Each account code represents an individual T account. In a manual accounting system used by the smallest of businesses all T accounts may fit into one book or ledger. In most businesses, however, the volume of transactions, and the need for more than one person to have access to make entries, means that similar transactions are entered into one particular ledger. This is also true of computerized accounting systems.
Typically there are three main ledgers:
Financial recording
ᔢ sales ledger;
ᔢ purchases ledger;
ᔢ nominal ledger.
The sales and purchases ledgers contain the T accounts for each individ- ual credit customer and supplier whilst the nominal ledger contains the T accounts for total sales, total purchases and every other expense, income, asset and liability.
Journals
Double entries are not made directly into the ledgers, but are first entered in a book of prime entry from whichpostings to the two relevant ledger accounts are made later. These books of prime entry are:
ᔢ sales day book or sales journal;
ᔢ purchases day book or purchases journal;
ᔢ journal;
ᔢ cash book(s).
The sales and purchase day books act as a kind of diary where all sales and purchases are entered in chronological order. At a later date each transaction is entered in the named account of the customer or supplier in the sales or purchases ledger respectively whilst the total of a batch of similar transactions is entered in the sales account or purchases account in the nominal ledger, so completing the double entry. Since the advent of value added tax (VAT) some years ago, a further entry in the sales and purchase journals is needed to record these tax amounts which are posted to the relevant side of the VAT account in the nominal ledger in batch totals. In this way large volumes of individual sales and purchases are kept out of the nominal ledger by only posting batch totals for a day or a week at a time.
In a similar way, large amounts of cash transactions are first entered in a cash receipts book or a cash payments book, both of which act as books of prime entry and as ledgers. These cash transactions are later posted to the named account of the customer or supplier in the sales ledger or purchases ledger respectively. This again completes the double entry.
The journal proper is a book of prime entry used to make the initial record of non-routine transactions which are later posted to two ledger
accounts to preserve the double entry principle. Typical entries in a journal might relate to:
ᔢ the correction of errors;
ᔢ adjustments for prepayments and accruals;
ᔢ the creation of provisions for bad debts or any other purpose;
ᔢ adjustments for stocks on hand at the end of an accounting period.
We have now seen how financial transactions are routinely recorded in journals and ledgers, and how a chart of accounts identifies each ledger account in a double entry bookkeeping system, all enabling the final accounts to be produced. The following chapters now examine each of these financial accounting statements in turn.
Further reading
Cox, Det al (1998)Business Record Keeping,Osborne.
Melville, A (1999)Financial Accounting, FT Prentice Hall, Harlow.
Wood, F and Robinson, S (2004) Book-keeping and Accounts,FT Prentice Hall, Harlow.
Self-check questions
1. Which system of bookkeeping is most suited to a self-employed plumber?
2. Define a receipts and payments account.
3. Prepare a receipts and payments account from the following infor- mation for Gosforth Gardeners Association, showing the cash balance at the end of the year:
Cash at start of year £1,270
Bulk purchase of seeds and fertilizers £2,510
Members’ annual subscriptions £560
Sales of seeds and fertilizers to members £2,250
Purchase of equipment for hire £1,500
Hire fees received £450
Financial recording
4. Identify whether the following are debit or credit account balances:
ᔢ expenses;
ᔢ liabilities;
ᔢ assets.
5. Name the two T accounts you would use to record the payment of a sum of money owed to a supplier (for goods bought on credit).
6. Prepare T accounts and a trial balance for John Deel, a market trader, who has provided you with the following information relating to his first year in business:
Opened a business bank account with £1,500 of his own capital.
Paid £1,200 for a stall and scales.
During the year he purchased goods worth £17,000 from A.
Wholesaler on credit.
Received £28,000 from cash sales to customers during the year.
He hired a van for business use at a cost of £300 per month inclusive of all running costs.
During the year he made drawings of £6,000 cash to live on.
Paid A. Wholesaler a total of £16,000 during the year.
He had no stock left at the year-end.
Assume there was no depreciation.
Trial balance
Fixtures and fittings a/c 6,300 Capital a/c 6,000
Purchases a/c 47,200 Creditors a/c 3,500
Wages a/c 22,700 Sales a/c 86,500
Rent, rates, electricity a/c 7,300 Sundry expenses a/c 2,700
Bank balance 9,800
£96,000 £96,000
7. Prepare a profit and loss account and balance sheet from the above trial balance relating to a baker’s shop. Ignore depreciation. Assume there was nil stock at the year-end and that any profit is retained in the business.
8. What is meant by a chart of accounts?
9. Explain the difference between a journal and a ledger.
The profit and loss account
INTRODUCTION
The annual accounts consist essentially of an income statement and a balance sheet, which are also usually produced each month for internal use by management. In addition, there is a third, less well-known cash flow statement, but this seems to generate less interest than the other two statements. The most well-known income statement is a profit and loss account, but a revenue accountor an income and expenditure account are alternatives used by non profit-seeking organizations. All three statements compare income with expenses consumed in the same period and broadly follow the same accounting principles.
One difference between the three income statements relates to their sources of income. For example, a local authority will have rates, council tax and government grants as its main sources of income in its revenue account. Any charges for services provided will be a minor source of income for a local authority, but in a profit-seeking company will be the main, or only, source of income.
The other main difference between types of income statements is the treatment of the resulting profit or loss. Non-profit-seeking organiza- tions will use the terms surplus or deficit. Profit-seeking enterprises will have to account for tax on the profit, and reward the owners of the business with dividends, if a limited company, or a share of profits if
3
unincorporated. Any profit remaining after these appropriations is left in the company as extra capital. Having highlighted the differences, we are going to concentrate our attention on the profit and loss account relating to companies. The income statements of the other business organizations are addressed in Chapter 6.