What are the different types of account and different ledgers?

This chapter extends your knowledge of bookkeeping principles by explaining the sales and purchase ledgers that are kept outside the main ledger. This main ledger, which is often known as the nominal ledger, is explained in more detail, and the various posting mediums are explained. Most importantly we recognize that there are five different types of account within the nominal ledger, although entries may freely be posted between them. The topics covered are:

•    The five different types of account.  

•    The nominal ledger.  

•    The books of prime entry.  

•    The nominal journal (or just journal).  

•    The sales ledger.  

•    The sales day book.  

•    The purchase ledger.  

•    The purchase day book.

The five different types of account

The five different types of account are explained in this section. They are all in the main nominal ledger and, despite their different features, entries may be posted freely between them. To repeat key points made in the last chapter, this must be done with debit receiving the benefit and credit giving the benefit, and with the total of the debits equaling the total of the credits. The five different accounts are treated differently when the accounts are prepared. They are:

Income accounts

These relate to sales or other income and they increase the profit. They almost always have a credit balance and are eventually credited to the profit and loss account. Of course, if goods are returned for a refund, there will be a debit to an income account.

In the last chapter the sale of £4,000 to J. K. Patel Ltd was credited to an income account. The other side of the posting went to an asset account.

Expenditure accounts

These accounts are made up of expenditure that reduces the profit. They almost always have a debit balance and are eventually debited to the profit and loss account.

In the last chapter the £2,000 invoice from King Brothers went into an expenditure account. The other side of the posting went to a liability account.

Asset accounts

These accounts normally have a debit balance and are made up of assets that retain their value. This is distinct from say the electricity account which is an expenditure account. Examples of asset accounts are stock, motor vehicles and bank accounts (if there is not an overdraft). Money owing to the business is in debtor accounts and these are asset accounts. Asset accounts eventually go into the balance sheet, not the profit and loss account.

In the last chapter the £2,700 for widgets went into stock, which is an asset account. The other side of the posting went to a liability account.

Liability accounts

These accounts are the debts of the business and they normally have a credit balance. Examples are the accounts for money owing to suppliers and these accounts are called creditors. A further example is the bank account (if there is an overdraft). Liability accounts eventually go into the balance sheet, not the profit and loss account.

In the last chapter the £2,000 invoice from King Brothers was credited to a liability account. The other side of the posting went to an expenditure account.

Capital accounts

These accounts represent the investment in the business by the owners. If the business is a company, it is the net worth owned by the shareholders. It might be hard to grasp but it is true for all businesses, even a sole trader. If the capital accounts in Deborah

Fountain's hat making business total £7,000, then this is her investment in the business. She could take the £7,000 out, close the business down and go on holiday. The business is separate from the person who owns it. An example of a capital account is Revenue Reserves.

If the business makes profits after tax, and disregarding dividends and other distributions, the value of the capital accounts will increase over time. So long as a business is solvent the capital accounts will have credit balances. A net debit balance is a desperate sign of trouble and often means that the closing of the business is imminent.

All this is illustrated by the following ten commonly used accounts. Marked by the side of each is whether they usually have a debit or credit balance and the type of account that they are.

The nominal ledger

The nominal ledger is the principal ledger. Other ledgers may be kept, particularly a sales ledger and a purchase ledger, and in a

Sizeable business this is very likely, but each one will be a subsidiary ledger and reconcile to a control account in the nominal ledger. This means that, for example, the net total of thousands of accounts in the sales ledger adds to just one figure which is a single account in the nominal ledger. According to circumstances other subsidiary ledgers may be kept. An example is a listing of the various fixed asset accounts.

The nominal ledger may be very big, perhaps containing thousands of individual accounts. This will certainly be the case for a major company and it is therefore necessary to have a system for coding and grouping the accounts.

In a simple system the accounts will just be listed, probably in alphabetical order. In a more complex system they will be grouped in a logical manner. For example, if there are several different bank accounts they may be listed next to each other. This is convenient and when the balance sheet is prepared all the bank accounts will be added to the one total that will appear in it. Similarly, it is usual to group all the overhead expenditure accounts by department.

In all but the very smallest systems, it is normal to give each account an identifying number. This is quicker to write out and if the system is mechanized or computerized, the person posting the entries will post according to the numbers only.

There are thousands of different accounting numbering systems and you may want to design your own to fit your business and individual circumstances. It is worth looking at the numbering system of your employer or some other organization. Whether or not it is a good system, make sure that you understand the principles of the numbering.

The books of prime entry

It is possible to write all entries directly into the nominal ledger without using subsidiary books at all. This is sometimes done, especially in very small businesses, but there are two major drawbacks:

• Unless the business is exceedingly small the main nominal ledger will become clogged up with a very large number of entries.

• It is a good idea to record a certain amount of detail about each entry, and not just the amount and the name of the account that completes the double entry. There just is not room in the nominal ledger for the necessary details.

It is good practice to post to the nominal ledger only from the books of prime entry. The necessary details should be recorded in these books and it is usually just totals that are posted to the nominal ledger. There are a number of books that may be encountered but the following three are used in most businesses and are examined in this chapter:

• The nominal journal (or just journal).

• The sales day book.

• The purchase day book.

The term 'day book' is used because it may, in theory at least, be totaled and posted daily. The cash book is another book of prime entry and this is examined in the next chapter.

The nominal journal (or just journal)

Although there may be other books of prime entry, it is likely that the great majority of postings to the nominal ledger will be made by means of three of them, namely the sales day book, the purchase day book and the cash book. This will inevitably leave a number of necessary postings, probably important but relatively small in number, that do not fit into any of these posting mediums. As

Already explained, it is not a good idea to post directly into the nominal ledger without a posting medium. Apart from anything else some narrative details are highly desirable, to reduce the risk of fraud, to assist auditors and to provide a trail of information for the bookkeeper and the managers. This leaves the nominal journal.

The journal is ruled to show the date, a reference number for the entry, the identity of the accounts to be debited and credited, the amounts to be debited and credited and a narrative explanation. An example of a journal entry is as follows:

This implies that the customer's account (Curzon & Co) is actually in the nominal ledger but, of course, it is much more likely to be in a separate sales ledger. If this is the case, the journal entry would be to credit the sales ledger control account and a separate posting must be made in the sales ledger. A computerized system will make the second posting automatically.

You will no doubt have noticed that the journal is not laid out like a ledger sheet. This is because it is not a ledger sheet. It is a book of prime entry. It is possible that you may encounter a journal with a slightly different layout. There is more than one view about what is exactly best.

This section of the chapter is completed by showing how three events are written in the journal. The three events are:

1. It is noticed that an invoice for £76 from J. L. lafferty Ltd has wrongly been debited to Printing and Stationery Account instead of Motor Expenses Account. The invoice was entered on 4 January as part of Purchase Day Book Batch 66.

2. Interest of £9 (at an annual rate of 5%) for the year to 28 February is charged to the Director's Loan Account.

3. Annual depreciation of 25% is posted relating to Ford Mondeo XRJ 617. This relates to the year to 28 February and the car was purchased two years ago for £16,000.

It is important that each journal entry has a reference number so that it can be readily identified. There are numerous reference number possibilities but JV (standing for Journal Voucher) or just J is often used. It is very likely that each nominal account mentioned

Will have an identifying reference number. This was explained earlier in this chapter in the section on the nominal ledger. In real life the narrative would mention the year as well as the day and month.

The entry relating to depreciation may need a little explanation, though the subject is covered in detail in Chapter 6. The debit to Depreciation Account will increase the amount debited to the profit and loss account. The credit to Depreciation on Motor Vehicles Account builds up a credit balance to offset the £16,000 debit balance in the balance sheet. After four years the motor vehicle will have a nil value in the balance sheet, represented by £16,000 debit and £16,000 credit.

The sales ledger

If you only have one customer, you will not need a detailed sales ledger, just one account in the nominal ledger. Nor will you need a sales ledger if your sales are entirely for cash. On the other hand, businesses that sell on credit may have many customers. For them, an efficient sales ledger outside the nominal ledger is essential.

A sales ledger account looks very like a nominal ledger account.

It is divided in the middle with debit on the left and credit on the right. There will be one account for each customer and the postings to it are:

Debit    invoices issued

Credit   Credit notes issued

Credit   cash received

Credit   invoices written off as bad debts

Normally the debits on each account will exceed the credits. This means that the account has a debit balance which the amount is owed to the business by the customers. This sum is represented by just one account (usually called the sales ledger control account) in the nominal system.

The bookkeeping system will be designed to ensure that the accounts in the sales ledger do actually add up to the balance of the control account. Sales ledger accounts ruled in the traditional way described may not be encountered too often, though they are still used. Many readers will only be familiar with computer printouts that do not look anything like the ledgers described. It is important to remember that a computer is just an efficient way of doing what could be done manually.

Some of the figures on the computer printout represent credits and some represent debits. They are just presented differently. It is worth proving this to you by marking the debits and credits on a computerized sales ledger.

A business needs to send out statements and operate credit control procedures. These are a by-product of the sales ledgers and a computerized system speeds up the process. A computerized system may operate on the open item principle. This means that cash payments are allocated to specific invoices, and customer statements only show unpaid invoices. A computerized system may readily give useful management information such as an ageing of the debts.

The sales day book

It is necessary to have a mechanism for posting sales invoices into the sales ledger and the nominal ledger. This could be done laboriously one by one, but it is better to group them together and cut down the work.

This posting medium is usually called the sales day book, though you might find it called the sales journal or some other name. The following is a typical example of a sales day book. However, the design can vary according to individual preference and business circumstances.

Please note the following about each column:

• Date this is the date of each individual invoice.

• Customer this is the customer to which each individual invoice is addressed.

• Invoice no. Each invoice must be individually numbered

• Folio no. This is the identifying code to each individual sales ledger account.

• Goods total this is the total value of each invoice excluding VAT. Sometimes this is further divided to include different totals for different product groups. The example given only shows total sales.

• VAT this is the VAT charged on each individual invoice.

• Invoice total this is the total amount of each individual invoice and the amount that the customer has to pay.

The columns may be added and the posting done whenever it is convenient to do so. Monthly posting is frequently encountered and in practice there would probably be more than six invoices. The posting to the nominal ledger would be:

If you have a computerized system, your records will probably not look like this example. The computer will follow exactly these principles and do the same job, but it will do it more quickly.

The purchase ledger

If you have thoroughly understood the section on the sales ledger you will have no trouble at all understanding this section on the purchase ledger. This is because the purchase ledger is a mirror image of the sales ledger. It is used for invoices submitted to the business by suppliers.

The layout is similar to the accounts in the nominal ledger and the sales ledger. Postings to it are:

Credit           suppliers' invoices received

Debit    suppliers' credit notes received

Debit                    cash payments made

Each account will normally have a credit balance and this represents the amount owing to the supplier by the business. The total of all the individual purchase ledger accounts is the same as the amount of the purchase ledger control account in the nominal ledger. Customers will submit statements to you and press you to make regular prompt payments to them.

The purchase day book

We have already seen that the purchase ledger is a mirror image of the sales ledger. You will therefore not be surprised to learn that the purchases day book is a mirror image of the sales day book. Do not be confused if you find it called the purchases journal or some other name, and do not be confused if it is a computerized system with a layout that makes sense to computer experts.

A typical purchase day book looks like the following:

    Date  Customer     Invoice  Folio Goods  VAT Invoice  

 

1  July   Jones Ltd      3001   J8   100.00   17.50   117.50  

9  July   King and Co.   3002   K3   300.00   52.50   352.50  

13 July   ABC Ltd        3003   A1   50.00    8.75    58.75  

20 JUly   Dodd & Carr    3004   D2   200.00   35.00   235.00  

28 July   Sugar Co. Ltd  3005   S8   30.00    5.25    35.25  

 

Total                                680.00   119.00  799.00  

The purchase day book is the medium through which a batch of suppliers' invoices is posted into the nominal system and into the purchase ledger. It avoids the need to enter them individually into the nominal system. It is usually ruled off and entered monthly but this can be done at any suitable interval.

Questions to test your understanding

1. In which of the five categories should each of the following ten accounts be listed? For each one show whether it normally has a debit balance or a credit balance, and whether it will go to the profit and loss account or the balance sheet.

• Plant and machinery 

• Sales  

• Wages  

• Capital reserves  

• Cash  

• Telephone  

• Computer equipment  

• Bank account (with an overdraft)  

• Six Per Cent Preference Shares  

• Rent

2. What is the function of the sales ledger control account?

3. Do you need a sales ledger if your sales are entirely for cash?

4. Write up the nominal journal entries made necessary by the following events:

• A decision is made on 4 June that a balance of £7n owing by F. Smith Ltd is wholly irrecoverable and should be treated as a bad debt. The company operates a sales ledger separate from the nominal ledger.

• A decision is taken on 4 June that a general bad debt reserve of £6,000 should be created.

INSTANT TIP

The narrative description in the journal should not be neglected. To do so may well cause difficulties later.