6
LEDGER ACCOUNTING
6.1
Introduction
In Chapter 1, each time that Percy Pilbeam’s business made a transaction, we produced a new
‘accounting equation’  effectively a new statement of financial position. We could also have
prepared a new income statement account each time as well.
In real-life businesses, which may have hundreds of transactions every day, this is clearly
impractical. What we need is a system for recording transactions in such a way that:
(a)
they appear individually in the records; and
(b)
they can be readily summarised at the end of a period so that a profit and loss account
and statement of financial position can be prepared.
Therefore we open a series of separate ‘accounts’ for each type of transaction, eg. sales,
purchases, wages and so on. These accounts are known as ledger accounts, because in the old
days, when all accounting records were handwritten, these accounts were written up in a large
book called the ledger. Nowadays records are usually written on loose-leaf sheets or appear on
computer print-outs, but the name ledger accounts is retained.
6.2
Debit and credit entries
This, at last, is the moment when the words debit and credit finally appear. As we said at the
end of Chapter 3, ‘debit’ and ‘credit’ are the conventional names used in writing up ledger
accounts so as to show the dual effect of each transaction.
As you will see from the pro forma example below, a ledger account has two sides; by
convention the left-hand side is called the debit side and right-hand side the credit side.
Of the two effects involved with every transaction, one produces a debit entry in a ledger
account, the other a credit entry in another ledger account. We shall see in a moment which is
which.
6.3
Layout of a ledger account
Title of account
Debit ((Dr)
Date Narrative Amount
£
Credit (CR)
Date Narrative Amount
£
Explanations:
(a)
‘Dr’ and ‘Cr’ are the conventional abbreviations for debit and credit.
(b)
‘Narrative’ refers to the description of the amount entered; the most usual narrative is
the name of the ledger account where the opposite entry of the pair is to be entered.
This will often involve an account number, code or page for easy reference.
Thus the double entry for, say, a payment of wages amounting to £100 would look like this:
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Cash
£
7.1.X4
Wages
£
100
Wages expense
7.1.X4
Cash
£
100
£
The next thing, of course, is to understand which entries go on which side (yes, it does matter).
6.4
The meaning of debit and credit
We said that debit and credit were merely conventions; it is true that the names themselves
mean little and have come a long way from their Latin origins. But what is important is that
certain entries go on particular sides.
The following is of vital importance throughout your accounting studies, so try to commit it to
memory.
A debit entry represents:
A credit entry represents:
(a) an increase in the value
of an asset;
(a)
or
or
(b) a decrease in the
amount of a liability;
(b)
or
a decrease in the value of
an asset;
an increase in the amount
of a liability;
or
(c) an item of expenditure
(c) an item of income.
Remember that:
(a)
Every transaction made by a business will involve two of these effects, one debit and
one credit.
(b)
For every debit entry there must be a corresponding credit entry, and vice versa.
Try to work out what the entries for cash and wages in paragraph 6.3 signify.
The credit entry in the cash account means a decrease in the value of an asset and is therefore a
credit.
The debit entry in the wages account means an item of expenditure and is therefore a debit.
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6.5
Link with the final accounts
Before we put all this into practice with an example, a reminder to you not to lose sight, in a sea
of double entry, of what bookkeeping is ultimately trying to achieve.
The purpose of bookkeeping (Chapter, paragraph 1.4) is to enable a business’s transactions to
be summarised at the end of a period so that accounts can be produced.
These summaries are the statement of financial position, showing assets and liabilities and the
income statement, showing expenditure and income.
6.6
Example: Percy Pilbeam revisited
To enable you to see how ledger accounting works, we will first write up Percy Pilbeam’s first
month’s transactions (as in Chapter 3), explaining what happens with each one as we go along:
we will then ask you to write up a series of transactions in his second month, so that eventually
you can produce a set of accounts for the two-month period. By the time you get to the second
month, you should be able to see that, for any number of transactions, ledger accounting is
much quicker than producing an accounting equation (or statement of financial position) after
each one.
So here we go with Percy’s first month.
Step 1
He opens a business bank account with £10,000 in cash.
First of all, what is the dual effect? (This, of course, is the
clue to what the double entry is going to be in the ledger
accounts
The business has:
(a)
£10,000 cash
(b)
£10,000 capital.
Taking cash first, what is it? (Asset, liability, income or expenditure).
An asset.
An increase in the value of an asset is a debit entry (paragraph 6.4 above).
So we make a debit entry in the cash account.
Capital is the amount owed by the business to its proprietor. So what is it? (Asset, liability,
income or expenditure  in the business’s books, remember).
A liability (the business owes the liability to the proprietor). An increase in the value of a
liability is a credit entry.
So we make a credit entry in the capital account.
Note
We refer in the narrative of the ledger account to the other account effect by the
transaction.
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Cash
£
10,000
Capital
£
Capital
£
£
10,000
Cash
Instead of doing an accounting equation, we now go straight on to the next transaction.
Step 2
The business buys fruit from Wooster Wholesalers for £4,000, paying cash for it.
Dual effect:
(a)
£4,000 inventory
(b)
£4,000 less cash.
When we looked at this transaction in Chapter 3, we recorded the purchase of fruit as an
increase in inventories (an asset). So it is: but because it will soon be sold (we hope) we don’t
show inventories as an asset except at the end of a period, when we create a inventories account
for the amount of inventory on hand then.
Instead, when a business buys and sells inventory we record these transactions as purchases
and sales. Since purchases are clearly an expense, this means a debit entry in the purchases
account.
The other side of the double entry is a decrease in cash; since cash is an asset this means a
credit entry in the cash account.
Cash
Capital
£
10,000
£
4,000
Purchases
Purchases
Cash
£
4,000
£
Step 3
The business buys £2,000 worth of vegetables from Wooster Wholesalers on credit.
Remembering what we have just said about inventories and purchases, what is the dual effect of
this?
(a)
Purchases of £2,000
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(b)
A payable of £2,000.
This means, again a debit entry in the purchases account (expenditure): the other side, the
liability, means a credit entry in an account for payables.
Purchases
Cash
Payables
£
4,000
2,000
£
Payables
£
£
2,000
Purchases
An alternative to a general ‘trade payables’ account would be an account specifically for
Wooster Wholesalers. Later in your studies, you will find that most sizeable businesses have
both a total trade payables account (or ‘trade payables control account’) and individual accounts
for each payable.
Exactly the same thing applies, not surprisingly, to receivables.
Step 4
The business sells all the fruit for £5,000 cash.
Once again, remember what we said about inventories and purchases; the same applies to sales,
and this should actually make it easier to understand the dual effect of the transaction and to
make the ledger account entries.
(a)
Sales of £5,000
(b)
£5,000 more cash.
If a purchase is an expense, a sale must be an item of income; we must therefore make a credit
entry in the sales account.
Cash  an asset  increases, so we debit the cash account.
Sales
£
£
5,000
Cash
Cash
Capital
Sales
£
10,000
5,000
£
4,000
Purchases
The profit element (£1,000) is included in sales, though not of course in purchases, and this will
eventually come through in the profit and loss account.
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Step 5
The business incurs, and pays, an electricity bill for £200.
Dual effect:
(a)
£200 less cash
(b)
An electricity expense of £200.
It should by now be easy, for you to see that we must debit the electricity account (an expense)
and credit the cash account (decrease in the asset).
Electricity
£
200
Cash
£
Cash
£
10,000
5,000
Capital
Sales
£
4,000
200
Purchases
Electricity
Step 6
The business buys a Ford van for £4,000 cash.
Dual effect:
(a)
A non-current asset of £4,000
(b)
£4,000 less cash.
Double entry:
Debit non-current asset account
Credit cash account
 because the non-current assets are increasing, and cash is decreasing.
Non-current assets
Cash
£
4,000
£
38
Cash
£
10,000
5,000
Capital
Sales
£
Purchases
4,000
Electricity
200
Non-current assets 4,000
Step 7
Percy draws £500 cash out of the business.
Dual effect:
(a)
£500 less cash
(b)
£500 drawings (reduces capital).
The asset ‘cash’ decreases, so we credit the cash account. Think of drawings as a decrease in
capital (the liability to the proprietor), not as an expense. We could debit the capital account,
but because there might be several drawings made during a period, it is more convenient to
open a separate drawings account.
Drawings
Cash
£
500
£
Cash
Capital
Sales
£
10,000
5,000
£
Purchases
4,000
Electricity
200
Non-current assets 4,000
Drawings
500
These were the transactions during Percy’s first month of trading. If we now list the
transactions of his second month, see if you can write them up, using the ledger accounts
provided, without looking at the answers.
6.7
The second month’s transactions
(1)
Sold all the vegetables bought in the first month for £2,500 cash.
(2)
Bought £6,000 worth of fruit from Wooster Wholesalers on credit.
(3)
Bought £3,000 worth of vegetables for cash.
(4)
Bought £500 worth of prunes from M Bassett on credit.
(5)
Sold all the fruit bought in (2) above for £7,500 on credit to R Glossop.
(6)
Sold half the vegetables bought in (3) above for £2,000 on credit to Jeeves & Co.
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6.8
(7)
Paid Wooster Wholesalers £3,500.
(8)
R Glossop paid for his fruit in full.
(9)
Received (but didn’t pay yet) a bill for £800 rent from S Malloy, his landlord.
(10)
Paid £200 for his telephone bill.
(11)
Received rent of £100 cash from F Bloggins for the use of his garage.
(12)
Drew £400 cash out of the business.
(13)
Bought a cash register for £300 on credit from Sioux Business Services.
The entries for the second month
You will find below all the ledger accounts you need to enter the second month’s transactions,
with the first month’s transactions already entered. Take one at a time and fill them in.
Remember  for each one there must be a debit entry and a credit entry.
The answers are on the pages following your version. Don’t look at them until you’ve finished!
Note
Don’t bother  yet  to add up the figures in the accounts. We are coming to this
in the next chapter.
Cash
Capital
Sales
£
10,000
5,000
£
Purchases
4,000
Electricity
200
Non-current assets 4,000
Drawings
500
Capital
£
£
10,000
Cash
Purchases
Cash
Payables
£
4,000
2,000
£
Sales
£
£
5,000
Cash
40
Payables
£
£
2,000
Purchases
Electricity
Cash
£
200
£
Non-current assets
Cash
£
4,000
£
Drawings
Cash
£
500
£
Receivables
£
£
Rent payable
£
£
Telephone
£
£
Rent receivable
£
£
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6.9
Answers
Cash
Capital
Sales
Sales
Receivables
Rent receivable
£
10,000
5,000
2,500
7,500
100
Purchases
Electricity
Non-current assets
Drawings
7,500
Purchases
Payables
Telephone
Drawings
£
4,000
200
4,000
500
3,000
3,500
200
400
Capital
£
£
10,000
Cash
Purchases
Cash
Payables
£
4,000
2,000
Payables
Cash
Payables
6,000
3,000
500
£
Sales
£
Cash
£
5,000
Cash
Receivables
Receivables
2,500
7,500
2,000
Payables
Cash
£
3,500
£
2,000
Purchases
Purchases
6,000
Purchases
500
Rent
800
Non-current assets 300
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7,500
2,000
Electricity
Cash
£
200
£
Non-current assets
Cash
Payables
£
4,000
£
300
Drawings
Cash
£
500
Cash
400
£
Receivables
Sales
£
7,500
Sales
2,000
£
7,500
Cash
Rent payable
Payables
£
800
£
Telephone
Cash
£
200
£
Rent receivable
£
£
100
Cash
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