Module 1 Accounting Cycle of a Service Business PDF

Module 1 Accounting Cycle of a Service Business Module Duration: Quarter III, Weeks 7-10 and Quarter IV, Weeks 1-4 About the Module Financial statements play a crucial role in presenting the true financial status of a business, enabling owners and management to make informed decisions. These stat...

Module 1 Accounting Cycle of a Service Business Module Duration: Quarter III, Weeks 7-10 and Quarter IV, Weeks 1-4 About the Module Financial statements play a crucial role in presenting the true financial status of a business, enabling owners and management to make informed decisions. These statements are also essential for various stakeholders who rely on them for economic decision-making. To ensure accuracy and reliability, the preparation of financial statements must adhere to Generally Accepted Accounting Principles (GAAP). Since financial statements are the final output of the accounting process, it is vital to follow every step of the accounting cycle meticulously. This module aims to equip learners with the knowledge and skills required to prepare financial statements for the accounting cycle of a service business, reinforcing their understanding of the fundamental accounting principles and procedures. Module Objectives By the end of this module, learners should be able to: Describe the nature and provide examples of business transactions (ABM_FABM11-IIIg-j-25). Identify the different types of business documents (ABM_FABM11-IIIg-j-26). Analyze common business transactions using the rules of debit and credit (ABM_FABM11-IIIg-j-27). Solve simple problems and exercises related to business transaction analysis (ABM_FABM11-IIIg-j-28). Explain the nature of transactions in a service business (ABM_FABM11-Iva-d-29). Record transactions of a service business in the general journal (ABM_FABM11-IVa-d-30). Post transactions into the ledger (ABM_FABM11-IVa-d-31). Prepare a trial balance (ABM_FABM11-IVa-d-32). Prepare adjusting entries (ABM_FABM11-IVa-d-33). Complete the accounting cycle (ABM_FABM11-IVa-d-34). This module will guide learners’ step by step through the accounting cycle, enhancing their comprehension of financial recording, processing, and reporting in a service business setup. Module Topics Definition of the Accounting Cycle Step 1: Analyzing Business Transactions from Source Documents Step 2: Journalizing Business Transactions Step 3: Posting to the Ledger Step 4: Preparing the Trial Balance Step 5: Journalizing and Posting Adjusting Journal Entries Step 6: Preparing the Adjusted Trial Balance Step 7: Preparing the Financial Statements Step 8: Journalizing and Posting Closing Entries Step 9: Preparing Post-Closing Trial Balance Step 10: Journalizing and Posting Reversing Journal Entries Pre-assessment What do you think does an accounting cycle entail? Put all your thoughts regarding the matter in the space below. Discussion Reading 1: Definition of the Accounting Cycle Let us establish a scenario to use as an example for this module: Jose Mercado has recently established a photocopying business. As advised by his friend and with your help as someone already knowledgeable in accounting, JM Photocopying Center set up a chart of accounts to guide the recording of all business transactions. At the start of the business, Jose Mercado invested P60,000 cash, P50,000 of which he had borrowed from his father and P10,000 from his personal savings. From this seed money, he bought a brand-new photocopying machine and paid start- up expenses. Thereafter, a series of business transactions took place. Being a first-time sole proprietor, Jose Mercado was eager to determine whether his business was making income. Initially, he prepared a schedule of cash-in and cash-out to calculate the "net income." While a good attempt, this method did not fully comply with the accrual principle of accounting. Your task now is to assist him in properly preparing an income statement and financial statements that accurately reflect the net income of JM Photocopying Center. Definition of the Accounting Cycle The accounting cycle is a series of recurring accounting steps or processes within one accounting period. It consists of the following steps: 1. Analyzing business transactions from source documents 2. Journalizing business transactions 3. Posting to the ledger 4. Preparing the trial balance 5. Journalizing and posting adjusting journal entries 6. Preparing the adjusted trial balance 7. Preparing the financial statements 8. Journalizing and posting closing journal entries 9. Preparing the post-closing trial balance 10. Journalizing and posting reversing journal entries Transactions in a Service Business Transactions in a service business are usually straightforward. The business renders services to clients or customers to generate revenues. This is why the main revenue account used for a service business is the Service Revenue account. In the case of JM Photocopying Center, revenues are generated when photocopying services are rendered. A more specific account, such as Photocopying Revenues, can be used instead of the generic Service Revenue account. In generating revenues, service businesses also incur expenses. For JM Photocopying Center, these expenses include salaries paid to staff, bond papers used for photocopying, and electricity costs. Just like any business, a service business begins with an investment by a sole proprietor or proprietors. From this investment transaction, a number of transactions followed. These transactions may be business or nonbusiness transactions. A business transaction results in an accounting transaction that requires a journal entry, while nonbusiness transactions do not require journal entries. Simply put, a transaction that has an effect on the accounting equation is a business transaction. Otherwise, it is a nonbusiness transaction. Examples of business transactions include: Investment of the owner Purchase of office supplies Payment of liabilities Rendition of services Withdrawal of the owner On the other hand, nonbusiness transactions include: Hiring of office staff Appointment of an office supervisor Operating of the business on a weekend or during a holiday The interplay between revenues and expenses results in either profit or loss. These transactions also include costs needed to operate the photocopying machine and other necessary expenses. Before we proceed with the first step of the accounting cycle, let us first establish the following chart of accounts for JM Photocopying Center, which will be very helpful in identifying the affected accounts in our transaction analysis: JM Photocopying Center Chart of Accounts Assets Account Number Account Name 101 Cash 111 Investment in Trading Securities 112 Accounts Receivable 113 Allowance for Doubtful Accounts 114 Notes Receivable 115 Interest Receivable 122 Unused Supplies 123 Prepaid Rent 151 Photocopying Equipment 152 Accumulated Depreciation - Photocopying Equipment 153 Furniture and Fixtures 154 Accumulated Depreciation - Furniture and Fixtures 199 Other Assets Liabilities Account Number Account Name 201 Accounts Payable 202 Notes Payable  203 Salaries Payable Owner's Equity Account Number Account Name 301 Mercado, Capital 302 Mercado, Drawing 399 Income Summary Revenues Account Number Account Name 401 Photocopying Revenues 402 Interest Income 499 Other Income Expenses Account Number Account Name 501 Taxes and License Expense 502 Salaries Expense 503 Supplies Expense Reading 2: Step 1 - Analyzing Business Transactions from Source Documents As introduced a few modules back, the accounting equation is fundamental in analyzing business (or accounting) transactions from source documents. Transaction analysis entails a thorough understanding of the business transaction itself and its implication on assets, liabilities, and owner's equity. The succeeding steps (especially journalizing and posting) in the accounting cycle will become less difficult once transaction analysis is understood. The summary of normal balances, increases, and decreases below will be very helpful as we begin analyzing business transactions. Summary of Normal Balances, Increases, and Decreases Account Type Normal Balance Increase Through Decrease Through Assets Debit Debit Credit Liabilities Credit Credit Debit Owner's Equity: - Owner, Capital Credit Credit Debit - Owner, Drawing Debit Debit Credit Revenues Credit Credit Debit Expenses Debit Debit Credit Valuation (Contra-Asset) Accounts: - Allowance for Doubtful Accounts Credit Credit Debit  - Accumulated Depreciation Credit Credit Debit Business Documents Used in Transaction Analysis Analyzing business transactions from source documents requires familiarity with business documents. Common business documents include: Official receipts (usually for service businesses) Sales invoices (usually for merchandising businesses) Statements of account or billing statements (e.g., electricity bills) Deposit slips and withdrawal slips (for banks) Payroll sheets (for salaries and wages) Debit memoranda Credit memoranda Transaction Analysis Steps Transaction analysis involves three simple steps: 1. Classify whether the transaction is a business or a nonbusiness transaction. If the transaction is nonbusiness, then there is no need to proceed to Step 2. 2. Identify the major account/s and the account title/s affected and the movements with respect to its/their normal balance/s. 3. Determine the amount/s to be credited or debited. Illustration of Transaction Analysis Transaction 1 Mr. Mercado invested cash of P30,000 in his business to be known as JM Photocopying Center. Step Analysis 1 It is a business transaction since it affects the accounting equation. 2 The major accounts affected are assets and owner's equity. Account titles: Cash (increase through a debit) and Mercado, Capital (increase through a credit). 3 Debit: P30,000 for Cash (accounts with normal debit balances increase through a debit). Credit: P30,000 for Mercado, Capital (accounts with normal credit balances increase through a credit). Transaction 2 Mr. Mercado invested a photocopying machine amounting to P30,000 (with sales invoice) in his business to be known as JM Photocopying Center.  Step Analysis 1 It is a business transaction since it affects the accounting equation. 2 The major accounts affected are assets and owner's equity. Account titles: Photocopying Equipment (increase through a debit) and Mercado, Capital (increase through a credit). 3 Debit: P30,000 for Photocopying Equipment (accounts with normal debit balances increase through a debit). Credit: P30,000 for Mercado, Capital (accounts with normal credit balances increase through a credit). Transaction 3 Mr. Mercado invested the following in his business to be known as JM Photocopying Center: Cash, P30,000; and Photocopying Equipment, P30,000 (with sales invoice). Moreover, his Loan Payable of P50,000 would be assumed by the business. Step Analysis 1 It is a business transaction since it affects the accounting equation. 2 The major accounts affected are assets, liabilities, and owner's equity. Account titles: Cash (increase through a debit), Photocopying Equipment (increase through a debit), Loan Payable (increase through a credit), and Mercado, Capital (increase through a credit). 3 Debits: P30,000 for Cash (accounts with normal debit balances increase through a debit). P30,000 for Photocopying Equipment (accounts with normal debit balances increase through a debit). Credits: P50,000 for Loan Payable (accounts with normal credit balances increase through a credit). P10,000 for Mercado, Capital (accounts with normal credit balances increase through a credit). Transaction 4 JM Photocopying Center paid P10,000 for the purchase of bond papers (with sales invoice). Step Analysis 1 It is a business transaction since it affects the accounting equation. 2 The major accounts affected are assets. Account titles: Unused Supplies (increase through a debit) and Cash (decrease through a credit). 3 Debit: P10,000 for Unused Supplies (accounts with normal debit balances increase through a debit). Credit: P10,000 for Cash (accounts with normal debit balances decrease through a credit). Transaction 5 Mr. Mercado hired one personnel with a weekly salary of P1,000 to look after the business (with employment contract). Step Analysis 1 The transaction is a nonbusiness transaction since it does not affect the accounting equation.  2 Mr. Mercado hired personnel with an agreed weekly salary of P1,000 but did not pay the employee nor did the employee render service. 3 No entry is required. Transaction 6 JM Photocopying Center paid salary of the personnel for the week, P1,000 (with payroll sheet). Step Analysis 1 It is a business transaction since it affects the accounting equation. 2 The major accounts affected are expenses and assets. Account titles: Salaries Expense (increase through a debit) and Cash (decrease through a credit). 3 Debit: P1,000 for Salaries Expense (accounts with normal debit balances increase through a debit). Credit: P1,000 for Cash (accounts with normal debit balances decrease through a credit). Transaction 7 JM Photocopying Center received P8,000 cash for services rendered (with official receipt). Step Analysis 1 It is a business transaction since it affects the accounting equation. 2 The major accounts affected are assets and revenues. Account titles: Cash (increase through a debit) and Photocopying Revenues (increase through a credit). 3 Debit: P8,000 for Cash (accounts with normal debit balances increase through a debit). Credit: P8,000 for Photocopying Revenues (accounts with normal credit balances increase through a credit). Transaction 8 JM Photocopying Center billed a customer for services rendered during the week, P2,000 (with billing statement). Step Analysis 1 It is a business transaction since it affects the accounting equation. 2 The major accounts affected are assets and revenues. Account titles: Accounts Receivable (increase through a debit) and Photocopying Revenues (increase through a credit). 3 Debit: P2,000 for Accounts Receivable (accounts with normal debit balances increase through a debit). Credit: P2,000 for Photocopying Revenues (accounts with normal credit balances increase through a credit). Transaction 9 Mr. Mercado made a P500 cash withdrawal for personal use. Step Analysis  1 It is a business transaction since it affects the accounting equation. 2 The major accounts affected are equity and assets. Account titles: Mercado, Drawing (increase through a debit) and Cash (decrease through a credit). 3 Debit: P500 for Mercado, Drawing (accounts with normal debit balances increase through a debit). Credit: P500 for Cash (accounts with normal debit balances decrease through a credit). Transaction 10 JM Photocopying Center collected the amount billed to a customer, P2,000 (with official receipt). Step Analysis 1 It is a business transaction since it affects the accounting equation. 2 The major accounts affected are assets. Account titles: Cash (increase through a debit) and Accounts Receivable (decrease through a credit). 3 Debit: P2,000 for Cash (accounts with normal debit balances increase through a debit). Credit: P2,000 for Accounts Receivable (accounts with normal debit balances decrease through a credit). Transaction 11 JM Photocopying Center paid rent for two months amounting to P10,000 (with statement of account). Step Analysis 1 It is a business transaction since it affects the accounting equation. 2 The major accounts affected are expenses and assets. Account titles: Rent Expense (increase through a debit) and Cash (decrease through a credit). 3 Debit: P10,000 for Rent Expense (accounts with normal debit balances increase through a debit). Credit: P10,000 for Cash (accounts with normal debit balances decrease through a credit). Transaction 12 JM Photocopying Center received a bill from an electric company, P2,500 (with statement of account). Step Analysis 1 It is a business transaction since it affects the accounting equation. 2 The major accounts affected are expenses and liabilities. Account titles: Utilities Expense (increase through a debit) and Accounts Payable (increase through a credit). The receipt of the statement of account means recognition of an expense and a liability. The business is obliged to pay for this bill. 3 Debit: P2,500 for Utilities Expense (accounts with normal debit balances increase through a debit). Credit: P2,500 for Accounts Payable (accounts with normal credit balances increase through a credit). Summary of the Effects of Transactions on Major Accounts Transaction Assets Liabilities Owner’s Equity 1 Increase of P30,000 (Cash) No effect Increase of P30,000 (Mercado, Capital) 2 Increase of P30,000 (Photocopying No effect Increase of P30,000 Equipment) (Mercado, Capital) 3 Increase of P60,000 (Cash P30,000 and Increase of P50,000 Increase of P10,000 Photocopying Equipment P30,000) (Loan Payable) (Mercado, Capital) 4 Increase of P10,000 (Unused Supplies) and No effect No effect Decrease of P10,000 (Cash) 5 No effect No effect No effect 6 Decrease of P1,000 (Cash) No effect Decrease of P1,000 (Salaries Expense) 7 Increase of P8,000 (Cash) No effect Increase of P8,000 (Photocopying Revenues) 8 Increase of P2,000 (Accounts Receivable) No effect Increase of P2,000 (Photocopying Revenues) 9 Decrease of P500 (Cash) No effect Decrease of P500 (Mercado, Drawing) 10 Increase of P2,000 (Cash) and decrease of No effect No effect P2,000 (Accounts Receivable) 11 Decrease of P10,000 (Cash) No effect Decrease of P10,000 (Rent Expense) 12 No effect Increase of P2,500 Decrease of P2,500 (Utilities (Accounts Payable) Expense)