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 an invoice or receipt—and turn it into structured, useful information for the business. Think of it as learning the correct filing system for every financial event.

We break down the accounting process into clear stages: collecting the evidence from source documents, recording entries in books of prime entry, posting to ledger accounts using double entry, and finally transferring closing balances to financial statements. Follow the flow step by step!

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 cannot officially be recorded.

What is a Source Document?

A source document is the original paper or electronic record providing the detailed evidence of a transaction—including the date, amount, descriptions, and parties involved.

Key Source Documents and Their Use
  • Sales Invoice: Issued when goods are sold on credit. Proof of the amount owed to us by a customer.
  • Purchases Invoice: Received when goods are bought on credit. Proof of the amount we owe to a supplier.
  • Debit Note: Sent to a supplier to request a credit note (e.g. for damaged goods or overcharges) or issued by a supplier if undercharged.
  • Credit Note (Issued): Sent to a customer acknowledging returns or allowances, reducing what they owe.
  • Credit Note (Received): Received from a supplier acknowledging goods returned, reducing what we owe them.
  • Statement of Account: A summary document sent periodically by a supplier to a customer listing transactions, invoices, credit notes, and the outstanding balance.
  • Cheque Counterfoils / Paying-in Slip Counterfoils / Bank Statements: Evidence of bank transactions, electronic transfers, and cash deposited or withdrawn.
  • Till Rolls / Receipts / Cash Vouchers: Evidence of cash sales, cash receipts, and small cash disbursements.
  • Journal Voucher: Internal authorization document providing evidence for entries made in the General Journal.

Trade Discounts vs. Cash Discounts

  • Trade Discount: A reduction in the catalogue price given to trade customers or for bulk buying. It is deducted directly on the invoice before recording and is never entered into ledger accounts.
  • Cash (Settlement) Discount: A discount given to encourage prompt payment within an agreed timeframe. It is recorded in the accounting records as Discount Allowed (an expense to the seller) or Discount Received (income/reduction of expense to the buyer).

Section 2: Step 1 – Books of Prime Entry (BPE)

The Books of Prime Entry (BPE), also called Journals or Day Books, are the books in which transactions are first recorded before being posted to the ledgers.

Why do we use Books of Prime Entry?

BPEs act as chronological lists that categorize similar transactions together. Recording individual items daily allows businesses to post summary totals periodically to the general ledger, reducing clutter and saving time.

The Major Books of Prime Entry
  1. Sales Day Book (Sales Journal):

    Records all sales of goods on credit at their net invoice values (after trade discount).
    Key Rule: Cash sales are NOT recorded here.

  2. Purchases Day Book (Purchases Journal):

    Records all purchases of inventory on credit at net invoice values.
    Key Rule: Credit purchases of non-current assets (e.g. machinery) are NOT recorded here; they go in the General Journal.

  3. Sales Returns Day Book (Sales Returns Journal):

    Records goods returned by customers or allowances granted, using copies of credit notes issued.

  4. Purchases Returns Day Book (Purchases Returns Journal):

    Records goods returned to suppliers, using credit notes received.

  5. Cash Book: (A Dual-Purpose Book)

    Records all receipts and payments of cash and bank funds. A three-column cash book includes columns for Discounts, Cash, and Bank on both Debit and Credit sides.
    Dual Role: The Cash Book is both a Book of Prime Entry and a part of the Ledger (representing the Cash and Bank accounts).

  6. Petty Cash Book:

    Records small, minor cash payments (e.g. postage, tea/coffee, bus fares).
    The Imprest System: Operates on a fixed float. At regular intervals, the petty cashier is reimbursed with the exact total spent, restoring the fund back to its original fixed float amount.

  7. General Journal (Journal Proper):

    The catch-all journal for non-routine transactions not recorded in the other day books.
    Common uses:

    • Purchase and sale of non-current assets on credit.
    • Opening entries for a new business.
    • Correction of errors.
    • Period-end adjusting and closing transfers.

    Crucial Requirement: Every General Journal entry must include a debit entry, a credit entry, and a short explanatory narrative.

Section 3: Step 2 – The Ledger Accounts (Double Entry)

The Ledger contains the formal accounts of the business. Here, the Double Entry Principle applies: every transaction has an equal and opposite Debit (DR) and Credit (CR) entry.

The Accounting Equation and Rules of Debit and Credit

All double entry is built on the fundamental equation:

\(\text{Assets} = \text{Capital} + \text{Liabilities}\)

  • Assets: Increases are Debited (DR); decreases are Credited (CR).
  • Expenses & Drawings: Increases are Debited (DR); decreases are Credited (CR).
  • Liabilities: Increases are Credited (CR); decreases are Debited (DR).
  • Capital: Increases are Credited (CR); decreases are Debited (DR).
  • Revenue / Income: Increases are Credited (CR); decreases are Debited (DR).

Helpful Mnemonic: DEAD CLIC
Debit: Expenses, Assets, Drawings.
Credit: Liabilities, Income, Capital.

Subdivision of the Ledger
  1. Sales Ledger (Receivables Ledger): Contains personal accounts for individual credit customers (Trade Receivables).
  2. Purchases Ledger (Payables Ledger): Contains personal accounts for individual credit suppliers (Trade Payables).
  3. General Ledger (Nominal Ledger): Contains all non-personal accounts (e.g. Sales, Purchases, Rent, Wages, Machinery, Capital) and control accounts.

Posting from Books of Prime Entry to Ledgers

  • From Sales Day Book: Individual credit sales are Debited to the individual customer accounts in the Sales Ledger. The periodic total of the SDB is Credited to the Sales Account in the General Ledger.
  • From Purchases Day Book: Individual credit purchases are Credited to the individual supplier accounts in the Purchases Ledger. The periodic total of the PDB is Debited to the Purchases Account in the General Ledger.
  • From Sales Returns Day Book: Individual items are Credited to the individual customer accounts; the periodic total is Debited to the Sales Returns Account.
  • From Purchases Returns Day Book: Individual items are Debited to the individual supplier accounts; the periodic total is Credited to the Purchases Returns Account.
  • From Cash Book: Payments and receipts are posted directly to the opposite side of the corresponding account in the General or subsidiary ledgers. Discount column totals are posted to the General Ledger: total Discount Allowed is debited, and total Discount Received is credited.

Section 4: Transferring Accounts to Financial Statements

Step 3a: Balancing Accounts and Preparing the Trial Balance

At the end of an accounting period, ledger accounts are balanced. The difference between debits and credits is entered as the balance carried down (c/d) and brought forward to the new period as the balance brought down (b/d).

A Trial Balance is prepared by listing all closing balances (b/d). It verifies the arithmetical accuracy of the double-entry bookkeeping by ensuring that total Debit balances equal total Credit balances.

Step 3b: Preparing the Financial Statements

Balances from the Trial Balance are then transferred into the final financial statements:

1. Income Statement

Calculates the net profit or loss generated over a financial period:

  • Trading Section: Compares Sales Revenue against Cost of Sales (Opening Inventory + Purchases - Closing Inventory) to find Gross Profit.
  • Profit and Loss Section: Adds other income (e.g. Discount Received, Rent Receivable) and subtracts operating expenses (e.g. Wages, Rent, Discount Allowed) to determine Profit or Loss for the year.
2. Statement of Financial Position

Summarizes the financial structure of the business at a specific date, illustrating the accounting equation:

  • Non-Current and Current Assets: Debit balances representing resources owned by or owed to the business.
  • Capital: Opening capital + Profit for the year (or - Loss) - Drawings.
  • Non-Current and Current Liabilities: Credit balances representing obligations owed to external parties.

Key Summary: Source Documents \(\rightarrow\) Books of Prime Entry \(\rightarrow\) Ledger Accounts \(\rightarrow\) Trial Balance \(\rightarrow\) Financial Statements (Income Statement and Statement of Financial Position).