Chapter-3-Accounting for Service Business, general journal, trial balance and adjusting entries PDF

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Republic of the PhilippinesPresident Ramon Magsaysay State UniversityCollege of Accountancy and Business Administration(Formerly Ramon Magsaysay Technological University)Iba, Zambales, PhilippinesTel/Fax No.: (047) 811-CHAPTER 3ACCOUNTING FOR A SERVICE BUSINESSINTRODUCTIONTransactions and events are...

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Republic of the Philippines President Ramon Magsaysay State University College of Accountancy and Business Administration (Formerly Ramon Magsaysay Technological University) Iba, Zambales, Philippines Tel/Fax No.: (047) 811-1683 College/Department

College of Accountancy and Business Administration

Course Code

Fun Acc

Course Title

Fundamentals of Accounting

Place of the Course in the Program

Minor Subject

Semester & Academic Year

Second Semester AY 2020-2021

CHAPTER 3 ACCOUNTING FOR A SERVICE BUSINESS INTRODUCTION Transactions and events are the starting points in the accounting cycle. By relaying on source documents, transactions and events can be analyzed as to how they will affect performance and financial positions. It can identify and describe transactions and events entering the accounting process. The original written evidence contain information about the nature and the amounts of transactions.

INTENDED LEARNING OUTCOMES 1. 2. 3. 4. 5. 6.

Describe the nature of transactions in a service business. Record transactions of a service business in the general journal. Post transactions in the ledger. Prepare a trial balance. Prepare adjusting entries. Complete the account cycle.

DISCUSSION 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 and their aims follow: Step 1 Step 2 Step 3 Step 4 Step 5 Step 6

Identification of events to be recorded. (Identifying and analyzing) Transaction are recorded in the journal. (Journalizing) Journal entries are posted to the ledger. (Posting) Preparation of trial balance. (Unadjusted trial balance) Preparation of the worksheet including adjusting entries Preparation of the financial statement

Step 7 Step 8 Step 9

Adjusting journal entries are journalized and posted. Closing journal entries are journalized and posted. Reversing journal entries are journalized and posted.

This 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. Identifying and analyzing This is the first step in the accounting cycle. It involves identifying a business transaction and analyzing whether or not that transaction affects the assets, liability, equity, income or expenses of the business. A transaction that has an effect on the accounts is an accountable event, which needs to be recorded in the books of accounts. On the other hand, a transaction that has no effect on the account is a non-accountable event which is not recorded in the books of accounts.

3.1 Journalizing After an accountable event is identified and analyzed, the second step is to record it in the journal by means of journal entry. This recording process is called journalizing. The journal is a chronological record of the entity‟s transactions. A journal entry shows all the effects of a business transaction in terms of debits and credits. Each transaction is initially recorded in a journal rather than directly in the ledger. A journal is called the book of original entry. A journal entry has the following format: 1. Date. The year and month are not rewritten for every entry unless the year or month changes 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. Generally, skip a line after each entry. 3. P.R. (posting reference). This will be used when the entries are posted, that is, until the amounts are transferred to the related ledger accounts. 4. Debit. The debit amount for each account is entered this column. 5. Credit. The credit amount for each account is entered in this column. Assume that Eliza Diaz established her own weeding consultancy with an initial investment of P250,000 on May 1.

The journal entry is shown below:

Journal

1 2 4 5

Date 2014 May 1

page 1

Account Title and Explanation

P.R.

Cash

Debit

Credit

250,000 Diaz, Capital Initial investment

250,000

Simple and Compound journal entries A journal entry may have one of the following formats: a. Simple journal entry – one which contains a single debit and a single credit element. The illustrated journal entry above is an example of a simple journal entry. b. Compound journal entry - one which contain two or more debits and credits. Illustration 1: Journal entries You opened a barbecue stand on January 1, 2018. The following were the business transactions on the date. Transaction #1 : Initial Investment You provided P800 cash initial investment to your business. Step 1: Transaction analysis  Accounts affected:  Effect on accounts:  Debit/Credit

„Cash” (asset) and “Owner‟s capital” (equity) Cash is increased; Owner‟s capital is increased. Asset is increased through debit. Equity is increased through credit.

Step# 2 Journal Entry Your initial investment is recorded in the journal as follows: Date 2018 Jan. 1

JOURNAL Account titles Cash Owner's equity to record the owner's initial investment to the business

Transaction #2: Journal entry

Debit

Credit

800 800

The business loan is recorded as follows Date 2018 Jan. 1

JOURNAL Account titles Cash

Debit

Credit

1,200 Notes payable to record the loan obtained

1,200

Both the journal entries above are examples of simple journal entries because they have single debits and credits. Transaction #3: Capital expenditures The business acquired the following for cash: Item description Barbeque grill Cooking accessories Beach umbrella Step #1: Transaction Analysis  Accounts affected:  Effect on accounts  Debit / Credit

Cost P1,000 120 400

“Equipment” (asset) and „Cash” (asset) Equipment is increased; Cash is decreased Asset is increased through debit and decreased through credit.

Step #2: Journal entry The acquisition of equipment is recorded as follows: Date 2018 Jan. 1

JOURNAL Account titles Equioment - Barbeque grill Equioment - Cooking accessories Equipment - Beach umbrella Cash (1,000 + 120 + 400) to record the acquisition of Equipment

Debit

Credit

1,000 120 400 1,520

The journal entry above is example of a compound journal entry because it has more than one debit. Transaction #4: Acquisition of inventory The business purchased inventory for P480 cash.

Step #1: Transaction analysis

 Accounts affected:  Effect on accounts  Debit / Credit

“Inventory” (asset) and “Cash” (asset) Inventory is increased; Cash is decreased. Asset is increased through debit and decreased through credit.

Step #2: Journal entry The purchase of inventory is recorded as follows: Date 2018 Jan. 1

JOURNAL Account titles Inventory Cash to record the acquisition of inventory

Debit

Credit

480 480

Illustration 2: Journal entries – Operations Your barbecue operations started on January 2, 2018. The following were the business transactions on this date: Transaction #5: Sale Total cash sales of barbecue amounted to P700. The total cost of the barbecues sold in P280. Step #1: Transaction analysis  Accounts affected:

 “Cash” (asset) and ”Sales” (income);  “Cost of sales” (expense) and “Inventory” (asset)  Cash is increased; Sales is increased.  Cost of sales is increased; Inventory is decreased.  Asset is increased through debit and decreased through credit.  Income is increased through credit.  Expense is increased through debit.

 Effect on accounts  Debit / Credit

Step #2: Journal entry The sales are recorded as follows: Date 2018 Jan. 2

JOURNAL Account titles Cash

Debit

Credit

700 Sales to record total sales of barbecue

The cost of sales is recorded as follows:

700

Date 2018 Jan. 2

JOURNAL Account titles Cost of goods sold Inventory to record the cost of the barbecue sold as expense

Debit

Credit

280 280

The entry above to record the cost of goods sold is an application of the matching concept. This concept costs that are directly associated with the earning of revenue are recognized as expenses in the same period where the related revenue is recognized. Transaction #6: Expense The business paid P20 for supplies expense. Step #1: Transaction analysis  Accounts affected:  Effect on accounts

“Supplies expense” (expense) and “Cash” (asset) Cash is decreased; Supplies expense is increased. Expense is increased through debit. Asset is decreased through credit.

 Debit / Credit

Step #2: Journal entry The supplies expense is recorded as follows: Date 2018 Jan. 2

JOURNAL Account titles Supplies expense Cash to record the supplies expense

Debit

Credit

20 20

Illustration 3: Non-accountable events A. You are planning to purchase new equipment in the future. You have not yet placed an order for the new equipment because you don‟t have the money yet. Step #1: Transaction analysis  Accounts affected:  Effect on accounts  Debit / Credit

None. A mere plan to purchase does not affect the accounts of the business. None None

Step #2: Journal entry No journal entry shall be made because the transaction is non-accountable.

B. Your dog “Buloy” died because he ate a barbecue stick. Step #1: Transaction analysis  Accounts affected:  Effect on accounts  Debit / Credit

None. The event does not affect any of the accounts of the business. None None

Step #2: Journal entry No journal entry shall be made because the transaction is non-accountable. Recording drills: Let us have the following recording drills: Case #1.1 Initial investment in cash On January 1, 201, the owner invests P100,000 cash to the business. The journal entry to record the transaction is as follows: Date 2019 Jan. 1

JOURNAL Account titles Cash

Debit

Credit

100,000

Owner's capital to record the owner's initial investment to the business

100,000

Case #1.2: Initial investment in non-cash assets On January 20, 2019, the owner provides a building valued at P1,000,000 and an automobile valued at P500,000 to the business. Step #1: Transaction analysis  Accounts affected:  Effect on accounts  Debit / Credit

“Building” (asset), “Transportation equipment” (asset), and “Owner‟s capita” (equity) Building and Transportation equipment are increased; Owner‟s capital is increased. Asset is increased through debit. Equity is increased through credit.

Step #2: Journal entry The compound journal entry to record the transaction is as follows:

Date 2019 Jan. 20

JOURNAL Account titles Building Transportation equipment Owner's capital to record the owner's non-cash investment to the business

Debit

Credit

1,000,000 500,000 1,500,000

Alternatively, the transaction above can be recorded through simple journal entries as follows: JOURNAL Date 2019 Jan. 20

Jan. 20

Account titles

Debit

Building Owner's capital to record the owner's non-cash investment to the business

1,000,000

Transportation equipment Owner's capital to record the owner's non-cash investment to the business

500,000

Credit

1,000,000

500,000

Both entries above – compound and simple, are acceptable. Case #2.1: Acquisition of asset – Equipment On January 25, 2019, the business acquires a machine for P20,000. The journal entry to record the transaction is as follows: JOURNAL Date 2019 Jan. 20

Account titles Machinery Cash to record the acquisition of machine

Debit 20,000

Case #2.2 : Acquisition of asset – Inventory (Cash basis) On January 26, 2019, the business acquires inventories for P50,000 cash.

The journal entry to record the transaction is as follows:

Credit

20,000

Date 2019 Jan. 26

JOURNAL Account titles Inventory Cash to record the acquisition of inventory on cash basis

Debit

Credit

50,000 50,000

Case #2.3A: Acquisition of asset – Inventory (On account/Credit) On January 27, 2019, the business purchases inventories worth P70,000 on account. Step #1: Transaction analysis  Accounts affected:  Effect on accounts  Debit / Credit

“Inventory” (asset) and “Accounts payable” (liability) Inventory is increased. Accounts payable is increased. Asset is increased through debit. Liability is increased through credit.

Step #2: Journal entry The journal entry to record the transaction is as follows: Date 2019 Jan. 27

JOURNAL Account titles Inventory Accounts payable to record the acquisition of inventory on account

Debit

Credit

70,000 70,000

Case #2.3B: Payment of accounts payable On January 31, 2019, the business settles the P70,000 account payable from the January 27, purchase. Step #1: Transaction analysis  Accounts affected:  Effect on accounts  Debit / Credit

“Accounts payable” (liability) and “Cash” (asset) Accounts payable is decreased through debit. Asset is decreased through credit. Liability is decreased through debit. Asset is decreased through credit.

Step #2: Journal entry The journal entry to record the transaction is as follows:

Date 2019 Jan. 26

JOURNAL Account titles

Debit

Accounts payable Cash to record the settlement of accounts payable

Credit

70,000 70,000

Case #3.1: Liability On February 1, 2019, the business obtains a bank loan of P80,000. The journal entry to record the transaction is as follows: Date 2019 Feb. 1

JOURNAL Account titles Cash

Debit

Credit

800

Notes payable to record the loan taken from a bank

800,000

Case #3.2: Payment of liability On March 1, 2019, the business makes a partial payment of P400,000 on the bank loan. Step #1: Transaction analysis  Accounts affected:  Effect on accounts  Debit / Credit

„Notes payable” (liability) and “Cash” (asset) Notes payable is decreased. Cash is decreased Liability is decreased through debit. Asset is decreased through credit.

Step #2: Journal entry The journal entry to record the transaction is as follows: Date 2019 Mar.1

JOURNAL Account titles Notes payable Cash to record the partial payment of notes payable

Debit

Credit

400,000 400,000

Case #4.1: Income – Cash sale On March 2, 2019, the business makes a cash sale of P100,000. The cost of inventories sold is P30,000.

The journal entries to record the transaction are as follows: Date 2019 Mar.2

JOURNAL Account titles Cash

Debit 100,000

Sales to record the cash sale Mar. 2

Credit

Cost of sale Inventory to charge the cost of inventories sold as expense

100,000

30,000 30,000

Case #4.2A: Income – Credit sales (Sales on account) On March 4, 2019, the business makes a sales on account of P800,000. The sales price is collectible on March 8, 2019. The cost of the inventories sold is P20,000. Step #1: Transaction analysis  Accounts affected:

 Effect on accounts

 Debit / Credit

 “Accounts receivable” (asset) and “Sales” (income);  “Cost of Sales” (expense) and “Inventory (asset)  Account receivable is increased; Sales is increased.  “Cost of Sales is increased; Inventory is decreased.  Asset is increased through debit and decreased through credit.  Income is increased through credit.  Expense is increased through debit.

Step #2: Journal entry The journal entry to record the transaction is as follows: Date 2019 Mar.4

Mar. 4

JOURNAL Account titles

Debit

Accounts receivable Sales to record the sales on account

80,000

Cost of sale Inventory to charge the cost of inventories

20,000

Credit

80,000

20,000

sold as expense

Case #4.2B: Collection of accounts receivable On March 8, 2019, the business collects P80,000 accounts receivable. Step #1: Transaction analysis  Accounts affected:  Effect on accounts  Debit / Credit

“Cash” (asset) and “Accounts receivable” (asset) Cash is increased. Accounts receivable is decreased Asset is increased through debit and decreased through credit.

Step #2: Journal entry The journal entry to record the transaction is as follows: Date 2019 Mar.8

JOURNAL Account titles Cash

Debit

Credit

80,000

Accounts receivable to record the collection of accounts receivable

80,000

Case #5 – Expense –Paid in cash On March 20, 2019, the business pays P5,000 an advertisement that was aired on the radio. The journal entry to record the transaction is as follows:

Date 2019 Mar.8

JOURNAL Account titles Advertising expense Cash to record the cost of advertisement as expense

Debit

Credit

5,000 5,000

Case #6 – Owner’s drawings On April 7, 2019, the owner makes temporary withdrawal of P10,000 cash from the business. Step #1: Transaction analysis  Accounts affected:  Effect on accounts  Debit / Credit

“Owner‟s drawings” (contra-equity) and “Cash” (asset) Owner‟s drawings is increased. Cash is decreased Contra-equity is increased through debit. Asset

is decreased through credit. Step #2: Journal entry The journal entry to record the transaction is as follows: Date 2019 April. 7

JOURNAL Account titles Owner's drawings Cash to record the owner's drawings

Debit

Credit

10,000 10,000

3.2 Posting The third step in the accounting cycle, is the process of transferring data from the journal to the appropriate accounts in the ledger. More specifically, posting is done by transferring the amounts of debits and credits in a recorded journal entry to the ledger account. The purpose of posting is to classify the effects of transactions on specific assets, liability, equity, income and expense accounts in order to provide more meaningful information. Illustration 1: Posting A business had the following transactions during the second week of January. Date Jan.8

Transactions Services woth P30,000 were rendered for cash.

Jan.9

Services worth P50,000 was disbursed for supplies expense

Jan.10

Cash amounting to P5,000 was disbursed for supplies expense.

Jan.11

Accounts recivable of P40,000 was collected

The transactions are recorded in the journal as follows: Date 2019 Jan.8

Jan. 9

Jan.10

JOURNAL Account titles Cash Service fees to record service fees in cash Accounts receivable Service fees to record...