1 Chapter 3: The Ledger and Double-Entry Accounting System Topic Outline: 1. Ledger 2. Ledger Account the T-account 3. How to record in Assets, Liabilities & Owner s Equity account: - the increases - the decreases 4. How to record in Revenue and Expenses account: - the increases - the decreases 5. Double-Entry Accounting Rule 6. Balancing the Asset and Liability accounts
2 Introduction - all transactions must be classified according to their nature. - then the data are grouped, summarized and entered under appropriate account headings examples: Cash Account Bank Account Capital Account Stock Account Loan Account Furniture Account Machinery A/c Sales Account Purchases Account - Cash account involves all payments and receipts of cash 3.1 Ledger and Ledger Account Ledger Account - is a record of the day-to-day changes to a specific person or item - there is an account or ledger account for each item Ledger - all accounts are kept in a ledger - may be a book, a set of loose cards or a file comprising all the accounts
3 Format of Accounts (a) T account format Dr Name of Account Cr Date Particulars Folio Amt Date Particulars Folio Amt (b) columnar account format Name of Account Date Particulars Folio Dr Cr Balance Note: 1. Dr and Cr entries - in T account: Left-hand side debit Right-hand side credit 2. Date - the date of the transaction. 3. Particulars refers to the name of the other account where the double-entry is recorded. 4. Folio for cross-reference i.e. to show the source and page where the transaction can be referred to. 5. Amount value of the transaction. Checkspot page 56
4 3.2 Methods of Recording Transactions- Assets, Liabilities and Owner s Equity Business transactions can be classified into 5 categories: - assets - liabilities - owner s equity - revenue and - expenses Worked Example page 57 In the following transactions, determine which accounts are affected and indicate clearly whether it is an increase or decrease. Transactions Commenced business with initial cash capital of $50 000. Bought office equipment for $8 000 in cash. Bought furniture for $1 000 in cash. Bought furniture for $2 000 on credit. Paid creditors $1 500 in cash. Owner withdrew cash of $500 for personal use. Owner brought into the business cash of $2 000 for business expansion.
5 3.3 Classification of Accounts and Accounting Rules Based on standardised accounting procedure: - increases in assets are recorded on the debit side - decreases in assets are recorded on the credit side Dr Asset Cr Increase vs - since liabilities and owner s equity are on the opposite side of the accounting equation, - any increase is recorded on the credit side and - any decrease is recorded on the debit side. Dr Liabilities Cr Increase Dr Owner s Equity Cr Increase Checkspot page 60
6 3.4 Double-Entry Accounting This is a system of recording business transactions that takes into account the dual effects of a transaction. Rules of double-entry recording: 1. Every transaction affects at least two accounts. 2. There must be at least one debit and one credit. 3. The total debits must be equal to the total credits. 4. The particulars in the account refer to the name of the other account where the double-entry is recorded. 3.4.1 Double-Entry Accounting for Recording Assets, Liabilities & Owner s Equity Example 1: Asset Account and Capital Account Transaction: Wesley commenced business with $80 000 cash. Dr Cash Cr Capital 80 000 Dr Capital Cr Cash 80 000 Example 2: Asset Accounts only Transaction: Wesley bought a computer for $4000 in cash. Dr Office Equipment Cr Capital 40 000 Dr Cash Cr Office Equipment 40 000
7 Example 3: Asset Account and Liability Account Transaction: Wesley took a bank loan of $20 000 cash from Rich Bank. Dr Cash Cr Loan from Rich Bank 20 000 Dr Loan from Rich Bank Cr Cash 20 000 Example 4: Asset Account and Drawings Account Transaction: Wesley withdrew cash of $1000 for personal use. Dr Cash Cr Drawings 1 000 Dr Drawings Cr Cash 1 000 Drawings account records all withdrawals of goods or cash from the business by the owner for personal use ( decreases the owner s equity) is set up to avoid too many entries in the Capital Account will appear in the Balance Sheet as a deduction from Capital A/c
8 How to Record Transactions using the double-entry accounting system: 1. Analyze the transactions. 2. Determine the accounts involved - asset, liability or owner s equity. 3. Decide whether the effect is an increase or decrease for each account. 4. Translate these increases or decreases into debits and credits of the accounts involved. 5. Ensure that the total debits are equal to the total credits. 6. Show the dates, particulars and amounts of the transactions correctly. Fill in the particulars column in each account with the name of the corresponding account.
9 Worked Example (page 63-65) (i) Analyse the following transactions for the month of January in the table below; (ii) Record them in the appropriate accounts in the Ledger of Mr Brown: debited credited Jan 1 Mr Brown commenced business with cash $50 000. 3 Bought office equipment in cash $5 000. 5 Bought office equipment for $2 000 on credit from High-Tech Ltd. 10 Bought a delivery van for $20 000 from Toyota Ltd. $10 000 was paid and the balance would be paid in equal instalments beginning next month. 12 Paid High-Tech Ltd $1 200. 15 Sold some of the office equipment to Black for $600 (at cost) as it was found unsuitable. 20 Bought more office equipment for $2 000 on credit from High-Tech Ltd. 25 Received $200 from Black. 31 Paid $2 000 to Toyota Ltd. Withdrew $300 for personal use.
10 3.4.2 Balancing Ledger Accounts for Assets and Liabilities Balancing account means comparing the total of the debit entries with the total of credit entries to find the difference between them. debit total > credit total debit balance credit total > debit total credit balance By balancing the accounts, a business will know the value of each asset and liability and the owner s equity. This helps it to determine its financial position and performance. Procedure: 1. Total the debit side and credit side separately. 2. Compare the two totals. 3. Enter the difference to the side that has a smaller total. Record as Bal c/d in the particulars column. 4. Record the Bal b/d to complete the double-entry. Note: Asset accounts have a debit balance Liability accounts have a credit balance Owner s Equity Capital Account has a credit balance Drawings Account has a debit balance Capital A/c is only balanced after the profit and loss of the firm is determined. Drawings A/c is closed by transferring to the Capital A/c at the end of the accounting period. Bal c/d balance carried down Bal b/d balance brought down Worked Example as above balance the accounts Checkspot page 68 Practice 1 page 68-70
11 3.4.3 Rules for Recording Revenue and Expenses Revenue earned increases in owner s equity examples: commission received, revenue from sales, discount received, fees from services rendered, etc therefore increase in revenue is recorded on the credit side of the revenue account How do you record a decrease in revenue? Dr Revenue Cr Increase Expense incurred decreases in owner s equity examples: rent, wages, insurance, purchase of goods for resale, discount allowed, interest on loan, etc therefore increase in expense is recorded on the debit side of the expense account How do you record a decrease in expense? Dr Expenses Cr Increase Revenue and expense items are closed either to: - the Trading Account and - Profit and Loss Account to determine the profits of the business. (see Chapter 5)
12 3.4.4 Double-Entry Accounting for Recording Revenues and Expenses Steps: 1. Analyze the transactions. 2. Determine the accounts involved - asset, liability, owner s equity, revenue or expenses 3. Decide whether the effect is an increase or a decrease for each account. 4. Translate these increases or decreases into debits or credits of the accounts involved. 5. Ensure that the total debits are equal to the total credits. 6. Fill in the dates, amounts and particulars of the transactions correctly. Sales Account - is only for recording sales of goods to customers - does not include sales of fixed assets (taught in Chapter 11) Sales Returns Account - refer to goods returned by customers - reduces revenue from sales - separate account is set up to provide a better picture of the total gross sales as well as the total sales returns Purchases Account - is only for recording purchases of goods from suppliers - does not include sales of fixed assets (Chapter 11) Purchases Returns Account - refer to goods returned to suppliers - reduces cost from purchases - separate account is set up to provide a better picture of the total gross purchases as well as the total purchases returns
13 Worked Examples page 73 to 79 Analyse the transactions in the following examples and complete the table. Then prepare the ledger accounts on a separate book-keeping paper. Example 1: Asset Account and Revenue Account Transaction (a) The business received cash of $1000 for rent. debited credited (b) Cash sales of $10 000. (c) Sold goods to S Tee for $2500 on credit. (d) S Tee returned defective goods worth $200. Example 2: Asset Account, Liability Account or Expense Account Transaction (a) Business paid cheque $1000 for insurance. debited credited (b) Purchased goods for $5000 by cheque. (c) Purchased goods for $3000 from Big Supplier on credit. (d) Returned goods worth $300 to Big Supplier because of different brand name.
14 Example 3: Transactions that Involve Three Accounts Transaction (a) Paid Big Supplier $1000 in cash and earned discount received of $50. debited credited (b) Paid Big Supplier $1000 in cash and earned discount received of $50. Note: (i) (ii) (iii) (iv) Expense Accounts debit balance Revenue Accounts credit balance Expense-reducing balance credit balance Revenue-reducing balance debit balance Worked Example page 80 Worked example page 82 Checkspot page 83 Practice 2 page 84-85 Review Questions page 86 MCQ page 87-90
15 Worked Example Recording Revenues and Expenses in the Ledger ( page 80) Record the following transactions in the Ledger using the double-entry system: $ Jan 1 Cash in hand 10 000 3 Cash purchases 3 245 4 Paid rent 800 8 Cash sales 2 400 12 Sold goods to Smith on credit 450 13 Bought goods from John & Sons on credit 1 670 16 Smith returned goods because of wrong brand 100 19 Returned goods to John & Sons 150 21 Cash sales 1 250 24 Paid cash for general expenses 400 28 Paid cash for wages 1 200 30 Paid John & Sons 1 000 31 Received cash from Smith Paid cash for insurance Received cash for commission 200 350 550 Worked Eg with Special Reference to Debtor and Creditor Accounts (page 82) Open the ledger accounts for the following in the books of Freeman on 1 Jan 02: Poorman $1 200 (Dr) Richman $2 000 (Cr) From the following transactions, record the entries that would only affect the two accounts listed above and balance off the two accounts as at 31 Jan 02. Pay particular attention to the wordings. Jan 6 Paid cheque to Richman for the amount owing, less 10% discount. 7 Received cheque from Poorman for the amount of his account, less 5% discount. 10 Sold goods to Poorman at list price $800 less 20% trade discount. 12 Purchased goods from Richman at list price $1 200 less 30% discount. 16 Poorman returned defective goods at list price $60 bought on 10 January. 20 Returned goods at list price $100 bought on 12 January to Richman.