To simplify the bookkeeping process the accounting system is divided into different types of accounts. Accounts are grouped into
Personal accounts always represent an individual or an organization. Examples of personal accounts are trade receivables and trade payables.
Trade receivables relate to individual or organization to which the business sold goods on credit. They are the credit customers of the business.
Trade payables relate to a person or business from which the business bought goods on credit. They are the credit suppliers of goods of the business.
Impersonal accounts are divided into real and nominal accounts.
Real accounts include accounts in the statement of financial position such as assets, liabilities and equity. These are considered permanent accounts because they are not closed at the end of each accounting period. An example of a real account is non-current assets such as equipment account.
Nominal accounts include all income and expenditure accounts in an income statement. Nominal accounts are always temporary accounts as they only last for an accounting period. At the end of the financial year, the balances of nominal accounts are transferred to the income statement.
Types of ledger
A ledger is a book where accounts are maintained in a summarized way for users to understand. A ledger forms part of the recording of all business transactions. There are 3 different types of ledgers
It is a grouping of all accounts related to customers to whom goods have been sold on credit by the business. It is used to record the accounts of credit customers (Trade Receivables) only.
It is a grouping of all accounts related to suppliers from which goods have been purchased on credit by the business. It is used to record the accounts of credit suppliers (Trade Payables) only.
A general ledger is a centralized compilation for all the ledger accounts of a business. It is used to record real and nominal accounts. It contains all types of accounts which can be found in an organization such as assets, liabilities, capital, revenue and expenses.
Advantages of dividing the ledger into 3 sections
Books of prime entry
The ledger accounts of a business are the main source of information used to prepare the financial statements. However, if a business were to update their ledgers each time a transaction occurred, the ledger accounts would quickly become cluttered and errors might be made. This would also be a very time consuming process. To avoid this complication, all transactions are initially recorded in a book of prime entry and then posted to ledger. Books of prime entry are also known as subsidiary books or books of original entries. The main books of prime entry are:
Book of prime entry
Record cash and bank transactions
Sales day book / Sales Journal
Record credit sales
Purchases day book / Purchases Journal
Record credit purchases
Sales returns day book / Sales return Journal
Record returns of goods sold on credit
Purchases returns day book / Purchases return Journal
Record returns of goods bought on credit
All transactions not recorded elsewhere
A source document is an original record which contains the detail that supports or substantiates a transaction that will be (or has been) entered in an accounting system. A source document is evidence that a transaction or event took place in the business. The main source documents are:
A sales invoice is a source document issued to credit customers showing full details of goods sold to them. It may include: Name and address of customer, description of goods, no of units, unit price and any trade discount.
A purchase invoice is a document received from suppliers showing full details of goods purchased from them. It is an evidence of goods purchased from supplier. It may include: Details of supplier, description and price of goods purchased and discount received from supplier.
Credit note issued
A customer may return goods to the trader if it is found to be damaged or of wrong order. A credit note is a document issued to customers showing full details of goods returned by them. It is an evidence of sales return by customers.
Credit note received
Similarly goods may be returned to suppliers by the trader if it is damage. A credit note will be received by suppliers to show details of goods returned to them. A credit note received is an evidence of purchases return to suppliers.
A debit note is a document sent to by the customer to a supplier asking for allowance for unsatisfactory good (reduction of the amount due). It may also be sent to the business to inform of any misstatements/ errors or shortages/overcharges made in his/her account.
Where cheques are used by a business to make payments, cheque counterfoils serve as the source documents to make entries in cash book. A cheque counterfoil is the part of the cheque kept by the drawer as a record of the transaction. It is evidence or a record that the cheque was written and the payment was made
Statement of Account
At the end of each month the trader will send a statement of account to its customers showing them the amount due. It is simply a summary of the customer’s transactions clearly showing sales, returns, receipts and balance due at end.
A receipt is a source document to record cash received by a business. It indicates the date the payment was received, the name of the person or business from whom the payment was received, and the amount of the payment.
This is a legal document sent by the business to its employees showing them their Gross pay, deductions / Tax and net pay during a particular period. It is a proof that wages and salaries have been paid to employees.
This is issued by the bank to the trader each month showing cheques deposited and withdrawn during the month. The bank statement is used to reconcile any difference in the cash book of the business.