Business Transactions and Their Analysis as Applied to the Accounting Cycle of a Service Business

MOTIVATION (30 MINS)

Give examples of service businesses in their community.

Review the discussion on five major accounts, namely: assets, liabilities, equity (capital), income, expenses.

Understanding these accounts is important in recording transactions involving service businesses.

INSTRUCTION

Recall the discussion on types of businesses according to activities

Discuss the nature of a service business

A service business provides a needed service for a fee. In general, service businesses actually have no physical
product sold to clients. Their services are designed to facilitate the work of clients and in return are paid. Service
businesses include salons or barbershops, laundry services, car repairs, medical centers and services of
professionals like lawyers and doctors. The revenue of a service business is usually realized once the service has
been substantially completed. Aside from the minor supplies, the service business does not maintain a high level
of inventory as compared to merchandising and manufacturing businesses. In relatively small service businesses,
all transactions are on cash payments. This means sales are collected immediately while most expenses are paid
outright in the form of cash or checks. The typical financial transactions recorded for a service company include
collecting a deposit from the customer, providing the service and receiving payment.

Ask the learners to assist you in walking through the operations of certain service business. Use a repair shop of
TVs and other electrical appliances as an example. Ask the learners what events or transactions usually occur in a
repair shop.

Discuss the accounting cycle of a service business

The accounting cycle is a continuous process of accumulating, summarizing and reporting financial information.

The steps include: (In this lesson, the first four steps are discussed. )

Step 1 - Transactions and/or Events

Identification and measurement of external transactions and internal events. At this stage, the documents used by
the business are analyzed whether it has financial impact or effect. Recall the rule that only financial transactions
are recorded and that the amount can be measured. These two conditions must exist in order that a particular
transaction is recognized or recorded. As defined, financial transactions are those activities that change the value
of an asset, liability or an equity.

Examples of financial transactions:

 Receipt of cash from a client as advance payment to repair a computer. In this case (asset) will increase. At
the same time, the advances from client (liability) will also increase. The advances from client is a liability
because the business has the obligation to render future service to the client.
 Payment of electric bill is a financial transaction. This will decrease the cash (asset) and reduce the income of
the business at the same time.

Examples of non-financial transactions:

• hiring and termination of employees

• recognition from the government as most outstanding business
• death of owner

The information needed when recording transactions are taken from forms used to document these transactions.
In a typical service business, the following are the business documents used:

1. Official Receipt or Cash Receipt

This document is used when a business receives money or a check. An Official Receipt or Cash Receipt is a
document that acknowledges that money or a check have been received.

SAMPLE OFFICIAL RECEIPT

2. Charge Invoice or Sales Invoice

A charge invoice is a document used when a service has been rendered, but the client will be billed only after a
certain number of days from the date of service. Often, a company will issue a statement of account to a
customer, with the charge or sales invoice attached. For example: in a laundry business, a customer may avail of
the services of the business. However, that customer and the owner of the business had a prior agreement that all
services availed by the customer will be paid only after 30 days. In this case, a charge invoice is issued on the day
the client availed of the services.

SAMPLE SALES INVOICE

3. Check or Cash Voucher

The check voucher is a document used when a check is issued to pay a certain supplier or vendor. For example, in
a laundry business, for the payment of monthly electricity bills, the business may pay either in cash or check. But
the company must prepare a cash or check voucher to support this payment. This document will serve as a record
of payment and, at the same time, as proof that payment has been made by the company.
 SAMPLE CHECK VOUCHER

Give examples of assets, liabilities and equity accounts as previously discussed.

Recall the previous discussion on the different books of accounts.

Step 2 - Preparation of Journal Entries (journalization)

Through the use of specialized journals (such as those for sales, purchases, cash receipts, and cash
disbursements) and the general journal, transactions and events are entered into the accounting records. These
are called the books of original entry.

Debits and Credits are an integral part of the journalization process. In accounting, debits or credits are
abbreviated as DR and CR respectively.

When to Debit and when to Credit: An increase in an asset account is called a debit and an increase in a liability
or equity account is called a credit. Likewise, if we decrease an asset account we credit that account. On the other
side of the equation, if we decrease a liability or equity account we debit those accounts.

Rules on Debits and Credits

 The name of the account to be debited is always listed first. The debited account is listed on the first line
with the amount in the left side of the register.
 The credited account is listed on the second line and is usually indented. The credited amount is recorded
on the right side of the register.
 The total amount of debit should always equal the total amount of credit.

Recall the discussion on the Chart of Accounts The Chart of Accounts is a listing of all account titles used in the
business to record all the transactions. It is arranged according to the order of their appearance in the financial
statements. Refer to Table X
TABLE X. SAMPLE CHART OF ACCOUNTS
 Statement of Financial Position Accounts Income Statement Accounts
Cash Service Revenue
Accounts Receivable Sales
Allowance for Bad Debts Sales Returns and Allowances
Inventory Sales Discounts
Prepaid Expenses Interest Income
Supplies Cost of Sales
Office Equipment Purchases
Accum Deprn - Off Eqpt Purchase Returns & Allowances
Store Equipment Purchase Discounts
Accum Deprn - Store Eqpt Freight In
Transportation Equipment Salaries Expense
Accum Deprn - Trans Eqpt Supplies Expense
Building Utilities Expense
Accum Deprn - Building Communication Expense
Land Travel Expense
Intangible Assets Rental Expense
Accounts Payable Fuel Expenses
Notes Payable Advertising Expense
Accrued Expenses Delivery Expense
Salaries Payable Commission Expense
Utilities Payable Depreciation Expense
Income Taxes Payable Taxes and Licenses
Owner’s, Capital Interest Expense
Owner’s, Withdrawal

Let us take the case of Pedro Matapang, a computer technician. Pedro decided to open his computer
repair shop on February 14, 2016, naming it Matapang Computer Repairs. Pedro knows that business
transactions should be separated from personal finances. Thus, he decided to invest PHP200,000 in this
business. He deposited the amount with Nation Bank.

Entry:

Notice that we have debited Cash, an asset account and credited Matapang, Capital, an equity
account.

February 15, 2016 - Pedro purchased one computer unit from XY Computer Store to be used for the
business. He issued check number 001 amounting to PHP25,000.

Entry:

Notice that the debit to office equipment increased the asset account and the credit to cash
decreased
the asset account.

February 16, 2016 - Pedro hired Juana Magaling, an experienced secretary.

Entry: No entry. This is not a financial transaction.
February 17, 2016 – Repaired the computer of Jean and collected PHP10,000

February 18, 2016 – Repaired Mike’s computer. However, Mike will pay PHP15,000 on March
18, 2016

February 19, 2016 – Pedro purchased Office Supplies from MM Merchandise amounting to
PHP5,000
on account. Pedro will pay this on March 30, 2016.

February 25, 2016 – Paid the salary of Juana amounting to PHP4,000

Journal Entries in a Corporate Set-up

The example above assumed that the business is a sole proprietorship. How are transactions
recorded if
the owner of the business is a Corporation? Basically, the same entries are made, except for
transactions
affecting capital or equity accounts. To illustrate, let us take the following case:

Sweeper Corporation was established to provide janitorial services to clients for a fee. The
corporation
issued 5,000 shares of common stock, at PHP100 par value to shareholders. The issue price
paid by the
shareholders on January 3, 2016 equal the par value. The entry to record this transaction is:

In the above example, if the issue price is PHP120 per share, what is the entry?

Step 3 – Posting

The summary (in specialized journals) or individual transactions (in the general journal) are
then posted
from the journals to the general ledger (and subsidiary ledgers). Nothing should ever get
posted to the
ledgers without first being entered in a journal.

Recall the lesson on the general ledger. We will now post the previous transactions of Pedro to
the
general ledger. For purposes of discussion, we will be using the three-column ledger.
Step 4 - Unadjusted Trial Balance

At the end of an accounting period (for example, one month or one year) the working trial
balance is
prepared. This involves copying each account name and account balance to a worksheet
(working trial
balance). The resulting first two columns of the worksheet are called the unadjusted trial
balance.
In the preparation of the unadjusted trial balance, the balances in all the general ledgers at
the end of
the reporting date are forwarded to the appropriate column. The unadjusted trial balance for
the
transactions in our example from Step 3 is the following:
Notice that all asset accounts are presented first, followed by liabilities, equity (or capital
account),
income accounts and lastly, expenses accounts.

Review of the Accounting Equation

The basic accounting equation is what drives double-entry bookkeeping. The equation reflects
the
accounts reported in the balance sheet. The basic accounting equation is as follows:

ASSETS = LIABILITIES + OWNERS' EQUITY

This is a very simple algebraic equation that reflects how the assets of an entity must be
supported by
either debt or equity. As in algebra, if we add or subtract something from one side of the
equation we
must add or subtract the same amount from the other side. For example, if we were to
increase cash
(an asset) we might have to increase note payable (a liability account) so that the basic
accounting
equation remains in balance.

ASSETS = LIABILITIES + OWNERS' EQUITY

PHP 500 = PHP 500 .

Applying, the formula to our transactions in Step 3 above, the effects of these transactions to
the
equation are shown below:
Notice that at all times, the effects of the transaction to the right and left side of the formula
should be
equal. If not, the journal entry is erroneous.
PRACTICE

Practice Set 1

Mr. Laban Deyro opened his laundry business in Iloilo City on January 2, 2016. The following
transactions
occurred during the month of January 2016:

Required Tasks
1. Prepare the general journal entries for the above transactions (ignore giving
explanations after every entry)
2. Post the following transactions to the general ledger.
3. Prepare the unadjusted trial balance as of January 30, 2016
Practice Set 2

On June 1, Maya Cruz opened the Ganda Beauty Salon. During the first month, the
following selected transactions occurred:

1. Deposited PHP5,000 cash in the City Bank in the name of the business
2. Paid PHP800 cash for beauty supplies
3. Purchased equipment at a cost of PHP12,000 paying PHP2,000 in cash and the
4. balance on account
5. Received PHP1,200 cash for services rendered
6. Paid PHP500 cash as a salary to a beautician
7. Withdrew PHP400 cash for personal expenses

Required Task

Using the following format, identify the effects of above transactions to the accounting
equation:

ASSETS = LIABILITIES + OWNERS' EQUITY

Example:

ASSETS = LIABILITIES + OWNERS' EQUITY

+200 = + 200