Hello and Welcome to the World of Accounting Records!
Hi there! This chapter is the absolute backbone of all accounting. It's where we learn how to take a simple piece of paper—like a receipt—and turn it into structured, useful information for the business. Think of it as learning the correct filing system for every financial event.
Don't worry if this seems like a lot of steps at first. We will break down the process into three simple stages: collecting the evidence, summarizing the evidence, and filing the evidence correctly. If you follow the flow, you'll master it!
Section 1: The Starting Point – Source Documents
Every single transaction in a business must have proof. This proof is called a Source Document. If you don't have the document, the transaction didn't officially happen!
What is a Source Document?
A source document is the original paper (or digital file) that provides the details needed to record a transaction. It tells you the date, amount, and the parties involved.
Key Source Documents and Their Use
- Sales Invoice: Used when we sell goods on credit (meaning the customer pays later). This is proof of the amount owed to us.
- Purchases Invoice: Used when we buy goods on credit (meaning we pay the supplier later). This is proof of the amount we owe.
- Credit Note (Issued): Used when a customer returns goods to us. It reduces the amount they owe.
- Credit Note (Received): Used when we return goods to a supplier. It reduces the amount we owe them.
- Cheque Stubs / Pay-in Slips / Bank Statements: Proof of cash/bank transactions (payments received or made).
- Voucher / Receipt: Proof of payment, usually for small cash expenses (e.g., fuel, stamps).
Quick Tip: Think of a source document as your entry ticket. You can't get into the accounts without one!
Section 2: Step 1 – Books of Prime Entry (BPE)
The Books of Prime Entry (BPE), also known as Journals or Day Books, are the first place a transaction is recorded. They are non-ledger books, meaning they don't use double entry yet. Instead, they act as chronological diaries that summarize similar transactions.
Why do we use Books of Prime Entry?
Imagine manually entering 100 sales invoices one by one into the ledger. It would take forever! BPEs let us record the details daily, then take the total amount at the end of the month and post that single total to the ledger. This saves huge amounts of time.
The Six Major Books of Prime Entry
- Sales Day Book (SDB):
Records all transactions where we sold goods on credit. Details include the date, invoice number, customer name, and amount.
Key Takeaway: Cash sales are NOT recorded here. - Purchases Day Book (PDB):
Records all transactions where we bought goods on credit. Details include the date, invoice number, supplier name, and amount.
Key Takeaway: Purchasing a non-current asset (like machinery) on credit is NOT recorded here; it goes in the General Journal. - Sales Returns Day Book:
Records goods returned by our customers. This is based on Credit Notes that we issue.
- Purchases Returns Day Book:
Records goods returned to our suppliers. This is based on Credit Notes that we receive.
- The Cash Book: (A special case!)
The Cash Book records all transactions involving cash (notes/coins) or bank (cheques/electronic transfers). It usually has a Cash column and a Bank column.
Did you know? The Cash Book is unique! It serves two purposes: it is a Book of Prime Entry AND a Ledger Account (the Cash Account and the Bank Account). Therefore, when we record a cash/bank transaction, we only need one more double entry. - Petty Cash Book:
Used to record small, minor expenses paid for in cash (e.g., postage, stationery, tea/coffee). It often uses the Imprest System.
The Imprest System: A fixed amount (the float) is kept for petty cash. When the cash is low, the cashier is reimbursed the exact amount spent to restore the fund back to the original fixed amount. (Example: Start with \$100 float. Spend \$40. Reimburse \$40. Float is back to \$100.)
- General Journal (or Journal Proper):
This is the "catch-all" BPE, used for transactions that don't fit into the other specific books.
Examples of transactions recorded here:- Purchasing a non-current asset (e.g., machine) on credit.
- Opening entries (setting up the ledger with initial balances).
- Correction of errors.
- Transfer of amounts (e.g., closing entries).
Crucial Requirement: Every entry in the General Journal MUST include a narrative—a brief explanation of the transaction.
Key Takeaway: BPEs organize transactions by type, allowing us to post monthly totals to the ledger efficiently.
Section 3: Step 2 – The Ledger Accounts (The Double Entry)
The Ledger is the principal book where all accounts are kept. This is where the Double Entry Principle is applied. For every transaction, there is a Debit (DR) entry and a Credit (CR) entry of equal value.
Understanding T-Accounts
Every account in the ledger (e.g., Sales, Rent Expense, Capital, Customer X) is represented by a T-Account:
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[Account Name]
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| | |
| DEBIT (DR) | CREDIT (CR) |
| | |
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The Golden Rule: Debit and Credit
Debit and Credit are NOT the same as "increase" or "decrease." Their meaning depends on the type of account. Don't worry if this is tricky—memorise the simple rules below!
The most important rule is the Equation of Accounting:
\(Assets = Capital + Liabilities\)
The rules for recording increases/decreases are based on where the account sits in this equation:
Memory Trick: DR = Left Side; CR = Right Side
- Assets (A): Increase on the Debit (DR) side. Decrease on the Credit (CR) side.
- Expenses (E): Increase on the Debit (DR) side. Decrease on the Credit (CR) side.
- Liabilities (L): Increase on the Credit (CR) side. Decrease on the Debit (DR) side.
- Capital (C): Increase on the Credit (CR) side. Decrease on the Debit (DR) side.
- Revenue (R) / Income (I): Increase on the Credit (CR) side. Decrease on the Debit (DR) side.
Mnemonic for Accounts with a normal DEBIT balance:
Dead: Debit all Expenses, Assets, Drawings.
The Three Main Ledgers
- Sales Ledger (or Debtors Ledger): Contains individual accounts for every credit customer (known as Trade Receivables).
- Purchases Ledger (or Creditors Ledger): Contains individual accounts for every credit supplier (known as Trade Payables).
- General Ledger: Contains all the remaining accounts (e.g., Cash, Capital, Rent, Sales, Purchases, Machinery).
Posting from Books of Prime Entry to the Ledger (The Flow)
This is where the magic happens. We take the totals from the BPEs and transfer them using double entry:
- SDB Total: The monthly total is Debited to the individual customer accounts (in the Sales Ledger) and Credited to the Sales Account (in the General Ledger).
- PDB Total: The monthly total is Credited to the individual supplier accounts (in the Purchases Ledger) and Debited to the Purchases Account (in the General Ledger).
- Cash Book Entries: Each transaction in the Cash Book is recorded immediately with its corresponding double entry in the relevant General Ledger account (e.g., Rent Expense, Commission Received).
- Journal Entries: Each journal entry involves a specific DR and CR posting to the respective accounts in the General Ledger.
Common Mistake to Avoid: Posting the total of the Sales Day Book to the individual Sales Ledger accounts. NO! Only the daily details are posted to individual accounts. The monthly total is posted only once to the Sales Account.
Key Takeaway: The ledger provides the complete double entry record, ensuring Debits always equal Credits.
Section 4: Transferring Accounts to Financial Statements
Once all transactions are recorded in the ledger and the accounts are balanced, we can move to the final stage: creating the financial reports.
Step 3a: Balancing the Ledger and the Trial Balance
At the end of the accounting period, every ledger account is 'balanced.' The difference between the total Debits and total Credits in an account is called the balance carried down (c/d), which becomes the balance brought down (b/d) for the next period.
The Trial Balance is a list of all these closing balances (b/d) from the ledger accounts. Its entire purpose is to check mathematical accuracy—it confirms that the Total of all Debit balances equals the Total of all Credit balances. If they don't agree, an error has occurred.
Step 3b: Creating the Financial Statements
The balances in the Trial Balance are sorted into two main reports:
1. The Income Statement (Profit and Loss Account)
This statement determines the profit or loss of the business over a period of time (e.g., one year).
- It includes all balances that represent Revenue (Income) and Expenses.
- Revenue accounts (e.g., Sales) and Gain accounts (e.g., Discount Received) have Credit balances in the Trial Balance.
- Expense accounts (e.g., Rent, Wages, Discount Allowed) have Debit balances in the Trial Balance.
- The final figure is the Net Profit or Net Loss.
2. The Statement of Financial Position (Balance Sheet)
This statement shows the financial state of the business at a specific moment in time (a snapshot).
- It includes all balances that represent the accounting equation: Assets, Liabilities, and Capital.
- Asset accounts (e.g., Machinery, Inventory, Trade Receivables) have Debit balances.
- Liability accounts (e.g., Loans, Trade Payables) and Capital accounts have Credit balances.
The Final Check: The Net Profit calculated in the Income Statement is transferred and added to the Capital in the Statement of Financial Position. This ensures that the entire system is linked and that the fundamental accounting equation remains perfectly balanced!
Key Takeaway: The Trial Balance is the bridge that sorts the ledger accounts into the Income Statement (for performance) and the Statement of Financial Position (for value).