ACC cycle - Step 2 - JOURNAL.docx.pdf

ACCOUNTING CYCLE The Accounting Cycle refers to the process of identifying, recording, and reporting a company’s financial transactions. It provides a systematic way to ensure that all financial activities are properly recorded and reported. Below are the key steps...

ACCOUNTING CYCLE The Accounting Cycle refers to the process of identifying, recording, and reporting a company’s financial transactions. It provides a systematic way to ensure that all financial activities are properly recorded and reported. Below are the key steps in the Accounting Cycle: 1. Identifying Transactions The process begins with identifying transactions and events that impact the financial position of the company. These transactions are analyzed to determine their financial impact. Example: Sale of goods, purchase of inventory, payment of expenses, etc. 2. Recording Transactions in the Journal (Journalizing) Transactions are recorded in a journal in chronological order using the double-entry accounting system. Each entry includes a debit and a credit to keep the accounting equation balanced. Example: Recording the purchase of equipment or payment of rent. 3. Posting to the Ledger The journal entries are posted to the general ledger, which is a collection of all accounts. Each account shows the debits and credits from transactions. Example: Posting entries for accounts such as Cash, Accounts Receivable, and Accounts Payable. 4. Preparing a Trial Balance After posting entries to the ledger, a trial balance is prepared to ensure that total debits equal total credits. If the trial balance doesn't balance, errors are investigated. Example: Preparing a list of balances from all ledger accounts. 5. Adjusting Entries Adjustments are made for any accrued or deferred items, such as unpaid expenses or unearned revenues, to ensure the accounts are up-to-date. Example: Recording depreciation or adjusting for accrued interest. 6. Adjusted Trial Balance After the adjustments, an adjusted trial balance is prepared to confirm that debits still equal credits, ensuring the financial statements can be accurately prepared. 7. Preparing Financial Statements The adjusted trial balance is used to prepare the financial statements: o Income Statement (Profit and Loss) – Shows the business’s revenues and expenses for the period. o Balance Sheet – Shows the company’s assets, liabilities, and equity. o Cash Flow Statement – Reports the cash inflows and outflows. o Statement of Retained Earnings – Shows changes in equity during the period. 8. Closing Entries At the end of the accounting period, closing entries are made to transfer balances from temporary accounts (revenues, expenses, dividends) to permanent accounts (retained earnings). 9. Post-Closing Trial Balance A final trial balance is prepared after the closing entries to ensure that debits still equal credits and that only permanent accounts (assets, liabilities, and equity) remain. 10. Reversing Entries (Optional) Reversing entries are made at the beginning of the next accounting period to reverse certain adjusting entries from the previous period, simplifying the recording of future transactions. Step 2 in the Accounting Cycle: Recording Transactions in the Journal (Journalizing) What is a Journal in Accounting? A journal is the first formal record where business transactions are documented in the accounting process. It's often called the "book of original entry" because every financial transaction is first recorded in the journal before being posted to the ledger. The journal serves as a chronological log of transactions, capturing key details of each financial event that affects a business. Double-Entry Accounting System: Debit: Increases in assets or expenses; decreases in liabilities, equity, or revenue. Credit: Increases in liabilities, equity, or revenue; decreases in assets or expenses. Every transaction must have at least one debit and one credit, and the total of debits must equal the total of credits. Parts of a Journal Entry:  Date: When the transaction occurred. Account Titles: Accounts affected by the transaction (from the Chart of Accounts). Debit & Credit: Amounts for each account. Explanation: A brief description of the transaction. Introduction to the Double Entry System Why Must the Accounting Equation Always Balance? The accounting equation must always balance because every financial transaction has a dual effect. This is known as the dual aspect concept, which means that for every transaction, at least two accounts are affected, ensuring that the equation remains in Account Type Debit Effect Credit Effect Assets Increases (Debit) Decreases (Credit) Liabilities Decreases (Debit) Increases (Credit) Equity Decreases (Debit) Increases (Credit) Expenses Increases (Debit) Decreases (Credit) Revenues Decreases (Debit) Increases (Credit) balance. Assets o Land 1. Current Assets: o Building o Cash o Equipment o Petty Cash o Vehicles o Accounts Receivable o Leasehold Improvements o Inventory o Furniture and Fixtures o Prepaid Expenses Liabilities o Supplies 1. Current Liabilities: o Short-term Investments o Accounts Payable o Notes Receivable o Accrued Expenses (Accrued 2. Non-Current Assets: Liabilities) o Property, Plant, and Equipment o Short-term Loans Payable (PP&E) o Wages Payable o Accumulated Depreciation o Taxes Payable o Long-term Investments o Unearned Revenue (Customer o Intangible Assets (e.g., Patents, Deposits) Trademarks, Goodwill) o Interest Payable  2. Non-Current Liabilities: o Long-term Loans Payable o Mortgage Payable o Bonds Payable o Deferred Tax Liability Equity 1. Owner’s Equity (Sole Proprietorship/Partnership): o Owner’s Capital o Owner’s Withdrawals o Retained Earnings o Additional Paid-in Capital 2. Stockholders’ Equity (Corporations): o Common Stock o Preferred Stock o Retained Earnings o Dividends Payable o Treasury Stock o Additional Paid-in Capital Revenue 1. Operating Revenue: o Sales Revenue (or Service Revenue) o Interest Revenue o Rent Revenue 2. Non-Operating Revenue: o Gain on Sale of Assets o Investment Income o Other Income Expenses 1. Operating Expenses: o Cost of Goods Sold (COGS) o Salaries and Wages Expense o Rent Expense o Utilities Expense o Insurance Expense o Depreciation Expense o Supplies Expense o Advertising and Marketing Expense o Repairs and Maintenance Expense o Office Supplies Expense o Bad Debt Expense 2. Non-Operating Expenses: o Interest Expense o Loss on Sale of Assets o Income Tax Expense Role of Accounting in Business Operations Accounting plays a critical role in business operations by tracking financial transactions and maintaining accurate records of a company's financial performance. It helps businesses monitor income, expenses, assets, and liabilities, ensuring that the company's financial position is clear. By organizing this data into financial statements (such as the income statement, balance sheet, and cash flow statement), accounting provides a clear picture of the financial health of the business. Importance of Accurate Accounting Information 1. Decision-Making: o Accurate accounting information helps management make informed decisions, such as budget allocation, pricing strategies, and investment opportunities. It allows businesses to assess profitability, control costs, and plan for future growth by relying on financial data. 2. Financial Reporting: o Financial statements generated through accounting are essential for presenting a company's financial status to external stakeholders such as investors, creditors, and regulators. Accurate reporting enhances trust and ensures businesses can attract investment, secure loans, and meet shareholder expectations. 3. Compliance: o Businesses are required to comply with local laws and regulations, including tax reporting and financial audits. Accurate accounting ensures that the company meets these legal requirements, avoids penalties, and maintains good standing with regulatory authorities. Three Types of Business Operations: 1. Business Operation (Service): o Definition: A service business provides intangible products or services to customers. These businesses do not deal in physical goods but offer expertise, labor, or professional services to fulfill customer needs. o Examples: Consulting firms, law firms, salons, restaurants, and accounting services. o Key Features: ▪ Generates revenue from providing services rather than selling goods. ▪ Focus on labor, skills, and expertise. ▪ Does not typically have inventory but may have supplies. ▪ Revenue is called Service Revenue. 2. Business Operation (Merchandise): o Definition: A merchandise business purchases finished goods from suppliers and sells them to customers at a markup. These businesses act as intermediaries between producers and consumers. o Examples: Retail stores, wholesalers, online e-commerce platforms. o Key Features:  ▪ Buys products in bulk and sells them at a profit. ▪ Holds Inventory (finished goods ready for sale). ▪ Revenue is generated through Sales Revenue. ▪ May incur Cost of Goods Sold (COGS), which includes the cost of purchasing the goods sold. 3. Business Operation (Manufacturing): o Definition: A manufacturing business produces goods by converting raw materials into finished products through labor, machines, and other equipment. These businesses sell the products directly to customers or to merchandise businesses. o Examples: Factories, automotive manufacturers, bakeries that produce and sell products. o Key Features: ▪ Involves Raw Materials, Work-in-Progress, and Finished Goods Inventory. ▪ Generates Sales Revenue by selling products it manufactures. ▪ Has a complex accounting system to track Cost of Goods Sold (COGS), including direct labor, materials, and manufacturing overhead costs. ▪ Focuses on production efficiency and cost management. Examples of Dual Aspects: 1. Buying Equipment with Cash: o Transaction: The company buys equipment for ₱5,000, paying cash. 2. Taking a Loan to Purchase Equipment: o Transaction: The company takes out a loan of ₱10,000 to buy equipment. 3. Owner's Investment: o Transaction: The owner invests ₱20,000 in the business. Analysis of Transactions (Values Received and Given Away) Transaction Values Values Given Explanation Received Away 1. Purchase of ₱5,000 ₱5,000 (Cash) The business receives equipment worth Equipment for (Equipment) ₱5,000 and gives away the same amount ₱5,000 (Cash) in cash. 2. Loan of ₱10,000 ₱10,000 ₱10,000 The business receives equipment and the to Purchase (Equipment) (Liability - Loan cash from the loan, but gives away a Equipment ₱10,000 (Cash Payable) future obligation to pay (liability of from Loan) ₱10,000). 3. Owner's ₱20,000 (Cash) ₱20,000 The business receives ₱20,000 in cash Investment of (Owner’s and gives away ownership interest in the ₱20,000 Capital) form of owner’s equity. Summary: Transaction 1: Value received is equipment, value given away is cash. Transaction 2: Value received is equipment and cash from the loan, value given away is the loan payable (a liability). Transaction 3: Value received is cash, value given away is the increase in owner's equity (investment). This breakdown provides a clear perspective on what the business gains and sacrifices in each transaction. Analysis of Transactions (According to Element) Transaction Assets Liabilities Equity Explanation 1. Purchase of +₱5,000 0 0 The business buys equipment by Equipment for ₱5,000 (Equipment paying cash. The asset (equipment) (Cash) ) increases, while another asset -₱5,000 (cash) decreases by the same (Cash) amount. 2. Loan of ₱10,000 to +₱10,000 +₱10,000 0 The company takes out a loan to Purchase Equipment (Equipment (Loan buy equipment. Both assets ) Payable) (equipment) and liabilities (loan payable) increase by ₱10,000. 3. Owner's Investment +₱20,000 0 +₱20,000 The owner invests cash in the of ₱20,000 in the (Cash) (Owner's business. Assets (cash) increase, Business Capital) and equity (owner’s capital) increases by the same amount. Summary: Transaction 1: Affects only assets (no impact on liabilities or equity). Transaction 2: Affects both assets and liabilities. Transaction 3: Affects both assets and equity. This table helps in understanding how various transactions impact the three elements of the accounting equation: Assets = Liabilities + Equity. General Journal Date Particulars PR Debit (₱) Credit (₱) (Year) Mon.x Values Received ₱ XX Values Given Away ₱ XX Exlanation Journal Entry of example:  Date Particulars P Debit Credit (Year) R (₱) (₱) Mon.1 Equipment ₱5,000 Cash ₱5,000 To record the purchase of equipment for cash Mon.2 Equipment 10,000 Loan Payable 10,000 To record purchase of equipment using loan Mon.3 Cash 20,000 Owner’s Capital 20,000 To record owner’s investment in the business Explanation of Transactions: 1. Transaction 1: The company buys equipment for ₱5,000, paying cash. o Values Received: Equipment (Debit ₱5,000) o Values Given Away: Cash (Credit ₱5,000) 2. Transaction 2: The company takes out a loan of ₱10,000 to buy equipment. o Values Received: Equipment (Debit ₱10,000) o Values Given Away: Loan Payable (Credit ₱10,000) 3. Transaction 3: The owner invests ₱20,000 in the business. o Values Received: Cash (Debit ₱20,000) o Values Given Away: Owner's Capital (Credit ₱20,000)