CHAPTER 5 – RECORDING BUSINESS TRANSACTIONS

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 Identification of Events to be Recorded

Aim: To gather information about transactions or events generally through the source documents.

Step 2 Transactions are Recorded in the Journal

Aim: To record the economic impact of transactions on the firm in a journal, which is a form that
facilitates transfer to the accounts.

Step 3 Journal Entries are Posted to the Ledger

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

Step 4 Preparation of a Trial Balance

Aim: To provide a listing to verify the equality of debits and credits in the ledger.

Step 5 Preparation of the Worksheet including Adjusting Entries

Aim: To aid in the preparation of financial statements.

Step 6 Preparation of the Financial Statements

Aim: To provide useful information to decision-makers.

Step 7 Adjusting Journal Entries are Journalized and Posted

Aim: To record the accruals, expiration of deferrals, estimations and other events from the
worksheet.

Step 8 Closing Journal Entries are Journalized and Posted

Aim: To close temporary accounts and transfer profit to owner's equity.

Step 9 Preparation of a Post-Closing Trial Balance

Aim: To check the equality of debits and credits after the closing entries.

Step 10 Reversing Journal Entries are Journalized and Posted

Aim: To simplify the recording of certain regular transactions in the next accounting period.

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. The discussion in this chapter
will focus on the first four steps. Steps 5 to 10 will be taken up in Chapters 6 and 7.
TRANSACTION ANALYSIS (Step 1)

The analysis of transactions should follow these four basic steps:

1. Identify the transaction from source documents.

2. Indicate the accounts-either assets, liabilities, equity, income or expenses- affected by the transaction.

3. Ascertain whether each account is increased or decreased by the transaction.

4. Using the rules of debit and credit, determine whether to debit or credit the account to record its
increase or decrease.

SOURCE DOCUMENTS

Transactions and events are the starting points in the accounting cycle. By relying on source documents,
transactions and events can be analyzed as to how they will affect performance and financial position.
Source documents identify and describe transactions and events entering the accounting process. These
original written evidences contain information about the nature and the amounts of the transactions.
These are the bases for the journal entries; some of the more common source documents are sales
invoices, cash register tapes, official receipts, bank deposit slips, bank statements, checks, purchase
orders, time cards and statements of account.

THE JOURNAL

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. The nature and volume of
transactions of the business determine the number and type of journals needed. The general journal is
the simplest journal.

Format

The standard contents of the general journal are as follows:

1. Date. The year and month are not rewritten for every entry unless the year or month changes or a
new page 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 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. The posting process will be described 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.

Assume that on Nov. 1, 2016, Galicano Del Mundo invests P450,000 to open his business, Del Mundo
Landscape Specialist. The journal entry follows:

Simple and Compound Entry

In a simple entry, only two accounts are affected-one account is debited and the other account credited.
An example of this is the entry to record the initial investment of Del Mundo. However, some
transactions require the use of more than two accounts. When three or more accounts are required in a
journal entry, the entry is referred to as a compound entry.

TRANSACTIONS ARE JOURNALIZED (Step 2)

After the transaction or event has been identified and measured, it is recorded in the journal. The
process of recording a transaction is called journalizing.

Illustration: To understand how to record a variety of transactions, we shall analyze the business of Del
Mundo Landscape Specialist. Some transactions contain notes (in italics) for clarification and guidance.

For better appreciation of the nature of the affected accounts, the letter A (for asset), L (liability) or OE
(owner's equity) is inserted after each entry. In addition, owner's equity is further classified into OE:I
(income) and OE:E (expenses).

Note that the rules of double-entry system are observed in each transaction:

1. Two or more accounts are affected by each transaction.

2. The sum of the debits for every transaction equals the sum of the credits.

3. The equality of the accounting equation is always maintained.

Initial Investment
Nov. 1 - The owner of the Del Mundo Landscape Specialist, Galicano Del Mundo, invests P450,000 to
open the business.
Analysis - Assets increased. Owner's equity increased.
Rules - Increases in assets are recorded by debits. Increases in owner's equity are recorded by credits.
Entry - Increase in assets is recorded by a debit to cash. Increase in owner's equity is recorded by a credit
to Del Mundo, Capital.
Dr. Cr.
Cash (A) 450,000
Del Mundo, Capital (OE) 450,000
Rent Paid in Advance
Nov. 1 - Rented office space and paid three months' rent in advance, P21,000. Given the length of time,
i.e., more than a month, that this contract is in effect, the matching principle requires that the contract's
cost initially be recorded as an asset since it provides a future benefit.
Analysis - Assets increased. Assets decreased.
Rules - Increases in assets are recorded by debits. Decreases in assets are recorded by credits.
Entry - Increase in assets is recorded by a debit to prepaid rent. Decrease in assets is recorded by a
credit to cash.
Dr. Cr.
Prepaid Rent (A) 21,000
Cash (A) 21,000
Vehicle Acquired by Issuing a Note
Nov. 2 - Del Mundo purchases a P300,000 used truck by paying P200,000 in cash and signing a P100,000
note payable which is due in eighteen months.
Analysis - Assets increased. Assets decreased. Liabilities increased.
Rules - Increases in assets are recorded by debits. Decreases in assets are recorded by credits. Increases
in liabilities are recorded by credits.
Entry - Increase in assets is recorded by a debit to vehicles. Decrease in assets is recorded by a credit to
cash. Increase in liabilities is recorded by a credit to notes payable.
Dr. Cr.
Vehicles (A) 300,000
Cash (A) 200,000
Notes Payable (L) 100,000
Equipment Acquired for Cash
Nov. 3 - Del Mundo purchases mechanical lawn mowers for P54,000 in cash.
Analysis - Assets increased. Assets decreased.
Rules - Increases in assets are recorded by debits. Decreases by credits.
Entry - Increase in assets is recorded by a debit to equipment. Decrease in assets is recorded by a credit
to cash.
Dr. Cr.
Equipment (A) 54,000
Cash (A) 54,000
Expenses Incurred and Paid
Nov. 4 - Del Mundo purchases P1,500 worth of gasoline.
Analysis - Assets decreased. Owner's equity decreased.
Rules - Decreases in assets are recorded by credits. Decreases in owner's equity are recorded by debits.
Entry - Decrease in owner's equity is recorded by a debit to gas expense. Decrease in assets is recorded
by a credit to cash.
Dr. Cr.
Gas Expense (OE:E) 1,500
Cash (A) 1,500
Insurance Premiums Paid
Nov. 5 - Del Mundo pays P24,000 for a one-year insurance contract that protects his business from Nov.
1 until Oct. 31 of the following year.
Analysis - An asset increased. Another asset decreased.
Rules - Increases in assets are recorded by debits. Decreases in assets are recorded by credits
Entry - Increase in assets is recorded by a debit to prepaid insurance. Decrease in assets is recorded by a
credit to cash.
Dr. Cr.
Prepaid Insurance (A) 24,000
Cash (A) 24,000
Supplies Purchased on Account
Nov. 8 - Del Mundo purchases P1,000 worth of office supplies, placing the purchase on his account with
the store rather than paying cash. Supplies are a prepaid expense (an asset) until they are used and
thereby become a cost of doing business (an expense). Accounts payable differ from notes payable.
Accounts payable are amounts the entity owes based on the good credit of the entity or the owner,
whereas notes payable are amounts the entity owes under formal obligations.
Analysis - Assets increased. Liabilities increased.
Rules - Increases in assets are recorded by debits. Increases in liabilities are recorded by credits.
Entry - Increase in assets is recorded by a debit to supplies. Increase in liabilities is recorded by a credit to
accounts payable.
Dr. Cr.
Supplies (A) 1,000
Accounts Payable (L) 1,000
Revenues Earned and Cash Collected
Nov. 14 - The Del Mundo Landscape Specialist cuts grass for seven customers, receiving P2,500 from
each. Analysis - Assets increased. Owner's equity increased.
Rules - Increases in assets are recorded by debits. Increases in owner's equity are recorded by credits.
Entry - Increase in assets is recorded by a debit to cash. Increase in owner's equity is recorded by a credit
to lawn cutting revenues.
Dr. Cr.
Cash (A) 17,500
Lawn Cutting Revenues (OE:I) 17,500
Unearned Revenues Collected
Nov. 20 - Del Mundo receives P13,500 from a customer for six future maintenance visits. An advance
deposit from a customer is an obligation to perform work in the future. It is a liability until the work is
performed, at which time it becomes revenue. Therefore, the advance deposit is called unearned
revenues.
Analysis - Assets increased. Liabilities increased.
Rules - Increases in assets are recorded by debits. Increases in liabilities are recorded by credits.
Entry - Increase in assets is recorded by a debit to cash. Increase in liabilities is recorded by a credit to
unearned revenues.
Dr. Cr.
Cash (A) 13,500
Unearned Revenues (L) 13,500
Revenues Earned on Account
Nov. 22 - Del Mundo Landscape Specialist cuts grass for eight customers, billing each one P2,500 but
receiving no cash. In accordance with the revenue recognition principle, revenue is recognized upon the
completion of a service or the delivery of a product, even if no cash changes hands at that time.
Analysis - Assets increased. Owner's equity increased.
Rules - Increases in assets are recorded by debits. Increases in owner's equity are recorded by credits.
Entry - Increase in assets is recorded by a debit to accounts receivable. Increase in owner's equity is
recorded by a credit to lawn cutting revenues.
Dr. Cr.
Accounts Receivable (A) 20,000
Lawn Cutting Revenues (OE:I) 20,000
Salaries Paid
Nov. 26 - Del Mundo pays P4,000 in salaries to a part-time employee.

Analysis - Assets decreased. Owner's equity decreased.

Rules - Decreases in assets are recorded by credits. Decreases in owner's equity are recorded by debits.
Entry - Decrease in owner's equity is recorded by a debit to salaries expense. Decrease in assets is
recorded by a credit to cash.
Dr. Cr.
Salaries Expense (OE:E) 4,000
Cash (A) 4,000
Advertising Paid
Nov. 28 - Del Mundo pays P1,750 to print advertising fliers.
Analysis - Assets decreased. Owner's equity decreased.
Rules - Decreases in assets are recorded by credits. Decreases in owner's equity are recorded by debits.
Entry - Decrease in owner's equity is recorded by a debit to advertising expense. Decrease in assets is
recorded by a credit to cash.
Dr. Cr.
Advertising Expense (OE:E) 1,750
Cash (A) 1,750
Withdrawal of Cash by Owner
Nov. 29 - Del Mundo withdraws P5,000 for personal use.
Analysis - Assets decreased. Owner's equity decreased.
Rules - Decreases in assets are recorded by credits. Decreases in owner's equity are recorded by debits.
Entry - Decrease in owner's equity is recorded by a debit to Del Mundo, Withdrawals. Decrease in assets
is recorded by a credit to cash.
Dr. Cr.
Del Mundo, Withdrawals (OE) 5,000
Cash (A) 5,000
Accounts Receivable Partially Collected
Nov. 30 - Five of the eight customers billed last Nov. 22 each pay P2,500.
Analysis - An asset increased. Another asset decreased.
Rules - Increases in assets are recorded by debits.
Entry - Decreases as credits. Increase in assets is recorded by a debit to cash. Decrease in assets is
recorded by a credit to accounts receivable.
Dr. Cr.
Cash (A) 12,500
Accounts Receivable (A) 12,500

THE LEDGER

A grouping of the entity's accounts is referred to as a ledger. Although some firms may use various
ledgers to accumulate certain detailed information, all firms have a general ledger. A general ledger is
the "reference book" of the accounting system and is used to classify and summarize transactions, and
to prepare data for basic financial statements. The accounts in the general ledger are classified into two
general groups:

1. balance sheet or permanent accounts (assets, liabilities and owner's equity).

2. income statement or temporary accounts (income and expenses). Temporary or nominal accounts are
used to gather information for a particular accounting period. At the end of the period, the balances of
these accounts are transferred to a permanent owner's equity account.

Each account has its own record in the ledger. Every account in the ledger maintains the basic format of
the T-account but offers more information (e.g., the account number at the upper right corner and the
journal reference column). Compared to a journal, a ledger organizes information by account.

CHART OF ACCOUNTS

A listing of all the accounts and their account numbers in the ledger is known as the chart of accounts.
The chart is arranged in the financial statement order, that is, assets first, followed by liabilities, owner's
equity, income and expenses. The accounts should be numbered in a flexible manner to permit indexing
and cross-referencing.
When analyzing transactions, the accountant refers to the chart of accounts to identify the pertinent
accounts to be increased or decreased. If an appropriate account title is not listed in the chart, an
additional account may be added. Presented below is the chart of accounts for the illustration:

Del Mundo Landscape Specialist

Chart of Accounts
Balance Sheet Income Statement Accounts
Accounts Income
110 Cash Assets 410 Landscaping Revenues
120 Accounts Receivable 420 Lawn Cutting Revenues
130 Supplies Expenses
140 Prepaid Rent 510 Salaries Expense
150 Prepaid Insurance 520 Supplies Expense
160 Vehicles 530 Rent Expense
165 Accumulated Depreciation-Vehicles 540 Insurance Expense
170 Equipment 550 Gas Expense
175 Accumulated Depreciation-Equipment 560 Advertising Expenses
Liabilities 570 Depreciation Expense-Vehicles
210 Notes Payable 580 Depreciation Expense-Equipment
220 Accounts Payable 590 Interest Expense
230 Salaries Payable
240 Interest Payable
250 Unearned Revenues
Owner’s Equity
310 Del Mundo, Capital
320 Del Mundo, Withdrawal
330 Income Summary

POSTING (Step 3)

Posting means transferring the amounts from the journal to the appropriate accounts in the ledger.
Debits in the journal are posted as debits in the ledger, and credits in the journal as credits in the ledger.
The steps are illustrated on the next page:

1. Transfer the date of the transaction from the journal to the ledger.

2. Transfer the page number from the journal to the journal reference (J.R.) column of the ledger.
3. Post the debit figure from the journal as a debit figure in the ledger and the credit figure from the
journal as a credit figure in the ledger.

4. Enter the account number in the posting reference column of the journal once the figure has been
posted to the ledger.

LEDGER ACCOUNTS AFTER POSTING

At the end of an accounting period, the debit or credit balance of each account must be determined to
enable us to come up with a trial balance.

 Each account balance is determined by footing (adding) all the debits and credits.
 If the sum of an account's debits is greater than the sum of its credits, that account has a debit
balance.
 If the sum of its credits is greater, that account has a credit balance.
Illustration. The ledger accounts of Del Mundo Landscape Specialist after posting are shown below. The
account numbers and journal reference columns are purposely omitted. The balance of each account
has been determined.
TRIAL BALANCE (Step 4)

The trial balance is a list of all accounts with their respective debit or credit balances. It is prepared to
verify the equality of debits and credits in the ledger at the end of each accounting period or at any time
the postings are updated.

The procedures in the preparation of a trial balance follow:

1. List the account titles in numerical order.

2. Obtain the account balance of each account from the ledger and enter the debit balances in the debit
column and the credit balances in the credit column.

3. Add the debit and credit columns.

4. Compare the totals.

The trial balance is a control device that helps minimize accounting errors. When the totals are equal,
the trial balance is in balance. This equality provides an interim proof of the accuracy of the records but
it does not signify the absence of errors. For example, if the bookkeeper failed to record payment of
rent, the trial balance columns are equal but in reality, the accounts are incorrect since rent expense is
understated and cash overstated. The trial balance for the illustration follows:

Del Mundo Landscape Specialist

Trial Balance
Nov. 30, 2016
Cash P182,250
Accounts Receivable 7,500
Supplies 1,000
Prepaid Rent 21,000
Prepaid Insurance 24,000
Vehicles 300,000
Equipment 54,000
Notes Payable P100,000
Accounts Payable 1,000
Unearned Revenues 13,500
Del Mundo, Capital 450,000
Del Mundo, Withdrawals 5,000
Lawn Cutting Revenues 37,500
Salaries Expense 4,000
Gas Expense 1,500
Advertising Expense 1,750
P602,000 P602,000
LOCATING ERRORS

An inequality in the totals of the debits and credits would automatically signal the presence of an error.
These errors include:

1. Error in posting a transaction to the ledger:

 an erroneous amount was posted to the account.

 a debit entry was posted as a credit or vice versa.
 a debit or credit posting was omitted.

2. Error in determining the account balances:

 a balance was incorrectly computed.

 a balance was entered in the wrong balance column.

3. Error in preparing the trial balance:

 one of the columns of the trial balance was incorrectly added.

 the amount of an account balance was incorrectly recorded on the trial balance.
 a debit balance was recorded on the trial balance as a credit or vice versa, or a balance was
omitted entirely.

What is the most efficient approach in locating an error? The following procedures when done in
sequence may save considerable time and effort in locating errors:

1. Prove the addition of the trial balance columns by adding these columns in the opposite direction.

2. If the error does not lie in addition, determine the exact amount by which the trial balance is out of
balance. The amount of the discrepancy is often a clue to the source of the error. If the discrepancy is
divisible by 9, this suggests either a transposition (reversing the order of numbers) error or a slide
(moving of the decimal point). For example, assume that the cash account balance is P21,750, but in
copying the balance into the trial balance the figures are transposed and written as P21,570. The
resulting error amounted to P180 and is divisible by 9. Another common error is the slide, or incorrect
placement of the decimal point, as when P21,750.00 is copied as P2,175.00. The resulting discrepancy in
the trial balance will also be an amount divisible by 9.

Assume that the office equipment account has a debit balance of P42,000 but it is erroneously listed in
the credit column of the trial balance. This will cause a discrepancy of two times P42,000 or P84,000 in
the trial balance totals. Since such errors as recording a debit in a credit column are common, it is
advisable, after determining the discrepancy in the trial balance totals, to scan the columns for an
amount equal to exactly one-half of the discrepancy.

It is also advisable to look over the transactions for an item of the exact amount of the discrepancy. An
error may have been made by recording the debit side of the transaction and forgetting to enter the
credit side.
3. Compare the accounts and amounts in the trial balance with that in the ledger. Be certain that no
account is omitted.

4. Recompute the balance of each ledger account.

5. Trace all postings from the journal to the ledger accounts. As this is done, place a check mark in the
journal and in the ledger after each figure is verified. When the operation is completed, look through the
journal and the ledger for unchecked amounts. In tracing postings, be alert not only for errors in amount
but also for debits entered as credits, or vice versa.

Note that even when a trial balance is in balance, the accounting records may still contain errors. A
balanced trial balance simply proves that, as recorded, debits equal credits. The following errors are not
detected by a trial balance:

1. Failure to record or post a transaction.

2. Recording the same transaction more than once.

3. Recording an entry but with the same erroneous debit and credit amounts.

4. Posting a part of a transaction correctly as a debit or credit but to the wrong account.

Reference:

Ballada, W. (2017). Fundamentals of Accountancy Business & Management 1. DomDane Publishers &
Made Easy Books.