 d. P19,000
Suggested Exercises
1. Problem 1-4, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp. 490-496.
2. Exercises E12.11 to E12.15, Accounting Principles 13th Edition (2018) by Weygandt, Kimmel & Kieso, pp. 12-34 to
12-35.
References
1. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City, Philippines:
Bandolin Enterprise.
2. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John Wiley & Sons
(Asia) Pte Ltd.

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MODULE

6
Accounting for Corporations
Corporations dominate the top companies around the world which employ thousands of
employees, earning billions of sales, and owning billions of assets. This shows that the
corporation seems to be the most favorable form of business organization among business
people and investors. The accounting cycle of a corporation is just the same with sole
proprietorships and partnerships except in accounting the equity section of the financial
statements.

This module has two lessons which will help account some important corporate equity
transactions as well as in the issuance of dividends. The terms used in this module are almost
new to you. You must understand each term so you can eventually relate as these are
mentioned in the discussion. Still, your mastery in the accounting cycle is much needed so
you can finish this last module fruitfully. The topics in this module will be explained further in
the intermediate accounting as this is part of the Financial Accounting and Reporting subject
in the CPALE.

LESSON
20 Accounting for Shareholders’ Equity
21 Accounting for Dividends

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Lesson 20 ACCOUNTING FOR SHAREHOLDERS’ EQUITY

Did you know that?

LEARNING OBJECTIVES Ayala Corporation is known to be the oldest
1. Describe the components of corporation in the Philippines that continues to exist
until today.
shareholders’ equity; and
2. Illustrate procedures in accounting
share capital and treasury shares.
A corporation is an artificial being created by the operation
of law, having the right of succession and the powers,
attributes, and properties expressly authorized by law or incident to its existence. Corporations are commonly
characterized by the following:

1. Separate legal personality  The corporation is distinct and separate from the shareholders.
2. Limited liability  The shareholders are normally liable up to their investment in the corporation.
3. Transfer of ownership  The shareholders can anytime sell their shares in a corporation.
4. Ability to acquire capital  The corporation can obtain capital through the issuance of shares.
5. Unlimited life  The life of a corporation is perpetual unless its existence is limited as stated in the
articles of incorporation.
6. Corporate management  The corporation is directly managed by the board of directors who were elected by
the stockholders.
7. Government regulations  A corporation is heavily regulated by the government.
8. Corporate taxes  The corporation must pay government taxes as a separate entity unlike in sole
proprietorship and partnership where they can include their share in earnings as part
of their individual income tax returns.

The new corporation code removed the minimum number of incorporators to form a corporation which allows
the creation of a one-person corporation. The Securities and Exchange Commission approves the Articles of
Incorporation which includes the maximum number of shares that the corporation can issue, also known as the
authorized share capital of which at least 25% must be subscribed and 25% of the total subscription must be paid upon
subscription. The paid-up capital must not be less than P62,500. Any decrease or increase in the authorized share
capital must be in a form of an amendment of the articles of incorporation and to be approved by the SEC.

A portion of authorized share capital that has been already issued is called issued share capital or share capital,
otherwise, it is unissued share capital. If the portion of the authorized capital is still subscribed but not yet issued,
it is called subscribed share capital. If the subscribed share capital is not yet paid, this is part of the subscription
receivable and to be deducted from the subscribed share capital.

The authorized share capital can be a par value share or no-par value share. A par value share has an assigned value
per share as stipulated in the articles of incorporation and as shown in the share certificate, otherwise it is a no-
par value share. However, in no-par value share, the stated value also known as issued value as indicated in the
articles of incorporation will be used. In no case, the consideration for issuance of a no-par value share will be less
than P5 per share. If the share capital is paid more than the par value, then it is called share premium also known
as additional paid-in capital.

Share capital is divided into shares that represent ownership in a corporation as evidenced in the share certificate.
The two types of share capital include the ordinary share and preference share. An ordinary share represents the
basic ownership class of the corporation while the preference share provides certain preferences over ordinary
shareholders such as preference as to dividend and as to claim in case of corporate liquidation. If the share capital
is in the hands of the shareholders, then it is called outstanding shares. If this share capital is acquired back by the
corporation, then it is called treasury shares.

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Each shareholder is accorded with the following basic rights such as the right to attend and vote in shareholders’
meetings, the right to purchase additional shares also known as preemptive right or stock right, the right to share in
the corporate profits also known as the right to dividends, and the right to share in the net assets of the corporation
upon liquidation.

In accounting for corporations, the following transactions are considered to have effects in the shareholders’
equity section of the financial statements which include the accounting of share capital, treasury shares, and
dividends. This lesson will discuss the accounting for share capital and treasures while the accounting for
dividends will be explained thoroughly in the next lesson.

In accounting for share capital, a corporation may either use the memorandum method or the journal entry
method. Under the memorandum method, only a memorandum is made for the authorized capitalization and the
subsequent issuances of shares are credited to the share capital. Under the journal entry method, the authorized
capitalization is recorded by crediting authorized share capital and debiting unissued share capital and the
subsequent issuances of shares are credited to unissued share capital. In practice, the memorandum method is
mostly used among corporations. To illustrate more the difference between these two methods, let us consider
the following:
MEMORANDUM METHOD JOURNAL ENTRY METHOD
1. On January 1, 2019, JM Corp. received authorization from the SEC to issue share capital of P2,000,000 divided into 200,000
shares with a par value per share of P10.
Memo entry – The authorized share capital is P2,000,000 Unissued share capital 2,000,000
divided into 200,000 shares with a par value of P10. Authorized share capital 2,000,000
2. 25% of the total authorized share capital was subscribed at par value and 25% of the total subscription was paid on the
subscription date.
Cash 125,000 Cash 125,000
Subscription receivable 375,000 Subscription receivable 375,000
Subscribed share 500,000 Subscribed share capital 500,000
capital
3. On January 30, 2019, JM Corp. received full payment of the 40,000 subscribed shares and issued the related shares.
Cash 300,000 Cash 300,000
Subscription receivable 300,000 Subscription receivable 300,000
Subscribed share capital 400,000 Subscribed share capital 400,000
Share capital 400,000 Unissued share capital 400,000
4. On March 31, 2019, JM Corp. received a cash subscription for 20,000 shares at par value.
Cash 20o,000 Cash 200,000
Share capital 20o,000 Unissued share capital 200,000

5. The share capital of JM Corp. as of March 31, 2019, is presented below.

Share capital P600,000 Authorized share capital P2,000,000

Subscribed share capital 100,000 Unissued share capital (1,400,000)
Subscription receivable (75,000) Issued share capital P600,000
Total share capital P625,000 Subscribed share capital 100,000
Subscription receivable (75,000)
Total share capital P625,000

Let us make another illustration about ordinary shares, preference shares, share premium, par value, and no-par
value shares using the memorandum entry method.
Jan. 1 Memo entry – The authorized share capital is P2,000,000
On January 1, 2019, JM Corp. has an authorized share
divided into 200,000 shares with a par value of P10.
capital of P2,000,000 divided into 200,000 shares
Jan. 1 Cash 150,000
with a par value of P10 per share. JM Corp received
Share capital 100,000
cash subscriptions for 10,000 shares at P15 per share.
Share premium 50,000

Jan. 1 Subscription receivable 200,000

On February 2, 2019, JM Corp. receives a subscription
Subscribed share capital 100,000
for 10,000 shares at P20 per share.
Share premium 100,000

Please take note that share capital and subscribed share capital are credited at par value and the excess is
credited to share premium. Ordinary share can be either par or no-par value share while preference share can only
be a par value share.

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Jan. 1 Cash 500,000

On January 1, 2019, JM Corp. issued 10,000 no-par Share capital 200,000
value shares with a stated value of P20 per share for Share premium 300,000
P50.

When a corporation incurs a cost in issuing shares, these expenses, also known as share issuance costs, are
charged against from share premium, if found insufficient, from retained earnings. Retained earnings refer to
cumulative profits retain by a corporation for future use. It is classified into appropriated and unappropriated
retained earnings. Appropriated retained earnings are a portion of the retained earnings that are restricted for
distribution to shareholders as it is allocated for a specific use, otherwise it is unappropriated retained earnings.

What if the problem in the previous illustration incurs Jan. 1 Share premium 10,000
a cost of P10,000. Cash 10,000

What if there was no balance in the share premium Jan. 1 Retained earnings 10,000
account. Cash 10,000

In accounting for treasury shares, the cost method is used in accounting for treasury share transactions. Under
this method, the reacquisition and subsequent re-issuance of treasury shares are recognized and derecognized,
respectively, at cost. Please take note that under the corporation code, a company may only purchase its own
issued shares only if it has enough unappropriated retained earnings.
Jan. 1 Treasury share 200,000
On January 1, 2019, JM Corp. decided to purchase its Cash 200,000
own 200 shares with par value at P500 for P1,000. Retained earnings-unappropriated 200,000
Retained earnings-appropriated 200,000
Dec. 31 Cash 200,000
On December 31, 2019, JM Corp. decided to Treasury shares 200,000
reissue the treasury shares at cost. Retained earnings-appropriated 200,000
Retained earnings-unappropriated 200,000
Dec. 31 Cash 300,000
On December 31, 2019, JM Corp. decided to Treasury shares 200,000
reissue the treasury shares at P1,500. Share premium-treasury shares 100,000
Retained earnings-appropriated 200,000
Retained earnings-unappropriated 200,000
Dec. 31 Cash 160,000
On December 31, 2019, JM Corp. decided to Retained earnings 40,000
reissue the treasury shares at P800. Treasury shares 200,000
Retained earnings-appropriated 200,000
Retained earnings-unappropriated 200,000

When the treasury shares are reissued above the cost, the excess shall be recorded to share premium-treasury
shares. When treasury shares are reissued below the cost, the difference is charged first to share premium-
treasury shares to the extent of its balance and if found insufficient, charged it to the retained earnings.
There are cases when a corporation decided not to reissue the treasury shares, instead, these were subsequently
retired. In this case, the share capital account is debited at par value. The treasury shares are retired at cost.
During issuance of shares
On December 31, 2019, JM Corp. decided to Cash 140,000
retire its 200 treasures shares which were Share capital 100,000
purchased at P1,000 per share. The said share Share premium 40,000
with a par value of P500 was issued for P700.
During reacquisition of shares
Treasury shares 200,000
Cash 200,000
When the retirement results to loss, the loss
will be charged to these accounts in the
During the retirement of shares
following order: 1. share premium of the
Share capital 100,000
related retired shares during issuance; 2. share
Share premium 40,000
premium-treasury shares; 3. retained earnings. Retained earnings 60,000
Treasury shares 200,000

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During issuance of shares

On December 31, 2019, JM Corp. decided to Cash 140,000
retire its 200 treasures shares which were Share capital 100,000
purchased at P400 per share. The said share Share premium 40,000
with a par value of P500 was issued for P700.
During reacquisition of shares
Treasury shares 80,000
When the retirement results into gain, the Cash 80,000
excess is credited to share premium.
During the retirement of shares
Share capital 100,000
Share premium 20,000
Treasury shares 80,000

Under the trust fund doctrine, legal capital is the portion of the contributed capital that cannot be distributed to
the shareholders during the existence of a corporation as a protection of its creditors. For par value shares, it
includes the aggregate par value of shares issued and subscribed. For no-par value shares, it comprises the total
consideration for the shares issued and subscribed which is inclusive of any amount more than the stated value.

Par No-par
This is the shareholders’ equity of the JM Corporation. 4% preference share, P20 par value 100,000 100,000
Ordinary shares 500,000 500,000
4% preference share, P20 par value 100,000
Share premium-ordinary shares 100,000
Share premium-preference shares 10,000
Subscribed share capital-ordinary shares 80,000 80,000
Ordinary shares 500,000
Share premium-ordinary shares 100,000 Legal Capital 680,000 780,000
Subscribed share capital-ordinary shares 80,000
Subscription receivable-ordinary shares (10,000)  Preference shares are par value shares, thus its related share
Retained earnings 200,000
premium is not included.
What is the legal capital if the ordinary shares are:  Share premium for ordinary shares is only included if it is a
1. par value no-par value share.
2. no-par value

The illustration below shows a sample of the shareholders’ equity section of the balance sheet.

JM CORPORATION
BALANCE SHEET
As of the Year Ended December 31, 2019

Shareholders’ equity
Share Capital
4% preference share, P20 par value P 100,000
Share premium-preference shares 10,000 P110,000
Ordinary shares 500,000
Share premium-ordinary shares 100,000 600,000
Subscribed share capital-ordinary shares 80,000
Less: Subscription receivable-ordinary shares 10,000 70,000
Retained Earnings 200,000
Total P 980,000
Less: Treasury shares 100,000
Total Shareholders’ equity P880,000

Treasury shares are deduction in the shareholders’ equity. They are not considered as an asset instead they
reduced the claims of the shareholders against corporate assets. In some instances, there are corporations
whose ordinary shares are classified into more than one class to delineate voting rights. A particular class of
ordinary shares has more voting rights than the other. This is to give the incorporators and founders more
control over the other shareholders particularly in making corporate policies.

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Review Exercises
1. JP Corporation’s share capital transactions during the year were the following:
a. On June 1, 2019, JP Corp. received authorization from the SEC to issue share capital of P1,500,000
divided into 50,000 shares with a par value per share of P30.
b. 30% of the total authorized share capital was subscribed at par value and 50% of the total subscription
was paid on the subscription date.
c. On July 31, 2019, JP Corp. received full payment of the 10,000 subscribed shares and issued the related
shares.
d. On August 31, 2019, JP Corp. received a cash subscription for 5,000 shares at par value.
You are required to prepare the journal entries under both the memorandum and journal entry method and
to prepare the shareholders’ equity of JP Corporation.

2. Provide the journal entries and prepare the shareholders’ equity section of the balance sheet.
a. On September 1, 2019, JP Corp. has an authorized share capital of P1,500,000 divided into 50,000 shares
with a par value of P30 per share. JP Corp received cash subscriptions for 20,000 shares at P40 per
share.
b. On September 2, 2019, JP Corp. receives a subscription for 15,000 shares at P35 per share.
c. On September 3, 2019, JP Corp. issued 5,000 no-par value shares with a stated value of P15 per share for
P40.
d. On September 4, 2019, JP Corp. incurred costs regarding previous issuance amounting to P8,000.
e. On October 1, 2019, JP Corp. decided to purchase its own 1,000 shares issued on September 2, 2019, for
P40.
f. On October 2, 2019, JP Corp. decided t0 reissue 200 shares purchased on October 1, 2019, for P45.
g. On December 1, 2019, JP Corp. decided to retire all the remaining treasury shares.

3. On June 1, 2015, five incorporators formed a corporation named Parisan Co., Inc. and filed with the Securities
and Exchange Commission (SEC) its Articles of Incorporation for approval. It has an authorized capital of
10,000 ordinary shares with a par value of 200 per share. On July 2, 2015, the SEC approved the Articles of
Incorporation showing the following information:

Authorized Share Capital, 10,000 shares, par P200 2,000,000

Share Capital 500,000
Subscribed Share Capital 600,000
Subscription Receivable 100,000
Share Premium 110,000

a. How much is the issued share capital?

b. How many shares have been issued?
c. How many shares are subscribed to?
d. How much is the total contributed capital?
e. How many shares are still unissued?
f. Prepare a shareholders’ equity section of the balance sheet.

4. This is the shareholders’ equity of the JP Corporation.

10% preference share, P60 par value 300,000

Share premium-preference shares 20,000
Ordinary shares 700,000
Share premium-ordinary shares 300,000
Subscribed share capital-ordinary shares 100,000
Subscription receivable-ordinary shares (20,000)
Retained earnings 400,000

What is the legal capital if the ordinary shares have a par value? no-par value?

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CPALE Simulation Level 20

1. Which of the following is not one of the basic 2. The entry to record the issuance of ordinary shares for
shareholder’s rights? fully paid share subscriptions is _____.
a. the right to participate in earnings. a. a memorandum entry
b. the right to maintain one's proportional interest in the b. Dr. common stock subscribed; Cr. common stock; Cr.
corporation. additional paid-in capital
c. the right to participate in the proceeds of the sale of c. Dr. subscribed share capital; Cr. subscriptions receivable
corporate assets upon liquidation d. Dr. subscribed share capital; Cr. share capital
d. the right to inspect the accounting records of the
corporation.
3. JC Corp. reacquires 10,000 of its own shares for P50. The 4. Two years ago, JZ Corp. reacquired 2,000 of its own
shares have a par value of P10 and were originally issued shares with a par value of P100 per share for P240,000.
at P15 per share. Subsequently, JC Corp. reissues the Today, JZ Corp. reissues half of the treasury shares at
10,000 shares at P48 per share. The journal entry to P160 per share. The journal entry to record the re-
record the re-issuance involves which of the following? issuance includes which of the following?
a. debit to retained earnings for P20,000 a. credit to retained earnings for P240,000
b. credit to cash for P480,000 b. debit to treasury shares for P120,000
c. debit to share premium for P50,000 c. credit to share premium-treasury shares for P80,000
d. debit to treasury shares for P500,000 d. credit to share premium-treasury shares for P40,000
5. Gains and losses on the purchase and resale of treasury 6. The issuance of shares of preferred stock to
stock may be reflected only in _______. shareholders ______.
a. share premium account a. increases preferred stock outstanding
b. share premium and retained earnings accounts b. does not affect preferred stock outstanding
c. income, paid-in capital, and retained earnings accounts c. increases preferred stock authorized
d. income and paid-in capital accounts d. decreases preferred stock authorized
7. On February 1, the authorized ordinary share was sold on 8. Legal capital is the portion of contributed capital that
a subscription basis at a price over par value, and 20 cannot be distributed to the owners during the lifetime
percent of the subscription price was collected. On May of the corporation unless the corporation is dissolved
1, the remaining 80 percent of the subscription price was and all of its liabilities are settled first. For no-par value
collected. Share premium would increase on _____. shares, legal capital is ______.
February 1 May 1 a. the aggregate par value of shares issued and subscribed
a. No Yes b. the total consideration received or receivable from
b. No No shares issued or subscribed
c. Yes No c. the aggregate stated value of shares issued and
d. Yes Yes subscribed
d. the aggregate market value of shares issued and
subscribed
9. Which of the following is an appropriate presentation of 10. Which of the following is not a component of
treasury stock? shareholders’ equity?
a. as a marketable security a. treasury shares
b. as a deduction at cost from total stockholders' equity b. share premium
c. as a deduction at cost from total contingent liabilities c. ordinary shares
d. as a deduction at par from total stockholders' equity d. preferential rights

Suggested Exercises

1. Problem 1-7, Basic Financial Accounting and Reporting 22nd Edition (2019) by Ballada & Ballada, pp. 15-31 to
15-37.
2. Problem 2-4, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp. 555-563.
3. Exercises E13.3 to E13.15, Accounting Principles 13th Edition (2018) by Weygandt, Kimmel & Kieso, pp. 13-26 to
13-29.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition. Manila, Philippines:
DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City, Philippines:
Bandolin Enterprise.
3. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John Wiley & Sons
(Asia) Pte Ltd.

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Lesson 21 ACCOUNTING FOR DIVIDENDS

Did you know that?

LEARNING OBJECTIVE The Philippine Institute of Certified Public
1. Perform procedures in accounting Accountants as the nationally accredited professional
organization of CPAs in the country is composed of 4
dividends. geographical areas, 9 regions, and 4 sectors.

A dividend is a distribution of a portion of the unrestricted retained earnings of a corporation to the shareholders.
This can be cash dividends, property dividends, or shares dividends. Cash dividends are distributions in the form of
cash. Property dividends are distributions in the form of non-cash assets. Share dividends are distributions in the
form of the company’s own shares. There are 3 important dates to remember in accounting dividends namely, the
date of declaration, the date of record, and the date of payment. The date of declaration is the date when the
board of directors formally announces the distribution of dividends. The date of record is the date on which the
stock and transfer book of the corporation is closed for registration. Only those who are listed as of the record
date are entitled to receive dividends. The date of payment is the date when the dividends declared are paid to
the shareholders.

In accounting for cash dividends, only the outstanding shares are entitled to dividends. When we say outstanding
shares, these are shares issued plus the subscribed shares minus the treasury shares. Please take note that only
subscribed shares with par value are included as part of outstanding shares, otherwise, if it is a no-par value
subscribed share, it is only considered legally issued when fully paid.

During the declaration of dividends

On May 1, 2019, the board of directors of JM
Retained earnings 490,000
Corporation declared a cash dividend of P10 per share.
Cash dividends payable 490,000
The dividends are to be paid on July 1, 2019, to
shareholders in the record as of June 1, 2019. The
entity has 50,000 shares issued of which 1,000 shares During the payment of dividends
are treasury shares. Cash dividends payable 490,000
Cash 490,000

Due to complexity, accounting for property dividends will be discussed in your intermediate accounting subject.

In accounting for share dividends, when the share dividends declared are less than 20% of the total outstanding
shares, which is known as small share dividends, the share dividends are accounted for at fair value. The
difference between the fair value and par value are charged to share premium. When the share dividends are 20%
or more of the total outstanding shares, also known as large share dividends, the share dividends are accounted
at par value and therefore, this will not result in a share premium.

During the declaration of dividends

On May 1, 2019, the board of directors of JM
May 1 Retained earnings 270,000
Corporation declared a 10% share dividend. The
Share dividends payable 225,000
dividends are to be paid on July 1, 2019, to shareholders
Share premium 45,000
in the record as of June 1, 2019. The entity has 50,000
shares issued with a par value of P50 of which 5,000
shares are treasury shares. The shares are currently During the payment of dividends
traded in the stock market at P60 per share. July 1 Share dividends payable 225,000
Share capital 225,000

Outstanding shares = 50,000-5,000 = 45,000 In computing the number of shares declared as dividends,
Share dividends @ fair value = 45,000 x 10% = 4,500 x P60 = P270,000
Share dividends @ par value = 45,000 x 10% = 4,500 x P50 = P225,000
simply multiply the % of share dividends with the outstanding
Share premium = P270,000 – P225,000 = P45,000 shares.

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During the declaration of dividends

On May 1, 2019, the board of directors of JM
May 1 Retained earnings 450,000
Corporation declared a 20% share dividend. The
Share dividends payable 450,000
dividends are to be paid on July 1, 2019, to shareholders
in the record as of June 1, 2019. The entity has 50,000
shares issued with a par value of P50 of which 5,000 During the payment of dividends
shares are treasury shares. The shares are currently July 1 Share dividends payable 450,000
traded in the stock market at P60 per share. Share capital 450,000

Outstanding shares = 50,000-5,000 = 45,000 Since this is a large share dividend, only the par value is
Share dividends @ par value = 45,000 x 20% = 9,000 x P50 = P450,000
considered and no share premium is recorded.

Share dividends change the composition of shareholders’ equity because of the transfer of a portion of retained
earnings to share capital. However, total shareholders’ equity remains the same. Share dividends also do not
affect the par or stated value per share, but the number of shares outstanding increases.
When treasury shares are declared as dividends, the cost method is used instead of rules on small and large share
dividends.

During the declaration of dividends

On May 1, 2019, the board of directors of JM
May 1 Retained earnings 270,000
Corporation declared a 10% share dividend from
Share dividends payable 270,000
its treasury shares which were acquired at P60
per share. The dividends are to be paid on July 1,
2019, to shareholders in the record as of June 1, During the payment of dividends
2019. The entity has 50,000 shares issued with a July 1 Share dividends payable 270,000
par value of P50 of which 5,000 shares are Treasury shares 270,000
treasury shares. Retained earnings-appropriated 270,000
Retained earnings-unappropriated 270,000

Outstanding shares = 50,000-5,000 = 45,000 Treasury shares have corresponding retaining earnings when
Share dividends @ par value = 45,000 x 10% = 4,500 x P60 = P270,000
acquired and to be reversed when reissued or retired.

Preference shareholders have preference over ordinary shareholders as assets during corporate liquidation and as
to dividends. Corporate liquidation will be discussed in advanced financial accounting reporting. In this lesson, we
will discuss only the basic accounting of dividends for preference shareholders. Preference over dividends
depends on preferential rights. These rights can be cumulative or non-cumulative. It can also be participating or
non-participating. The preferential rates can be expressed as a percentage of par value or a specific amount per
share. A 10% preference share is entitled a dividend of 10% of its par value while a P10 preference share is entitled to a
dividend of P10 per share.
Cumulative preference share entitles to be paid both the current year and any unpaid prior year dividends, also
knowns as dividends in arrears, before ordinary shareholders are paid dividends, otherwise, it is non-cumulative
and only the current year dividends are to be paid. Participating preference shares entitle to additional dividends
aside from the fixed dividends if there is an excess of the declared dividends after payment of the basic dividends
of both preference and ordinary shareholders. Basic dividends for preference shareholders depend on whether
cumulative or non-cumulative. Basic dividends of ordinary shareholders are computed by multiplying the aggregate
par value of outstanding ordinary shares by the lowest preferential rate if there is more than one class of
preference shares. Non-participating preference shareholder entitles only up to their basic dividends. Participating
preference shares can either be fully participating or partially participating. Fully participating entitles a
preference shareholder to fully participate for any excess dividends while partially participating entitles only up to
a certain percentage for any excess dividends. Preference shares are presumed to be non-cumulative and non-
participating unless expressly stated.

On December 31, 2019, JM Corp. declared P3,000,000 cash dividends to its preference and ordinary shareholders. No
dividends have been declared since 2017. The shareholders’ equity is composed of:

5% preference shares, P100 par, 30,000 shares issued and outstanding P3,000,000
Ordinary shares, P50 par, 100,000 shares issued and outstanding 5,000,000
Retained earnings 5,000,000
Total shareholders’ equity P13,000,000

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LEARNING MODULES

Compute the distribution of dividends to Total declared dividends 3,000,000

preference and ordinary shareholders 5% preference shares, P100 par, 30,000 shares issued and outstanding
assuming the preference shares are non- (5% x P100 x 30,000 shares) 150,000
cumulative and non-participating. Ordinary shares, P50 par, 100,000 shares issued and outstanding
(3,000,000-150,000=2,850,000) 2,850,000
Total dividends as allocated -

Compute the distribution of dividends to Total declared dividends 3,000,000

preference and ordinary shareholders 5% preference shares, P100 par, 30,000 shares issued and outstanding
assuming the preference shares are (5% x P100 x 30,000 shares x 3 years) 450,000
cumulative and non-participating. Ordinary shares, P50 par, 100,000 shares issued and outstanding
(3,000,000-150,000=2,850,000) 2,550,000
Total dividends as allocated -

Compute the distribution of dividends to Total declared dividends 3,000,000

preference and ordinary shareholders Basic dividend for 5% preference shares, P100 par, 30,000 shares issued
assuming the preference shares are and outstanding (5% x P100 x 30,000 shares x 3 years) 450,000
cumulative and fully participating. Basic dividend for ordinary shares, P50 par, 100,000 shares issued and
outstanding (5,000,000 x 5%=250,000) 250,000
Excess dividends 2,300,000
Participation of preference shares (2,300,00 x 3,000,000/8,000,00) 862,500
Participation of ordinary shares (2,300,00 x 5,000,000/8,000,00) 1,437,500
Total dividends as allocated -

Compute the distribution of dividends to Total declared dividends 3,000,000

preference and ordinary shareholders Basic dividend for 5% preference shares, P100 par, 30,000 shares issued
assuming the preference shares are non- and outstanding (5% x P100 x 30,000 shares) 150,000
cumulative and fully participating. Basic dividend for ordinary shares, P50 par, 100,000 shares issued and
outstanding (5,000,000 x 5%=250,000) 250,000
Excess dividends 2,600,000
Participation of preference shares (2,600,00 x 3,000,000/8,000,00) 975,000
Participation of ordinary shares (2,600,00 x 5,000,000/8,000,00) 1,625,000
Total dividends as allocated -

Compute the distribution of dividends to Total declared dividends 3,000,000

preference and ordinary shareholders Basic dividend for 5% preference shares, P100 par, 30,000 shares issued
assuming the preference shares are and outstanding (5% x P100 x 30,000 shares x 3 years) 450,000
cumulative and participating up to 20%. Basic dividend for ordinary shares, P50 par, 100,000 shares issued and
outstanding (5,000,000 x 5%=250,000) 250,000
Excess dividends 2,300,000
Participation of preference shares (20%-5%=15%x3,000,000) 450,000
Participation of ordinary shares (2,300,00 -450,000) 1,850,000
Total dividends as allocated -

When a preference share is participating partially to a certain percentage, get the difference between the participating rate
and preferential rate and multiply it to the par value of the participating preference shares to get its share in the excess
dividends.

Liquidating dividends arises when the company declares dividends out of the share capital especially if it is on the
process of corporate liquidation. However, there are wasting assets corporations e.g. mining corporations that
can declare liquidating dividends during its existence as governed under the wasting assets doctrine. The
liquidating dividend is to be debited as capital liquidated which is a deduction from total shareholders’ equity.
During the declaration of dividends
On May 1, 2019, the board of directors of JM
May 1 Capital liquidated 1,000,000
Corporation declared a P2,000,000 cash
Retained earnings 1,000,000
dividend. The dividends are to be paid on July
Cash dividends payable 2,000,000
1, 2019, to shareholders in the record as of June
1, 2019. 50% of the dividends are liquidating
dividends since JM Corp. is a liquidating During the payment of dividends
concern. July 1 Cash dividends payable 2,000,000
Cash 2,000,000

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 FINANCIAL ACCOUNTING AND REPORTING
LEARNING MODULES

There are cases when corporations split the shares either split up, also known as share split, or split down, also
known as a reverse share split primarily as an equity financing tool to make the shares affordable to potential
investors. Split up occurs when old shares are canceled and replaced by a larger number of new shares but with a
reduced par value or stated value per share. Split down is the opposite of split up whereby old shares are canceled
and replaced by a smaller number of new shares but with an increased par value or stated value per share. In both
cases, they do not affect the elements of the financial statements except that the number of shares is either
decreased or increased and its par value or stated value is either increased or decreased. Thus, only a memo entry
is made to record the transaction.

JM Corp. has 100,000 shares with a par value of Memorandum entry

P1,000. JM Corp. declares a “4 for 1 share split”. Issued 400,000 shares with a par value of P250 as a result of a “4
for 1 share split” of 100,000 old shares with a par value of P1,000.

Memorandum entry
JM Corp. has 100,000 shares with a par value of P1,000.
JM Corp. declares a “4 for 1 reverse share split”. Issued 25,000 shares with a par value of P4,000 as a result of a “4
for 1 share split” of 100,000 old shares with a par value of P1,000.

Review Exercises
1. On January 1, 2019, the board of directors of JP Corporation declared a cash dividend of P20 per share. The
dividends are to be paid on April 1, 2019, to shareholders in the record as of March 1, 2019. The entity has
500,000 shares issued of which 10,000 shares are treasury shares. Provide the journal entries in recording the
transactions.
2. On January 1, 2019, the board of directors of JP Corporation declared a 15% share dividend. The dividends are
to be paid on April 1, 2019, to shareholders in the record as of March 1, 2019. The entity has 500,000 shares
issued with a par value of P70 of which 50,000 shares are treasury shares. The shares are currently traded in
the stock market at P90 per share. Provide the journal entries in recording the transactions.
3. On January 1, 2019, the board of directors of JP Corporation declared a 25% share dividend. The dividends are
to be paid on April 1, 2019, to shareholders in the record as of March 1, 2019. The entity has 500,000 shares
issued with a par value of P70 of which 50,000 shares are treasury shares. The shares are currently traded in
the stock market at P90 per share. Provide the journal entries in recording the transactions.
4. On January 1, 2019, the board of directors of JP Corporation declared a 10% share dividend from its treasury
shares which were acquired at P100 per share. The dividends are to be paid on April 1, 2019, to shareholders
in the record as of March 1, 2019. The entity has 500,000 shares issued with a par value of P40 of which
50,000 shares are treasury shares. Provide the journal entries in recording the transactions.
5. On December 31, 2019, JP Corp. declared P2,000,000 cash dividends to its preference and ordinary
shareholders. No dividends have been declared since 2016. The shareholders’ equity is composed of:

8% preference shares, P200 par, 10,000 shares issued and outstanding P2,000,000
Ordinary shares, P100 par, 25,000 shares issued and outstanding 2,500,000
Retained earnings 3,000,000
Total shareholders’ equity P7,500,000

Compute the distribution of dividends to preference and ordinary shareholders assuming that:
a. The preference shares are non-cumulative and non-participating.
b. The preference shares are cumulative and non-participating.
c. The preference shares are cumulative and fully participating.
d. The preference shares are non-cumulative and fully participating.
e. The preference shares are cumulative and participating for up to 15%.
6. On January 1, 2019, the board of directors of JP Corporation declared a P500,000 cash dividend. The
dividends are to be paid on April 1, 2019, to shareholders in the record as of March 1, 2019. 40% of the
dividends are liquidating dividends since JP Corp. is a liquidating concern. Provide the journal entries in
recording the transactions.
7. JP Corp. has 200,000 shares with a par value of P100. JP Corp. declares a “5 for 1 share split”. Provide a
memorandum entry.
8. JP Corp. has 200,000 shares with a par value of P100. JP Corp. declares a “5 for 1 reverse share split”. Provide
a memorandum entry.

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 FINANCIAL ACCOUNTING AND REPORTING
LEARNING MODULES

CPALE Simulation Level 21

1. Cash dividends payable or stocks dividends payable is 2. Which of the following causes a change in the total
credited on the ____. amount of shareholders’ equity?
a. date of dividend declaration a. share dividends
b. date of dividend subscription b. split-up
c. date of record c. split-right
d. any of these d. split-down
3. JD Corp. has 30,000 shares outstanding. If JD Corp. 4. Which of the following does not increase the balance of
declares 3,000 share dividends, the share dividends will the share premium account?
be accounted for _____. a. subscription of shares above the stated value
a. at cost b. re-issuance of treasury shares at more than their
b. at par value reacquisition cost
c. at fair value c. split-up
d. at no-par value d. issuance of small share dividends
5. Which of the following is not a liability account? 6. The dividend account is most similar to a ______.
a. accounts payable a. drawings account
b. utilities payable b. partner’s capital account
c. current tax payable c. owner’s capital account
d. stock dividends payable d. none of these
7. These are dividends declared out of capital, rather than 8. A preference share whose dividend entitlement for a
from retained earnings. year is forfeited when the dividends are not declared.
a. liquidating dividends a. non-cumulative
b. dissolving dividends b. cumulative
c. investment dividends c. non-participating
d. capital dividends d. participating
9. It refers to the distributions to shareholders. 10. Small share dividends are recorded at _____.
a. retained earnings a. fair value
b. share premium b. book value
c. treasury shares c. par value
d. dividends d. carrying amount
11. This method is used in accounting for treasury shares 12. It represents the cumulative profits that are retained in
declared as dividends. the business and not yet distributed to the shareholders.
a. fair value method a. retained earnings
b. zonal value method b. share premium
c. market value method c. treasury shares
d. cost method d. share dividends
13. It is the most common distribution to shareholders. 14. Which of the following is not a contra equity account?
a. cash dividends a. capital liquidated
b. share dividends b. treasury shares
c. property dividends c. subscription receivable
d. liquidating dividends d. share premium
15. In allocating dividends to preference shares and ordinary
shares and there are two types of preference shares,
both participating but with different rates, the basic
dividends on the ordinary shares are computed using __.
a. the lower preferred dividend rate
b. the higher preferred dividend rate
c. the average preferred dividend rate
d. any of these
Suggested Exercises

1. Problem 1-7, Basic Financial Accounting and Reporting 22nd Edition (2019) by Ballada & Ballada, pp. 15-31 to 15-37.
2. Problem 2-4, Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp. 555-563.
3. Exercises E13.3 to E13.15, Accounting Principles 13th Edition (2018) by Weygandt, Kimmel & Kieso, pp. 13-26 to 13-29.
References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition. Manila, Philippines: DomDane
Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio City, Philippines: Bandolin
Enterprise.
3. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition. Asia: John Wiley & Sons (Asia) Pte
Ltd.

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POST-TEST
Instruction: Read the questions carefully. Write your answer in a ½ lengthwise sheet of paper. Choose
the best answer only!
1. While making a delivery, the driver of Super Man collided with another vehicle causing both
property damage and personal injury. The party sued Faster for damages that could exceed Man's
insurance coverage. The existence of the lawsuit was reported in the notes to Man's financial
statements. What accounting principle, assumption, or constraint is being applied in this situation?
a. full-disclosure b. conservatism c. matching principle d. unit-of-measure
2. A business has total assets of P640,000 and total equity of P360,000 at the beginning of the
period. The business earns an income of P220,000 during the period and reports a profit of
P80,000. There were no transactions with the owner during the period. Total liabilities increased
by P40,000 by the end of the period. How much are the total assets at the end of the period?
a. P560,000 b. P440,000 c. P860,000 d. P760,000
3. What is the primary purpose of accounting?
a. to count money
b. to provide accounts
c. to provide information that is intended to be useful in making economic decisions
d. to produce accountants
4. Accounts are listed in the trial balance in this sequence.
a. asset, liabilities, equity, expense, and income
a. asset, equity, liabilities, expense, and income
b. asset, liabilities, equity, income, and expense
c. asset, expense, liabilities, equity, and income
5. The following are decisions made by internal users except _____.
a. to analyze the profitability of product lines
b. to impose taxes
c. to decide whether to continue or discontinue product lines
d. to decide whether to build new production facilities
6. The branch of accounting that deals with providing financial information to external decision-
makers is ______.
a. public accounting b. government accounting
c. financial accounting d. managerial accounting
7. The first step in the accounting cycle is ______.
a. posting to the ledger b. journalizing
c. preparing the adjusting entries d. analyzing events
8. When uncertainty exists, the convention of conservatism or prudence uses estimates of a
conservative nature in an attempt to ensure which of the following?
a. Assets, income, liabilities, and expenses are not overstated.
b. Assets, income, liabilities, and expenses are not understated.
c. Assets and income are not understated; liabilities and expenses are not overstated.
d. Assets and income are not overstated; liabilities and expenses are not understated.
9. The information has this qualitative characteristic if two different users could reach a general
agreement as to what the information intends to represent.
a. relevance b. comparability c. faithful representation d. verifiability

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10. At the beginning of the period, a business has a cash balance of P20,000. During the period, total
cash collections and total cash payments amounted to P100,000 and P70,000, respectively. How
much is the ending balance of cash?
a. P10,000 b. P30,000 c. P50,000 d. P70,000
11. In a service-type of business, revenue is considered earned _______.
a. at the end of the month b. at the end of the year
c. when the service is performed d. when cash is received
12. At the beginning of the period, Addy had a cash balance of P20,000 and notes payable of P15,000.
During the period, Addy collected P11,000 accounts receivable, paid P8,000 notes payable, and
issued additional notes payable of P5,000 in exchange for cash. How much are the ending
balances of cash and notes payable, respectively?
Cash Notes payable
a. P17,000 P20,000
b. P20,000 P12,000
c. P28,000 P12,000
d. P36,000 P20,000
13. If a resource has been consumed but a bill has not been received at the end of the accounting
period, then _______.
a. an expense should be recorded when the bill is received
b. an expense should be recorded when the cash is paid out
c. an adjusting entry should be made recognizing the expense
d. it is optional whether to record the expense before the bill is received
14. Which of the following would result in an income of P320,000?
a. total expenses of p280,000 and loss of p40,000
b. total expenses of p360,000 and profit of p40,000
c. total expenses of p220,000 and loss of p100,000
d. total expenses of p360,000 and loss of p40,000
15. The term posting as used in accounting means ______.
a. recording an accountable event in debit-credit format
b. transferring the debits and credits of journal entries from the journal to the affected accounts in
the ledger
c. checking the equality of the monetary totals of debits and credits of accounts in the ledger
d. uploading photographs to the internet
16. A law firm received P2,000.00 cash for legal services to be rendered in the future. The full amount
was credited to unearned legal fees. If the legal services have been rendered at the end of the
accounting period and no adjusting entry is made, this would cause _____.
a. expenses to be overstated b. net income to be overstated
c. liabilities to be understated d. revenues to be understated
17. When preparing closing entries, which of the following accounts is debited when closing to the
income summary account?
a. depreciation expense b. owner’s drawings
c. sales d. salaries payable
18. Revenues earned from rendering services are recorded in this account.
a. sales b. service fees c. interest income d. gains
19. Polok Company purchased office supplies costing P6,000 and debited office supplies for the full
amount. At the end of the accounting period, a physical count of office supplies revealed P2,400
still on hand. The appropriate adjusting journal entry to be made at the end of the period would
be
a. debit office supplies expense, P2,400; credit office supplies, P2,400
b. debit office supplies expense, P3,600; credit office supplies expense, P3,600
c. debit office supplies expense, P3,600; credit office supplies, P3,600
d. debit office supplies, P2,400; credit office supplies expense, P2,400

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20. At the time of dissolution, ________.
a. all assets and liabilities are restated at their fair values
b. only current assets are restated at their fair values
c. non-cash assets are restated at their fair values
d. only non-current assets are restated at their fair values
21. The financial statement that shows the information on assets, liabilities, and equity is the ___.
a. balance statement b. income sheet c. balance sheet d. income statement
22. Mr. C and Ms. D formed a partnership and agreed to divide the initial capital equally even though
Mr. C contributed P100,000 and Ms. D contributed P84,000 in identifiable assets. The partners
agree that the difference in the amount of contribution and the amount of credit to the partner’s
capital shall be treated as compensation for the expertise that the partner will be bringing to the
partnership. How much is the correct valuation of C’s capital immediately after the partnership
formation?
a. P84,000 b. P92,000 c. P100,000 d. P108,000
23. The accounts debited when recording purchases of inventory under the perpetual inventory
system and periodic inventory system, respectively, are
Perpetual Periodic
a. inventory purchases
b. purchases inventory
c. inventory merchandise inventory
d. purchases purchases
24. The account to be used under the periodic inventory system to record the transportation costs
incurred on purchases.
a. freight-out b. transportation out c. freight-in d. purchases-in
25. Inventory, beg. P50,000; net purchases, p120,000; cost of goods sold, P80,000. How much is the
ending inventory?
a. P90,000 b. P120,000 c. P70,000 d. P80,000
26. JP Corp. has a beginning inventory of P340,000. During the period JP Corp. purchased inventories
costing P990,000. Freight paid on the purchase totaled P40,000. The ending inventory was
P360,000. If the net sales were P1,200,000, how much is the gross profit?
a. P1,010,000 b. P1,200,000 c. P190,000 d. P260,000
27. F and G share in partnership profits and losses on a 40:60 ratio. During the year, F’s capital
account has a net increase of P50,000. Partner F made contributions of P10,000 and capital
withdrawals of P60,000 during the year. How much was the share of G in the partnership profit
for the year?
a. P100,000 b. P150,000 c. P200,000 d. P180,000
28. L and M formed a partnership. L contributed cash of P500,000 while M contributed land with a
carrying amount of P400,000 and a fair value of P800,000. The land has an unpaid mortgage of
P200,000 which is assumed by the partnership. How much is the correct valuation of M’s capital
immediately after the partnership formation?
a. P400,000 b. P500,000 c. P600,000 d. P800,000
29. Which of the following best describes the nature of salary and interest allowance in a partnership
profit and loss sharing agreement?
a. expenses of the business that should be deducted from revenue in determining the income
b. the amount upon which each partner will have to pay personal income tax
c. a means of distributing net income to services rendered and capital invested by partners
d. a means of determining reasonable monthly withdrawals by each partner
30. If gross sales are P40,000, sales returns and allowances P1,000, sales discounts P400, and delivery
expenses P100, the net sales of the business will total ______.
a. P38,500 b. P38,600 c. P40,000 d. P39,000

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31. JS Corp. reacquires 10,000 of its own shares for 50. The shares have a par value of P10 and were
originally issued at P15 per share. Subsequently, JS Corp. reissues the 10,000 shares at P48 per
share. The journal entry to record the re-issuance involves which of the following?
a. debit to retained earnings for P20,000
b. credit to cash for P480,000
c. debit to share premium for P50,000
d. debit to treasury shares for P500,000
32. Cash dividends payable or stock dividends payable is credited on the _____.
a. date of dividend declaration b. date of dividend subscription
c. date of record d. any of these
33. An example of a nominal contra account is ______.
a. accumulated depreciation b. freight-in
c. premium on bond liability d. sales return
34. At the time of admission of a new partner, the firm is _____.
a. dissolved b. continued c. not affected d. either a or b
35. Legal capital is the portion of contributed capital that cannot be distributed to the owners during
the lifetime of the corporation unless the corporation is dissolved and all of its liabilities are
settled first. For no-par value shares, legal capital is _____.
a. the aggregate par value of shares issued and subscribed
b. the total consideration received or receivable from shares issued or subscribed
c. the aggregate stated value of shares issued and subscribed
d. the aggregate market value of shares issued and subscribed
36. A partner’s loss absorption balance is calculated by ______.
a. dividing the partner’s capital balance by his percentage interest in the capital
b. dividing the partner’s total interest by his profit and loss sharing percentage
c. multiplying the partner’s total interests by his profit and loss sharing percentage
d. multiplying distributable assets by the partner’s profit-sharing percentage
37. Two years ago, PJ Corp. reacquired 2,000 of its own shares with a par value of P100 per share for
P240,000. Today, PJ Corp. reissues half of the treasury shares at P160 per share. The journal entry
to record the re-issuance includes which of the following?
a. credit to retained earnings for P240,000
b. debit to treasury shares for P120,000
c. credit to share premium-treasury shares for P80,000
d. credit to share premium-treasury shares for P40,000
38. Green and Yellow are partners who share profits and losses in the ratio of 6:4, respectively. On
May 1, 2016, their respective capital accounts were P60,000 and P50,000 respectively. On that
date, Blue was admitted as a partner with a one-third interest in capital and profits for an
investment of P40,000. The new partnership began with total capital of P150,000. Blue’s capital
account was credited equally to her proportionate share in the partnership net assets.
Immediately after Blue’s admission, Green’s capital should be ______.
a. P50,000 b. P54,000 c. P56,667 d. P60,000
39. As of December 31, 2016, the books of FMJ Partnership showed capital balances of Famado,
P40,000; Menteng, P25,000; Jando, P5,000. The partner’s profit and loss ratio were 3:2:1,
respectively. The partners decided to liquidate and they sold all non-cash assets for P37,000. After
the settlement of all liabilities amounting to P12,000, they still have cash of P28,000 left for
distribution. Assuming that any capital deficiency is uncollectible, the share of Famado in the
distribution of cash would be:
a. P17,000 b. P17,800 c. P18,000 d. P19,000
40. Which of the following is not one of the basic shareholder’s rights?
a. the right to participate in earnings.
b. the right to maintain one's proportional interest in the corporation.
c. the right to participate in the proceeds of the sale of corporate assets upon liquidation
d. the right to inspect the accounting records of the corporation.

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REFERENCES
1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition.
Manila, Philippines: DomDane Publishers.
2. International Federation of Accountants. (2007). IFAC: 30 Years of Progress Encouraging
Quality and Building Trust https://www.ifac.org/system/files/downloads/IFAC_History_-_
Nov_2007.pdf.
3. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio
City, Philippines: Bandolin Enterprise.
4. Philippine Institute of Certified Public Accountants (2016). History of the PICPA.
https://www.picpa.com.ph/content.html?article=History&page=About
5. Philippine Institute of Certified Public Accountants - Northern Metro Manila Chapter.
(2018). PFRS.
6. Smith, M. (2018). Luca Pacioli: The father of accounting (2018). Available at SSRN:
https://ssrn.com/abstract=2320658 or http://dx.doi.org/10.2139/ssrn.2320658
7. Torres, J. (2018). 95 years of invaluable service. https://www.manilatimes.net/2018/03/08/
opinion/analysis/95-years-of-invaluable-service/384747/
8. Valcarcel, L. (2018). CPA Examination in the Philippines. https://businessmirror.com.ph/
2018/10/01/cpa-examination-in-the-philippines/
9. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition.
Asia: John Wiley & Sons (Asia) Pte Ltd.

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 VISION
A high quality corporate University of Science, Technology and Innovation.

MISSION
SLSU will develop science, technology and innovative leaders and
professionals, produce high impact technologies from research and
innovations, contribute to sustainable development through responsive
community engagement programs, and generate revenues to be
self-sufficient and financially viable.

CORE VALUES
Service Excellence
Leadership Competence
Stewardship and Accountability
Unity in Diversity

QUALITY POLICY
We, at Southern Leyte State University, commit enthusiastically to satisfy
our stakeholders’ needs and expectations by adhering to good governance,
relevance, and innovations of our instructions, research and development,
extension and other support services and continually improve the
effectiveness of Quality Management System in compliance to ethical
standards and applicable statutory, regulatory, industry and stakeholders’
requirements.

Prepared by:
College of Business and Management
Southern Leyte State University
San Juan, Southern Leyte, Philippines