CHAPTER 4

ACCOUNTING CYCLE OF A SERVICE PROVIDER:

Journalizing, Posting, Trial Balance, Adjustments
and Financial Statements

Learning Outcomes

After reading this chapter, the learners should be able to

1. Identify the basic steps in the accounting cycle;

2. Explain what is journal and its use in the accounting process;
3. Analyze business transactions and journalize accounting entries;
4. Explain what is ledger and its use in the accounting process;
5. Post journal entries to the ledger;
6. Prepare trial balance;
7. Explain why adjusting entries are needed;
8. Record adjusting entries;
9. Prepare adjusted trial balance;
10. Prepare statement of profit or loss, statement of changes in equity;
and statement of financial position

OVERVIEW OF ACCOUNTING CYCLE

Accounting cycle can be described as the series of steps performed

during the accounting process from the time a transaction is analyzed,
recorded, and summarized, up to the preparation and presentation of
financial statements. The accounting process of bookkeeping and financial
statements preparation can only be done efficiently through observing the
accounting cycle.

The series of steps in the accounting cycle are the following:

Chapter 4 – Accounting Cycle of Service Provider

Steps Activity

1 Gather business documents and analyze the transaction.

2 Record the transaction in the journal. This step is also called
journalizing.
3 Transfer the entries from journal to the ledger. This step is
also called posting.
4 Prepare the unadjusted trial balance.
5 Record the adjusting journal entries.
6 Prepare the adjusted trial balance.
7 Prepare the financial statements.
8 Record the closing entries.
9 Post the closing entries.
10 Prepare the post-closing trial balance.
11 Prepare the reversing entries.

ANALYZING SOURCE DOCUMENTS

The very first step in the accounting cycle is the analysis of

transaction through the business document obtained. Business document
or source document is the record that evidences a transaction. It may be a
record of an external transaction, which involves the entity and another
entity, or internal transaction which involves divisions or divisions within
an entity. Source documents provide for the details of the transaction
including but not limited to the date of the transaction, parties involved,
the nature or the activity, and the amounts.

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Examples of source documents:

1. Invoice. An invoice is issued when an entity has sold goods or

provided services to a customer or a client. Sales invoice is issued
for merchandise sold, while service invoice is issued for services
rendered.

2. Official receipt. Official receipt is issued when an entity received

cash or other form of payment from another party.

3. Delivery receipt. When an entity delivered goods to a customer or

buyer, it is accompanied by a delivery receipt which must be
signed by the said customer to prove that the goods delivered were
received in good condition.

4. Promissory note. This is a written promise to pay a certain sum of

money at a future date.

5. Statement of account. When an entity bills a customer for goods

delivered, the entity shall issue statement of account which details
the obligation of the customer. Statement of account includes the
details of the goods sold and the due date.

6. Bank statement. A bank document issued periodically to the

company, usually every month, which shows the records of the
bank pertaining to the cash receipts and cash disbursements of the
company in that month.

7. Check. A check is a negotiable document that orders a certain

bank to pay a specific amount of money to the payee (whose name
the check has been issued) from a maker's account.

It is important for an accountant to be familiar with the source

documents since the analysis of the transaction which transpired can only
be done if one understands what the document purports to present.

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RECORDING PHASE:
JOURNALIZING AND POSTING ACTIVITIES

Journalizing and posting are the two complementary steps in the

accounting cycle which collectively is called the recording phase. After
all the transactions have been recorded in a journal, the amounts are then
posted in their respective T-Accounts in a book called ledger.

The definition of accounting, as discussed in Chapter 1, mentioned

three steps: [1] identifying; [2] measuring; and [3] communicating.
Identifying, as a phase, deals with evaluating whether a transaction or
event that occur in an entity has to be recorded or recognized. On the other
hand, measuring is the process of peso amounts or any other unit of
measure to a transaction relevant to the element/s of financial statements
consequently affected. Communicating is the phase where Financial
statements and reports are prepared and communicated to the identified
users of information embodied in the financial statements.

Not all transactions and events that occur in the business are to be
recorded in the books. A business transactions is considered to be
accountable, meaning an accounting entry has to be prepared, if it satisfies
all of the following criteria:

1. It is between at least two parties. The transaction must involve at

least two parties and the entity must be a party to that transaction. A
company cannot transact with itself: buy goods from itself, sell
goods to itself, loan money from itself, and etc.

2. There is an exchange of values. In a business transaction, one party

may be obliged to pay a sum of money or other assert to another
party in consideration to the goods or services received. On the other
hand, the other party will receive the sum of money or other asset
from another party in consideration of the goods delivered or
services rendered. Transactions without any exchange of values may
not be considered a recordable business transaction.

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3. It is measurable in terms of money. A business transaction has

monetary consequence. And this monetary consequence must be
incorporated in an accounting entry. Financial Accounting and
Reporting involves two levels of measurement: initial measurement
and subsequent measurement. What is discussed in this phase is the
initial measurement.

4. At least two accounts are affected. An accounting journal entry

requires at least one debit and one credit. If the transaction affects
only one accounts, which is unlikely, it is not recordable.

To illustrate, Dolores Laundry Services signed a purchase order

with Pingkoy Groceries for 100 boxes of bar soap at P1,000 per box. Does
the foregoing constitute an accountable event? Let us evaluate:

1. Is it between two parties?

Yes, Dolores Laundry Services and Pingkoy Groceries

2. Is there an exchange of values?

None, Dolores Laundry Services merely ordered the products
from Pingkoy Groceries.

3. Is it measurable in terms of money?

Yes, 100 boxes of bar soap at P1,000 per box.

4. Does it affect at least two accounts?

Yes. Cash and inventory.

Since not all the answers are affirmative, the event is not
accountable and therefore no entry will be made. Accounting journal
entries are prepared only for accountable events.
Another illustration: Suppose Emiliano Barber Shop purchased
500 units of hair cream from Elsa Hair and Skin Supplies and paid a total
of P50,000. Is this a recordable transaction? Does the foregoing constitute
an accountable event? Let us evaluate:

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1. Is it between two parties?

Yes, Emiliano Barber Shop and Elsa Hair and Skin Supplies

2. Is there an exchange of values?

Yes, Emiliano Barber Shop purchased 500 units of hair cream
and paid cash, while Elsa Hair and Skin Supplies received
P50,000 cash in exchange of inventory sold.

3. Is it measurable in terms of money?

Yes, P50,000.

4. Does it affect at least two accounts?

Yes. Cash and inventory.

The transaction is recordable since all the requirements were

satisfied. Hence, a journal entry has to be prepared.

The Journal

The journal, also called book of original entry, is the book where
transactions which have been analyzed and are deemed recordable, are
entered into as a journal entry. In practice, journals are classified
according to class of transactions. There are special journals, which store
specific major transactions such as sales on account, purchases on account,
cash receipts, and cash disbursements. Any other transactions not
belonging to the four major transactions are recorded in the general
journal. In this chapter, general journal is used for recording transactions.
Special journals will be discussed separately.

When preparing journal entry, information about the date of

transaction, accounts affected, explanations, and amounts are being
required. A sample of a journal entry follows:

GENERAL JOURNAL GJ 1
Date Ac c o un ts and Explanatio ns PR De b it Cre d it

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Below are the steps observed in filling-out a journal:

1. Enter the date (mm/dd) on the “date” column.
2. Enter the debit account title on the “accounts and explanations”
column, and the debit amount on the “debit” money column.
Observe the money places starting from the right to the left. The
first column is for centavos, then for ones, tens, hundred, and so
forth.
3. Enter the credit account title on the “accounts and explanations”
column with an indention so as not to be aligned with the debit
account title, and the debit amount on the “debit” money column.
Observe the same rules in the money column as you did in no. 2.
4. Write a short explanation of the transaction after the last credit
account title entered.
5. The “PR” (posting reference) column will only be filled out once
the entry is posted in the ledger

In preparing journal entries, the accounts used must be based on

the company’s chart of accounts. Chart of accounts is the list of all
accounts with their relative account numbers. Only accounts included in
the chart of accounts are used in the journal entries.

To illustrate the journalizing process, let us use the transactions of

Dolores Company in the preceding chapter:

In January 2018, Dolores Company opened an accounting services firm

named Dolores & Associates. The following are the transactions that
occurred in January 2018:

1/3 Dolores contributed cash of P100,000, land worth P1,000,000,

and office building worth P800,000.

1/10 Dolores borrowed P250,000 cash from Metrobank for use in

business.

1/13 Dolores bought tables and chairs for P125,000 cash and office
equipment in exchange for P200,000 notes payable.

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1/15 Dolores withdrew P10,000 from the business.

1/20 Dolores paid advertising cost of P15,000 to market the services

of the firm.

1/25 Dolores had its first customer. Dolores billed and collected from
the customer, P50,000.

1/28 Dolores paid 50% of the notes payable.

1/29 Dolores paid 5,000 for water, electricity and telephone expenses.

1/31 Dolores paid the salary of her accounting staff in the amount of
P15,000.

In addition, Dolores Company presented the following chart of accounts:

Dolore s & As s oc iate s

Chart of Ac c ounts

As s et acco unts
Cash 1100
Account receivable 1200
Allowance for doubtful accounts 1200-1
Merchandise Inventory 1300
Office supplies 1400
Furniture and fixture 1500
Land 1600
Office building 1700
Accumulated depreciation - Office building 1700-1
Office equipment 1710
Accumulated depreciation - Office equipment 1710-1
Store equipment 1720
Accumulated depreciation - Store equipment 1720-1
Delivery equipment 1730
Accumulated depreciation - Delivery equipment 1730-1

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Dolore s & As s oc iate s

Chart of Ac c ounts

Liability ac co unts
Account payable 2100
Note payable 2200
Interest payable 2300
Utilities payable 2400
Salaries payable 2500
Mortgage payable 2600

Capital ac c o unts
Dolores, drawing 3100
Dolores, capital 3200

Inc o me acc o unts

Service income 4100
Interest income 4200
Miscellaneous income 4300
Other income 4400

Expe ns e ac co unts
Advertising expense 5100
Interest expense 5200
Utilities expense 5300
Salaries expense 5400

The journal entries for the foregoing transactions are as follows:

GENERAL JOURNAL GJ 1
Date Ac c o unts and Explanatio ns PR De bit Credit
03-Jan Cash 100,000
Land 1,000,000
Office Building 800,000
Dolores, Capital 1,900,000
Original investment

10-Jan Cash 100,000

Loan payable 100,000
Receipt of the proceeds of loan
from the bank

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GENERAL JOURNAL GJ 1
Date Ac co unts and Explanatio ns PR De bit Cre dit
13-Jan Furniture and fixture 125,000
Office equipment 200,000
Note payable 325,000
Purchase of furniture and equipment
for cash

15-Jan Dolores, Drawing 10,000

Cash 10,000
Withdrawal of cash by the owner

20-Jan Advertising expense 15,000

Cash 15,000
Payment of advertising services

25-Jan Cash 50,000

Service income 50,000
Collection of service fees

28-Jan Note Payable 162,500

Cash 162,500
Payment of 50%of the note payable

29-Jan Utilities expense 5,000

Cash 5,000
Payment of water, utilities and
telephone expenses

31-Jan Salaries expense 15,000

Cash 15,000
Payment of staff salaries

Another illustration: Mr. Fran Lee, a retired accounting center, decided

to put up a training center which will offer continuing professional
development (CPD) programs to cater the CPD needs of certified public
accountants in the Metro Manila region. He processed all the requirements
for the accreditation as CPD Provider. On April 20, 2018, the Professional
Regulatory Board of Accountancy has released his Certification as CPD
Provider in Accountancy.

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The following transactions happened in the month of May, the first month
of operations of Fran Lee CPD Center.

5/1 Mr. Lee invested P500,000 to Fran Lee CPD Center.

5/1 Mr. Lee paid 30,000 equivalent to one month rent to Boral
Realties for the 200-seater training room and P15,000 for the
adjacent small room as the CPD office.

5/1 Mr. Lee purchased the following: one unit of desktop computer
and printer set worth P25,000, P10,000 of which is determined to
be the value of the printer; one unit of photocopy machine worth
P15,000; one unit of LCD projector worth P24,000; and 2 sets of
tables and chairs worth P20,000;

Mr. Lee issued check worth P60,000

5/3 Mr. Lee purchased one set of sound equipment for the training
room, on account. Mr. Lee issued a promissory note for P35,000.

5/6 Mr. Lee purchased office supplies from National Book Store
worth P3,500.

5/10 Mr. Lee conducted the first CPD program for the month of May.
150 CPAs attended the program and each paid P1,500
registration fee.

5/12 Mr. Lee received the bill from the caterer in the amount P60,000
for the meals of the participants during the May 10 CPD
program.

5/15 Mr. Lee paid the semi-monthly salary of the office staff in the
amount of P8,000.

5/18 Mr. Lee purchased office supplies worth P4,500.

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5/22 Mr. Lee conducted the second CPD program for the month of
May. 98 CPAs attended the program and each paid P1,500
registration fee.

The bill from the caterer showed P45,000 for the meals of the
participants during the program.

5/28 Mr. Lee withdrew P10,000 for personal use.

5/29 Mr. received the Meralco and Maynilad bills during the month of
May, in the amounts of P1,200 and P400, respectively. Mr. paid
the bills using his own money.

5/30 Mr. Lee paid the honorarium of the two speakers in the May 10
and May 22 CPD programs. Each is paid P15,000.

5/31 Mr. Lee paid the semi-monthly salary of the office staff in the
amount of P8,000.

Mr. Lee paid the caterer for the meals during the May 10 and
May 22 CPD programs.

Mr. Lee paid the note issued on May 3, 3018.

The journal entries for the foregoing transactions are as follows:

GENERAL JOURNAL GJ 1
Date Ac co unts and Explanatio ns PR Debit Cre dit
01-May Cash 500,000
Lee, Capital 500,000
Investment of cash by the owner

Rent expense 45,000

Cash 45,000
Payment for rent of the training rooms and office

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GENERAL JOURNAL GJ 1
Date Ac co unts and Explanatio ns PR Debit Cre dit
Office equipment-computer 15,000
Office equipment-printer 10,000
Office equipment-photocopier 15,000
Office equipment-LCD projector 24,000
Furniture and fixtures 20,000
Cash 84,000
Purchase of equipment and furniture
and fixtures for cash

03-May Sound equipment 35,000

Cash 35,000
Purchase of sound equipment
for cash

06-May Office supplies 3,500

Cash 3,500
Purchase of office supplies for cash

10-May Cash 180,000

Registration fees 180,000
Collection of registration fees

12-May Food expense 60,000

Account payable 60,000
Receipt of invoice from caterer

15-May Salaries expense 8,000

Cash 8,000
Payment of office staff salary

18-May Office supplies 3,500

Cash 3,500
Purchase of office supplies for cash

22-May Cash 147,000

Registration fees 147,000
Collection of registration fees

Food expense 45,000

Account payable 45,000
Receipt of invoice from caterer

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GENERAL JOURNAL GJ 1
Date Ac co unts and Explanatio ns PR Debit Cre dit
28-May Lee, Drawing 10,000
Cash 10,000
Withdrawal of cash for personal use

29-May Utilities expense 1,600

Lee, Capitak 1,600

20-May Honorarium 30,000

Cash 30,000
Payment of honorarium of speakers

31-May Salaries expense 8,000

Cash 8,000
Payment of office staff salary

Account payable 105,000

Cash 105,000
Payment for the caterer

The Ledger

A ledger, also called the book of final entry, is the collection of

all accounts used by the business. Each account used in the business has a
corresponding one ledger account which summarizes the movements or
changes in the accounts based on the transactions that transpired. The
ledger accounts are based on the company’s chart of accounts. For
example, a cash account has one ledger account in the ledger which
summarizes the movements of cash during the period, and sums up the
balance of cash at the end of the period.

Below is an example of a ledger:

Ac c o unt Ac c o unt No .:

Date Explanatio n Re f De bit Cre dit

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The following steps are observed in filling out a ledger:

1. Using the chart of accounts, fill out the “Account” and “Account
No.”. Ensure that all account titles have their own ledger accounts.

2. From the general journal, identify the account used and locate the
ledger account in the ledger.

3. Copy the date in the general journal.

4. Provide a very short explanation of the transaction.

5. In the “JR” (journal reference) column, write GJ followed by page

of the general journal where the journal entry is located. You may
use other reference as you deemed relevant.

6. Transfer the amount in general journal to the ledger. If the account

is debited in the general journal, transfer the amount to the debit
column of the ledger account. If the account is credited in the
general journal, transfer the amount to the credit column of the
ledger account.

7. Go back to the general journal and enter in the “PR” column the
account number. Entering the account number in the PR column
means the transaction has been posted to the ledger. Needless to
say, if the PR column remained blank, then the transaction has not
yet been posted.

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To illustrate the posting process, refer to the following:

Using the illustration for Dolores Company, if the journal entry is

properly posted to the ledger, the general journal and general ledger will
appear as follows:

Ac c ount CASH Ac c ount No .: 1100

Da te Ex plana tion Re f De bit Cre dit

03-Jan Original investment 100,000
10-Jan Loan from Metrobank 100,000
15-Jan Cash withdrawal 10,000
20-Jan Advertising service 15,000
25-Jan Collection of service fee 50,000
28-Jan Payment of 50% of note 162,500
29-Jan Water, utilities and electricity 5,000
31-Jan Salaries of staff 15,000
Balanc e 42,500

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Ac c o unt FURNITURE AND FIXTURES Ac c o unt No .: 1500

Date Explanatio n Re f De bit Cre dit

13-Jan Purchase for cash 125,000

Ac c o unt OFFICE EQUIPMENT Ac c o unt No .: 1710

13-Jan Purchase for cash 200,000

Ac c o unt OFFICE BUILDING Ac c o unt No .: 1700

Date Explanatio n Re f De bit Cre dit

03-Jan Original investment 800,000

Ac c o unt LAND Ac c o unt No .: 1600

Date Explanatio n Re f De bit Cre dit

03-Jan Original investment 1,000,000

Ac c o unt NOTE PAYABLE Ac c o unt No .: 2200

Date Explanatio n Re f De bit Cre dit

13-Jan Purchase of F&F and Equip't 325,000
28-Jan Payment of 50% of note 162,500
Balanc e 162,500

Ac c o unt LOAN PAYABLE Ac c o unt No .: 2210

Date Explanatio n Re f De bit Cre dit

03-Jan Loan from Metrobank 100,000

Ac c o unt DOLORES, DRAWING Ac c o unt No .: 3100

Date Explanatio n Re f De bit Cre dit

15-Jan Cash withdrawal 10,000

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Ac c o unt DOLORES, CAPITAL Ac c o unt No .: 3200

Date Explanatio n Re f De bit Cre dit

03-Jan Original investment 1,900,000

Ac c o unt ADVERTISING EXPENSE Ac c o unt No .: 5100

Date Explanatio n Re f De bit Cre dit

20-Jan Advertising service 15,000

Ac c o unt UTILITIES EXPENSE Ac c o unt No .: 5300

Date Explanatio n Re f De bit Cre dit

29-Jan Water, utilities and electricity 5,000

Ac c o unt SALARIES EXPENSE Ac c o unt No .: 5400

Date Explanatio n Re f De bit Cre dit

31-Jan Salaries of staff 15,000

Ac c o unt SERVICE INCOME Ac c o unt No .: 4100

Date Explanatio n Re f De bit Cre dit

25-Jan Collection of service fee 50,000

UNADJUSTED TRIAL BALANCE

Trial balance is a summary of all the accounts and their working

balances, and indicates that total debits equal total credits. If the total
debits and total credits do not agree, it means that not all entries recorded
and posted have equal debits and credits or an error has been committed in
posting the transaction. And if total debits and total credits are equal, it
means that all entries recorded and posted have equal debits and credits,

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but it does not guarantee that all entries are recorded and posted nor the
correctness of all the entries.

The following rules are observed in preparing a trial balance:

1. The heading should present the name of the company, the name of
the report as “Unadjusted Trial Balance”, and the date covered.

2. There shall be four columns properly labeled as follows: Account

No., Account Titles, Debit, and Credit. The debit and credit
columns are for the working balance of each account. The rules on
money columns apply.

3. The totals of the debit and credit columns are double ruled. Double
ruling indicates that the totals of debit agree with credit totals. In
the event that the two totals do not agree, consider the possibility
that an error may have been committed in the recording or in
posting. Try to locate the error before double ruling the totals.

Errors in trial balance

There are instances that total debits and total credits are not equal.
In such a case, an error must have been committed. Some of the errors that
would cause disagreement between totals in the trial balance are error in
footing, transposition and transplacement. Transposition is made when
the order of digits in the money column is interchanged. For example,
P102,340 was posted as P120,340. On the other hand, transplacement or
sliding error, occurs when a decimal point “slides” or has been misplaced.
Example, P102,340 was posted as P10,234.
As mentioned earlier, a “balanced” trial balance does not guarantee
the correctness of the entries in the journal and ledger. There are errors
that are not found or identified by trial balance. Some errors of this kind
are:
1. Non-recording of a transaction.
2. Over-recording or double-recording of a transaction.
3. Recorded in the general journal but was not posted in the general
ledger.

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4. Incorrect account titles with the same normal balance such as

miscellaneous income instead of gain on sale.

The trial balance of Dolores Company will appear as follows:

Do lo re s Co mpany
Unadjusted Trial Balance
January 31, 2018

De bit Cre dit

Cash 42,500
Furniture and fixtures 125,000
Office equipment 200,000
Office building 800,000
Land 1,000,000
Note payable 162,500
Loan payable 100,000
Dolores, drawing 10,000
Dolores, capital 1,900,000
Advertising expense 15,000
Utilities expense 5,000
Salaries expense 15,000
Service income 50,000
To tals 2,212,500 2,212,500

ADJUSTING JOURNAL ENTRIES

Adjusting journal entries or end of year adjustments are the

accounting journal entries prepared at the end of the reporting period to
determine the correct amount of income and expenses, and to properly
reflect the correct balances of the accounts, prior to the preparation of the
financial statements. The preparation of adjusting entries are also
important so that the entity’s income are assigned to the accounting period

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when it is earned, and the entity’s expense are assigned to the accounting
period when it is incurred.

There are five major types adjusting entries that are prepared at the
end of the accounting period, namely:
1. adjusting entries for accrual;
2. adjusting entries for deferrals;
3. adjusting entries for depreciation; and
4. adjusting entries for impairment of receivable (doubtful accounts);

Accounting for accruals

IAS 1 Presentation of Financial Statements paragraph 27 states

“An entity shall prepare its financial statements, except for cash flow
information, using the accrual basis of accounting”. The accrual basis of
accounting recognizes revenue when the amount is earned even if the
related cash is not yet received, and expenses are recognized when
incurred, regardless of the date it is paid. Hence, income is recognized
when the earnings process of such income is complete and the right to
collect can be demonstrated. While expense is recognized when the said
expense is already incurred and the obligation to settle the same already
existed.

There are two classifications of accrual adjusting entries: accrual

of income and accrual of expense. Accrual of income is accounting for
uncollected revenue. Uncollected revenue is income earned in the current
period but not yet collected and recorded in the same period. Since this
income is already earned, it should be reported in the books by
recognizing a receivable account. Example of this

On the other hand, accrual of expense, is accounting for unpaid

expenses. Unpaid expense is an expense already incurred but remained
unpaid and unrecorded at the end of the accounting period. Such expense
is recorded by recognizing a liability account.

The pro-forma entries to record accrued income and expense are as follows:

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Accrued income Accrued expense

Interest receivable xx Interest expense xx

Interest income xx Interest payable xx

Illustration: On October 1, 2018, Bank of Manila granted a P5,000,000

loan to Calbayog, Inc. at 12%. Both principal and interest are payable on
September 30, 2019. Bank of Manila’s accounting yearend is December
31.

Analysis: Bank of Manila earned interest income from October 1 to

December 31, 2018 in the amount of P150,000 (P5,000,000 x 12% x
3/12). However, the total interest will be collected only after one year.
Hence, Bank of Manila shall report interest receivable on December 31,
2018.

Books of Bank of Manila Books of Calbayog, Inc,

10/1 Loan receivable 5,000,000 Cash 5,000,000

Cash 5,000,000 Loan payable 5,000,000

12/31 Interest receivable 150,000 Interest expense 150,000

Interest income 150,000 Interest payable 150,000

Another illustration: On November 1, 2018, Katreena Javier Manpower

Services signed a one-year contract to provide janitorial services to
Geraldine Co Residences. The contract provided that Geraldine Co
Residences shall pay Katreena Javier Manpower Services a total of
P1,200,000 divided into four installments of P300,000 each on January 31,
2019, April 30, 2019, July 2019 and October 31, 2019.

Analysis: On December 31, 2018, Katreena Javier Manpower Services

earned P200,000 income equivalent to two months of the contract price

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(P1,200,000 x 2/12) while Geraldine Co Residences incurred the same

amount of expense.

The entry in their respective books are as follows:

Books of Katreena Books of Geraldine

Account receivable 200,000 Janitorial expense 200,000

Service income 200,000 Account payable 200,000

Accounting for deferrals

Deferral is the opposite of accrual. If accrual involves recognizing

income and expenses prior to cash collection and payment, respectively,
deferral comprises collection of income even if it is not yet earned and
payment of expense even if it is not yet incurred. For instance, a lessee
maybe required to make advance rental to the lessor prior to actual
possession of the rented premises. Needless to say, the lessor collects the
advance rental from the same lessee.

Deferral is classified into two: deferral of income and deferral of

expense. Deferral of income is accounted for by the one who collects the
advances. At the time of collection, an entry debiting cash and crediting
either an income account or liability account shall be made. Aggressive
accounting would favor the use of an income account (income method)
while conservative accounting would use a unearned income account
(liability method). Both methods are acceptable although the use of the
liability method is more theoretically correct.

The pro-forma entries to record the collection of the deferred

income and the related adjusting journal entries at yearend are as follows:

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Income method Liability method

Cash xx Cash xx
Income xx Unearned income xx

Income method Liability method

Income xx Unearned income xx

Unearned income xx Income xx

Illustration: Lorraine Dy Properties is into leasing business. On June 1,

2018, Lorraine Dy leased out one of its machineries to Aira Granada
Manufacturing for three years commencing June 1, 2018, for an annual
rental of P480,000. On the same date, Aira Granada paid the one year rent.

Analysis: On June 1, 2018, Lorraine Dy shall record the cash collection by

debiting cash and crediting either an rent income account or unearned rent
account.

Income method Liability method

Cash 480,000 Cash 480,000

Rental income 480,000 Unearned rent 480,000

On December 31, 2018, an adjusting entry shall be prepared to

reflect the correct amount of rental income and correct balance of
unearned rent accounts. Using the income method, the income of
P480,000, if remained unadjusted, will be overstated since only seven
months of the one-year contract period is earned. On the other hand,
unearned rent of P480,000, if remained unadjusted, will also be overstated
since out of twelve months, seven months have been earned leaving five
months to be unearned. Hence, to adjust the accounts, the following
adjusting entries should be prepared on December 31, 2018.

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Income method Liability method

Rental income 200,000 Unearned rent 280,000

Unearned rent 200,000 Rental income 280,000

On the other hand, deferral of expense is accounted for by the one

who makes the advances. When the advances is paid, the payor records
either an expense account (expense method) or a prepaid expense account
(asset method).

The pro-forma entries to record the payment of the deferred

expense and the related adjusting journal entries at yearend are as follows:

Expense method Asset method

Expense xx Prepaid expense xx

Cash xx Cash xx

Expense method Asset method

Prepaid expense xx Rent expense xx

Expense xx Prepaid expense xx

Using the same illustration, Aira Granada Manufacturing will

prepare the following entries on June 1, 2018.

Expense method Asset method

Rent expense 480,000 Prepaid rent 480,000

Cash 480,000 Cash 480,000

On December 31, 2018, Aira Granada Manufacturing will prepare

the following adjusting entries:

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Expense method Asset method

Prepaid rent 200,000 Rent expense 280,000

Rent expense 200,000 Prepaid rent 280,000

Accounting for depreciation

IAS 16 Property, Plant and Equipment defines depreciation as the

systematic allocation of the depreciable amount of an asset over its useful
life. To simplify, depreciation is the process of apportioning the cost of an
asset over the periods which benefited the same asset. For example, the
cost of an asset acquired in year one but can be used until year three shall
be allocated over three years. The amount allocated per year is reported in
the statement of profit or loss as depreciation expense.

. Depreciation is computed by dividing the depreciable amount over

the useful life. Depreciable amount is the cost of an asset, or other
amount substituted for cost, less its residual value, while residual value
of an asset is the estimated amount that an entity would currently obtain
from disposal of the asset, after deducting the estimated costs of disposal,
if the asset were already of the age and in the condition expected at the
end of its useful life. Additionally, useful life is the period over which an
asset is expected to be available for use by an entity, or the number of
production or similar units expected to be obtained from the asset by an
entity. Therefore, the formula for annual depreciation expense is

cost - residual value

=
useful life

Note: Only the straight-line method of depreciation is used in the discussion.

Other depreciation methods will be discussed in intermediate accounting.

Depreciation expense are stored in a valuation account called

accumulated depreciation. The accumulated depreciation is a real
account. It increases from period to period as the asset is being used or the

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mere passage of time. At the end of the period, the balance of the
accumulated depreciation account is deducted from the cost of the related
asset to determine its carrying value.

The pro-forma entry to record depreciation expense is

Depreciation expense xx
Accumulated depreciation xx

Illustration: On May 1, 2018, Docallos, Inc. purchased a delivery truck

for a total cost of P1,500,000. The useful life of the said truck is determine
to be 10 years from the date of acquisition, while its residual value is
P100,000.

Analysis: The depreciation of the truck starts on May 1, 2018 up to April

30, 2028, or ten years. In 2018, only eight months of depreciation shall be
reported from May 1 up to December 31, 2018. Hence, depreciation in
2018 is determined as follows:

P 1,500,000 - P 100,000 8
2018 depreciation = x
10 years 12
= P 93,333.33

The adjusting journal entry to record the depreciation expense on

December 31, 2018 is

Depreciation expense 93,333

Accumulated depreciation 93,333

On December 31, 2018, the delivery truck is reported in the

statement of financial statement at its carrying value of P1,406,667 (cost
of P1,500,000 less accumulated depreciation of P93,333). Needless to say,
in 2019, the carrying value of the delivery truck is P1,266,667 (cost
P1,500,000 less accumulated depreciation of P233,333). Notice that the

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Chapter 4 – Accounting Cycle of Service Provider

cost of the asset remained constant but the accumulated depreciation

increased.
12/31/18 12/31/19
Cost 1,500,000 1,500,000
Accumulated depreciation 93,333 243,323
Carrying Value 1,406,667 1,256,677

Adjusting entries for impairment of receivable

Impairment loss of receivables or most commonly known as

doubtful accounts, are receivables which are doubtful of collection or the
collectability is unlikely. Reporting receivables gross of uncollectible
accounts may not be appropriate since it is not a realistic depiction of the
amount that maybe realized as cash.

There are two methods of accounting for doubtful accounts: the

allowance method and the direct write-off method. The allowance
method provides for doubtful accounts during the period the revenue is
earned and uses an allowance account which is a contra account. Using the
allowance method, the receivable account is not directly affected when
doubtful accounts are reported, although the balance of the allowance
account is deducted from the receivable account to determine its
amortized cost.

Doubtful accounts which proved to be uncollectible are written-off

by a deduction from both the allowance account and the receivable
account. Meanwhile, if the account which has been written-off is
subsequently recovered, the account is restored first in the allowance
account and receivable account and then collected by a charge against the
receivable account.

On the other, direct write-off method provides for doubtful

accounts only when the receivable is proved to be uncollectible. A direct
charge to the receivable account is made instead of any valuation account,
hence, receivable is automatically decreased.

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When the account is recovered, the account is reinstated in the

receivable account and consequently collected by a credit to the receivable
account. To illustrate the comparison of the allowance and direct write-off
methods of recording impairment loss of receivables, refer to the
following:
Allowance method Direct write-off method

Provision for doubtful account

Impairment loss xx No entry

Allowance xx

Doubtful account proved uncollectible and written-off

Allowance xx Impairment loss xx

Receivable xx Receivable xx

Account written off is subsequently recovered

Receivable xx Receivable xx
Allowance xx Impairment loss xx

Cash xx Cash xx
Receivable xx Receivable xx

Notice that in both methods, the balance of the receivable account

is not affected when previously written off-account is subsequently
recovered.

Illustration: On October 1, 2018, Liban & Co, an accounting firm,

decided to classify P30,000 of the P300,000 receivable from one of its
clients as doubtful of collection as it has been overdue for several months
already. On December 1, 2018, Liban & Co wrote-off half of the doubtful

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account. Subsequently on December 28, 2018, Liban & Co recovered and

collected P10,000 of the account written-off.

Journal entries for the foregoing transactions are as follows:

Allowance method Direct write-off method

Reporting the P30,000 as doubtful account

Impairment loss 30,000 No entry

Allowance 30,000

Write-off of the P15,000

Allowance 15,000 Impairment loss 15,000

Receivable 15,000 Receivable 15,000

Recovery and collection of the P10,000 account written-off

Receivable 10,000 Receivable 10,000

Allowance 10,000 Impairment loss 10,000

Cash 10,000 Cash 10,000

Receivable 10,000 Receivable 10,000

Determining the amount of impairment loss

There are two methods to determine impairment loss of

receivables: as percentage of receivables and aging of receivables.
Impairment loss as a percentage of receivable is assigning a percentage of
uncollectibility, normally based on past experience, and then applied to the
outstanding balance of receivable at yearend. Meanwhile, impairment loss
based on aging is determined by preparing an aging schedule which

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classifies the receivables based on age with corresponding percentage of

collectability. Under the aging of receivables, the longer the time the
receivable is outstanding, the less likely it is to be collectible.

The amount of determined using these two methods is the required

ending balance of the allowance account. Hence, to determine the
impairment loss during the period, we must also consider the beginning
balance of the allowance account. The difference of the beginning and
ending balances of the allowance account will the impairment loss for the
period.

Illustration: On December 31, 2018, Payad Company provided the

following ledger balances:

Accounts receivable P 2,000,000

Allowance for impairment loss (unadjusted) 60,000

Based on past experience, Payad’s policy is to assign 5% of the

accounts receivable as uncollectible.

Analysis: Using the percentage of receivable method, the required balance

of the allowance account is P100,000 (P2,000,000 x 5%). But since the
allowance account has an adjusted balance of P60,000, the impairment
loss account is debited for P40,000 (P100,000 required balance less
P60,000 beginning balance).

The entry to record the additional impairment loss during the year is as
follows:

Impairment loss 40,000

Allowance 40,000

Using the same illustration, but this time, Payad’s policy is to

determine impairment loss using an aging schedule. And the aging of the
P2,000,000 accounts receivable indicates the following:

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Age Amount % of collectability

0 – 30 days P1,400,000 98%

31 – 60 days 350,000 90%
61 – 90 days 150,000 80%
More than 91 days 100,000 70%

Age Amount % of collectability Impairment

0 – 30 days 1,400,000 98% 28,000
31 – 60 days 350,000 90% 35,000
61 – 90 days 150,000 80% 30,000
More than 91 days 100,000 70% 30,000
2,000,000 Total 123,000

Analysis: Using the aging of receivable method, the required balance of

the allowance account is P123,000. This means that the allowance account
should be increased to P123,000, thereby crediting the account for
P63,000 (P123,000 required balance less P60,000 beginning balance).

The entry to record the additional impairment loss during the year is as
follows:

Impairment loss 63,000

Allowance 63,000

Accounts receivable is reported in the statement of financial

position at its amortized cost. Amortized cost is determined by deducting
the balance of the allowance account from the accounts receivable. The
amortized cost of Payad Company’s account receivable using the
percentage of receivable method and aging of receivable methods are as
follows:

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% of AR Aging of AR
Method Method
Cost 2,000,000 2,000,000
Allowance for impairment loss 100,000 123,000
Amortized cost 1,900,000 1,877,000

ADJUSTED TRIAL BALANCE

The adjusted trial balance is the trial balance which shows the
adjusted amount of each account after incorporating the adjustments. The
balances in the adjusted trial balance are taken from the unadjusted trial
balance, plus or minus the end of year adjustments. However, it should be
noted that not all accounts in the adjusted trial balance have been adjusted
not all accounts require adjustments at the end of the period.

The preparation of the adjusted trial balance does not denote that
the accounts are properly adjusted and that no errors have been committed
in the preparation of the adjustments. The same with the unadjusted trial
balance, a “balanced” adjusted trial balance may still contain some errors.
There may be un-recording or over-recording of adjustments that will still
leave the adjusted trial balance, “balanced”.

FINANCIAL STATEMENTS

The financial statements are prepared based on the accounts and

adjusted amounts in the adjusted trial balance. As discussed in Chapter 2,
a complete set of financial statements comprises statement of financial
position, statement of profit or loss, statement of changes in equity,
statement of cash flows, and notes to financial statements.

The asset, liability and equity accounts, known as real or

permanent accounts, will consist the statement of financial position. Real
or permanent accounts are the accounts with permanent balances.
Meaning, these balances of these accounts are not closed or “zeroed in” at

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the end of the accounting period, but are carried over to the next
accounting period and become the beginning balances. Hence, statement
of financial position, when prepared, is dated as of the end of reporting
period.

The income and expenses accounts including gains and losses

accounts, known as nominal or temporary accounts, will consist the
statement of profit or loss. These accounts are closed every year. Hence,
income statement accounts begin each year with zero balances. When
prepared, statement of profit or loss is dated for the period ended to show
that the accounts and amounts presented only refer to a specific period,
which is usually the period of the accounting year.

The statement of changes in equity will show the changes in the

equity accounts during the period. Transactions that affect the equity
account are additional investment, withdrawal, and the profit or loss. Like
statement of profit or loss, statement of changes in equity is dated for the
period ended since it only shows the changes in the equity during a
particular period.

The statement of cash flows presents the movements of cash,

inflows and outflows, during the period. Inflows mean receipts and
outflows mean disbursements or payments. IAS 7 Statement of Cash
Flows suggests that the statement of cash flows shall report cash flows
during the period classified by operating, investing and financing
activities. Because classification by activity provides information that
allows users to assess the impact of those activities on the financial
position of the entity and the amount of its cash and cash equivalents

Operating activities are the principal revenue-producing activities

of the entity and other activities that are not investing or financing
activities. Cash flows from operating activities are primarily derived from
the principal revenue-producing activities of the entity. Therefore, they
generally result from the transactions and other events that enter into the
determination of profit or loss. Examples of operating activities are cash

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receipts from the sale of goods and the rendering of services and cash
payments to suppliers for goods and services.

Investing activities are the acquisition and disposal of long-term

assets and other investments not included in cash equivalents. Investing
cash flows represent the extent to which expenditures have been made for
resources intended to generate future income and cash flows. Only
expenditures that result in a recognized asset in the statement of financial
position are eligible for classification as investing activities. Examples of
cash flows arising from investing activities are cash payments to acquire
property, plant and equipment, intangibles and other long-term assets and
cash receipts from sales of property, plant and equipment, intangibles and
other long-term assets.

Financing activities are activities that result in changes in the size

and composition of the contributed equity and borrowings of the entity.
Financing cash flows are cash flows that result from transactions with
providers of capital, which are the equity holders and creditors. Examples
of cash flows arising from financing activities are cash proceeds from
issuing shares or other equity instruments and cash proceeds from issuing
debentures, loans, notes, bonds, mortgages and other short-term or long-
term borrowings.

Statement of cash flows is also dated for the period ended since it
presents the movements of cash during a particular covered period.

THE WORKSHEET APPROACH

The process of preparing the adjusted trial balance up to the

preparation of financial statements can be simplified through the
worksheet approach. Worksheet is a spreadsheet used to prepare
accounting reports. It has an even number of columns, ranging from ten to
sixteen, depending on the required number of columns of the report being
generated. In this topic, a ten-column worksheet will suffice.

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Chapter 4 – Accounting Cycle of Service Provider

To facilitate the use of worksheet approach, observe the following

steps:
1. In the particulars column, enter the account titles observing the
arrangement in the chart of accounts. Asset accounts are listed
first, followed by liability and equity accounts. Income
accounts precede the expense accounts.

2. In the first two columns (Column 1 and 2), enter the balances
of the accounts and write “Unadjusted Trial Balance” as its
heading. Observe the debit and credit balances and ensure that
the totals of debits and credits are equal. Adding the amounts
vertically is called footing. Column 1 is for debits while
Column 2 is for credits.

3. In Columns 3 and 4, enter the adjusting journal entries and

write “Adjusting Entries” as its heading.. Again, observe the
debit and credit balances and ensure that the totals of debits
and credits are equal. Column 3 is for debits while Column 4 is
for credits.

4. The adjusted balances of the accounts are entered in Columns 5

and 6, with “Adjusted Trial Balance” as the heading. Adding
the balances horizontally (unadjusted balance plus or minus the
adjustments) is called cross-footing. Again, observe the debit
and credit balances and ensure that the totals of debits and
credits are equal. Column 5 is for debits while Column 6 is for
credits.

5. From the adjusted trial balance, copy the balances of the real
accounts to 7th and 8th Columns and write “Statement of Profit
or Loss” as the heading. Notice that after footing, the totals of
debit and credit columns are not equal. The balancing figure is
the profit during the period. Like the statement of financial
position, the totals of debit and credit columns are not equal.
The balancing figure is the profit during the period. If the credit
total is higher than the debit total, the operation resulted to a

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profit. If the debit total is higher than the credit total, the
operation resulted to a loss.

6. From the adjusted trial balance, copy the balances of the real
accounts to 9th and 10th Columns and write “Statement of
Financial Position” as the heading. Like the statement of profit
or loss, the totals of debit and credit columns are not equal. The
balancing figure is the profit during the period.

7. Enter the profit or loss as the balancing figure of the statement

of financial position and statement of profit or loss. The
balancing figure must be the same for both statements. Finally,
foot their columns.

8. Draw two lines under the totals of each column. These two
lines are called double rule. Double rule indicates that the totals
are equal.

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To illustrate the use of a worksheet, refer to the following

illustration.

On December 31, 2018, Iladia Vedasto Appraisers, Inc. presented its

unadjusted trial balance as follows:

Iladia Vedasto Appraisers, Inc.

Unadjusted Trial Balance
December 31, 2018

Debit Credit
Cash 300,000
Accounts receivable 125,000
Allowance for impairment loss 8,000
Office supplies 5,000
Equipment 900,000
Accumulated depreciation - equipment 180,000
Accounts payable 80,000
Unearned service income 120,000
Notes payable 200,000
Vedasto, Drawing 4,000
Vedastor, Capital 391,000
Service income 790,000
Advertising expense 30,000
Salaries expense 180,000
Lease expense 120,000
Insurance expense - equipment 60,000
Utilities expense 45,000
Totals 1,769,000 1,769,000

Additional information:
a. 10% of the accounts receivable are determined to be doubtful
accounts. Iladia Vedasto, Inc. uses the allowance method of
recording doubtful accounts.

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b. Inventory of the office supplies account on December 31, 2018

showed P1,200 cost.
c. The equipment account was purchased on December 31, 2015.
Iladia Vedasto, Inc. provided no salvage value for this equipment.
d. The unearned service income is account credited when Iladia
Vedasto, Inc. received annual retainers fee from one of its clients
on September 1, 2018.
e. The note payable is dated October 1, 2018, subject to 6% interest.
f. Iladia Vedasto, Inc. advertises on a quarterly basis. The amount
debited to advertising expense is for the quarter beginning
November 1, 2018.
g. The lease and the insurance expenses are for the annual rental and
insurance paid by Iladia Vedasto, Inc. on May 1, 2018.
h. The utilities expense does not include the December 1 - 15, 2018
billing amounting to P4,000.

The adjusting entries will be determined as follows:

a. Impairment loss 4,500

Allowance for impairment loss 4,500

b. Supplies expense 3,800

Office supplies 3,800

c. Depreciation expense 90,000

Accumulated depreciation 90,000

d. Unearned service income 40,000

Service income 40,000

e. Interest expense 3,000

Interest payable 3,000

f. Prepaid advertising 10,000

Advertising expense 10,000

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Chapter 4 – Accounting Cycle of Service Provider

g. Prepaid lease 40,000

Advertising expense 40,000

Prepaid insurance 20,000

Insurance expense 20,000

h. Utilities expense 4,000

Utilities payable 4,000
Unadjusted Trial Statement of Statement of
Account Titles Adjustments Adjusted Trial Balance
Balance Profit or Loss Financial Position
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit
Cash 300,000 300,000 300,000
Accounts receivable 125,000 125,000 125,000
Allowance for impairment loss 8,000 4,500 12,500 12,500
Prepaid advertising 10,000 10,000 10,000
Prepaid lease 40,000 40,000 40,000
Prepaid insurance 20,000 20,000 20,000
Office supplies 5,000 3,800 1,200 1,200
Equipment 900,000 900,000 900,000
Accumulated depreciation - equipment 180,000 90,000 270,000 270,000
Accounts payable 80,000 80,000 80,000
Interest payable 3,000 3,000 3,000
Utilities payable 4,000 4,000 4,000
Unearned service income 120,000 40,000 80,000 80,000
Notes payable 200,000 200,000 200,000
Vedasto, Drawing 4,000 4,000 4,000
Vedastor, Capital 391,000 391,000 391,000
Service income 790,000 40,000 830,000 830,000
Intrerest expense 3,000 3,000 3,000
Advertising expense 30,000 10,000 20,000 20,000
Salaries expense 180,000 180,000 180,000
Lease expense 120,000 40,000 80,000 80,000
Insurance expense - equipment 60,000 20,000 40,000 40,000
Utilities expense 45,000 4,000 49,000 49,000
Impairment loss 4,500 4,500 4,500
Supplies expense 3,800 3,800 3,800
Depreciation expense 90,000 90,000 90,000
Totals 1,769,000 1,769,000 215,300 215,300 1,870,500 1,870,500 470,300 830,000 1,400,200 1,040,500
Profit 359,700 359,700
Totals 830,000 830,000 1,400,200 1,400,200

From the worksheet, we prepare the adjusted trial, statement of

financial position, statement of changes in equity, and statement of profit
or loss balance as follows:

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Iladia Vedasto Appraisers, Inc.

Adjusted Trial Balance
December 31, 2018

Cash 300,000
Accounts receivable 125,000
Allowance for impairment loss 12,500
Prepaid advertising 10,000
Prepaid lease 40,000
Prepaid insurance 20,000
Office supplies 1,200
Equipment 900,000
Accumulated depreciation - equipment 270,000
Accounts payable 80,000
Interest payable 3,000
Utilities payable 4,000
Unearned service income 80,000
Notes payable 200,000
Vedasto, Drawing 4,000
Vedastor, Capital 391,000
Service income 830,000
Intrerest expense 3,000
Advertising expense 20,000
Salaries expense 180,000
Lease expense 80,000
Insurance expense - equipment 40,000
Utilities expense 49,000
Impairment loss 4,500
Supplies expense 3,800
Depreciation expense 90,000
Totals 1,870,500 1,870,500

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Iladia Vedasto Appraisers, Inc.

Statement of Profit or Loss
For the Year Ended December 31, 2018

Revenue
Service income 830,000
Less: Expenses
Interest expense 3,000
Advertising expense 20,000
Salaries expense 180,000
Lease expense 80,000
Insurance expense - equipment 40,000
Utilities expense 49,000
Impairment loss 4,500
Supplies expense 3,800
Depreciation expense 90,000 470,300
Profit 359,700

Iladia Vedasto Appraisers, Inc.

Statement of Changes in Equity
For the Year Ended December 31, 2018

Vedasto Capital, 1/1/18 391,000

Add: Profit 359,700
Total 750,700
Less: Drawing 4,000
Vedasto Capital, 12/31/18 746,700

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Iladia Vedasto Appraisers, Inc.

Statement of Financial Position
As of December 31, 2018

Assets
Cash 300,000
Accounts receivable 125,000
Allowance for impairment loss (12,500) 112,500
Prepaid advertising 10,000
Prepaid lease 40,000
Prepaid insurance 20,000
Office supplies 1,200
Equipment 900,000
Accumulated depreciation - equipment (270,000) 630,000
Total Assets 1,113,700

Liabilities
Accounts payable 80,000
Interest payable 3,000
Utilities payable 4,000
Unearned service income 80,000
Notes payable 200,000
Total liabilities 367,000

Owner's Equity
Vedastor, Capital 746,700
Total equity 746,700

Total Liabilities and Owner's Equity 1,113,700

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