CIMA - C2 Fundamentals of Financial Accounting
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60 4: Sources, records and the books of prime entry ⏐ Part B Accounting systems and accounts preparation
Answers to quick quiz
1 Choose five from:
(1) Name and address of supplier and customer (6) Invoice number
(2) Details of goods purchased (7) Reference number of sales order
(3) Details of any discount (8) VAT details
(4) Date of the sale (9) Sometimes, the payment terms
(5) Total amount due
2 B Correct
A Incorrect, the ledgers are posted from day books
C Incorrect, an invoice would be recorded in the sales day book.
D Incorrect, the journal is used to make transfers or correct errors or to record transactions which do not go
through another prime entry record
3 D Correct
A This would be recorded in the cash book
B This would be referred to as the sales ledger
C This would be the purchase day book
4 C Correct
A This would be recorded in the cash book
B This would be referred to as the purchase ledger
D This would be the sales day book
5 The cash book records money received into and paid out of the business bank account.
The petty cash book records minor items of expenditure (eg postage stamps) paid or received in cash.
6 D is correct (90 – 35 + 5 + 30 = 90). The imprest total is the balance to which the petty cash is restored at the end of
each month.
Now try the question below from the Question Bank
Question number Page
12 394
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61
Ledger accounting
and double entry
Introduction
We have studied the theory of preparing accounts for a business. We have seen, by means of
the accounting equation, that it is possible to prepare an income statement and a statement
of financial position on any date, relating to any period of time. A business is continually
making transactions and we do not want to prepare accounts after every transaction. To do
so is too time-consuming.
A business should keep a record of its transactions and, when the time comes to prepare the
accounts, the relevant information can be taken from those records. The records of
transactions, assets and liabilities should be in chronological order and dated so that
transactions can be related to a particular period of time (eg daily, weekly, monthly, yearly).
We have already seen the first step in this process, which is to list all the transactions in
various books of prime entry. Now we study the method used to summarise these records.
This chapter introduces double entry bookkeeping, the cornerstone of accounts preparation.
This is a very important topic and you must understand it before proceeding further in your
studies.
Topic list Syllabus references
1 The nominal ledger B (6)
2 Double entry bookkeeping B (2)
3 The journal B (6)
4 Posting from day books to nominal ledger accounts B (2)
5 The imprest system B (3)
6 The sales and purchase ledger B (4)
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62 5: Ledger accounting and double entry ⏐ Part B Accounting systems and accounts preparation
1 The nominal ledger
The nominal ledger is an accounting record which summarises the financial affairs of a business. It contains accounts
for each asset, liability, capital, income, expenditure and profit and loss.
The nominal ledger is sometimes called the 'general ledger'. It consists of a large number of different accounts, each
account having its own purpose or
'
name
'
and an identity code.
The nominal ledger contains a separate account for each item which appears in a statement of financial position or
income statement.
1.1 Examples of accounts included in the nominal ledger
• Plant and machinery at cost (non-current asset)
• Motor vehicles at cost (non-current asset)
• Plant and machinery, provision for depreciation (liability)
• Motor vehicles, provision for depreciation (liability)
• Proprietor
'
s capital (liability)
• Inventory – raw materials (current asset)
• Inventory – finished goods (current asset)
• Total receivables (current asset) often called sales ledger control account
• Total payables (current liability) often called purchase ledger control account
• Wages and salaries (expense item)
• Rent (expense item)
• Advertising expenses (expense item)
• Bank charges (expense item)
• Motor expenses (expense item)
• Telephone expenses (expense item)
• Sales (income)
• Total cash or bank overdraft (current asset or liability) often called cash control account
• Petty cash (current asset)
1.2 The format of a ledger account
If a ledger account is kept in an actual book, its format is as follows.
ADVERTISING EXPENSES
Date Narrative Ref $ Date Narrative Ref $
20X6
15 April JFK Agency for quarter
to 31 March
PL 348 2,500
Only one entry is shown here, as an example simply to illustrate the general format.
There are two sides to the account and a heading on top, so it is usually called a
'T' account.
Key term
FA
S
T F
O
RWAR
D
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Part B Accounting systems and accounts preparation ⏐ 5: Ledger accounting and double entry 63
NAME OF ACCOUNT
DEBIT SIDE $ CREDIT SIDE $
2 Double entry bookkeeping
The double entry system of bookkeeping means that for every debit there is an equal credit. This is sometimes referred
to as the concept of duality.
Remember the accounting equation said that the total of liabilities plus capital is always equal to total assets, so any
transaction which changes the amount of total assets must also change the total liabilities plus capital, and vice versa.
Alternatively, a transaction may use up assets of a certain value to obtain other assets of the same value. For example, a
business pays $50 for some goods. Its total assets will be unchanged, but the amount of cash falls by $50 and the value
of inventory rises by $50.
2.1 Debits and credits
Ledger accounts, with their debit and credit sides, allow the two-sided nature of business transactions to be recorded.
This system of accounting was first used in Venice in 1494 AD.
2.1.1 The rules of double entry bookkeeping
The basic rule is that every financial transaction gives rise to two accounting entries, one a debit and one a credit. The
total value of debit entries in the nominal ledger is therefore always equal to the total value of credit entries. The meaning
of the terms 'debit' and 'credit' are given below. It will be worth spending some time, at this point, committing them to
memory.
Debit
Credit
•
Increase in an expense (eg purchase of stationery
•
Increase in income (eg a sale)
•
Increase in an asset (eg a purchase of office
furniture
•
Increase in a liability (eg obtaining a bank loan)
•
Decrease in a liability (eg clearing a payable)
•
Decrease in an asset (eg making a cash payment)
A good starting point is the cash account where receipts and payments of cash are recorded. The rule to remember
about the cash account is as follows.
(a) A cash payment is a credit entry, because the cash asset is decreasing. Cash may be used to pay an
expense (eg rent) or to purchase an asset (eg a machine). The matching debit entry is made in the
appropriate expense or asset account.
(b) A cash receipt is a debit entry, because the cash asset is increasing. Cash is received by a retailer who
makes a cash sale. The credit entry is then made in the sales account.
2.2 Example: double entry for cash transactions
A business has the following transactions.
(a) A cash sale (ie a receipt) of $200
(b) Payment of a rent bill totalling $150
(c) Buying some goods for cash at $100
(d) Buying some shelves for cash at $200
How would these four transactions be posted to the ledger accounts?
FA
S
T F
O
RWAR
D
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64 5: Ledger accounting and double entry ⏐ Part B Accounting systems and accounts preparation
Solution
(a) The two sides of the transaction are: cash is received (debit entry in the cash account) because the asset cash is
increasing) and sales increase by $200 (credit entry in the sales account because sales income is increasing).
CASH ACCOUNT
$ $
Sales a/c 200
SALES ACCOUNT
$ $
Cash a/c 200
Note how the entry in the cash account is cross-referenced to the sales account and vice-versa. This enables a
person looking at one of the accounts to trace where the other half of the double entry can be found.
(b) The two sides of the transaction are: cash is paid (credit entry in the cash account because the asset cash is
reduced) and rent expense increases by $150 (debit entry in the rent account because the expense is increasing).
CASH ACCOUNT
$ $
Rent a/c 150
RENT ACCOUNT
$ $
Cash a/c 150
(c) The two sides of the transaction are: cash is paid (credit entry in the cash account because the asset cash is
reduced) and purchases increase by $100 (debit entry in the purchases account because purchase expense is
increasing).
CASH ACCOUNT
$ $
Purchases a/c 100
PURCHASES ACCOUNT
$ $
Cash a/c 100
(d) The two sides of the transaction are: cash is paid (credit entry in the cash account because the asset cash is
reduced) and assets increase by $200 (debit entry in shelves account because the non-current asset is
increasing).
CASH ACCOUNT
$ $
Shelves a/c 200
SHELVES (ASSET) ACCOUNT
$ $
Cash a/c 200
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Part B Accounting systems and accounts preparation ⏐ 5: Ledger accounting and double entry 65
The cash account of the business would end up looking as follows.
CASH ACCOUNT
$ $
Sales a/c 200 Rent a/c 150
Purchases a/c 100
Shelves a/c 200
Question
Posting transactions
Show how these transactions would be recorded in the accounts in the nominal ledger.
The bank has a balance of $1,000.
(a) Buy goods for resale costing $100
(b) Sell goods for $150
(c) Pay electricity bill for $120
(d) Buy a delivery van for $600
(e) Buy petrol costing $10
Answer
CASH ACCOUNT
$ $
Balance b/d 1,000 Purchases a/c (a) 100
Sales a/c (b) 150 Electricity expense a/c (c) 120
Non-current asset van a/c (d) 600
Motor expense a/c (e) 10
PURCHASES ACCOUNT
$ $
Cash a/c (a) 100
SALES ACCOUNT
$ $
Cash a/c (b) 150
ELECTRICITY EXPENSE ACCOUNT
$ $
Cash a/c (c) 120
NON-CURRENT ASSET VAN ACCOUNT
$ $
Cash a/c (d) 600
MOTOR EXPENSES ACCOUNT
$ $
Cash a/c (e) 10
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66 5: Ledger accounting and double entry ⏐ Part B Accounting systems and accounts preparation
2.3 Credit transactions
Cash transactions are settled immediately. Credit transactions give rise to receivables and payables.
Transactions that are settled immediately are known as cash transactions, even if paid by means of a cheque, as they
usually are. However, not all transactions are settled immediately in cash. A business can purchase goods or non-current
assets from its suppliers on credit terms. Equally, the business can grant credit terms to its customers. Clearly no
entries can be made in the cash book when a credit transaction occurs, because no cash has been received or paid. The
solution is to use receivables and payables accounts instead. A receivable is someone who owes money to the business.
A payable is someone to whom the business owes money.
2.4 Example: credit transactions
Recorded in the sales day book and the purchase day book are the following transactions.
(a) The business sells goods on credit to a customer Mr A for $2,000.
(b) The business buys goods on credit from a supplier B Co for $100.
How and where are these transactions posted in the ledger accounts?
Solution
(a) RECEIVABLES ACCOUNT
$ $
Sales a/c 2,000
SALES ACCOUNT
$ $
Receivables account 2,000
(b) PAYABLES ACCOUNT
$ $
Purchases a/c 100
PURCHASES ACCOUNT
$ $
Payables a/c 100
2.5 When cash is paid to payables or by receivables
What happens when a credit transaction is eventually settled in cash?
Example continued
Suppose that, in the example above, the business paid $100 to B Co one month after the goods were acquired. The two
sides of this new transaction are: cash is paid (credit entry in the cash account) and the amount owing to payables is
reduced (debit entry in the payables account).
CASH ACCOUNT
$ $
Payables a/c (B Co) 100
FA
S
T F
O
RWAR
D
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Part B Accounting systems and accounts preparation ⏐ 5: Ledger accounting and double entry 67
PAYABLES ACCOUNT
$ $
Cash a/c 100
Bringing together the two parts of this example.
CASH ACCOUNT
$ $
Payables a/c 100
PURCHASES ACCOUNT
$ $
Payables a/c 100
PAYABLES ACCOUNT
$ $
Cash a/c 100 Purchases a/c 100
The two entries in the payables account cancel each other out, indicating that no money is owing to payables any more.
We are left with a credit entry of $100 in the cash account and a debit entry of $100 in the purchases account. These are
exactly the entries which would have been made to record a cash purchase of $100 (compare example above). After the
business has paid off its payables, it is in exactly the same position as if it had made cash purchases of $100.
Similar reasoning applies when a customer settles his debt. In the example above when Mr A pays his debt of $2,000 the
two sides of the transaction are: cash is received (debit entry in the cash account) and the amount owed by receivables
is reduced (credit entry in the receivables account).
CASH ACCOUNT
$ $
Receivables a/c 2,000
RECEIVABLES ACCOUNT
$ $
Cash a/c 2,000
The accounts recording this sale to, and payment by, Mr A now appear as follows.
CASH ACCOUNT
$ $
Receivables a/c 2,000
SALES ACCOUNT
$ $
Receivables a/c 2,000
RECEIVABLES ACCOUNT
$ $
Sales a/c 2,000 Cash a/c 2,000
The two entries in the receivables account cancel each other out, while the entries in the cash account and sales account
reflect the same position as if the sale had been made for cash.
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68 5: Ledger accounting and double entry ⏐ Part B Accounting systems and accounts preparation
Question
Debits and credits
List the debit and credit entries for the following transactions.
(a) Bought a machine on credit from A, cost $8,000.
(b) Bought goods on credit from B, cost $500.
(c) Sold goods on credit to C, value $1,200.
(d) Paid D (a payable) $300.
(e) Collected $180 from E, a receivable.
(f) Paid wages $4,000.
(g) Received rent bill of $700 from landlord G.
(h) Paid rent of $700 to landlord G.
(i) Paid insurance premium $90.
Answer
$ $
(a) DEBIT Machine account (non-current asset) 8,000
CREDIT Payables account (A) 8,000
(b) DEBIT Purchases account 500
CREDIT Payables account (B) 500
(c) DEBIT Receivables account (C) 1,200
CREDIT Sales account 1,200
(d) DEBIT Payables account (D) 300
CREDIT Cash account 300
(e) DEBIT Cash account 180
CREDIT Receivables account (E) 180
(f) DEBIT Wages account 4,000
CREDIT Cash account 4,000
(g) DEBIT Rent account 700
CREDIT Payables account (G) 700
(h) DEBIT Payables account (G) 700
CREDIT Cash account 700
(i) DEBIT Insurance account 90
CREDIT Cash account 90
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Part B Accounting systems and accounts preparation ⏐ 5: Ledger accounting and double entry 69
Question
Ledger entries
Record the ledger entries for the following transactions in appropriate ledger accounts. Ron Knuckle set up a business
selling keep fit equipment. He put $7,000 of his own money into a business bank account (transaction A) and in his first
period of trading, the following transactions occurred.
$
Transaction
B Paid rent of shop for the period 3,500
C Purchased equipment for resale on credit 5,000
D Raised loan from bank 1,000
E Purchased shop fittings (for cash) 2,000
F Sales of equipment: cash 10,000
G Sales of equipment: on credit 2,500
H Payments to trade payables 5,000
I Payments from receivables 2,500
J Interest on loan (paid) 100
K Administration expenses (all paid in cash) 1,900
L Drawings 1,500
All keep fit equipment purchased during the period were sold and so there were no closing inventories.
Try to do as much of this exercise as possible yourself before reading the solution.
Answer
CASH ACCOUNT
$
$
Capital – Ron Knuckle (A)
7,000
Rent (B)
3,500
Bank loan (D)
1,000
Shop fittings (E)
2,000
Sales (F)
10,000
Trade payables (H)
5,000
Receivables (I)
2,500
Bank loan interest (J)
100
Other expenses (K)
1,900
Drawings (L)
1,500
14,000
Balancing figure – the amount of
`
cash left over after payments
have been made
6,500
20,500
20,500
CAPITAL (RON KNUCKLE) ACCOUNT
$ $
Cash (A) 7,000
BANK LOAN ACCOUNT
$ $
Cash (D) 1,000
PURCHASES ACCOUNT
$ $
Trade payables (C) 5,000
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