Chapter 1

Review of the Accounting

Cycle of a Service and
Merchandising Business
Overview
Accounting performs important tasks of recording daily
transactions, classifying recorded data, summarizing recorded
and classified data in order to prepare financial reports and
providing interpretation of the summarized facts in informing
interested people about business operation and financial
condition. Accounting information is summarized in at least four
basic financial reports, namely, (1) Statement of Comprehensive
Income (SCI); (2) Statement of Changes in Equity (SCE); (3)
Statement of Financial Position (SFP); and (4) Cash Flows
Statement (CFS) together with its accompanying notes to the
financial statements.

The work for each accounting period follows a cycle, which is

called the accounting cycle. This refers to a series of sequential
steps or procedures performed to accomplish the accounting
process.

The accounting cycle starts with Step 1, the analysis of various

business transactions through the different business documents
and journalizing or recording these transactions in the general
and special journals. Step 2 is the posting to the general ledger
of the business transactions recorded in Step 1. The trial balance
is prepared in Step 3 followed by the worksheet preparation in
Step 4 which is an optional step in the accounting cycle. Step 5

REVIEW OF ACCOUNTING CYCLE OF A SERVICE AND MERCHANDISING BUSINESS 1

requires the journalizing and posting of adjusting entries in order
to prepare fairly valued financial statements which is Step 6. The
last three steps namely, Step 7 Closing the books, Step 8
Preparing post-closing trial balance, and Step 9 recording and
posting reversing entries are accomplished to prepare the books
for the next reporting/accounting period. Recording and posting
reversing entries is also an optional step similar worksheet
preparation.
Learning Objectives
After studying this chapter, the student should be able to acquire
the following competencies:

1. Practice the use of general journal by recording

business transactions and applying the rules of
debits and credits
2. Do the step posting in the general ledger using T-
accounts.
3. Prepare and understand the importance of different
trial balance.
4. Prepare the Statement of Financial Position of a
single proprietorship.
5. Prepare the functional Income Statement for a
single proprietorship.
6. Prepare Cash Flows Statement using the direct
method.
7. Perform the rest of the steps in completing the
accounting cycle.

REVIEW OF ACCOUNTING CYCLE OF A SERVICE AND MERCHANDISING BUSINESS 2

Business Case to Understand the Accounting Cycle of a
Service and Merchandising Business

Joseph Landscaping and Plants Store

How time flies so fast! It seems just like yesterday when Joseph
started a small store selling various plants out of his hobby of
gardening in the backyard of his house after his retirement as a
professional electrical engineer. He also made use of his spare
time when business is not so busy in his small store accepting
landscaping of gardens of clients in the neighborhood and
nearby towns. Look where his favorite pastime brought him! He
is now considered by many to be a successful entrepreneur after
putting his landscaping and plant store two years ago!

Joseph more than ever is really so concerned with the progress

of his business operations on its third year of operation. He never
forgets that the business to operate successfully must embody
the principles of earning profits with outmost concern for the
welfare of people and planet!

He reviewed the lessons on the different steps of the accounting

cycle which he tried to learn when he was starting his small
business. He started with the chart of accounts of the business as
follows.

REVIEW OF ACCOUNTING CYCLE OF A SERVICE AND MERCHANDISING BUSINESS 3

 CHART OF ACCOUNTS

Account Account
No. Account Title No. Account Title
ASSETS OWNER'S EQUITY
101 Cash in Bank 401 Joseph de Jesus, Capital
102 Petty Cash Fund 401-A Joseph de Jesus, Drawing
Financial Assets at Fair
Value
103 Through Profit or Loss REVENUES
104 Accounts Receivable 501 Service Income
Allowance for Doubtful
104-A Accounts 502 Sales
105 Notes Receivable 502-A Sales Discounts
Sales Returns and
106 Interest Receivable 502-B Allowances
107 Merchandise Inventory 503 Interest Income
108 Office Supplies on Hand EXPENSES
109 Store Supplies on Hand 601 Purchases
201 Land 601-A Purchases Discounts
Purchases Returns and
202 Buildings 601-B Allowances
Accumulated Depreciation-
202-A Building 602 Freight in
203 Equipment 610 Freight out
Accumulated Depreciation- Salaries and Wages
203-A Equipment 611 Expense
204 Furniture and Fixture 612 Depreciation Expense
Accumulated Depreciation –
204-A Furniture 613 Utilities Expense
LIABILITIES 614 Insurance Expense
301 Accounts Payable 615 Office Supplies Expense
302 Notes Payable 616 Store Supplies Expense
Repairs and Maintenance
303 Withholding Taxes Payable 617 Expense
SSS, Philhealth, and
304 Utilities Payable 618 Pag-ibig Expense
Doubtful Accounts
305 Interest Payable 619 Expense
310 Mortgage Payable 620 Miscellaneous Expense
630 Interest Expense

REVIEW OF ACCOUNTING CYCLE OF A SERVICE AND MERCHANDISING BUSINESS 4

The following is the trial balance prepared for Joseph
Landscaping and Plant Store as of November 30, 2023.
Joseph Landscaping and Plants Store
Trial Balance
November 30, 2023
Account Title Debit Credit
Cash in Bank P 95,000
Petty Cash Fund 10,000
Financial Assets at Fair Value Through
Profit or Loss 100,000
Accounts Receivable 95,000
Allowance for Doubtful Accounts P 7,000
Merchandise Inventory, January 1 17,800
Office Supplies on Hand 10,500
Store Supplies on Hand 15,000
Land 400,000
Buildings 440,000
Accumulated Depreciation-Building 57,600
Equipment 220,000
Accumulated Depreciation-Equipment 50,000
Furniture and Fixture 120,000
Accumulated Depreciation – Furniture 44,000
Accounts Payable 37,000
Notes Payable 12,000
Withholding Taxes Payable 5,600
Mortgage Payable 200,000
Joseph de Jesus, Capital 842,950
Joseph de Jesus, Drawing 10,000
Service Income 140,000
Sales 776,850
Sales Discounts 15,000
Sales Returns and Allowances 12,500
Purchases 325,000
Purchases Discounts 10,000
Purchases Returns and Allowances 14,700
Freight in 6,850
Freight out 9,500
Salaries and Wages Expense 194,000
Insurance Expense 28,450
Utilities Expense 26,000
Repairs and Maintenance Expense 16,750
SSS, Philhealth, and Pag-ibig Expense 11,550
Miscellaneous Expense 12,400
Interest Expense 6,400
Total P 2,197,700 P 2,197,700

REVIEW OF ACCOUNTING CYCLE OF A SERVICE AND MERCHANDISING BUSINESS 5

Step 1: Analyzing Business Transactions and Journalizing in
the General Journal
Joseph reviews the first step which is journalizing business
transaction, now that all the business documents of his business
for the month of December were properly sorted and filed. He
recalled the definition that journalizing is the chronological
recording of the business transactions in the book called the
general journal. A journal is a daily record of business
transactions that shows in one place the complete debit and
credit effect of each transaction on the accounts of the business
in chronological order.

Journalizing transactions of service and merchandising business

requires knowledge as to the difference between the two
activities undertaken by Joseph Landscaping and Plants Store.
Merchandising or trading means the company is engaged in the
buying and selling of merchandise such us soil, flower pots,
plants, fertilizers, decorative rocks and stones among others.
Service activity on the other hand is rendering service, e.g.,
landscaping and garden maintenance.

A business firm selling a product like Joseph Landscaping and

Plant Store must use an inventory record system to value the
merchandise on hand at the end of an accounting period. Two
different inventory systems may be used to record trading
transactions in the accounting records. These systems are the
periodic and perpetual inventory system. In a perpetual
inventory system a continual, or perpetual, record of the
inventory activity is maintained. Consequently, any items that
are sold or otherwise physically removed from inventory must
be removed from the Merchandise Inventory account, and items
that are purchased are added to the Merchandise Inventory
account. This may result in significant extra record keeping as
compared to a periodic system. However, a perpetual inventory
system does have advantages, and businesses with a relatively
low number of high-value transactions often find the extra effort
to be worthwhile. Computers are also making it practical for

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businesses to use perpetual systems than would have been not
feasible in the past.

In the periodic inventory system, the ending inventory is

determined by a physical count of the merchandise on hand at
the end of an accounting period. The periodic inventory system
receives its name because the balance in the inventory account
is known only at the beginning and at the end of the accounting
period. The periodic inventory is the simpler system commonly
used in practice and was the only practical alternative for most
businesses with large number of transactions before the advent
of computers. The periodic inventory system will be used in the
Joseph Landscaping and Plants Store review business case.

Exercise 1-1: Journalizing business transactions

• The following is the list summarizing the various
transactions of Joseph Landscaping and Plants Store for the
month of December 2023 which you are asked to record in
a worksheet using the periodic inventory system.
Dec. 1 Sold merchandise to Argem Day Care Center for
P20,000 and received a 3-month, 12% note.
2 Purchased merchandise from Stephen Trading
amounting to P25,000 on terms P10,000 down payment
and the balance 2/10,n/30. FOB Shipping Point,
Collect, P800.
3 Rendered landscaping services to Guadalupe's Garden,
P30,000. Terms: 50% down payment balance on
account.
4 Sold merchandise to Emmanuel Merchandising
amounting to P70,000. Terms: P20,000 down payment
and the balance 2/10,1/15,n/30. FOB Destination Point,
Prepaid, P1,200.
5 Issued a debit memorandum to Stephen Trading for
P500 worth of defective goods.

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6 Joseph made additional investment in the form of
merchandise for P20,000.
7 Issued a credit memorandum to Emmanuel
Merchandising amounting to P1,000 for goods sold not
in accordance to specifications.
8 Sold merchandise to Rafael Novelty Shop P50,000,
C.O.D.
9 Made partial payment amounting to P5,000 to Stephen
Trading.
10 Purchased additional store supplies worth P5,000 and
office supplies amounting to P10,000 from Gabriel
Supermart. Terms: P5,000 down payment and the
balance 2/10, n/30.
12 Paid account with Stephen Trading in full.
15 Joseph withdrew in anticipation of future profits
merchandise which was originally purchased for
P8,000 but is being sold for P12,000.
17 Returned P500 worth of store supplies to Gabriel
Supermart.
19 Collected in full the receivable from Emmanuel
Merchandising.
20 Paid account with Gabriel Supermart in full.
26 Rafael Novelty Shop returned P1,000 worth of
defective merchandise.
28 Rendered landscaping services to Shalom House of
Prayer P50,000 on account.
31 Collected in full the receivable from Guadalupe's
Garden.

REVIEW OF ACCOUNTING CYCLE OF A SERVICE AND MERCHANDISING BUSINESS 8

Step 2: Posting to the General Ledger

After recording the above transactions, let us recall the lessons

in posting to the general ledger. Posting is the process of
transferring journal entries to the ledger accounts. The ledger is
also called the book of final entry. It is in this book where all
the accounts listed in the company’s chart of accounts are
maintained. This book keeps all the information about the
changes in every account balance and often very useful for
management. An account is used as an accounting tool to record
increases and decreases to individual accounting record in a
specific asset, liability, or owner's equity item. An open account
in the general ledger means that there is an amount posted in the
ledger and has an existing balance. There are two possible forms
of general ledger, namely: (1) running balance form and (2)
standard form.

In lieu of the actual general ledger accounts, accountants use T-

accounts to analyze business transactions. As the term implies,
a T-account really looks like a capital letter T which consists of
a horizontal and a vertical line. To make use of this tool of
analysis for accounting, the account title is written just above the
horizontal line. The vertical line provides an imaginary left and
right side of the account where increases or decreases will be
recorded similar to the standard form of general ledger.

Exercise 1-2: Analyzing Business Transactions Using T-

accounts
• Using a second worksheet, draw T-accounts and post the
journal entries recorded for the December transactions of
Joseph Landscaping and Plants Store. The first transaction
was posted for your sample.
• After posting the journal entries, compute for the December
31 balance of all the accounts that were affected by the
December business transactions of Joseph Landscaping and
Plants Store.

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EXAMPLE of posting using T-accounts

December 1- Sold merchandise to Argem Day Care Center for

P20,000 and received a 3-month, 10% note.

Notes Receivable Sales

12/1 20,000 11/30 776,850
12/1 20,000

Step 3: Trial Balance preparation

The trial balance is a list of schedule of open accounts in the

general ledger with their corresponding account balances, i.e.,
the difference between the total debits and total credits of an
account in the ledger. It is prepared to verify the equality of
debits and credits in the ledger at the end of each accounting
period or at any time the postings are updated.

The previous section has shown journalizing and posting

business transactions, at this point in the sequence, it is advisable
to check the work for arithmetic accuracy. Preparing the trial
balance does this. The trial balance summarizes all the accounts
in the general ledger and thus, provides a check on the equality
of the debits and credit entries in the ledger. This schedule has
the following characteristics:

1. It is a list of accounts.
2. The list of accounts is unclassified; it does not attempt to
state whether accounts listed are assets or liabilities,
current or long term.
3. The accounts listed are normally those with open
balances, that is, they have peso amount balances.
4. The accounts are listed in ledger orders.

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If the accounts have been debited and credited with equal
amounts for each transaction during the accounting period, and
if the balances of all accounts have been accurately calculated,
the sum of the debit balance accounts (the assets and the
expenses) will equal the sum of the credit balance accounts
(contra asset accounts, the liabilities, proprietor’s capital and
revenues).

It is important to note that the trial balance is a list prepared for

all accounts with open (debit or credit) balances. Accounts with
zero balances are excluded. The trial balance is not a complete
proof of the correctness of the accounting entries recorded.

Exercise 1-3: Preparing trial balance

• Using the provided trial balance, complete the amounts to

prepare the trial balance of Joseph Landscaping and Plants
Store as of December 31, 2023.

Joseph Landscaping and Plants Store

Trial Balance
December 31, 2023
Account Title Debit Credit
Cash in Bank P
Petty Cash Fund 10,000
Financial Assets at Fair Value Though
Profit or Loss 100,000
Accounts Receivable
Allowance for Doubtful Accounts P 7,000
Notes Receivable
Merchandise Inventory, January 1 17,800
Office Supplies on Hand
Store Supplies on Hand
Land 400,000
Buildings 440,000
Accumulated Depreciation-Building 57,600

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 Equipment 220,000
Accumulated Depreciation-Equipment 50,000
Furniture and Fixture 120,000
Accumulated Depreciation – Furniture 44,000
Accounts Payable
Notes Payable 12,000
Withholding Taxes Payable 5,600
Mortgage Payable 200,000
Joseph de Jesus, Capital
Joseph de Jesus, Drawing
Service Income
Sales
Sales Discounts
Sales Returns and Allowances
Purchases
Purchases Discounts
Purchases Returns and Allowances
Freight in
Freight out
Salaries and Wages Expense 194,000
Insurance Expense 28,450
Utilities Expense 26,000
Repairs and Maintenance Expense 16,750
SSS, Philhealth, and Pag-ibig Expense 11,550
Miscellaneous Expense 12,400
Interest Expense 6,400
Total P P

Step 4: Worksheet Preparation

The worksheet is a multicolumn devised used to systematically
assemble the accounting data used in the adjustment process,
financial statements preparation and closing entries. A
worksheet is just a temporary accounting record. It is not a
journal or a part of the general ledger. The worksheet is
commonly known as the “working paper” of accountants which
makes it easier for them to record adjusting entries, determines
the result of the firm’s operation (whether net income or net loss)
and is used as a tool in preparing financial statements and closing
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Reference:

Manalo, M., and Rapatan, M. (2016). Learning to Succeed in

Business with Accounting. Volume 1 and 2. Phoenix
Publishing House, Inc.

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