THE ACCOUNTING CYCLE

TRANSACTION ANALYSIS

The analysis of transactions shown 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 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, timecards, and
statements of account.

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
During the Aim: To record the economic impact of transactions on
accounting the firm in a journal, which is a form that facilitates
period 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.
At the end Step 7 Adjusting Journal Entries are Journalized and Posted
of the accounting Aim: To record the accruals, expiration of deferrals,
period 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.
At the start Step 10 Reversing Journal Entries are Journalized and Posted
of the next Aim: To simplify the recording of certain regular transactions
period 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 General Journal Shows all the effects of a transaction

(the book of original entry) in terms of debits and credits.

Office Equipment xx

Cash xx

Accounts payable xx Posting

Transferring the amounts from the

general journal to appropriate accounts

in the ledger.

Cash

The Ledger

A grouping of accounts.
Office
Equipment
Used to classify and

Accounts Payable
summarize transactions

and to prepare data for

basic financial statements.

Trial Balance
Listing of all ledger
accounts, in order, with Assets
their respective debit or Liabilities
credit balances. Owner's Equity
Revenues
Expenses
 THE JOURNAL

The journal is 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 accounts 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 Maria Concepcion Jennifer Perez-Manalo established her own wedding
consultancy with an initial investment of P250,000 on May 1.
The journal entry is shown below:

Journal page 1

Date Account Titles and Explanation P.R. Debit Credit

1 2019
2 May 1 Cash 250,000
3 Perez-Manalo, Capital 250,000
4 Initial Investment.
5

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 Perez-Manalo. 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. The following
are the transactions for Weddings “R” Us during the month of May. The double-
entry system will be used.

To understand 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 of every transaction equals the sum of the credits.
3. The equality of the accounting equation is always maintained.
______________________________________________________________________

Initial Investment (Source of Assets)

May 1 Maria Concepcion Jennifer Perez-Manalo is a social entrepreneur from

the South. She is into a lot of interesting causes. Her fine taste is
preeminent such that she is considered an authority in planning weddings.
Upon the advice and prodding of an esteemed colleague, Bendalyn
Landicho, Perez Manalo decided to organize her wedding consultancy.
She invested P250,000 into this entity.

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 Increases in assets is recorded by a debit to cash. Increase in owner’s
equity is recorded by a credit to Perez-Manalo, Capital.

Dr. Cr.
Cash (A) 250,000
Perez-Manalo, Capital (OE) 250,000
____________________________________________________________________________

____________________________________________________________________________

Rent paid in Advance (Exchange of Assets)

May 1 Rented office space and paid two months’ rent in advance, P8,000.

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) 8,000
Cash (A) 8,000
____________________________________________________________________________

Note Issued for Cash (Source of Assets)

May 2 Maria Concepcion Jennifer Perez-Manalo issued a promissory note for a
P210,000 loan for Metrobank. This availment will be used for the
acquisition of a service vehicle. The note carries a 20% interest per
annum. The arrangement with the bank is that both the interest and the
principal are payable in full in one year.

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 notes payable.

Dr. Cr.
Cash (A) 210,000
Notes Payable (L) 210,000
____________________________________________________________________________
______________________________________________________________________
May 2 Hired an office assistant and an account executive each with a P7,800
monthly salary. Or each is to receive P300 per day for the 26-day work
month. No entry is necessary at this point. They started work immediately.
________________________________________________________________

________________________________________________________________
Service Vehicle Acquired for Cash (Exchange of Assets)

May 4 Acquired service vehicle for P420,000.

Analysis Assets increased. Assets decreased.

Rules Increases in assets are recorded by debits. Decreases by credits.
Entry Increase in assets is recorded by a credit to cash.

Dr. Cr.
Service Vehicle (A) 420,000
Cash (A) 420,000
____________________________________________________________________________

________________________________________________________________
Insurance Premiums Paid (Exchange of Assets)
May 4 Paid Prudential Guarantee and Assurance, Inc. P14,400 for a one-year
comprehensive insurance coverage on the service vehicle.

Analysis As 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) 14,400
Cash (A) 14,400
____________________________________________________________________________

________________________________________________________________
Office Equipment Acquired on Account (Exchange and Source of Assets)

May 5 Acquired office equipment from Fair and Square Emporium for P60,000,
paying P15,000 in cash and the balance next month.
Note: A compound entry is needed for this transaction.

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 office equipment.
Decrease in assets is recorded by a credit to cash. Increase in
Liabilities is recorded by a credit to accounts payable.

Dr. Cr.
Office Equipment (A) 60,000
Cash (A) 15,000
Accounts Payable (L) 45,000

________________________________________________________________

Supplies Purchased on Account (Source of Assets)

May 8 Purchased supplies on credit for P18,000 from San Jose Merchandising
Analysis Assets increased. Liabilities increased.
Rules Increases in assets are recorded by debits. Increases in liabilities
are recorded by credits.
Entry Increases in assets in recorded by a debit to supplies. Increase in
liabilities are recorded by a credit to accounts payable.

Dr. Cr.
Supplies (A) 18,000
Accounts Payable (L) 18,000
____________________________________________________________________________

________________________________________________________________

Accounts Payable Partially Settled (Use of Assets)

May 9 Paid San Jose Merchandising P10,000 of the amount owed.

Analysis Assets decreased. Liabilities decreased.

Rules Decreases in assets are recorded by credits. Decrease in liabilities
are recorded by debits.
Entry Decrease in liabilities is recorded by a debit to accounts payable.
Decrease in assets is recorded by a credit to cash.

Dr. Cr.
Accounts Payable (L) 10,000
Cash (A) 10,000
____________________________________________________________________________

____________________________________________________________________________

Revenues Earned and Cash Collected (Source of Assets)

May 10 Coordinated and finalized simple bridal arrangements for three couples
and collected fees of P8,800 per couple. Service includes prospecting and
selecting the church and reception location, couturier, caterer, car service,
flowers, souvenirs, and invitations.

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 consulting revenues.

Dr. Cr.

Cash (A) 26,400

Consulting Revenues (OE:I) 26,400
____________________________________________________________________________

Salaries Paid (Use of Assets)

May 13 Paid salaries, P6,600. The entity pays salaries every two Saturdays (refer
to the calendar in Chapter 5)

Analysis Assets decreased. Owner’s equity decreased.

Rules Decrease 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) 6,600

Cash (A) 6,600
____________________________________________________________________________
______________________________________________________________________

Unearned Revenues Collected (Source of Assets)

May 15 The entity is earning additional revenues by referring consulting clients too
friendly hotels, caterers, printers, and couturiers.
Received P10,000 advance fees for three clients referred.

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 referral revenues.

Dr. Cr.
Cash (A) 10,000
Unearned Referral Revenues (L) 10,000
____________________________________________________________________________

______________________________________________________________________

Revenues Earned on Account (Source of Assets)

May 19 Coordinated and finalized elaborate bridal arrangements for three couples
and billed fees of P12,000 per couple. Additional services include
documents preparation, consultation with a feng shui expert as to the ideal
wedding date for prosperity and harmony, provision for limousine service
and honeymoon trip.

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 Increases in assets is recorded by a debit to accounts receivable.
Increases in owner’s equity is recorded by a credit to consulting
revenues.

Dr. Cr.
Accounts Receivable (A) 36,000
Consulting Revenues (OE:I) 36,000
______________________________________________________________________

Withdrawal of cash by Owner (Use of Assets)

May 25 Perez-Manalo withdrew P14,000 for personal expenses.

Analysis Assets decreased. Owner’s equity decreased.

Rules Decreases in assets are recorded by the credits. Decreases in
owner’s equity are recorded by debits.
Entry Decrease in owner’s equity is recorded by a debit to Perez-Manalo,
Withdrawals. Decrease in assets is recorded by a credit to cash.

Dr. Cr.
Perez-Manalo, Withdrawals (OE) 14,000
Cash (A) 14,000
______________________________________________________________________
______________________________________________________________________

Salaries Paid (Use of Assets)

May 27 Paid salaries, P7,200

Analysis Assets decreased. Owner’s equity decreased.

Rules Decrease 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) 7,200
Cash (A) 7,200
______________________________________________________________________
______________________________________________________________________

Expenses Incurred but Unpaid (Exchange of Claims)

May 30 Received the ICC-Bayan Tel telephone bill, P1,400.

Analysis Liabilities increased. Owner’s equity decreased.

Rules Increases in liabilities are recorded by credits. Decreases in owner’s
equity are recorded by debits.
Entry Decrease in owner’s equity is recorded by a credit to utilities payable.

Dr. Cr.
Salaries Expense (OE:E) 1,400
Utilities Payable (L) 1,400
______________________________________________________________________
______________________________________________________________________

Accounts Receivable Partially Collected (Exchange of Assets)

May 30 Received P24,000 from two clients for services billed last May 19.

Analysis An asset increased. Another asset decreased.

Rules Increases in assets are recorded by debits. Decreases as credits.
Entry Increase an assets is recorded by a credit to accounts receivable.
 Dr. Cr.
Cash (A) 24,000
Accounts Receivable (A) 24,000
______________________________________________________________________
______________________________________________________________________

Expenses Incurred and Paid (Use of Assets)

May 31 Settled the electricity bill of P3,000 for the month.

Analysis Assets decreased. Owner’s equity decreased.

Rules Decreases in assets recorded by credits. Decreases in owner’s equity are
recorded by debits.
Entry Decrease in owner’s equity is recorded by a debit to utilities expense.
Decrease in assets is recorded by a credit to cash.

Dr. Cr.
Utilities Expense (OE:E) 3,000
Cash (A) 3,000
______________________________________________________________________
______________________________________________________________________

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 summarized 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, 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.

While 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 id the
chart of accounts for the illustration:

Weddings “R” Us
Chart of Accounts

Balance Sheet Accounts Income Statement Accounts

___________________________ __________________________
Assets Income

110 Cash 410 Consulting Revenues

120 Accounts Receivable 420 Referral Revenues
130 Supplies
140 Prepaid Rent Expenses
150 Prepaid Insurance 510 Salaries Expense
160 Service Vehicle 520 Supplies Expense
165 Accumulated Depreciation 530 Rent Expense
170 Office Equipment 540 Insurance Expense
175 Accumulated Depreciation 550 Utilities Expense
Liabilities 560 Depreciation
210 Notes Payable Service Vehicle
220 Accounts Payable 570 Depreciation Expense
230 Salaries Payable Office Equipment
240 Utilities Payable 580 Miscellaneous Expense
250 Interest Payable 590 Interest Expense
260 Unearned Referral Revenues
Owner’s Equity
310 Perez-Manalo, Capital
320 Perez-Manalo, Withdrawals
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 as follows:

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.

The Journal
2

------- --------
Page 1--------

-------- ------------- -------- ------- -------- --------

Date Account Titles and Explanation P.R. Debit Credit

1 1 2019

------- 2 May 1 Cash 110 250,000

--------- --------- ---------

------- -------- -------- ------------- --------

3 Perez-Manalo, Capital 310 250,000

------- ------- -----------

4 Initial investment 4

The Ledger 3 ---------------------- 3

---------------

-------- ----- --------

Account: Cash Account No. 110 --------

-- -- ----- ----- -----

-- --

--
-- -------- --------

------- -------- -------- --------

Date Explanation J.R. Debit Credit Balance

1 2019

2 May 1 J-1 250,000 250,000

-
-------- -------- --------

----- ----- -- ----- ----- ----- -----

------------------------------------------------------------------------------------------------------------
------------------------- -----
----- ------------- -------- ----- -------- ----

Account: Perez-Manalo, Capital Account No. 310

--
-------- -------

Date Explanation J.R. Debit Credit Balance

1 2019

- 2 1-May J-1 250,000 250,000 250,000

----------------------- -
-------------------
----------------------------------------------------------------------------------------------------------------------------

LEDGER ACCOUNTS ARE 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 credit is greater, the account has a credit balance.

Illustration. The ledger accounts of Weddings “R” Us after posting are shown below.
The account numbers and journal reference columns are purposely omitted. The
balance of each account gas been determined.

Cash Notes Payable

May 1 250,000 May 1 8,000 May 2 210,000
2 210,000 4 420,000 Balance 210,000
1
0 26,400 4 14,400
1
5 10,000 5 15,000 Accounts Payable
3 Ma
0 24,000 9 10,000 y 9 10,000 May 5 45,000
1
3 16,600 8 18,000
2
5 14,000 10,000 63,000
2
7 7,200 Balance 53,000
3
1 3,000
520,400 498,200
Balance 22,200 Utilities Payable
3
May 0 1,400
Balance 1,400

Accounts Receivable Unearned Referral Revenues

1 3 1
May 9 36,000 May 1 24,000 May 5 10,000
Balance 12,000 Balance 10,000

Supplies Perez-Manalo, Capital

May 8 18,000 May 1 250,000
Balance 18,000 Balance 250,000

Prepaid Rent Perez-Manalo, Withdrawals

Ma 2
May 1 8,000 y 5 14,000
 Balance 8,000 Balance 14,000

Prepaid Insurance Consulting Revenues

1
May 4 14,400 May 0 26,400
1
Balance 14,400 May 9 36,000
62,400
Balance 62,400

Service Vehicle Salaries Expense

Ma 1
May 4 420,000 y 3 6,600
2
Balance 420,000 7 7,700
13,800
Balance 13,800

Office Equipment Utilities Expense

Ma 3
May 5 60,000 y 0 1,400
3
Balance 60,000 1 3,000
Balance 4,400
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 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 expenses is understated and cash
overstated.