LIABILITY ACCOUNTS PRACTICE ENTRIES
*Journal entry format: Practice putting indention before the credited accounts.
1. Obtaining a loan
When businesses enter a contract of loans, they have to pay it back as stipulated in the contract.
"The business took out a loan from PNV Bank in the amount of P1,000,000.00. The said loan is payable in 10 monthly installments of P100,000.00 plus 10% interest on the outstanding balance."
The business will obtain "money" from this transaction. "Money" is an asset that is accounted for using the account "Cash". When an asset increases, the asset account is debited. Therefore, in this transaction, we debit Cash.
On the other hand, the business also recognizes that, from the same contract, it also obtained a responsibility to pay such loan, an obligation to pay, or in accounting parlance, "a Liability." The most appropriate liability account for this transaction is "Loans Payable."
The "normal balance" of Liability accounts is Credit. That is, whenever the company's obligations/ liabilities increase, the appropriate Liability account is credited.
Therefore the journal entry in this transaction is:
Cash -- P1,000,000.00
Loans Payable -- P1,000,000.00
Cash - P1,000,000.00 (Assets increase)
Loans Payable - P1,000,000.00 (Liabilities increase)
2. Receiving Advance Payments from Customers
When the business receives advance payments from its customers, it recognizes the responsibility/ obligation that on a later time, they have to either deliver the goods or render/ perform the service the that the customer paid for in advance.
"The business rents out office spaces. One client/ customer deposited P1,200,000.00 for a 12 month rent which will begin next month."
The business will obtain "money" from this transaction. "Money" is an asset that is accounted for using the account "Cash". When an asset increases, the asset account is debited. Therefore, in this transaction, we debit Cash.
On the other hand, the business also recognizes that, from the same contract, it also obtained a responsibility to lend out the office space to that customer for a 12 month-period. While this lending of office space is the business' source of revenue, but the P1,200,000.00 cannot be recognized as Service Revenue as yet because the 12 month-period of lending out the space has not been performed yet. Therefore, the P1,200,000.00 is yet a liability to the part of the business. It will only become a revenue by the passage of months.
The most appropriate liability account for this transaction is "Unearned Rent Revenue." This is a liability account even if it has the term "Revenue" in it.
Therefore the journal entry in this transaction is:
Cash -- P1,200,000.00
Unearned Rent Revenue -- P1,200,000.00
Cash - P1,000,000.00 (Assets increase)
Unearned Rent Revenue- P1,000,000.00 (Liabilities increase)
In the future, the business will reclassify the Unearned Rent Revenue to Rent Revenue if the business has already fulfilled its part, that is, it has lent out the office space to that customer as per contract.
The entry for the fulfillment/ performance of such responsibility will be:
Unearned Rent Revenue -- P1,200,000.00
Rent Revenue ------------P1,200,000.00
*The generic account is "Service Revenue" but the company can specify it for better reporting and call it "Rent Revenue" because their service is "Rent".
3. Accrued Expenses
Accrued expenses are expenses that the company has already incurred but have not paid yet.
"Electricity bill for the month of January is P1,000,000.00. The bill is due on February 16, 2025."
In this event, the business has made use of the electricity from the provider but has not paid it yet. The bill from the provider is the formal notice of the peso liability of the business as to their utility use.
The journal entry in this transaction is:
Utilities Expense -- P1,000,000.00
Utilities Payable -- P1,000,000.00
Utilities Expense - P1,000,000.00 (Expenses increase)
Utilities Payable- P1,000,000.00 (Liabilities increase)
*The generic account is "Utilities Expense" and "Utilities Payable" but the company can specify them for better reporting and call them "Electricity Expense" and "Electricity Payable".
"Utilities Expense" is also used for Water and Janitorial Services. You can also specify "Water Expense" of "Janitorial Expense" if the amounts are material to the interpretation of the report.