The Accounting Cycle

Study Guide

An accounting cycle is as a series of recurring accounting activities from the beginning to the end of a
given period. Illustration 1-1 flowcharts the steps in the accounting cycle. These are the accounting
procedures normally used by enterprise to record transactions and prepare financial statements.

Illustration 1-1
Identification and Measurement of
Transaction and Other Events

Journalization
General Journal
Cash Receipts Journal
Reversing Entries
Cash Disbursement Journal
(Optional) Purchase Journal
Sales Journal
Other Special Journal

Post-closing Trial Posting

Balance General ledger (usually
monthly)
(Optional) Subsidiary Ledger (usually
daily)

Closing Entries Trial Balance Preparation

Statement Preparation Adjustments

Balance Sheet Accruals
Worksheet Deferrals
Income Statement (Optional)
Statement of Changes in Estimated items
Earnings
Statement of Cash Flows

Adjusted Trial Balance

Identifying and Recording Transactions and Other Events

The first step in the accounting cycle is analysis of transactions and other events. The problem is to
determine what to record. As per generally accepted standard, accountant will only record
transactions that can be quantified or measured in items of peso and is relevant in the
preparation of the financial statement. Most agree that changes in personnel and value of company’s
human resource, thought important, should not be recorded in the accounts. On the other hand, when
the company makes a cash sale or purchase – no matter how small – it should be recorded.
Journalizing

After transactions and events have been analyzed, these will be recorded in chronological order in the
appropriate journals (book of original entry). In some small businesses, all transactions are recorded
in a single journal. Most business enterprises, however, maintain various special journals, designed to
meet their specific needs. A Special Journal is used to record a particular type of frequently recurring
transactions. It is commonly used, for example, to record each of the following types of transactions:
Sales, Purchases, Cash Disbursements, and Cash Receipts. A General journal is used to record all
transactions for which a special journal is not maintained.

Posting to the ledger accounts

When the transactions and events have already been journalized, all entries in the journal will be
transferred to the ledger. This transfer is referred to as posting. Note that posting is a copying
process, it involves no new analysis. The most convenient way of illustrating it is through the “T”
account.

Preparing a Trial Balance

A trial balance is a list of accounts and their balances at a given time. It is normally prepared at the
end of accounting period. The primary purpose of a trial balance is to prove the mathematical equality
of debits and credits after posting. Under the double-entry system this equality will occur when the
sum of the debit account balances equals the sum of the credit account balances. Through trial
balance, errors in journalizing and posting will be uncovered. In addition, it is useful in the preparation
of financial statements.

Preparing Adjusting Entries

In order for revenues to be recorded in the period in which they are earned, and for expenses to be
recognized in the period in which they are incurred, adjusting entries are made at the end of the
accounting period. In short, adjustments are needed to ensure that the revenue recognition
and matching principles are followed.

Adjustments are often prepared after the balance sheet date. However, the entries are dated as of the
balance sheet date.

Adjusting entries may be classified into three major types: deferred items, accrued items, and cost
allocations.

A. Deferred items – result form transactions in which cash flow precedes recognition of the
related expense or revenue. The two general situations are:

1. Deferred expense (an asset account; usually called prepaid expense) – cash is paid before the
related expense should be recognized; for example, rent paid in advance.
2. Deferred revenue (a liability account; usually called unearned revenue) – cash is collected
before the related revenue should be recognized; for example, rent revenue collected in advance
of occupancy.

B. Accrued items – result form transactions in which cash flow lags (i.e. follows) recognition of
the related expense is incurred; for example wages earned by an employee but not yet paid.

1. Accrued expense (a liability account; usually called accrued liabilities) – cash is paid after the
related expense is incurred; for example, wages earned by an employee but not yet paid.
2. Accrued revenue (an asset account related to revenue other than to sales and services sold on
credit; often called revenue receivable) – cash is collected after the related revenue is earned;
for example, interest revenue earned but not yet collected.

C. Other items – internal cost allocations not yet recorded; for example, estimated bad debt
expense and depreciation expense, and cost of goods sold (with a periodic inventory system).

Preparing Financial Statements

Once all accounts have been brought up to date through the adjustment process, financial statements
are prepared. The data used to prepare financial statements may be taken directly from the adjusted
accounts balances in the ledger, or a worksheet may used. Financial statements are prepared by
determining which accounts go on which financial statement, appropriately listing those accounts, and
summing to obtain totals.

Closing the Nominal Accounts

The mechanics of closing the nominal accounts are straightforward. All revenue accounts with credit
balances are closed by being debited; all expense accounts with debit balance are closed be being
credited. This process reduces these temporary accounts to zero balance. The difference between the
closing debit amounts for revenue and the credit amount for expense is net income/(loss) and is
charged to Retained Earnings. Dividends are also closed at the end of each period. The closing of
Dividends serves to reduce Retained Earnings.

Preparing a Post-Closing Trial Balance

After the closing entries are posted, a post-closing trial balance may be prepared to verify the equality
of the debits and credits for all accounts. The post-closing trial balance represents the end of the
accounting cycle.

The purpose of a trial balance are to (a) verify the equality of the debits and credits and (b) have the
account balances ready for other uses. There are three different trial balances: the unadjusted trial
balance, taken immediately after all of the current entries are journalized and posted for the
accounting period but before the adjusting entries; the adjusted trial balance, which reflects the
account balances after the adjusting entries; and the post-closing trial balance, which used to verify
that the debits and credits are equal at the start of the next accounting period.

Reversing Entries

Reversing entry serves only one purpose, that is, to facilitate (or simply) a related entry in the
next accounting period. These entries are always optional; the same end result can be obtained
whether or not they are used. If used, only certain of the adjusting entries are reversed.

The following adjusting entries should be reversed:

1. Accrued expenses
2. Accrued revenue (income)
3. Deferred expenses that were originally recorded in a temporary account.
4. Deferred revenues that were originally recorded in a temporary account.
5. Adjustment to the allowance for sales returns and discounts.

Summary of Transportation Terms

Terms of transportation Accountability Actual payor of Effect on claims or

transportation obligation
FOB Shipping point, freight prepaid Buyer Seller Increase
FOB Shipping point, freight collect Buyer Buyer No effect
FOB Destination, freight prepaid Seller Seller No effect
FOB Destination, freight collect Seller Buyer Decrease

Problem 1-1 –Accounting Cycle

The following is the post-closing trial balance of Abagon Shop dated January 1, 2002:

Debit Credit
Cash 120,000
Accounts receivable 280,000
Allowance for doubtful accounts 2,800
Unused shop supplies 800
Shop equipment 240,000
Accumulated depreciation- Shop equipment 48,000
Accounts payable 88,800
Notes payable 100,000
Accrued interest payable 1,200
Abagon, Capital 400,000
Totals 640,800 640,800
For the month of February, the following information are the transactions of Abagon Shop.

1. Abagon withdrew P100,000 cash from the business for her personal use.
2. Paid P12,000 insurance premium.
3. Paid P24,000 rent.
4. Total service rendered to various customers, P140,000, 40% of total sales are cash basis and
the balance on open account.
5. Received promissory note from customer to replace P40,000 accounts receivable.
6. Collected in cash P164,000 of accounts receivable
7. Paid the notes payable of P100,000 plus the P2,400 interest
8. Purchased P2,400 shop supplies on cash basis
9. Paid salaries, P24,000

At the end of the month, the following information are available to effect adjustments.

a. The insurance in number 2 for P12,000 is applicable for six months starting February.
b. The rent of P24,000 paid in number 3 is for months, starting February.
c. The note receivable is number 5 earning 12% interest per year. The note is dated February 1,
and is due on April 30.
d. Bad debts expense is estimated at 20% of accounts receivable balance.
e. The annual depreciation is P48,000
f. The unused supplies balance is P1,000.

Required:
1. Prepare the journal entries to record the transactions.
2. Prepare the working paper for the preparation of interim financial statements for the month of
February.
3. Using the working paper, answer the following questions:
a. Cash at the end of February is __________
b. Net Realizable value of accounts Receivables at the end of February is __________
c. Unused shop supplies at the end of February is __________
d. Net book value of Shop Equipment at the end of February is __________
e. Accounts Payable at the end of February is __________
f. Notes Payable at the end of February __________
g. Abagon Capital, net of drawing at the end of February is __________
h. Net income of the company at the end of February is __________
i. Total Revenue of the company at the end of February __________
j. Total Expenses of the company at the end of February __________

Problem 1-2 – Multiple Choice (Merchandising Concern)

Instruction: Indicate your answer by encircling the letter that contains your choice in each of the
following questions.

1. One is using periodic inventory system. For the year, its total purchases amounted to
P250,000. Its unsold merchandise at the end of the year has a cost of P5,000 which is 80% of
its beginning inventory. One’s cost of sale is
a. P250,000 b. P251,250 c. P249,000 d. 248,750

2. Two’s purchase per purchase invoice is P150,000. The purchase discount is 2/10, n/30.
Freight is P500, FOB shipping point collect. The net purchase amounts under net method is
a. P147,000 b. P147,500 c. P148,500 d.
P150,500

3. Using the information in item 2, the amount paid by the buyer is

a. P147,000 b. P147,500 c. P148,500 d.
P150,500

4. The purchase invoice shows the amount of P250,000, 2/10, 1/20, n/30; FOB destination
collect, P200. If the account is paid 15 days after the invoice date, the net payment should be
a. 245,000 b. 247,500 c. 247,300 d.
244,800

5. Using the information in Item 4, the net purchase is

a. 245,000 b. 247,500 c. 247,300 d.
P244,800
 6. Three purchased merchandise for P5,000 and paid P200 for freight, FOB destination collect.
The merchandise was sold at 120% of cost. The gross profit is
a. P1,000 b. P1,040 c. P6,000 d. P6,240

7. The total purchase is P1,176, net of 2% cash discount. Unsold portion of purchase is P176.
The sale is at mark-up of 10%. The gross profit is
a. P11.60 b. P88.24 c. P115.25 d. P100.00

8. The term of a P300,000 purchase is 2/20, n/60, FOB shipping point prepaid, P300. If the
account is paid on the 25th say from the invoice date, the total payment would be
a. P294,000 b. P299,700 c. P294,300 d.
P300,000

9. Four paid freight for P200 on its purchase on account from Five, FOB shipping point. The
journal entry in both books of Four and Five would be
Books of Four Books of Five
a. Freight-out 200 Freight-in 200
Cash 200 Accounts payable 200
b. Freight-in 200 No entry
Accounts receivable 200
c. Freight-in 200 No entry
Cash 200
d. Freight-in 200 Freight-out 200
Cash 200 Accounts receivable 200

10. Six sold merchandise at list price of 250,000; 5; n/30. Part of the sale amounting to P10,000
was returned due to defect. The amount to be collected by Six is
a. P205,000 b. P203,750 c. P204,000 d.
P195,200

Problem 1-3 – Adjusting entry

Listed below are six transactions of Aguilon Talent Center for the month of January:
a. On January 5, purchased a public address system for P12,000. The useful life was estimated at
five years.
b. On January 15, purchased a three-year fire insurance effective the current year for P36,000.
c. On January 2, Aguilon Talent Center sold tickets for P1,200,000 cash for a Drama Subscription
Series consisting of six different plays, to be presented ad follows; Play 1, January 10-17; Play
2, January 20-27; Play 3, February 4-10; Play 4, February 14-20; Play 5, February 24-March
1, and Play 5, March 10-17.
d. On January 4, an agreement was reached with Dennis to give solo performances (as a singer),
January 28 to February 3, inclusive. Compensation was arranged at 15% of total box office
receipts for the first six performances, to be paid in one lumps sum after the sixth
performances. Box office receipts for three performances ending January 31 amounted to
P1,300,000.
e. On January 15, borrowed P120,000 from the PBCom. To be repaid six months later, plus
interest at 12% per annum. A promissory note was signed.

Required: Prepare adjusting entry for each of the transactions above. Assume the company is using
nominal accounts in recording each cash payment and cash receipts.

Problem 1-4 – Adjusting and correcting entries

Upon inspecting the books and records for Macel Company for the year ended December 31, 2002, you
find the following.

a. A receivable of P380 from Clair Realty is determined to be uncollectible. The company maintains
an allowance for doubtful accounts for such losses.
b. A creditor, Savior Co., has just been awarded damages of P2,200 as a result of a breach of
contract during the current year by Macel Company. Nothing appears on the books in connection
with this matter.
c. A fire destroyed part of a branch office. Furniture and fixtures that cost P10,200 and had a book
value of P7,800 at the time of the fire were completely destroyed. The insurance company has
agreed to pay P6,500 under the provisions of the fire insurance policy.
d. Advances of P1,150 to salesperson have been previously recorded as sales salaries expense.
 e. Machinery at the end of the year shows a balance of P18,460. it is discovered that additions to
this account during the year totaled P4,460, but of this amount, P800 should have been recorded
as repairs. Depreciation is to be recorded at 10% on machinery owned throughout the year but
at one-half this rate on machinery purchased or sold during the year.

Required: Record the entries required to adjust and correct the accounts. (Ignore income tax
consequences.)

Problem 1-5 Multiple choice Question (Adjusting Entries)

1. Amar Company received P96,000 on April 1, 2002 for one year’s rent in advance and recorded the
transaction with a credit to a nominal account. The December 31, 2002 adjusting entry is
a. Debit rent revenue and credit unearned rent revenue, P24,000.
b. Debit rent revenue and credit unearned rent revenue, P72,000.
c. Debit unearned rent revenue and credit revenue, P24,000.
d. Debit unearned rent revenue and credit rent revenue, P72,000.
2. Andoy Company paid P72,000 on June 1, 2002 for a two-year insurance policy and recorded the
entire amount as insurance expense. The December 31, 2002 adjusting entry is

a. Debit insurance expense and credit prepaid insurance, P21,000.

b. Debit insurance expense and credit prepaid insurance, P51,000.
c. Debit prepaid insurance and credit insurance expense, P21,000.
d. Debit prepaid insurance and credit insurance expense, P51,000.
3. Antipuesto Company purchase equipment on November 1, 2002 and gave a 12-month, 9% note
with a face value of P480,000. The December 31,2002 adjusting entry is

a. Debit interest expense and credit interest payable, P7,000.

b. Debit interest expense and credit interest payable, P10,000.
c. Debit interest expense and credit cash, P7,200.
d. Debit interest expense and credit interest payable, P43,200.
4. On December 31, 2002, Asilo Company’s bookkeeper made an adjusting entry debiting supplies
expense and credit supplies inventory for P12,600. The supplies inventory accounts had a P15,300
debit balance on December 1, 2001. The December 31, 2002 balance sheet showed supplies
inventory of P11,400. Only one purchase of supplies was made during the month, on account. The
entry for that purchase was

a. Debit supplies inventory and credit cash, P8,700.

b. Debit supplies expense and credit accounts payable, P8,000.
c. Debit supplies inventory and credit accounts payable, P8,700.
d. Debit supplies inventory and credit accounts payable, P16,500.
5. Astillo Company loaned P300,000 to another company on December 1, 2002 and received a 3-
month, 15%, interest-bearing note with a face value of P300,000. What adjusting entry should
Astillo Company make on December 31, 2002?

a. Debit interest receivable and credit interest income, P7,500.

b. Debit cash and credit interest income, P3,750.
c. Debit interest receivable and credit interest income, P3,750.
d. Debit cash and credit interest receivable, P7,500.
6. The supplies inventory account balance at the beginning of the period was P66,000. Supplies
totaling P128,250 were purchased during the period and debited to supplies inventory. A physical
count shows P38,250 of supplies inventory at the end of the period. The year-end adjusting entry
is
a. Debit supplies inventory and credit supplies expense, P90,000.
b. Debit supplies expense and credit supplies inventory, 128,250.
c. Debit inventory and credit supplies expense, P156,000.
d. Debit supplies expense and credit supplies inventory, 156,000.
7. At the end of 2002, Avila company made four adjusting entries for the following items: (1)
depreciation expense, P35,000; (2) expired insurance, P2,200 (originally recorded as prepaid
insurance); (3) interest payable, P9,000; and (4) rental revenue receivable, P10,000.

In the normal situation, to facilitate subsequent entries, the adjusting entry or entries that may
be reversed is/are
a. Entry 1 c. Entries 3 and 4
b. Entry 4 d. Entries 2,3 and 4
8. Bagaipo Company reported an allowance for doubtful of P12,000 (credit) at December 31, 2002
before performing an aging of accounts receivable. As a result of the aging, Bagaipo determined
that an estimated P20,000 of the December 31, 2002 accounts receivable would prove
uncollectible. The adjusting entry at December 31, 2002 would be

a. Doubtful accounts expense 20,000

Allowance for doubtful account 20,000
b. Doubtful accounts expense 20,000
Accounts receivable 20,000
c. Allowance for doubtful accounts 8,000
Doubtful accounts expense 8,000
d. Doubtful accounts expense 8,000
Interest revenue 28,125
9. Assuming that the company does not reverse the adjusting entries, what should be made on April
1, 2002 when the annual interest payment is received?

a. Debit cash and credit interest revenue, P9,375.

b. Debit cash and credit interest receivable, P28,125.
c. Debit cash, P37,500; credit interest receivable, P28,125; and interest revenue, P9,375.
d. Debit cash and credit interest revenue, P37,500.
10. Using the data on No. 9, but assuming that the company does reverse its adjusting entries, what
entry should be made on April 1, 2003 when the annual interest payment is received?

a. Debit cash and credit interest revenue, P9,375.

b. Debit cash and credit interest receivable, P28,125.
c. Debit cash, P37,500; credit interest receivable, P28,125; and interest revenue, P9,375.
d. Debit cash and credit interest revenue, P37,500.

Problem 1-6 – Working Paper Preparation

Below is the trial balance for Sondres Company as of December 31.

Debit Credit
Cash 58,000
Investment 402,000
Inventories 57,000
Prepaid Expenses 54,000
Land 65,000
Plant and Equipment 1,167,000
Other Assets 1,563,000
Accounts Payable 147,000
Wages, Interest and Taxes Payable 215,000
Unearned Revenue 33,000
Long-term Debt 1,201,000
Other Liabilities 185,000
Retained Earnings 1,112,000
Dividends 139,000
Sales 2,801,000
Interest Revenue 23,000
Cost of goods sold 1,565,000
Selling, General & Admin Exp. 640,000
Interest Expense 79,000
Income Tax Expense 264,000 _________
TOTALS 6,053,000 6,053,000

Consider the following information:

a. Sonia uses a perpetual inventory system.
b. The prepaid expenses were paid on September 1 and relate to a 3-year insurance policy
that went into effect on September 1.
c. The unearned revenue relates to rental of an unused portion of the corporate offices.
The P33,000 was received on April and represents payment in advance for one years rental.
d. Plant and Equipment includes P10,000 for routine equipment repairs that were
erroneously recorded as equipment purchases. The repairs were made on December 30.
 e. Other assets include P8,000 for miscellaneous office supplies, which were purchased in
mid-October. An end of year count reveals that only P6,500 of the office supplies remain.
f. Selling, General and Administrative expenses incorrectly includes P15,000 for office
furniture purchases (Other Assets). The purchase were made on December 30.
g. Inventory wrongly includes P6,000 of inventory that Sonia had purchase on account but
that was returned to the supplier on December 28 because of unsatisfactory quality.

Required: Prepare Working Paper of Sondres Company as of December 31.

Problem 1-7 – Reversing Entry

Using the information in Problem 1-5, Prepare Reversing Entry as of January 1 the following year.

Problem 1-8

Selected pre-adjustment account balances and adjusting information of NAPPY COMPANY for the year
ended December 31, 2002 are as follows:

Retained earnings, January 1, 2002 440,670

Sales Salaries and Commissions 35,000
Advertising Expense 16,000
Legal Services 2,225
Insurance and Licenses 8,500
Travel Expense – Sales Representative 4,560
Depreciation Expense 10,900
Interest Revenue 700
Utilities Expense 6,400
Telephone and Postage Expense 1,475
Supplies Inventory 2,180
Miscellaneous Selling Expenses 2,200
Dividends 33,000
Dividend Revenue 7,150
Interest expense 4,520
Allowance for bad debts (cr. Bal.) 370
Officers’ Salaries Expense 36,600
Sales 495,200
Sales Return and Allowances 11,200
Sales Discounts 880
Gain on sales of assets 18,500
Inventory, January 1, 2002 89,700
Inventory, December 31, 2002 20,550
Purchases 173,000
Freight-in 5,525
Accounts Receivable, December 31, 2002 261,000
Shares of common stock outstanding 39,000

Adjusting information:
1. Cost of inventory in the possession of consignee as of December 31, 2002, was not
included in the ending inventory balance,P33,600.
2. After preparing an analysis of aged accounts receivable, a decision was made to increase
the allowance for bad debts to a percentage of the ending account receivable balance to 3%.
Accounts totaling P7,480 were written off as uncollectible during the year.
3. Purchase returns and allowances amounting to 6% of purchases (not including freight-
in) were not recorded at year end.
4. Sales commission for the last day of the year had not been accrued. Total sales for the
day, P3,600. Average sales commission as a percent of sales is 3%.
5. No accrual has been made for a freight bill received on January 3, 2003, for goods
received on December 29, 2002, P800.
6. An advertising campaign for 1,818 was initiated November 1, 2002. This amount was
recorded as “prepaid advertising” and should be amortized over a 6-month period. No
amortization was recorded.
7. Freight charges paid on sold merchandise and not passed to the buyer were netted
against sales. Freight charges on sales during 2002 is P4,200.
8. Interest earned but not accrued, P690.
9. Depreciation expense on a new forklift (estimated life is 10 years) purchased for P7,800
on March 1, 2002 had not been recognized. (Assume all equipment will have no salvage value
and the SLM is used. Depreciation is calculated to the nearest month.)
 10. A “real” account is debited upon the receipt of supplies. Supplies on hand at the year-
end is P1,600.
11. Income tax rate (on all items) is 32%.

Answer the following multiple choice questions:

1. Net sales is
a. P487,320 b. P499,200 c. P489,300 d. P488,500

2. Purchases net of returns and allowances is

a. P164,000 b. P165,200 c. P162,620 d. P161,200

3. Freight-in is
a. P6,325 b. P5,200 c. 5,000 d. P4,125

4. Inventory – 12/31/02 is
a. P54,150 b. P52,200 c. P53,600 d. P54,700

5. Cost of sale is
a. P114,795 b. P205,350 c. P265,440 d. P204,495

6. Sales salaries and commission is

a. P35,000 b. P35,108 c. 34,700 d. 35,100

7. Advertising expense is
a. P16,750 b. P16,606 c. P16,800 d. P24,696

8. Deprecation expense is
a. P11,550 b. P12,500 c. P14,600 d. P12,000

9. Doubtful accounts expense is

a. P7,500 b. P7,460 c. P7,200 d. P7,300

10. Interest revenue is

a. P1,540 b. P1,300` c. P1,290 d. P1,390

11. Income tax expense is

a. P54,605 b. P53,693 c. P57,654 d. P58,554

12. Net income is

a. P115,558 b. P104,445 c. P114,098 d. P115,586