ACCOUNTING CYCLE
FOR SERVICE BUSINESS
MODULE 3 Part 1
ACCOUNTING CYLE FOR
SERVICE BUSINESS
Accrual accounting versus Cash basis accounting
Standards and standard setting bodies
Step 1 to 10 of the accounting process
LEARNING OBJECTIVES
After studying this module the students should be able to:
1. List and explain in brief the sequential steps in the accounting cycle.
2. Describe the use of the two books of accounts-General Journal and General Ledger and
what purposes it serve.
3. Outline the steps in analyzing transactions and the important role of the source documents.
4. Develop chart of Accounts and distinguish between permanent or temporary accounts.
5. Analyze the impact of transactions on the accounting elements and specific accounts by
applying the rules of debits and credits.
6. Journalize transactions in proper form using the general journal.
7. Post entries from the general journal to the general ledger.
8. Prepare and explain the worksheet and the various financial reports derived from it.
9. Explain the importance of adjusting entries.
10. Perform the proper procedures in closing of the books.
Standard and standard-setting bodies
Generally Accepted Accounting Principles (GAAP).
It refers to a common set of accounting principles,
standards, and procedures which aims to improve the clarity,
consistency and comparability of the communication of
financial information.
Standard Setting Bodies:
Financial Accounting Standards Board (FASB)
Securities and Exchange Commission (SEC)
International Accounting Standards Board (IASB)
ACCRUAL VERSUS CASH BASIS
ACCOUNTING
Accrual Accounting.
Means revenue and expenses are recognized and recorded when they occur,
paid or unpaid. It focuses on anticipated revenue and expenses.
∙ Revenue is accounted for when it is earned such that when a product or service is
delivered to a customer with future expectation that it will be paid.
∙ Expenses are recorded despite no cash is being paid out yet for those expenses.
ACCRUAL VS. CASH BASIS CONTINUED...
Cash Basis Accounting.
∙ Revenue is reported on the income statement only when cash is received, and
expenses are only recorded when cash is paid out.
∙ Cash method is a more immediate recognition of revenue and expenses and is mostly
used by small businesses or for personal finances for its simplicity.
∙ Tracking the cash flow of a company is also easier, however it might overstate the
health of the company that is cash-rich but has large sums of accounts payable that
could exceed the cash on the books and the company’s current revenue stream.
CHART OF ACCOUNTS
∙ It is an index of all financial accounts in the general ledger
of a company.
∙ It is an organizational tool that provides a listing of the
accounts used in business to define each class of items for
which money or its equivalent is spent or received.
THE ACCOUNTING PROCESS
STEP 1. IDENTIFICATION OF EVENTS TO BE RECORDED
Aim: To analyze information from the source documents for proper recording and transfer to
their respective accounts.
The analyzing stage follows these four basic steps:
1. Identify transactions from source documents
2. Indicate the accounts affected by the transaction, either assets,
liabilities, equity, income or expenses.
3.Ascertain whether each account is increased or decreased by the
transaction.
4.Using your knowledge of the rules of debits and credits, determine
whether to debit or credit the account to record the increase or decrease,
taking into consideration the monetary impact on the financial reports.
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 transactions. Common source documents are
sales invoices, cash register tapes, official receipts, bank deposit slips, bank statements, checks, purchase orders,
timecards and statements of account.
Illustration: Both documents were received by Accounting Department from Human Resource
Department. Which of the two (2) documents is a valid accountable transaction that will merit a journal entry?
Analysis:
Source document B is a valid transaction evidenced by the payroll
form with names, rate and period covered of their actual services
rendered.
Value received in this transaction is the creation of an expense
account, Salaries Expense; and Value parted with is the obligation of
the company to pay the salary, Salaries Payable.
EXPENSE = LIABILITY
The expense account is increased by P7,500 which is a debit and a
corresponding increase of P7,500 also in the liability account which
is a credit.
RECORDING PROCESS
STEP 2. TRANSACTIONS ARE RECORDED IN THE JOURNAL
Aim: To record the economic events that took place within the firm in a journal known as “general journal” using
the rules of debits and credits.
General Journal (GJ).The journal is the simplest form of journal which reflects the chronological record of
the entity’s transaction in terms of debits and credits. The journal is considered the book of original entry.
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 of the
book 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. Explanation is usually made on the line below the
credit entry. Generally, SKIP a line after each entry.
3. P.R. (posting reference) The column for P.R. 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 into this column.
5. Credit. The credit amount for each account is entered into this column
JOURNALIZING TRANSACTIONS
For our illustration in Step 1, the transaction is “to record payroll covering
the period July 1-15 for Salesclerks A, B and C in the amount of P7,500.
Simple and Compound Entry
In simple entry , only two accounts are affected-one account is debited
and one account is credited.
There are transactions that will require the use of more than two
accounts known a compound entry , an entry wherein one or more debit
account or one or more credit account is required.
Illustration of Compound Entry
POSTING PROCESS
STEP 3. JOURNAL ENTRIES ARE POSTED TO THE LEDGER
Aim: To transfer the information from the journal to the ledger for classification.
General Ledger (GL). The “book of final entry” and the purpose is to summarize ,to
group similar accounts with corresponding account codes, one account title per page
of the GL or T-Account.
It is the reference book of the accounting system and is used to classify and summarize
transactions, and to prepare data for basic financial statements.
100 CASH
7/1 P100,000 P50,000 7/1
100,000 50,000
-50,000
Bal. P 50,000
WHAT IS A TRIAL BALANCE?
STEP 4. PREPARATION OF THE TRIAL BALANCE
Aim: To prove the arithmetical accuracy of bookkeeping and the ledgers.
Trial Balance. Is a type of financial report that is generated at the end of an accounting period
prior to the creation of the company’s financial statements and shows the equality of total
balances of the debit column to the total balances of the credit column. It provides a good
check on the accuracy of the work done in preparing the ledger accounts but equality of both
debits and credits is not a guarantee of the absence of errors.
Example: A receipt of P5,000 Cash was erroneously recorded by the bookkeeper as a debit to
Accounts Receivable instead of using Cash account. To this effect, the Trial Balance would
still be equal because both have debit normal balances. This should be corrected since the
Cash account will be understated by such amount and Accounts Receivable will be overstated
also by the same amount.
Kamsahamnida!
