CONCEPTUAL FRAMEWORK AND REPORTING STANDARDS

Topic 1: Accounting in Action

➤ A. Definition of Accounting

Accounting is a service activity. Its Accounting is the process of Accounting is the art of recording,
function is to provide quantitative identifying, measuring and classifying and summarizing in a
information, primarily financial in communicating economic information significant manner and in terms of
nature, about economic entities, that to permit informed judgment and money, transactions and events which
is intended to be useful in making decision by users of the information. are, in part at least, of a financial
economic decision. (Accounting (American Accounting Information) character, and interpreting the results
Standards Council) thereof (American Institute of Certified
Public Accountants)

➤ B. Nature of Accounting
Accounting is the language of business. It is the medium of communication through which financial reports are furnished to
different parties for decision-making. It interprets and communicates the true status of the business in terms of its
operating results and financial condition.

➤ C. Forms of Business Organizations

As to type of business or purpose: As to ownership:

Service Organizations – are those engaged in rendering Sole or Single proprietorship – is a form of business owned
services. Examples are the accounting firms, janitorial by one person only. The owner is called the proprietor.
services, collection agencies, tutorial services, massage Generally, the proprietor of this type of business has unlimited
parlors, voice lessons etc. liability towards his creditors.

Trading or merchandising – are those engaged in buying Partnership – is an association of two or more persons who
and selling goods like sari-sari stores, department stores, have agreed to contribute money, property or industry to a
supermarket and others. These firms buy goods and sell “as common fund, with the intention of dividing the profit among
is” without changing the form of the goods. The operating themselves. The owners are called Partners. Generally, the
cycle of a merchandising business refers to the number of partners have unlimited liability towards their creditors.
days from the acquisition of the merchandise inventory to the
conversion of these inventory to cash.

Manufacturing firms – are those engaged in buying raw Corporation – is an artificial being created by operation of
materials and transforming them into finished products. law, having the right of succession and the powers,
They change the form of what they buy by producing a attributes and properties expressly authorized by law or
different kind of product. Examples of small business incident to its existence. The owners of a corporation are
engaged in manufacturing are: garments manufacturing, called shareholders or stockholders. Generally, the
furniture Shops, food products manufacturers etc. stockholders have limited liability towards their creditors.

➤ D. Purpose of Accounting

The accounting function is part of the broader business system, and does not operate in isolation. It handles the financial
operations of the business but also provides information and advice to other departments. Accounting provides the decision-
makers with information to make reasoned choices among alternative uses of scarce resources in the conduct of business and
economic activities.

➤ E. Career Opportunities

The professional accountant is presented with a myriad of opportunities. The demand for accounting services has increased
with the increase in number, size and complexity. The accountant may be engaged in any of the following areas of
competence:
 ➥Accountants who render services on a fee basis and staff accountants
employed by them are engaged in public practice. Public accountants, who
practice individually or as members of public accounting firms, should be
Public practice
certified public accountant CPAs). They offer their professional services to the
public. Their work includes auditing, taxation and management advisory
services.

➥Accountants employed in this area vary widely in their scope of activities and
Commerce and industry responsibilities.

➥Government service accountants may be hired by the following: Congress of the

Philippines, Commission on Audit (COA), Bureau of Internal Revenue (BIR), Department
Government of finance, Department of Budget and Management, Bangko Sentral ng PIlipinas (BSP)
and the local government units (e.g. provincial, city or municipal governments).

➥This area guarantees the continued development of the profession by endeavoring to

clarify and address emerging issues through research and sharing the results obtained
with their colleagues. Considered as modern day heroes, they make others understand
Education/Academe
the body of accounting knowledge. In addition, they painstakingly prepare candidates for
the tough CPA exams. With the advent of information technology, this sector is being
challenged to focus accounting education from the “transfer of knowledge approach” to
the more effective “learning to learn “approach.

TOPIC: 2 Accounting Equation and Double Entry System

➤ A. Accounting Equation
The two basic elements of a business are what it owns and what it owes. Assets are the resources a business controlled.
For example, Google has total assets of approximately P93.8 billion. Liabilities and owner’s equity are the rights or claims
against these resources. Thus, Google has P93.8 billion of claims against its P93.8 billion of assets. Claims of those to whom
the company owes money (creditors) are called liabilities. Claims of owners are called owner’s equity. Google has liabilities
of P22.1 billion and owners’ equity of P71.7 billion.

We can express the relationship of assets, liabilities, and owner’s equity as an equation, as shown in Illustration 1-5
Illustration: The Basic Accounting Equation

Assets = Liabilities + Owner’s Equity

Illustration 1-5: The Basic Accounting Equation

This relationship is the basic accounting equation. Assets must equal the sum of liabilities and owner’s equity. Liabilities
appear before owner’s equity in the basic accounting equation because they are paid first if a business is liquidated. The
accounting equation applies to all economic entities regardless of size, nature of business, or form of business
organization. It applies to a small proprietorship such as a corner grocery store as well as to a giant corporation such as
PepsiCo. The equation provides the underlying framework for recording and summarizing economic events. Let’s
look in more detail at the categories in the basic accounting equation

➧ Assets
As noted above, assets are resources a business controlled. The business uses its assets in carrying out such activities as
production and sales. The common characteristic possessed by all assets is the capacity to provide future services or benefits.
In a business, that service potential or future economic benefit eventually results in cash inflows (receipts). For
example, consider Campus Pizza, a local restaurant. It owns a delivery truck that provides economic benefits from delivering
pizzas. Other assets of Campus Pizza are tables, chairs, jukebox, cash register, oven, tableware, and, of course, cash.

➧ Liabilities
Liabilities are claims against assets—that is, existing debts and obligations. Businesses of all sizes usually borrow money
and purchase merchandise on credit. These economic activities result in payables of various sorts:
• Campus Pizza, for instance, purchases cheese, sausage, flour, and beverages on credit from suppliers. These obligations
are called accounts payable.
• Campus Pizza also has a note payable to First National Bank for the money borrowed to purchase the delivery truck. \
• Campus Pizza may also have salaries and wages payable to employees and sales and real estate taxes payable to the local
government.
All of these persons or entities to whom Campus Pizza owes money are its creditors. Creditors may legally force the liquidation
of a business that does not pay its debts. In that case, the law requires that creditor claims be paid before ownership claims.

➧ Owner’s Equity
The ownership claim on total assets is owner’s equity. It is equal to total assets minus total liabilities. Here is why: The assets
of a business are claimed by either creditors or owners. To find out what belongs to owners, we subtract the creditors’ claims
(the liabilities) from assets. The remainder is the owner’s claim on the assets—the owner’s equity. Since the claims of
creditors must be paid before ownership claims, owner’s equity is often referred to as residual equity.

INCREASES IN OWNER’S EQUITY INCREASES IN OWNER’S EQUITY

In a proprietorship, owner’s drawings and expenses In a proprietorship, owner’s drawings and expenses
decrease owner’s equity. decrease owner’s equity.

INVESTMENTS BY OWNER Investments by owner are the DRAWINS An owner may withdraw cash or other assets for
assets the owner puts into the business. These investments personal use. We use a separate classification called
increase owner’s equity. They are recorded in a category drawings to determine the total withdrawals for each
called owner’s capital. accounting period. Drawings decrease owner’s equity. They
are recorded in a category called owner’s drawings.

REVENUES. Revenues are the gross increase in owner’s EXPENSES. Expenses are the cost of assets consumed or
equity resulting from business activities entered into for the services used in the process of earning revenue. They are
purpose of earning income. Generally, revenues result from decreases in owner’s equity that result from operating the
selling merchandise, performing services, renting property, business. For example, Campus Pizza recognizes the
and lending money. Common sources of revenue are sales, following expenses: cost of ingredients (meat, flour, cheese,
fees, services, commissions, interest, dividends, royalties, tomato paste, mushrooms, etc.); cost of beverages; salaries
and rent. and wages expense; utilities expense (electric, gas, and
Revenues usually result in an increase in an asset. They water expense); delivery expense (gasoline, repairs,
may arise from different sources and are called various licenses, etc.); supplies expense (napkins, detergents,
names depending on the nature of the business. Campus aprons, etc.); rent expense; interest expense; and property
Pizza, for instance, has two categories of sales revenues— tax expense.
pizza sales and beverage sales.

In summary, owner’s equity is increased by an owner’s investments and by revenues from business operations. Owner’s equity
is decreased by an owner’s withdrawals of assets and by expenses. Illustration 1-6 expands the basic accounting equation by
showing the items that comprise owner’s equity. This format is referred to as the expanded accounting equation .

Basic Accounting Equation Assets =Liabilities + Owner’s Equity

Expanded Accounting Equation Assets = Liabilities + Owner’s - Owner’s +

Revenues - Expenses Capital Drawings
Illustration 1-6 Expanded accounting

➤B. The Account

An account is an individual accounting record of increases and decreases in a specific asset, liability, or owner’s equity item.
It means that one item is recording and maintained separately from another items. For example, “cash account is recorded
separately from “accounts receivable account”

➧ Form of an Account
In its simplest form, an account consists of three parts: (1) a title, (2) a left or debit side, and (3) a right or credit side.
Because the format of an account resembles the letter T, we refer to it as a T-account. Illustration 2-1 shows the basic form
of an account.

Illustration: 2-1 Basic

Form of Account

Debits and Credits

The term 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. They do not mean increase or decrease, as is commonly thought. We use the terms
debit and credit repeatedly in the recording process to describe where entries are made in accounts. For example, the act of
entering an amount on the left side of an account is called debiting the account. Making an entry on the right side is
crediting the account.

DEBIT AND CREDIT PROCEDURE

You have learned the effect of a transaction on the basic accounting equation. Remember that each transaction must affect
two or more accounts to keep the basic accounting equation in balance. In other words, for each transaction, debits must
equal credits. The equality of debits and credits provides the basis for the double-entry system of recording transactions.

Under the double-entry system, the dual (two-sided) effect of each transaction is recorded in appropriate accounts. This system
provides a logical method for recording transactions and also helps ensure the accuracy of the recorded amounts as well as the
detection of errors. If every transaction is recorded with equal debits and credits, the sum of all the debits to the accounts must
equal the sum of all the credits. The double-entry system for determining the equality of the accounting equation is much more
efficient than the plus/minus procedure.

DR./CR. PROCEDURES FOR ASSETS AND LIABILITIES

We know that both sides of the basic equation (Assets = Liabilities + Owner’s Equity) must be equal. It therefore follows that
“increases and decreases in liabilities will have to be recorded opposite from increases and decreases in assets”. Thus,
increases in liabilities must be entered on the right or credit side, and decreases in liabilities must be entered on the left or debit
side.

The effects that debits and credits have on assets and liabilities are
summarized in Illustration 2-3.

Illustration 2-3: Debit and credit effects— assets and liabilities

Asset accounts normally show debit balances. That is, debits to a specific asset account should exceed credits to that
account. Likewise, liability accounts normally show credit balances. That is, credits to a liability account should exceed
debits to that account. The “normal balance of an account is on the side where an increase in the account is recorded”.
Illustration 2-4 shows the normal balances for assets and liabilities:

Knowing the normal balance in an account may help you trace errors. For example, a credit balance in an asset account such
as Land or a debit balance in a liability account such as Salaries and Wages Payable usually indicates an error. Occasionally,
though, an abnormal balance may be correct. The Cash account, for example, will have a credit balance when a company has
overdrawn its bank balance (i.e., written a check that “bounced”).

The following example presents how an asset account, specifically “cash”, is maintained using a dual entry system:
TRANSACTION:
1. The owner invested 15,000 cash.
2. Purchased equipment for 7,000 cash.
3. Received 1,200 cash for services rendered.
4. Rendered services worth 1,500 cash.
5. Purchase of supplies for cash, 1,700.
6. Paid rent expense of 250.
7. Received 600 cash for services rendered.
8. The owner withdrew 1,300 cash.

Every positive item in the tabular summary represents a receipt of cash. Every negative amount represents a payment of cash.
Notice that in the account form, we record the increases in cash as debits and the decreases in cash as credits. For
example, the P15,000 receipt of cash (in red) is debited to Cash, and the 2P7,000 payment of cash (in blue) is credited to
Cash.

Having increases on one side and decreases on the other reduces recording errors and helps in determining the totals of each
side of the account as well as the account balance. The balance is determined by netting the two sides (subtracting one
amount from the other). The account balance, a debit of P8,050, indicates that Softbyte had P8,050 more increases than
decreases in cash. In other words, Softbyte started with a balance of zero and now has P8,050 in its Cash account.

DR. /CR. PROCEDURES FOR OWNER’S EQUITY

As discussed in Topic 1, Owner’s Equity has four components, namely, owner’s investments, revenues, drawings and
expenses. You also learned that owner’s investments and revenues increase owner’s equity while owner’s drawings and
expenses decrease owner’s equity. Companies keep accounts for each of these types of transactions.

Investments by owners are credited to the Owner’s Capital

 account. Credits increase this account, and debits decrease
it. When an owner invests cash in the business, the
OWNER’S CAPITAL. company debits (increases) Cash and credits (increases)
Owner’s Capital. When the owner’s investment in the
business is reduced, Owner’s Capital is debited (decreased)

An owner may withdraw cash or other assets for personal

use. Withdrawals could be debited directly to Owner’s
OWNER’S DRAWINGS Capital to indicate a decrease in owner’s equity. However, it
is preferable to use a separate account, called Owner’s
Drawings. This separate account makes it easier to
determine total withdrawals for each accounting period.

Owner’s Drawings is increased by debits and decreased by credits. Normally, the drawings account will have a
debit balance

REVENUES AND EXPENSES.

The purpose of earning revenues is to benefit the owner(s) of the business. When a company recognizes revenues, owner’s
equity increases. Therefore, the effect of debits and credits on revenue accounts is the same as their effect on Owner’s
Capital. That is, revenue accounts are increased by credits and decreased by debits. Expenses have the opposite effect.
Expenses decrease owner’s equity. Since expenses decrease net income and revenues increase it, it is logical that the
increase and decrease sides of expense accounts should be the opposite of revenue accounts. Thus, expense accounts are
increased by debits and decreased by credits.

SUMMARY OF DEBIT/CREDIT RULES

Illustration below shows a summary of the debit/credit rules and effects on each type of account. Study this diagram
carefully. It will help you understand the fundamentals of the double-entry system.

➤C. Double entry system

Accounting is based on a double-entry system which means that the dual effects of a business transaction is recorded. A
debit side entry must have a corresponding credit side entry. For every transaction, there must be one or more accounts
credited. Each transaction affects at least two accounts. The total debits for a transaction must always equal the total
credits.
An account is debited when an amount is entered on the left side of the account and credited when an amount is entered on
the right side. The abbreviations for debit and credit are Dr. (from Latin debere) and Cr. (from the Latin credere),
respectively.

➤D. Normal balance of an account

The normal balance of an account refers to the side of the account- debit or credit- where increases are recorded. Asset,
owner’s withdrawal and expense accounts normally have debit balances; liability, owner’s equity and income accounts
normally have credit balances. This result occurs because increases in an account are usually greater than or equal to
decreases.

Increase recorded by Normal balance

Account category Debit Credit Debit Credit

Assets ✔ ✔

Liabilities ✔ ✔

Owner’s equity:

Owner’s capital ✔ ✔

Withdrawals ✔ ✔

Income ✔ ✔

Expenses ✔ ✔

Topic 3: Identification of events to be recorded

➤ A. Transaction

Transactions (business transactions) are a business’s economic events recorded by accountants. Transactions may be
external or internal. External transactions involve economic events between the company and some outside
enterprise. For example, Campus Pizza’s purchase of cooking equipment from a supplier, payment of monthly rent to the
landlord, and sale of pizzas to customers is external transactions. Internal transactions are economic events that occur
entirely within one company. The use of cooking and cleaning supplies is internal transactions for Campus Pizza. Companies
carry on many activities that do not represent business transactions. Examples are hiring employees, responding to emails,
talking with customers, and placing merchandise orders. Some of these activities may lead to business transactions.
Employees will earn wages, and suppliers will deliver ordered merchandise. The company must analyze each event to find
out if it affects the components of the accounting equation. If it does, the company will record the transaction.

Illustration:

➤ B. Transaction Analysis
To demonstrate how to analyze transactions in terms of the accounting equation, we will review the business activities of
Softbyte, a smartphone app development company. Softbyte is the creation of Ray Neal, an entrepreneur who wants to create
focused apps that inspire and engage users of all ages. Ray was encouraged to start his own business after the success of
“FoodAlert,” a customizable app he developed that tracks the daily location of local food trucks. The following business
transactions occur during Softbyte’s first month of operations.

TRANSACTION (1). INVESTMENT BY OWNER Ray Neal starts a smartphone app development company which he names
Softbyte. On September 1, 2017, he invests P15,000 cash in the business. This transaction results in an equal increase in
assets and owner’s equity.
Observe that the equality of the accounting equation has been maintained. Note that the investments by the owner do not
represent revenues, and they are excluded in determining net income. Therefore, it is necessary to make clear that the
increase is an investment (increasing Owner’s Capital) rather than revenue.

TRANSACTION (2). PURCHASE OF EQUIPMENT FOR CASH Softbyte purchases computer equipment for P7,000 cash. This
transaction results in an equal increase and decrease in total assets, though the composition of assets changes

Observe that total assets are still P15,000. Owner’s equity also remains at P15,000, the amount of Ray Neal’s original
investment

TRANSACTION (3). PURCHASE OF SUPPLIES ON CREDIT Softbyte purchases for P1,600 from Mobile Solutions headsets
and other computer accessories expected to last several months. Mobile Solutions agrees to allow Softbyte to pay this bill in
October. This transaction is a purchase on account (a credit purchase). Assets increase because of the expected future
benefits of using the headsets and computer accessories, and liabilities increase by the amount due to Mobile Solutions.

TRANSACTION (4). SERVICES PERFORMED FOR CASH Softbyte receives P1,200 cash from customers for app
development services it has performed. This transaction represents Softbyte’s principal revenue-producing activity.
Recall that revenue increases owner’s equity.

The two sides of the equation balance at P17,800. Service Revenue is included in determining Softbyte’s net income.
Note that we do not have room to give details for each individual revenue and expense account in this illustration. Thus,
revenues (and expenses when we get to them) are summarized under one column heading for Revenues and one for
Expenses. However, it is important to keep track of the category (account) titles affected (e.g., Service Revenue) as they will be
needed when we prepare financial statements later in the chapter.

TRANSACTION (5). PURCHASE OF ADVERTISING ON CREDIT Softbyte receives a bill for P250 from the Daily News
for advertising on its online website but postpones payment until a later date. This transaction results in an increase in
liabilities and a decrease in owner’s equity.
The two sides of the equation still balance at P17,800. Owner’s equity decreases when Softbyte incurs the expense. Expenses
are not always paid in cash at the time they are incurred. When Softbyte pays at a later date, the liability Accounts Payable will
decrease, and the asset Cash will decrease [see Transaction (8)]. The cost of advertising is an expense (rather than an asset)
because the company has used the benefits. Advertising Expense is included in determining net income.

TRANSACTION (6). SERVICES PERFORMED FOR CASH AND CREDIT Softbyteperforms

P3,500 of app development services for customers. The company receives cash of P1,500 from customers, and it bills
the balance of P2,000 on account. This transaction results in an equal increase in assets and owner’s equity.

Softbyte recognizes P3,500 in revenue when it performs the service. In exchange for this service, it received P1,500 in
Cash and Accounts Receivable of P2,000. This Accounts Receivable represents customers’ promises to pay P2,000 to
Softbyte in the future. When it later receives collections on account, Softbyte will increase Cash and will decrease
Accounts Receivable.

TRANSACTION (7). PAYMENT OF EXPENSES Softbyte pays the following expenses in cash for September: office rent
P600, salaries and wages of employees P900, and utilities P200. These payments result in an equal decrease in assets
and owner’s equity.

The two sides of the equation now balance at P19,600. Three lines in the analysis indicate the different types of
expenses that have been incurred.

TRANSACTION (8). PAYMENT OF ACCOUNTS PAYABLE Softbyte pays its P250 Daily
News bill in cash. The company previously [in Transaction (5)] recorded the bill as an increase in Accounts Payable and
a decrease in owner’s equity.

Observe that the payment of a liability related to an expense that has previously been recorded does not affect owner’s
equity. The company recorded this expense in Transaction (5) and should not record it again.
TRANSACTION (9). RECEIPT OF CASH ON ACCOUNT Softbyte receives P600 in cash from customers who had been
billed for services [in Transaction (6)]. Transaction (9) does not change total assets, but it changes the composition of those
assets.
Note that the collection of an account receivable for services previously billed and recorded does not affect owner’s equity.
Softbyte already recorded this revenue in Transaction (6) and should not record it again.

TRANSACTION (10). WITHDRAWAL OF CASH BY OWNER Ray Neal withdraws P1,300 in

ash from the business for his personal use. This transaction results in an equal decrease in assets and owner’s equity.

Observe that the effect of a cash withdrawal by the owner is the opposite of the effect of an investment by the owner.
Owner’s drawings are not expenses. Expenses are incurred for the purpose of earning revenue. Drawings do not
generate revenue. They are a disinvestment. Like owner’s investment, the company excludes owner’s drawings in
determining net income.

Summary of Transactions
Illustration above summarizes the September transactions of Softbyte to show their cumulative effect on the basic
accounting equation. It also indicates the transaction number and the specific effects of each transaction.

1. Each transaction is analyzed in terms of its effect on:

(a) The three components of the basic accounting equation.

(b) Specific items within each component.

2. The two sides of the equation must always be equal.

Illustration: Tabular summary of transactions of Softbyte Company

➤ C. The Accounting Cycle

The accounting cycle refers to a series of sequential steps or procedures performed to

accomplish the accounting process. The steps in the cycle:

Step 1 Identification of events to be recorded

 Step 2 Transactions are recorded in the journal

Step 3 Journal entries are posted to the ledger

Step 4 Preparation of an adjusted trial balance

Step 5 Adjusting journal entries are journalized and posted

Step 6 Preparation of the worksheet

Step 7 Preparation of the financial statements

Step 8 Closing journal entries are journalized and posted

Step 9 Preparation of a post-closing trial balance

Step 10 Reversing journal entries are journalized and posted

The cycle is repeated each accounting period. The first three steps in the accounting cycle are
accomplished during the period. The fourth to the ninth steps generally occur at the end of the
period. The last step is optional and occurs at the beginning of the next period.

Topic 4: The Journal

➤ A. Steps in the recoding process

Although it is possible to enter transaction information directly into the accounts without using a journal, few businesses
do so. Practically every business uses three basic steps in the recording process:

1. Analyze each transaction for its effects on the accounts.

2. Enter the transaction information in a journal.
3. Transfer the journal information to the appropriate accounts in the ledger.

The recording process begins with the transaction. Business documents, such as a sales receipt, a check, or a bill,
provide evidence of the transaction. The company analyzes this evidence to determine the transaction’s effects on
specific accounts. The company then enters the transaction in the journal. Finally, it transfers the journal entry to the
designated accounts in the ledger.

➤ B. Journal

Companies initially record transactions in chronological order (the order in which they occur). Thus, the journal is referred
to as the book of original entry. For each transaction, the journal shows the debit and credit effects on specific accounts.

Companies may use various kinds of journals, but every company has the most basic form of journal, a general journal.
Typically, a general journal has spaces for dates, account titles and explanations, references, and two amount columns.
Whenever we use the term “journal”, we mean the general journal unless we specify otherwise. The journal makes
several significant contributions to the recording process:

1. It discloses in one place the complete effects of a transaction.

2. It provides a chronological record of transactions.
3. It helps to prevent or locate errors because the debit and credit amounts for each entry can be easily compared.
➤ C. The Journal Format

Journal J1

Date Account Titles and Explanation Ref. Debit Credit

 2019
Jan. 1 Cash 250, 000
A, Capital 250, 000
Initial investment

1. Date. The year and month are not rewritten for every entry unless the year or moth changes or a new
page is needed.
2. Account titles and Explanation. The account to be debited is entered at the extreme left of the first line
while the account to be credited is entered slightly indented on the next line. A brief description of the
transaction is usually made on the line below the credit. Generally, skip the line after each entry.
3. Ref. (reference). This will be used when the entries are posted, that is, until the amounts are
transferred to the related ledger accounts. The posting process will be discussed later.
4. Debit. The debit amount for each account is entered in this column.
5. Credit. The credit amount for each account is entered in this column.

➤ D. Simple and Compound entry

Some entries involve only two accounts, one debit and one credit. (See, for example, the entries in Illustration in No. 3.)
This type of entry is called a simple entry. Some transactions, however, require more than two accounts in journalizing.
An entry that requires three or more accounts is a compound entry. To illustrate, assume that on July 1, Butler Company
purchases a delivery truck costing P14,000. It pays P8,000 cash now and agrees to pay the remaining P6,000 on
account (to be paid later). The compound entry is as follows.

In a compound entry, the standard format requires that all debits be listed before the credits.

➤ E. Journalizing
Entering transaction data in the journal is known as journalizing. Companies make separate journal entries for each transaction.
A complete entry consists of (1) the date of the transaction, (2) the accounts and amounts to be debited and credited, and (3) a
brief explanation of the transaction.

Illustration:
The following is the October transactions of Pioneer Advertising:
1. On October 1, C. R. Byrd invests P10,000 cash in an advertising company called Pioneer Advertising.
2. On October 1, Pioneer purchases office equipment costing P5,000 by signing a 3-month, 12%, P5,000
note payable.
3. On October 2, Pioneer receives a P1,200 cash advance from R. Knox, a client, for advertising services
that are expected to be completed by December 31.
4. On October 3, Pioneer pays office rent for October in cash, P900.
5. On October 4, Pioneer pays P600 for a one-year insurance policy that will expire next year on
September 30.
6. On October 5, Pioneer purchases an estimated 3-month supply of advertising materials on account
from Aero Supply for P2,500.
7. On October 9, Pioneer hires four employees to begin work on October 15. Each employee is to
receive a weekly salary of P500 for a 5-day work week, payable every 2 weeks—first payment made
on October 26.
8. On October 20, C. R. Byrd withdraws P500 cash for personal use.
9. On October 26, Pioneer owes employee salaries of P4,000 and pays them in cash (see October 9
event).
10.On October 31, Pioneer receives P10,000 in cash from Copa Company for advertising services
performed in October.

Summary Illustration of Journalizing

 Topic 5: The Ledger

➤ A. Ledger
The entire group of accounts maintained by a company is the ledger. The ledger provides the balance in each of the accounts
as well as keeps track of changes in these balances.
Companies may use various kinds of ledgers, but every company has a general ledger. A general ledger contains all the
asset, liability, owner’s equity, income and expense accounts.
Companies arrange the ledger in the sequence in which they present the accounts in the financial statements, beginning
with the balance sheet accounts. First in order are the asset accounts, followed by liability accounts, owner’s capital,
owner’s drawings, revenues, and expenses. Each account is numbered for easier identification.

The ledger provides the balance in each of the accounts. For example, the Cash account shows the amount of cash
available to meet current obligations. The Accounts Receivable account shows amounts due from customers. Accounts
Payable shows amounts owed to creditors.

➤ B. Permanent and
The accounts in the general ledger are classified into two general groups Temporary Accounts
a. Balance sheet or permanent accounts (assets, liabilities and owner’s equity)

b. Income statement or temporary accounts (income and expenses).

➤ C. Standard form of account

The simple T-account form used in accounting textbooks is often very useful for illustration purposes. However, in practice, the
account forms used in ledgers are much more structured.

This format is called the three-column form of account. It has three money columns—debit, credit, and balance. The balance in
the account is determined after each transaction. Companies use the explanation space and reference columns to provide
special information about the transaction.

➤ D. Chart of Accounts
The number and type of accounts differ for each company. The number of accounts depends on the amount of detail
management desires. For example, the management of one company may want a single account for all types of utility
expense. Another may keep separate expense accounts for each type of utility, such as gas, electricity, and water.
Similarly, a small company like Softbyte will have fewer accounts than a corporate giant like Dell. Softbyte may be able to
manage and report its activities in 20 to 30 accounts, while Dell may require thousands of accounts to keep track of its
worldwide activities.

Most companies have a chart of accounts. This chart lists the accounts and the account numbers that identify their
location in the ledger. The numbering system that identifies the accounts usually starts with the balance sheet accounts
and follows with the income statement accounts. Only those titles listed in the chart of accounts are used in the recording
process, unless a new account title is required to be listed.
An example of a chart of account is shown below. This chart of accounts of Pioneer Advertising will be used in topics to
be discussed.
➤ E. Posting
Transferring journal entries to the ledger accounts is called posting. This phase of the recording process accumulates the
effects of journalized transactions into the individual accounts. Posting involves the following steps.

1. In the ledger, in the appropriate columns of the account(s) debited, enter the date, journal page, and
debit amount shown in the journal.
2. In the reference column of the journal, write the account number to which the debit amount was posted.
3. In the ledger, in the appropriate columns of the account(s) credited, enter the date, journal page, and
credit amount shown in the journal.
4. In the reference column of the journal, write the account number to which the credit amount was posted.

Illustration 2-17 shows these four steps using Softbyte’s first journal entry. The boxed numbers indicate the sequence of the
steps.

Posting should be performed in chronological order. That is, the company should post all the debits and credits of
one journal entry before proceeding to the next journal entry. Postings should be made on a timely basis to ensure that
the ledger is up-to-date.

The reference column of a ledger account indicates the journal page from which the transaction was posted. The
explanation space of the ledger account is used infrequently because an explanation already appears in the journal.

Illustrations below show the basic steps in the recording process, using the October transactions of Pioneer
Advertising. Pioneer’s accounting period is a month. In these illustrations, a basic analysis, an equation analysis, and a
debit-credit analysis precede the journal entry and posting of each transaction. For simplicity, we use the T-account form
to show the posting instead of the standard account form.

Illustration 2-19: Investment by the owner

 Illustration 2-20: Purchase of office equipment

Illustration 2-21: Receipt of cash for future service

Illustration 2-22: Payment of monthly rent

 Illustration 2-23: Payment for insurance

Illustration 2-24 Purchase of supplies on credit

Illustration 2-25: Hiring of employees

 Illustration 2-26: Withdrawal of cash by

Illustration 2-27: Payment of salaries

Illustration 2-28: Receipt of cash for services performed

➤ F. Ledger accounts after posting

Topic 6: The Trial Balance

➤ A. Preparing trial balance

A trial balance is a list of accounts and their balances at a given time. Customarily, companies prepare a trial balance at
the end of an accounting period. They list accounts in the order in which they appear in the ledger. Debit balances
appear in the left column and credit balances in the right column.

The trial balance proves the mathematical equality of debits and credits after posting. Under the double-entry system,
this equality occurs when the sum of the debit account balances equals the sum of the credit account balances. A trial balance
may also uncover errors in journalizing and posting.
 The steps for preparing a trial balance are:

1. List the account titles and their balances in the appropriate debit or credit column.

2. Total the debit and credit columns.

3. Prove the equality of the two columns.

Illustration 2-31 shows the trial balance prepared from Pioneer Advertising’s ledger. Note that the total debits
equal the total credits.

A trial balance is a necessary checkpoint for uncovering certain types of errors. For example, if only the debit
portion of a journal entry has been posted, the trial balance would bring this error to light.

➤ B. Limitations of trial balance

A trial balance does not guarantee freedom from recording errors, however. Numerous errors may exist even though the totals
of the trial balance columns agree. For example, the trial balance may balance even when:
1. A transaction is not journalized.
2. A correct journal entry is not posted.
3. A journal entry is posted twice.
4. Incorrect accounts are used in journalizing or posting.
5. Offsetting errors are made in recording the amount of a transaction.
As long as equal debits and credits are posted, even to the wrong account or in the wrong amount, the total debits will equal
the total credits. The trial balance does not prove that the company has recorded all transactions or that the ledger is correct.

➤ C. Locating Errors

Errors in a trial balance generally result from mathematical mistakes, incorrect postings, or simply transcribing data incorrectly.
What do you do if you are faced with a trial balance that does not balance? First, determine the amount of the difference
between the two columns of the trial balance. After this amount is known, the following steps are often helpful:

1. If the error is P1, P10, P100, or P1,000, re-add the trial balance columns and recompute the account
balances.
2. If the error is divisible by 2, scan the trial balance to see whether a balance equal to half the error has been
entered in the wrong column.
3. If the error is divisible by 9, retrace the account balances on the trial balance to see whether they are
incorrectly copied from the ledger. For example, if a balance was P12 and it was listed as P21, a P9 error
has been made. Reversing the order of numbers is called a transposition error.

4. If the error is not divisible by 2 or 9, scan the ledger to see whether an account balance in the amount of
the error has been omitted from the trial balance, and scan the journal to see whether a posting of that
amount has been omitted.

➤ D. Peso Signs and Underlining

Note that peso signs do not appear in journals or ledgers. Peso signs are typically used only in the trial balance and
the financial statements. Generally, a peso sign is shown only for the first item in the column and for the total of that column.
A single line (a totaling rule) is placed under the column of figures to be added or subtracted. Total amounts are double-
underlined to indicate they are final sums.