TOPIC 3

PREPARATION OF LEDGER ACCOUNTS

Principles of Bookkeeping
The primary principle of bookkeeping is to record on a day-to-day basis the financial
transactions and information pertaining to a business. The bookkeeping principles
ensure that the individual financial transactions are up to date and comprehensive.
Also, to provide information from which accounts are to be prepared.

They include:

Revenue Principle
The revenue principle defines a point in time when bookkeepers may record a
transaction as 'revenue' in the books. It states that revenue for the business is
earned and recorded at the point of sale.

This principle states that the revenue occurs at the time when the buyer takes legal
possession of the item sold or the service is performed. This implies that revenue is
not necessarily at the time when cash for the transaction is accepted by the seller.
This concept is also called a revenue recognition principle.

Expense Principle
The expense principle defines a point in time at which the bookkeeper may log a
transaction as an expense in the books. It states that an expense occurs at the time
when the business accepts goods or services from another entity.

The logic behind this principle is that the expenses occur when the goods are
received or the service is performed, regardless of when the business is billed or
pays for the transaction.

Matching Principle
The matching principle propounds that, when you record revenue, you should
record all related expenses at the same time. Thus, you charge inventory to
the cost of goods sold at the same time that you record revenue from the sale of
those inventory items.

Cost Principle
This principle states that you should use the historical cost of an item in the books,
not the resell cost. Let’s say if a business owns the property, such as real estate or
vehicles, then those assets should be listed as the historical costs of the property
and not at the current fair market value of the property.

Objectivity Principle
This principle states that you should use only factual, verifiable data in the books,
never a subjective measurement of values. Even if the subjective data seems better
than the verifiable data, the verifiable data should always be used.

In inclusion to these basic principles, the accounting world operates under a set of
assumptions, or things that accountants can assume to always be true.

JOURNAL ENTRIES

JOURNAL

For accounting purposes, a journal is a physical record or digital document

kept as a book, spreadsheet, or data within accounting software. When a
business transaction is made, a bookkeeper enters the financial transaction as a
journal entry.
Types of Journals
In double-entry bookkeeping, companies usually keep 7 different
types of accounting journals. This is done in order to further
organize the kind of transactions into the specific journal type where
it fits.

This way, it will be easier to analyze the effects of the transactions

than if they were recorded in one journal.

The seven types of accounting journals are:

Purchase Journal
The purchase journal is where all credit purchases of merchandise
or inventory are recorded. Thus, this kind of journal must not
contain transactions such as the purchase of assets on credit
because this should only be exclusively for merchandise or
inventory.
Also, merchandise or inventory purchases paid by cash should not
be recorded in this journal as it is exclusively for credit purchases.

Purchase Returns Journal

This type of journal houses all returns of inventory that were
originally purchased on credit. Take note that inventory returns that
were originally purchased in cash cannot be entered into this
journal.

Cash Receipts Journal

The cash receipts journal is where all cash receipts, which could
be payments from customers for the service or product that you
sell, are recorded.

Sources of cash could also include, but are not limited to,
debtors, income, or loans received. This is where one would record
items such as customer payments and bank deposits.

Cash Disbursements Journal

The cash disbursements journal is where all payments to creditors
using cash are noted down. This includes payments for a variety of
expenses such as payroll, suppliers’ bills, interest paid on a loan, or
mortgage payment.

The cash disbursements journal is also otherwise known as the

“cash payments journal.” Note that some companies may have
specific journals for each type of expense category they have in
order to track costs more effectively.

Sales Journal
This journal records all sales of goods on credit. Sales to customers
who pay in cash should not be recorded here, but instead entered in
the Cash Receipts Journal.
Sales Returns Journal
This journal is where all credit returns of merchandise or inventory
are recorded. Also, if the items were originally purchased in cash
and returned in credit, they should not be entered here but instead
entered in the Purchase Returns Journal.

General Journal
The general journal is where one will record all the journal entries
that do not fit into any of the six types mentioned above. An
example of a financial transaction that could be recorded here is the
purchase of an asset on credit.

This is also where we list information about credits and debits so as

to form a complete accounting system for recording transactions in
double-entry bookkeeping
Journal vs Ledger
Both journals and ledgers are useful tools in bookkeeping but each
of these serves different purposes and uses. As has been already
mentioned, a journal is where a financial transaction is first
recorded.

A ledger, on the other hand, is where the results of the transactions

are kept permanently. During preparation, all financial transactions
will have to be recorded first in the journal before they are
translated into the ledger.

Here are some points to remember to differentiate a journal from a

ledger:
Journal entry format
Standard Format of Journal Entry
in Accounting
The basic format of a Journal Entry in accounting is shown
below:

Journal

Date Particulars of Business Transaction Folio Debit Credit

XX Debit A/C $0.00

Credit A/C $0.00

(Brief Narration of the Transaction)

Column 1: Transaction Date

The first column in the Journal book consists of the
transaction date. The transaction date refers to the actual
date on which the transaction has been incurred and not the
date of reporting the transaction.

Column 2: Journal Entry

The second column is where we record the business
transaction by passing a Journal Entry. Journal entries refer to
the systematic recording of business events and transactions
on a given date by applying fundamental rules of
bookkeeping. At the bottom of the Journal Entry, we post a
brief narration describing the transaction.

For example, suppose on Oct 15, 2019, A Ltd bought furniture

worth US $ 1,000/- for business purposes. In this case, we will
debit the Furniture Account (Debit what comes in) and credit
the Bank Account (Credit what goes out) with the US $
1,000/-

The journal entry format in excel for this transaction will be

as follows:

Column 3: Folio
The third column is the folio number, which indicates the
reference number used to identify the particular entry in
respective ledger accounts. This reference number could be
numeric or alphanumeric as well.
Column 4: Debit Amount
The fourth column shows the amount by which the respective
account is debited in the transaction.

For Instance, On Feb 07, 2019, ABC Inc. paid office rent of US
$ 250.00 and Building insurance of US $ 400.00.

Now, since office rent and building insurance is an expense

for ABC Inc., we will debit both the accounts (Debit all
expenses and losses), i.e., the Rent account by the US $
250.00 & Insurance account by the US $ 400.00, and the will
credit the bank account by the US $ 650.00(Credit what goes
out) as:

The format in excel for this transaction will be as follows:

The format in excel for this transaction will be as follows:

Now, with the help of the fourth column, we can clearly

distinguish which account is affected by how much money.

Column 5: Credit Amount

Like column 4, which shows the amount by which an account
is debited, column 5 represents the amount by which the
respective account is credited.

Continuing the above example, the payment of rent

and Insurance expenses shows an outflow of money from
the business. Thus we credited the bank account with a total
of US $ 650.00

Examples
On Oct 15, 2019, ABC Inc. sold 200 units @ SH.10/unit
to Mr. John on credit.

To record the transaction, we will enter the transaction date,

which is Oct 15, 2019, in the first column.

In the second column, we will pass the accounting journal

entry of the transaction, i.e.; we will credit the Sales account
(credit all income and gains). As Mr. John has received the
 goods on credit and will make the payment in the future, he
is the debtor of ABC Inc. By the rule of a personal account;
we will debit his account by the amount of sale value (Debit
the receiver).
The journal entry format in excel for this transaction will be
as follows:

Essential Points to Note

About Journal Entry Format
 Journal Entry should be recorded with the transaction date only.
 Consider the fundamental accounting principle to identify the relevant ledger accounts affected
in the business transaction.
 Once you have identified the relevant ledger accounts to record the journal entry, pay attention to
3 golden rules of bookkeeping to determine which ledger account is debit and which one to
credit.
 Make sure the total of the debt amount and the credit amount are always equal for each
transaction.
 The transaction amount should be mentioned in the reporting currency. Reporting currency refers
to the country’s domestic currency where the registered office of the company is located. If the
company does business in multiple countries, transactions done in foreign currencies should be
first converted into reporting currency and then recorded in Journal.


Ledger Accounts
The record of trading transactions is kept on the folios or pages of
these account books, called ledgers. The ledger folios have special
rulings to suit the needs of the business.

The bank statement style lends itself to modern accounting, but

for the time being, double entry will be explained by the older
traditional method.
 Format of Ledger Accounts
This is the ordinary ruling for the older style of ledger account:

In practice, separate ledgers are kept for the different classes of

accounts: customers, suppliers, business property, trading revenue,
expenses, and so on.

Batches or groups of similar accounts are kept together, and ledgers

are indexed so that information pertaining to a particular account
can be obtained quickly.

A critical point to remember is the following:

It is important to check the accuracy of entries made in ledger

accounts at regular intervals as failing to debit a customer's account
for goods bought on credit, for instance, may result in no payment
reminder being sent.
Types of Ledger Accounts
There are two popular formats for ledger accounts:

1. Standard format (or T-shaped format) of ledger account

2. Self-balancing format

Standard Format
 In the standard format of a ledger account, the page is divided
into two equal halves. The left-hand side is known as the debit side
and the right-hand side is the credit side. As it takes the shape of
the capital letter “T”, it is also known as the T-shaped format.

The debit side is used to record debit entries and the credit side is
used to record credit entries. The title of the account is written in
the center at the top of the page. The account number is written in
the extreme right-hand corner.

The standard form of a ledger account does not show the balance
after each entry. The balance is calculated after a certain period (or
when needed). This is why this type of account is also called
the periodical balance format of a ledger account.

Format of a Standard Ledger Account

Notice that each side of the ledger account is divided into four
columns. The purpose of these columns is briefly described
below: (1) Date: The year, month, and date of the entry are
recorded in the same manner as in the general journal. (2)
Description: The title of the corresponding account is entered into
this column (i.e., the other account included in the journal
entry). (3) Posting reference: In this column, the general journal
page number is recorded. (4) Amount: The amount of the account
is recorded in this column.

Method of Posting
The posting process consists of the following steps:

1. Trace the ledger account in which the entries are to be posted.

2. If an account is debited in the general journal, it will be posted on
the debit side in the ledger account, and if it is credited in the
general journal, it will be posted on the credit side.

3. In the description column, the title (name) of the account included in

the other part of the journal entry is written. For example, when
posting an account included in the journal entry's debit part, the
account(s) in the credit part will be written in the description
column.

4. The amount of the entry is written in the amount column of the

ledger account.

Balancing the Ledger Account

Balancing means finding out the debit or credit balance of a ledger
account. This process may be divided into the following steps:

1. Total the debit and credit sides of the account.

2. Calculate the difference between the two totals found in the

previous step.

3. Put the difference on the lighter side.

To elaborate on the third point above, this difference so placed is

the balance of the account.

If the debit side of the account is heavier than the credit side, the
account is said to have a debit balance. In case the credit side of the
account is heavier than the debit side, the account is said to have a
credit balance.

If the totals of the two sides of the account are equal, the balance
will be zero.

Example
Record the following transactions in the general journal and post
them to the ledger accounts:

 Jan. 01: Mr. A started a business with cash of $45,000

 Jan. 04: Purchased merchandise for cash amounting to $4,500
 Jan. 10: Sold merchandise to Mr. John for $1,450
 Jan. 31: Cash received from Mr. John amounting to $1,400 with
a discount of $50

Solution

E
xample
Record the following transactions in the general journal and post them to the ledger accounts:

 Jan. 01: Mr. A started a business with cash of $45,000

 Jan. 04: Purchased merchandise for cash amounting to $4,500
  Jan. 10: Sold merchandise to Mr. John for $1,450
 Jan. 31: Cash received from Mr. John amounting to $1,400 with a discount of $50

Solution
Self-balancing Format
In the standard format of a ledger account, the balance is not stated after each transaction. In
organizations where account balances are required after each transaction, the self-balancing or
running balance format of a ledger account is used.

The main advantage of this ledger account format is that it shows the current balance at a glance.
Banks and other financial institutions are examples of business organizations that use self-
balancing ledger accounts.

Format of a Self-balancing Ledger Account

The standard format of a self-balancing ledger account is given below:

Posting and Balancing

The method used for posting and balancing in a self-balancing ledger account is similar to that of
the standard ledger account format. The only difference is that the balance is ascertained after
each entry and is written in the debit or credit column of the account.

The following example is useful to clarify the posting and balancing procedure.

Example
Journalize the following transactions and post them to the ledger accounts. Use the self-
balancing/running balance ledger account format.

 Mar. 01: Started a business with $40,000 cash

 Mar. 04: Purchased machinery for $4,000 cash
 Mar. 08: Purchased merchandise for $1,400 on account from S Brothers
 Mar. 12: Sold merchandise to a customer for $700 cash
 Mar. 15: Paid $1,380 cash to S Brothers and received a cash discount of $20

Solution
Recording Transactions in Ledger Accounts
After recording the opening balances (i.e., the amounts at the beginning of an accounting period)
in the ledger account, the next step is to record transactions as they take place.

Transactions result in an increase or decrease in the value of various individual balance

sheet items. The following rules are applied to record these increases and decreases in individual
ledger accounts.

1. Assets
Assets are recorded on the debit side of an account. Any increase in an asset is recorded on the
debit side of the relevant account, while any decrease in an asset is recorded on the credit side.
For example, the amount of cash in hand at a particular date (e.g., the first day of the accounting
period) is recorded on the debit side of the cash in hand account. Whenever an amount of cash
is paid out, an entry is made on the credit side of this account.

2. Liabilities
Liabilities are recorded on the credit side of an account. Any increase in liability is recorded on
the credit side of the account, while any decrease is recorded on the debit side.

For example, the amount payable to United Traders on the first day of the accounting period is
recorded on the credit side of the United Traders Account.

If more goods are bought from United Traders (thereby incurring an additional liability to United
Traders), an entry is made on the credit side of the United Traders Account.

Additionally, if an amount is paid to United Traders (thereby reducing the liability to United
Traders), an entry is made on the debit side of the United Traders Account.

3. Capital
Capital is recorded on the credit side of a ledger account. Any increase in capital is also
recorded on the credit side, and any decrease is recorded on the debit side of the respective
capital account.

For example, the amount of capital that Mr. John has on the first day of the accounting period
(see the previous example) will be shown on the credit side of Mr. John’s capital account.

If he introduces any additional capital, an entry will be made on the credit side of his capital
account. If he draws any money or goods from the business, this will reduce his capital, meaning
that an entry should be made on the debit side of his capital account.

An important point to note is that the treatment for assets is exactly the opposite of the treatment
for liabilities and capital.

Another important fact to note stems from the fact that total assets are equal to total liabilities
and capital at any given time.

Due to this, the amounts entered on the first day of the accounting period on the debit side of the
accounts (in respect of various assets) will be equal to the total of all the amounts entered on the
credit side of various accounts (in respect of various liabilities and capital).
The Double Effects of Transactions in Ledger Accounts
A balance sheet remains in balance after each transaction.

This is to ensure that each transaction affects the balance sheet in such a way that an increase on
one side of the balance is offset either by a decrease on the same side or by an increase on the
other side.

Therefore, various double effects of transactions in ledger accounts should be borne in mind.

1. Since increases in assets are debited and decreases in assets are credited, a transaction
resulting in an increase in one asset and a decrease in another asset will in effect have equal
debit and credit entries.

These entries will, of course, be made in two different asset accounts, but the amount will be
equal.

For example, a receipt of $3,000 from Adam, a debtor, will be recorded on the debit side of the
cash in hand account (as this asset is increasing) and on the credit side of Adam’s account (as
the amount due from him is decreasing).

The entries in both of these asset accounts will amount to $3,000 each.

2. Since increases in assets are debited and increases in liabilities are credited, a transaction
resulting in an increase in an asset and an equal increase in a liability (or capital) will in
effect have equal debit and credit entries.

For example, when furniture is bought on credit for $4,000 from Fine Furniture Co., we will
need to make an entry of $4,000 on the debit side of the furniture account (i.e., because this asset
is increasing).

We will also need to make an entry of $4,000 on the credit side of the furniture account because
the liability to this creditor is increasing.

4. Since decreases in liabilities are debited and decreases in assets are credited, a
transaction resulting in a decrease in a liability (or capital) account and an equal
decrease in an asset account, will in effect have equal debit and credited entries

There are two types of ledgers used in accounting:

the general ledger and
the subsidiary ledger.
 A subsidiary ledger is a group of similar accounts whose combined balances equal the
balance in a specific general ledger account. The general ledger account that
summarizes a subsidiary ledger's account balances is called a control
account or master account. For example, an accounts receivable subsidiary ledger
(customers' subsidiary ledger) includes a separate account for each customer who
makes credit purchases. The combined balance of every account in this subsidiary
ledger equals the balance of accounts receivable in the general ledger. Posting a debit
or credit to a subsidiary ledger account and also to a general ledger control account
does not violate the rule that total debit and credit entries must balance because
subsidiary ledger accounts are not part of the general ledger; they are supplemental
accounts that provide the detail to support the balance in a control account.
The general ledger contains information on all of the accounts, while the
subsidiary ledger contains information for a specific general ledger
account..

What is a general ledger?

A general ledger is an accounting record of all financial transactions in your business.
This includes debits (money leaving your business) and credits (money coming into
your business). These transactions can occur across areas such as revenue, expenses,
assets and liabilities.

6 common types of general ledger

accounts
A general ledger typically records the following accounts:

 Assets
 Liabilities
 Equity
 Revenue
 Expenses
 Other income accounts

Asset accounts
Asset accounts record assets owned by your company. These accounts are
debited if assets enter the company and are credited if assets leave the company.
Assets provide economic benefits to the company, either now or in the future.
Some examples of asset accounts include:

 Accounts receivable
 Cash
 Inventory
 Investments

Liability accounts
This account type records all of your company’s liabilities (also referred to as the
company’s debts). Whenever your company incurs more debt, these accounts are
credited to increase liabilities. If your company makes a payment toward its debt,
the liability account is debited.

The following are examples of liability accounts:

 Accounts payable
 Notes payable
 Accrued expenses
 Customer deposits

Stockholders’ equity accounts

Stockholders’ equity can also refer to shareholders’ or owner’s equity. You can
calculate the equity of your company by subtracting the company’s liabilities from
its assets.

We can conclude that stockholders’ equity is equal to the remaining assets

available to the company after all liabilities have been paid.

Below are some examples of stockholders’ equity accounts:

 Common stock
 Retained earnings
 Treasury stock
Revenue accounts
Revenue refers to the assets that your company has earned through its business
activities, such as revenue earned by delivering a service. For example, if you own
a plumbing company and have delivered a plumbing service to a customer, the
service revenue account will be credited since revenue accounts increase on the
credit side.

The following are examples of revenue accounts:

 Sales
 Service fee revenues

Expense accounts
Expense accounts represent the expenses that your company has incurred. This
generally includes all money spent on business activities with the hopes of
generating a profit.

Expense accounts record the cost of doing business and include the following
accounts:

 Salaries
 Rent
 Advertising
 Cost of goods sold

Non-operating or other income accounts

Non-operating or other income accounts refer to business income that’s unrelated
to core business operations and generally takes place outside of day-to-day
operations.

For example, your business might sell an asset that you’ve owned for years and
record the revenue received from the sale of the asset in a non-operating income
account.
Below are examples of non-operating or other income accounts:

 Gain on sale of assets

 Interest
 Loss on disposal of assets

How do you write a general ledger?

A general ledger contains the date and description of each transaction, along with a
debit and credit side of a T-shaped visual depiction of the transaction. This model
is known as a T-account. Follow these basic steps to write a general ledger:

1. Write the name of the account at the top of the page so it’s easy to find
later on. Each account should have at least one entire page in the general
ledger.
2. Add the account numbers below the account name in the general ledger.
3. When recording the transactions, go in chronological order to keep your
financial records organized so it’s easy to find specific items by date.
4. In the description column, record what the transaction involves so you can
easily keep track of all financial transactions.
5. Decide whether the account needs to be debited or credited. Assets and
expenses increase on the debit side and decrease on the credit side of the
T-account. Liabilities, equity, and revenue increase on the credit side and
decrease on the debit side.

To balance the general ledger, the account balances of both your debits and your
credits must be equal. If your ledger doesn’t balance, you’ll need to investigate and
include appropriate adjusting entries at the end of the accounting cycle.

TRIAL BALANCE

The trial balance is a source of locating errors in a

company's ledger. Trial balance is the third phase of
the accounting cycle. Before complex accounting procedures are
applied, it is necessary to check the accuracy of the work that has
already been done. Therefore, a trial balance provides the basis to
check the accuracy of a ledger. The trial balance consists of a two-
column statement of debit and credit balances derived from the
ledger. The total of the debit and credit balances should be equal;
otherwise, the work done to maintain the ledger cannot be
considered accurate. In a nutshell, a trial balance is an informal
accounting statement, prepared with the help of ledger account
balances. It is prepared on a particular date to summarize the
records and check the arithmetical accuracy of the books
of accounts.
Trial Balance: Explanation
The stage after completing all postings involves extracting
information from the books of all balances to create a trial balance.
The trial balance is not an account; it is simply a list of all the debit
and credit balances. The financial information, which is classified
and grouped in the various ledger accounts, is now totaled for
each account. Also, the debit and credit balances are listed on the
trial balance, including the final balance of the cash account.
balances are listed on the trial balance, including the final balance

of the cash account. The

grouping of account balances does not happen in a specific order.
However, to avoid omission, it is recommended to extract the
final cash balance first, after which the remaining ledger balances
can be listed in either page or book sequence. There are no
complexities regarding double entries here; at this stage, it has
been completed. Debit balances are merely listed on the debit of the
trial balance, with credit balances on the credit

Purpose of Preparing a Trial Balance

The basic purpose of preparing a trial balance is to test the
arithmetical accuracy of the ledger. If all debit balances listed in the
trial balance equal the total of all credit balances, this shows the
ledger's arithmetical accuracy. Importantly, the trial balance is not
an account. It is not part of the double-entry system of
accounting. The trial balance is simply a list of debit and credit
balances taken from the books, normally at the end of a specific
trading period (monthly, biannually, or annually) for the purpose of:

 Checking the arithmetical accuracy of the postings

  Increasing the convenience of the work of the accountant or
bookkeeper in creating financial summaries, often with a view
to preparing revenue trading accounts and a balance
sheet
 Example
Consider the following trial balance from a trading business:

The above trial balance shows that on 31 March 2016, the total of debit balances in the ledger
amounted to $260,116, which is equal to the total of credit balances. This fact provides a
reasonable assurance that every debit entry in the ledger accounts does have a corresponding
credit entry and that no arithmetical error has been made during the balancing process. It also
shows that all accounts with a non-zero balance have been duly reported in the trial balance on
its correct side (i.e., those having debit balance are reported in the debit column, and those
having credit balance are reported in the credit column). In addition to the above, trial balance
performs another important function. If you check the above trial balance again, you'll realize
that this list of balances is also a summary of all transactions made during the accounting
period. Let's analyze the contents of the above trial balance:
1. Asset accounts like cash, accounts receivable, inventory,
furniture, etc., show the position of the assets at the end of the
accounting period.

2. Liability and owner's equity accounts such as accounts

payable and capital reflect the position of liabilities and capital
at the end of the accounting period.