Books of Original Entry and Types of Ledgers: Your Accounting Starting Point!
Hello! Welcome to one of the most fundamental topics in accounting. Don't worry if you're new to this, we're going to break it down step-by-step. Think of a business's daily activities – selling products, buying supplies, paying rent. How do they keep track of everything without getting into a huge mess? The answer is by using Books of Original Entry and Ledgers.
In this chapter, you'll learn how businesses first record their financial transactions and then how they organise them neatly. Mastering this is like learning the basic grammar of accounting – it's the key to everything that comes later!
Analogy Time: Imagine you're keeping a food diary. The Book of Original Entry is your daily log where you write down everything you eat, in the order you eat it. The Ledger is like a summary report where you have separate pages to total up your "Breakfasts", "Lunches", and "Dinners". Both are essential to see the full picture!
Part 1: The Big Picture - A Quick Recap of the Accounting Flow
Before we dive in, let's remember the first few steps of the accounting cycle. It’s a logical flow that makes perfect sense once you see it.
Business Transaction Happens (e.g., sell a phone on credit) ➔ Record it in a Book of Original Entry (the first diary entry) ➔ Post it to a Ledger (organise it in the filing cabinet) ➔ Prepare a Trial Balance (check our work).
This chapter focuses on the second and third steps. And remember, everything is based on the golden rule of accounting: the double-entry system.
Quick Review: Double-Entry & DEAD CLIC
Every transaction has two effects, a Debit (Dr) and a Credit (Cr), and they must always be equal.
A super helpful mnemonic to remember what to Debit and Credit is DEAD CLIC:
- Debits increase: Expenses, Assets, Drawings
- Credits increase: Liabilities, Income (Revenue), Capital
Keep this in your mind as we go through the examples. You've got this!
Part 2: Books of Original Entry (The Daily Diaries)
A Book of Original Entry (also called a Day Book or Journal) is where a transaction is formally recorded for the very first time. Think of it as a chronological list of everything that happened each day.
Why do we use them?
- To keep things organised: Instead of one giant messy book, we have several specialised books for different types of transactions.
- To reduce errors: Recording transactions here first, before putting them into the main accounts, helps catch mistakes.
- To provide details: They contain important details like invoice numbers and a description of the transaction, which is super useful for reference.
- To save time: We can post totals to the main accounts instead of every single transaction, which is much more efficient.
The Main Types of Books of Original Entry
Let's meet the team! Each book has a very specific job.
1. The Sales Day Book (or Sales Journal)
Job: To record all CREDIT SALES of GOODS.
- Credit Sales: This means the customer will pay us later. Cash sales go in the Cash Book!
- Goods: This means the items the business normally sells. Selling an old office computer on credit goes in the General Journal!
Example: On 5 June, we sell $500 of goods on credit to ABC Co. on Invoice 101.
Double-entry impact: Debit ABC Co. (a trade receivable, which is an asset), Credit Sales (income).
2. The Purchases Day Book (or Purchases Journal)
Job: To record all CREDIT PURCHASES of GOODS.
- Credit Purchases: We will pay the supplier later. Cash purchases go in the Cash Book!
- Goods: Items we buy with the intention to resell them. Buying a new delivery van on credit goes in the General Journal!
Example: On 8 June, we buy $1,200 of goods on credit from Supplier XYZ.
Double-entry impact: Debit Purchases (an expense), Credit Supplier XYZ (a trade payable, which is a liability).
3. The Sales Returns Day Book (or Returns Inwards Journal)
Job: To record GOODS returned to us by our CREDIT CUSTOMERS.
Memory Aid: The goods are returning INWARDS to our business.
Example: On 10 June, ABC Co. returns $50 of the goods they bought from us. We issue them Credit Note 05.
Double-entry impact: Debit Sales Returns (reduces our income), Credit ABC Co. (reduces the amount they owe us).
4. The Purchases Returns Day Book (or Returns Outwards Journal)
Job: To record GOODS we return to our CREDIT SUPPLIERS.
Memory Aid: We are sending the goods OUTWARDS from our business.
Example: On 12 June, we return $100 of faulty goods to Supplier XYZ.
Double-entry impact: Debit Supplier XYZ (reduces the amount we owe them), Credit Purchases Returns (reduces our expense).
5. The Cash Book
This one is special! The Cash Book is both a book of original entry AND a part of the ledger. It's a one-stop-shop for all money coming in and going out.
Job: To record all receipts and payments of money, whether through CASH or the BANK.
We typically use a two-column cash book, with columns for cash and bank on both the debit (receipts) and credit (payments) sides.
- Debit Side (Left): Records all money received (cash sales, payments from customers, capital injected).
- Credit Side (Right): Records all money paid out (cash purchases, payments to suppliers, rent, wages).
Focus on: Contra Entries
A contra entry is a transaction that appears on both sides of the Cash Book. It happens when we move money between our cash tin and our bank account. Don't let it scare you, it's simple!
Example: We withdraw $200 from the bank for office use (to put in the cash tin).
- The Bank account is decreasing. A decrease in an asset (Bank) is a Credit. So, we enter $200 in the bank column on the credit side.
- The Cash account is increasing. An increase in an asset (Cash) is a Debit. So, we enter $200 in the cash column on the debit side.
- We write 'C' or 'Contra' in the folio column to show it's a contra entry.
6. The General Journal (or Journal Proper)
Job: This is the "catch-all" book for any transaction that doesn't fit into the other five books.
Common uses include:
- Buying or selling non-current assets on credit (e.g., buying a machine and agreeing to pay later).
- Writing off bad debts.
- Opening entries to start a new set of books.
- Correction of errors found in the accounts.
The General Journal format is very specific. It shows the account to be debited, the account to be credited, and most importantly, a narrative – a short sentence explaining the transaction.
Example: On 15 June, we buy office equipment on credit from HK Furnishings for $3,000.
General Journal Entry:
Dr Office Equipment $3,000
Cr HK Furnishings $3,000
(Being the purchase of office equipment on credit)
Key Takeaway: Books of Original Entry
Think of it as sorting your mail. Each book is a different mailbox for a specific type of letter!
- Credit Sales of Goods? ➔ Sales Day Book
- Credit Purchases of Goods? ➔ Purchases Day Book
- Money In or Out? ➔ Cash Book
- Anything else? ➔ General Journal
Part 3: Ledgers (The Filing Cabinets)
Once we've recorded transactions in the day books, we need to organise them. That's the job of the ledger. The ledger is a collection of all the accounts of a business.
The process of transferring information from the books of original entry into the ledger accounts is called posting.
What is the function of a ledger?
Its main function is to classify and summarise all the transactions related to a particular item (like an asset, a person, or an expense) in one place. If you want to know how much a customer owes you, you look at their account in the ledger, not through every page of the day book!
Types of Ledgers
Just like we have different day books, we split the main ledger into smaller, more manageable parts to stay organised, especially in a large business.
1. The Sales Ledger (or Trade Receivables Ledger)
Job: This is a special book that contains the personal accounts of all our credit customers (trade receivables). Each customer gets their own T-account here. This ledger helps us easily track how much each customer owes us.
2. The Purchases Ledger (or Trade Payables Ledger)
Job: This book contains the personal accounts of all our credit suppliers (trade payables). Each supplier gets their own T-account here. This ledger helps us see exactly how much we owe to each supplier.
3. The General Ledger (or Nominal Ledger)
Job: This is the principal, or main, ledger. It contains all the remaining accounts that are not in the sales or purchases ledgers. It's the home of the "REAL" accounts:
- All asset accounts (e.g., Motor Vehicles, Equipment, Cash, Bank)
- All liability accounts (e.g., Bank Loan)
- Capital and Drawings accounts
- All income accounts (e.g., Sales, Rent Received)
- All expense accounts (e.g., Purchases, Wages, Rent Expense)
How Posting Works: An Example
Let's follow a single transaction from start to finish.
Transaction: On 20 June, we sell $400 of goods on credit to Tom.
- Book of Original Entry: We record this in the Sales Day Book.
- Posting to the Subsidiary Ledger: We go to the Sales Ledger and find Tom's account. We DEBIT his account with $400. This shows he now owes us more money.
- Posting the Total to the General Ledger: At the end of the month, let's say total credit sales were $10,000. We post this TOTAL figure from the Sales Day Book to the General Ledger. We find the Sales Account and CREDIT it with $10,000. This efficiently updates our total income from sales.
Key Takeaway: Ledgers
The ledger system is all about organisation. We split the accounts into three main "filing cabinets" to keep things tidy:
- Sales Ledger: Who owes us money?
- Purchases Ledger: Who do we owe money to?
- General Ledger: Everything else! (The main financial story).
Part 4: Common Mistakes to Avoid
Everyone makes mistakes when they're learning, but here are a few common ones to watch out for!
- Confusing Cash and Credit: Remember, the Sales and Purchases Day Books are for CREDIT transactions ONLY. If cash or a bank payment is involved, it belongs in the Cash Book.
- Confusing Goods and Non-Current Assets: The Sales and Purchases Day Books are for GOODS (items for resale) ONLY. Buying a van on credit or selling an old desk on credit goes in the General Journal.
- Forgetting the Narrative: When you make an entry in the General Journal, always include a short sentence explaining what the transaction is for. It's an easy mark to get, and an easy one to lose!
- Mixing up Returns Inwards and Outwards: Just remember: Inwards = coming back IN to us from a customer. Outwards = going OUT from us to a supplier.
And that's it! You've just learned the foundational recording process for all accounting. It might seem like a lot of steps, but with practice, it will become second nature. Well done!