Various Types of Transactions – Part 5, Disbursement or Release of Principal Sum of Loans or Borrowings from Third Parties

Business entities may apply for loans or borrow money from third parties (usually financial institutions; sometimes in the form of short term loans or advances from owners, directors & etc.). THIS IS NOT A SOURCE OF REVENUE OR OTHER INCOME. This is because the principal sum borrowed is a liability (resource – money that you get from others temporarily and you need to pay the price for this – interest). I include it together with the series of discussion of revenue and other income to follow the sequence of discussing various types of transactions appearing in the cash book. Upon fulfilling the terms and conditions set and agreement reached between the borrowers and the lenders, the principal sum of the loan will be realeased to the borrowers

The double entry involved in the recording of the realease of the loan is as follows:-

 

Balance Sheet

Income Statement

 

DR

CR

DR

CR

Cash at bank

24,000

     
Loan from XXX Bank

 

24,000

 

 

A decision need to be made as to whether the loan should be classified as current liability or non-current liability. This involves “splitting” the loan into the current portion and non-current portion in accordance with the repayment terms. Some business entities do not split the loan into current and non-current since it received the realease of the loan, nor during the financial year. The splitting of the loan into current and non-current portion is done ONLY as at the end of the financial year for proper financial statements presentation purposes. This is achieved by way of a reclassification journal entry once the current portion and non-current portion of the loan is calculated (this must be reflective of the position of the loan to the business entities as at the end of the financial year).

Assume the $24,000 loan received from XXX Bank is repayable over 5 years with monthly principal repayment of $500 (the interest on loan is purposely omitted), and as at the end of the financial year, the balance of the loan is $19,500 (This means 9 installments of $500 have been repaid). The portion of the loan to be classified as current liability is $6,000 (i.e. the amount expected to be repaid over the next 12 months from the end of the financial year, $500 x 12 months). The non-current portion of the loan is therefore $13,500 ($19,500 – $6,000). Assume the Loan from XXX Bank was originally classified as a current liabilities account, the reclassification journal entry is:-

 

Balance Sheet

Income Statement

 

DR

CR

DR

CR

Loan from XXX Bank (Current liabilities)

13,500

     
Loan from XXX Bank (Non-Current liabilities)

 

 

13,500

 

 

Further Example

The financial period of ABC Co. Ltd. is from 1 January to 31 December. On 1 January 2006, ABC Co. Ltd receive $100,000 loan from Northern Bank upon approval of its application submitted earlier. Interest is charged at 7% per annum calculated monthly. Based on these terms, the repayment schedule is tabulated as follows:-

Example Of Loan Repayment Schedule 

Assume ABC Co. Ltd. pays the installments on time

The double entries to record the transactions during the year ended 31 December 2006 are as follows:-

 

Balance Sheet

Income Statement

 

DR

CR

DR

CR

1 January 2006

 

     
 

 

     
Cash at bank

100,000

     
Loan from Northern  Bank

 

 

100,000

 

 

 

 

     
31 January 2006

 

     
 

 

     
Loan from Northern Bank

1,396.67

     
Interest expense

 

 

583.33

 
Cash at bank

 

1,980

   
(Please refer to instalment No. 1 of the repayment schedule)

 

     
 

 

     
28 February 2006

 

     
 

 

     
Loan from Northern Bank

1,404.81

     
Interest expense

 

 

575.19

 
Cash at bank

 

1,980

   
(Please refer to instalment No. 2 of the repayment schedule)

 

     
 

 

     
31 March 2006

 

     
 

 

     
Loan from Northern Bank

1,413.01

     
Interest expense

 

 

566.99

 
Cash at bank

 

1,980

   
(Please refer to instalment No. 3 of the repayment schedule)

 

     
 

 

     
30 April 2006

 

     
 

 

     
Loan from Northern Bank

1,421.25

     
Interest expense

 

 

558.75

 
Cash at bank

 

1,980

   
(Please refer to instalment No. 4 of the repayment schedule)

 

     
 

 

     
31 May 2006

 

     
 

 

     
Loan from Northern Bank

1,429.54

     
Interest expense

 

 

550.46

 
Cash at bank

 

1,980

   
(Please refer to instalment No. 5 of the repayment schedule)

 

     
 

 

     
30 June 2006

 

     
 

 

     
Loan from Northern Bank

1,437.88

     
Interest expense

 

 

542.12

 
Cash at bank

 

1,980

   
(Please refer to instalment No. 6 of the repayment schedule)

 

     
 

 

     
31 July 2006

 

     
 

 

     
Loan from Northern Bank

1,446.27

     
Interest expense

 

 

533.73

 
Cash at bank

 

1,980

   
(Please refer to instalment No. 7 of the repayment schedule)

 

     
 

 

     
31 August 2006

 

     
 

 

     
Loan from Northern Bank

1,454.71

     
Interest expense

 

 

525.29

 
Cash at bank

 

1,980

   
(Please refer to instalment No. 8 of the repayment schedule)

 

     
 

 

     
30 September 2006

 

     
 

 

     
Loan from Northern Bank

1,463.19

     
Interest expense

 

 

516.81

 
Cash at bank

 

1,980

   
(Please refer to instalment No. 9 of the repayment schedule)

 

     
 

 

     
31 October 2006

 

     
 

 

     
Loan from Northern Bank

1,471.73

     
Interest expense

 

 

508.27

 
Cash at bank

 

1,980

   
(Please refer to instalment No. 10 of the repayment schedule)

 

     
 

 

     
30 November 2006

 

     
 

 

     
Loan from Northern Bank

1,480.31

     
Interest expense

 

 

499.69

 
Cash at bank

 

1,980

   
(Please refer to instalment No. 11 of the repayment schedule)

 

     
 

 

     
31 December 2006

 

     
 

 

     
Loan from Northern Bank

1,488.95

     
Interest expense

 

 

491.05

 
Cash at bank

 

1,980

   
(Please refer to instalment No. 12 of the repayment schedule)

 

     

The relevant “T” accounts shown below provide a clearer picture of the figures involved in respect of the release of loan and the repayments recorded during the year ended 31 December 2006:-

ABC Co. Ltd

General Ledger

Loan From Northern Bank (Balance Sheet)

DEBIT

CREDIT

Date Descriptions Folio

 $

Date Descriptions Folio

 $

2006

     

2006

     

31-Jan

Cash at bank  

         1,396.67

01-Jan

Cash at bank  

   100,000.00

28-Feb

Cash at bank  

         1,404.81

     

 

31-Mar

Cash at bank  

         1,413.01

     

 

30-Apr

Cash at bank  

         1,421.25

       

31-May

Cash at bank  

         1,429.54

       

30-Jun

Cash at bank  

         1,437.88

       

31-Jul

Cash at bank  

         1,446.27

       

31-Aug

Cash at bank  

         1,454.71

       

30-Sep

Cash at bank  

         1,463.19

       

31-Oct

Cash at bank  

         1,471.73

       

30-Nov

Cash at bank  

         1,480.31

       

31-Dec

Cash at bank  

         1,488.95

       

31-Dec

Balance C/F  

       82,691.68

       
     

     100,000.00

     

   100,000.00

     

 

     

 

               

Cash at bank (Balance Sheet)

DEBIT

CREDIT

Date Descriptions Folio

 $

Date Descriptions Folio

 $

2006

   

 

2006

     

01-Jan

Balance B/F  

         5,467.98

31-Jan

Loan from Northern Bank  

       1,396.67

01-Jan

Cash at bank  

     100,000.00

31-Jan

Interest expense  

           583.33

     

 

28-Feb

Loan from Northern Bank  

       1,404.81

     

 

28-Feb

Interest expense  

           575.19

     

 

31-Mar

Loan from Northern Bank  

       1,413.01

     

 

31-Mar

Interest expense  

           566.99

     

 

30-Apr

Loan from Northern Bank  

       1,421.25

     

 

30-Apr

Interest expense  

           558.75

     

 

31-May

Loan from Northern Bank  

       1,429.54

     

 

31-May

Interest expense  

           550.46

     

 

30-Jun

Loan from Northern Bank  

       1,437.88

     

 

30-Jun

Interest expense  

           542.12

     

 

31-Jul

Loan from Northern Bank  

       1,446.27

     

 

31-Jul

Interest expense  

           533.73

     

 

31-Aug

Loan from Northern Bank  

       1,454.71

     

 

31-Aug

Interest expense  

           525.29

     

 

30-Sep

Loan from Northern Bank  

       1,463.19

     

 

30-Sep

Interest expense  

           516.81

     

 

31-Oct

Loan from Northern Bank  

       1,471.73

     

 

31-Oct

Interest expense  

           508.27

     

 

30-Nov

Loan from Northern Bank  

       1,480.31

     

 

30-Nov

Interest expense  

           499.69

     

 

31-Dec

Loan from Northern Bank  

       1,488.95

     

 

31-Dec

Interest expense  

           491.05

     

 

31-Dec

Balance C/F  

     81,707.98

     

     105,467.98

     

   105,467.98

     

 

     

 

               

Interest expense (income statement)

DEBIT

CREDIT

Date Descriptions Folio

 $

Date Descriptions Folio

 $

2006

     

2006

     

31-Jan

Interest expense  

             583.33

31-Dec

To income statement  

       6,451.68

28-Feb

Interest expense  

             575.19

     

 

31-Mar

Interest expense  

             566.99

     

 

30-Apr

Interest expense  

             558.75

     

 

31-May

Interest expense  

             550.46

     

 

30-Jun

Interest expense  

             542.12

     

 

31-Jul

Interest expense  

             533.73

     

 

31-Aug

Interest expense  

             525.29

     

 

30-Sep

Interest expense  

             516.81

     

 

31-Oct

Interest expense  

             508.27

     

 

30-Nov

Interest expense  

             499.69

     

 

31-Dec

Interest expense  

             491.05

     

 

     

         6,451.68

     

       6,451.68

     

 

     

 

Before the income statement and balance sheet of ABC Co. Ltd. are finalized, a reclassification journal entry is required to present correctly the current portion and non-current portion of the Loan from Northern Bank. From the “T” account shown above, the outstanding amount of Loan from Northern Bank as at 31 December 2006 was $82,691.68 (31-Dec Balance C/F). From the loan repayment schedule, the principal sum expected to be repaid in Year 2 is $18,559.53. This is the portion of the loan expected to be repaid within 12 months from the year end i.e. 31 December 2006 and therefore should be presented as a current liabilities item. The non-current portion of the loan is calculated as follows:-

Principal sum outstanding as at 31 December 2006

            82,691.68

Principal sum expected to be repaid in the next 12 months

            (18,559.53)

Principal sum expected to be repaid after the next 12 months

            64,132.15

Assume the Loan from Northern Bank was originally classified as a current liabilities account, the following reclassification journal entry is required to reflect correctly the current portion and the non-current portion of the loan on the balance sheet:-

 

Balance Sheet

Income Statement

 

DR

CR

DR

CR

Loan from Northern Bank (Current liabilities)

 

64,132.15

     
Loan from Northern Bank (Non-Current liabilities)

 

 

 

64,132.15

 

 

The income statement and balance sheet of ABC Co. Ltd. after the above transactions being recorded in the respective accounts and also the impact of the $64,132.15 reclassification journal entry are as follows: –

Income Statement and Balance Sheet of ABC Co. Ltd.
         
Income Statement for the year ended 31 December 2006
  BEFORE

 Adjustment

 AFTER
   

 DR

 CR

 
 

 $

   

 $

Sales

          109,270.00

   

             109,270.00

Cost of Sales

–          40,875.00

   

–              40,875.00

Gross profit

            68,395.00

   

               68,395.00

Other income: –        
Rental income

            12,000.00

   

               12,000.00

Operating expenses: –        
Accountancy fee

–                800.00

   

–                    800.00

Depreciation of property, plant and equipment

–             4,400.00

   

–                4,400.00

Donation

–                500.00

   

–                    500.00

Electricity & water

–             3,340.00

   

–                3,340.00

Interest expense

–   6,451.68

   

–                6,451.68

Printing & stationery

–             1,697.00

   

–                1,697.00

Rental of premises

–          12,000.00

   

–              12,000.00

Salaries

–          27,865.00

   

–              27,865.00

Upkeep of office

–             3,547.00

   

–                3,547.00

Telephone charges

–             1,285.00

   

–                1,285.00

Travelling, petrol & toll charges

–             2,648.00

   

–                2,648.00

 

–          64,533.68

   

–              64,533.68

Net profit for the year

            15,861.32

   

               15,861.32

Retained profits B/F

            27,654.00

   

               27,654.00

Retained profits C/F

            43,515.32

   

               43,515.32

         
Balance Sheet as at 31 December 2006        
 

 $

   

 $

Non-current assets        
Property, plant and equipment

            19,600.00

   

               19,600.00

         
Current assets        
Inventories

              5,000.00

   

                  5,000.00

Trade receivables

            32,807.00

   

               32,807.00

Other receivables, deposits & prepayments:

 

   

 

Rental receivable

              3,000.00

   

                  3,000.00

Rental deposit

              3,000.00

   

                  3,000.00

Utility deposit

                  500.00

   

                     500.00

Cash and bank balances

          105,467.98

   

             105,467.98

 

          149,774.98

   

             149,774.98

Current liabilities        
Trade payables

–             3,588.00

   

–                3,588.00

Other payables and accruals

–          24,579.98

   

–              24,579.98

Loan from Northern Bank

– 82,691.68

   64,132.15

 

–   18,559.53

 

–        110,859.66

   

–              43,139.51

Net current assets

            38,915.32

   

             106,635.47

 

            58,515.32

   

             126,235.47

Financed by: –        
Share capital

            15,000.00

   

               15,000.00

Retained profits

            43,515.32

   

               43,515.32

 

            58,515.32

   

               58,515.32

Non-current Liabilities        
Loan from Northern Bank

 

  64,132.15

     64,132.15

 

            58,515.32

   

             122,647.47

Revenue Expenditure (25 September 2009)

Revenue expenditure is recorded as expenses in Income Statement. Examples of revenue expenditure are office rentals, utilities such as water & electricity, printing & stationery & etc.. Revenue expenditure also includes those incurred to maintain the earning capacity of non-current assets such as repairs and maintenance. It is the expenditure on goods or services which will be used up i.e. the benefits that come with the goods or services will be consumed. The unused goods purchased would then be recognised as inventory on Balance Sheet i.e. part of Current Assets.

Example – On 31/1/2007, Dragon Co. Ltd. issue a cheque of $88.98 to pay its electricity bill and another cheque of $1,500 to pay its monthly rental of shop. The double entry to record these transactions is: –

Click Here For Double Entry In Excel Format

Capital Expenditure (24 September 2009)

Capital expenditure refers to the expenditure made by business entities which result in non-current assets or long-term assets and therefore are recognised and shown on the balance sheet of the business entities and not charged as expense in the income statement. Capital expenditure relates to the following items being acquired but take note that this is not the exhaustive list:

  1. Property, plant and equipment
  2. Investments in shares of companies
  3. Other form of investments e.g. property acquired for its investment potential ie capital appreciation and earnings by way of rental income earned

There is an important difference between capital expenditure on property, plant and equipment and capital expenditure made for investment purposes. For property, plant and equipment or fixed assets, the assets are acquired with a view or clear intention to use them in the operations of the business to generate the revenue (i.e. major source of income to the business entities). This is different to capital expenditure made for investment purposes such as b. and c. above. For capital expenditure made to acquire assets for their investment potential such as b. and c. above, the business entities have the intention to acquire the assets for their capital appreciation i.e. increase in market value over time and also for specific return from their acquisition e.g. dividend income for investment in shares of companies and rental income for investment in property.

This is the reason that property, plant and equipment acquired are subject to depreciation over the life of using the assets. Depreciation can be more easily understood as recognition of the consumption of the benefits that the assets give to the business entities systematically in the course of using them to generate the revenue of the business entities. However, business entities do not depreciation investment in shares or investment in property but they do recognise the decrease in value (market value is a good guide to be used as fair value) of the investments made earlier. I shall not discuss the effect of increase or decrease in value of investments and how to recognise them in accounting here because this is the topic of advance accounting.

Example – Purchase of Fixed Assets Or Property, Plant And Equipment

  • On 1/1/2007, Dragon Co. Ltd. purchased a car by issuing a cheque of $5,000 to Fantastic Cars Co. Ltd. as cash deposit. The balance of $145,000 is under hire purchase financing obtained from Rich Bank. The double entry to record this transaction is: –

  • On 31/1/2007, Dragon Co. Ltd. makes a monthly depreciation of $1,250 based on the annual depreciation rate of 10% on cost. The double entry to record this transaction is: –

The depreciation charge of $1,250 per month shall be done every month until the cost of acquiring the car of $150,000 is fully depreciated.

Click Here For Effect Of Depreciation Reflected In Balance Sheets And Income Statements

Capital Vs Revenue Expenditure (24 September 2009)

When a business entity spends money (or purchase on credit) to acquire goods or services, a decision need to be made as to the purpose and nature of the expenditure. The questions asked include something along these lines:-

  • What did I pay for?
  • Is the thing that I paid for have some value or benefits to my business over the long run? (e.g. more than one year)
  • Is it something that I paid because of something that the business had already enjoyed or used in the past? (e.g. electricity, phone, water & etc.)
  • Is it for something that the business intends to resell later?
  • Is it for packing of the goods meant to be sold later?

In accounting, the classification of the expenditure into either capital expenditure or revenue expenditure is required. Wrong classification of the expenditure may have a great impact on the financial position (meaning is the balance sheet of the business entity concerned) and the financial performance/results (meaning is the profit or loss performance of the business entity concerned referring to the income statement) of the business entity.

Do not get yourself confused between the capital expenditure and the capital contribution by business owners. They are two different things.

Capital expenditure refers to the expenditure made by business entities to acquire assets (usually non-current or fixed assets) that are expected to give the business entities future economic benefits (by way of using the assets in the business to generate revenue or income). Capital expenditure is recorded as asset and therefore would appear on the balance sheet of the business entities. Examples of capital expenditure are property acquired and used as office premises, computers, furniture, fixtures and fittings & etc. On the other hand, revenue expenditure refers to those expenses incurred to acquire goods or services that are also essential in terms of the daily operations of the businesses. However, the benefits that revenue expenditure gives to the business entities are of a shorter term in nature and usually in the day to day operations and DO NOT provide future economic benefits, i.e. the benefits are consumed over a short period of time (usually one year is the period that is used as the measurement).

Revenue expenditure is recorded as expenses in the Income Statement. Examples of revenue expenditure are office rentals, utilities such as water & electricity, printing & stationery, repairs and maintenance & etc. revenue expenditure also includes those incurred to maintain the earning capacity of non-current assets such as repairs and maintenance.

More On Books of Original Entry – Cash Book

Cash Book is used to record cash transactions. However, due to the fact that there is a difference between cheques and the “hard cash”, normally these two types of transactions are recorded in two separate Books of Original Entry – Cheques transactions in Cash or Bank Book (I just refer to it as Cash Book) and “hard cash” transactions in Petty Cash Book.

For small businesses, a common format of Cash Book adopted is to present the “T” account and in multi-columns manner. For receipts, the transactions are recorded on the debit side of the Cash Book and for payments, on the credit side of the Cash Book. The total of each column at the end of each month would then be posted to the respective accounts in the General Ledger. The month end balance of each account would then be used to construct the Trial Balance before the Balance Sheet and the Income Statement are prepared (Method 1). However, when the daily collection from customers (it could be cash sales, collections from trade debtors or both), and also payments to suppliers are of large volume, recording of cash receipts in Cash Receipts Day Book or Journal and recording of cash payments in Payments Day Book or Journal may be a better option (Method 2).Refer to the examples in my previous post, “General Ledger? Journals? Day Books? Debtors Ledger? Creditors Ledger? Trial Balance?” and continue with the following additional transactions in the month of February 2007:-

Transactions in February 2007
  Date Descriptions Reference No. Amount Remark

1

01-Feb-07

Receive $3,000 from Big Co Ltd. OR01022007 3,000.00 Official Receipt No. OR01022007 issued.

2

01-Feb-07

Cash sales OR02022007 500.00 Official Receipt No. OR02022007 issued.

3

01-Feb-07

Collect rental of shop space for the month of February 2007 OR03022007 300.00 Official Receipt No. OR03022007 issued.

4

02-Feb-07

Purchase of stationery and printing of documents PV01022007 578.00 Cheque No: 20021 issued and payment voucher PV01022007 prepared to record payment

5

15-Feb-07

Cash purchases PV02022007 1,500.00 Cheque No: 20022 issued and payment voucher PV02022007 prepared to record payment

6

16-Feb-07

Cash purchases PV03022007 5,000.00 Cheque No: 20023 issued and payment voucher PV03022007 prepared to record payment

7

17-Feb-07

Cash Sales OR04022007 1,000.00 Official Receipt No. OR04022007 issued.

8

20-Feb-07

Sales on credit to Big Co Ltd. INV1005 2,000.00 Invoice no. 1005 issued.

9

28-Feb-07

Cash Sales OR05022007 6,000.00 Official Receipt No. OR05022007 issued.

10

28-Feb-07

Pay electricity biil for February 2007 PV04022007 157.89 Cheque No: 20024 issued and payment voucher PV04022007 prepared to record payment

11

28-Feb-07

Pay water bill for February 2007 PV05022007 37.87 Cheque No: 20025 issued and payment voucher PV05022007 prepared to record payment

12

28-Feb-07

Pay telephone bill for February 2007 PV06022007 46.68 Cheque No: 20026 issued and payment voucher PV06022007 prepared to record payment

13

28-Feb-07

Pay rental for February 2007 PV07022007 1,000.00 Cheque No: 20027 issued and payment voucher PV06022007 prepared to record payment

Method 1

Before proceed to recording the above transactions, you should first identify for each transaction what are the Books of Original Entry to use. All transactions EXCEPT transaction No. 8 are cash transactions and therefore Cash Book is to be used. For transaction No. 8 the Sales Day Book is the correct Book of Original Entry to be used.

 The Sales Day Book for the month of February 2007 is simple because there was only one transaction for the whole month:-

Sales Day Book

For ABC Co. Ltd, transaction No. 1 and No. 8 would have an impact on the amount owing by Big Co. Ltd. as at 28 February 2007. As there were no other transactions affecting the other trade debtors, the end balances brought forward from 31 January 2007 (refer to Balance B/F dated 1 February 2007) would also be the balance carried forward to the month of March 2007. The Sales Ledger after incorporating all the transactions in February 2007 would be as follows:-

Sales Ledger Or Debtors Ledger

The Cash Book of ABC Co. Ltd. is as follows:-

ABC Co. Ltd.

Cash at Bank

Northern Bank, Account No.: 123-456-789

Debit Side (Cash Receipts) Of the Cash Book

Debit Side (Cash Receipts) Of The Cash Book

Credit Side (Cash Payments) Of the Cash Book

At the end of February 2007, before ABC Co. Ltd. closes its books, all the transactions recorded in the Books of Original Entry (ie. The Sales Day Book and the Cash Book) would be added up and posted to the General Ledger by way of the following journal entries in the General Journals: –

After the posting of the transactions, the General Ledger would appear as follows:-

Did you notice that Rental Income, Electricity & Water, Telephone, Rent of Premises and Printing & Stationery are the new accounts created as a result of the transactions in the month of February 2007? All these accounts belong to the Income Statement and not the Balance Sheet as they are of income (Rental Income) and expense (Electricity & Water, Telephone, Rent of Premises and Printing & Stationery) in nature.

Also take note that the total of the end balance of each trade debtor in the Sales Ledger as at 28 February of $24,000 (Big Co. Ltd = $2,000; Small Co. Ltd. = $10,000; Not So Big Co. Ltd. = $7,000; Not So Small Co. Ltd. = $5,000) is exactly the same as the end balance of the Trade Debtors account in the General Ledger? The procedure of adding all the end balances in the Sales Ledger and checked for its agreement to the end Trade Debtors balance in the General Ledger is called “Reconciliation of debtors balances to the General Ledger”. This is an important procedure to detect errors of recording transactions in relation to trade debtors.

Based on the end balances of each account in the General Ledger, a trial balance would then be prepared: –

The Income Statement for the two months ended 28 February 2007 (ie. Comprising the month of January 2007 & February 2007) and the Balance Sheet as at 28 February 2007 would then be prepared: –

Method 2

Instead of preparing the Cash Book in “T” account manner, a Cash Receipts Journal and also a Cash Payment Journal are used to record cash transactions.

Referring to the transactions in the month of February 2007, all transactions are cash transactions except for transaction No. 8 and they would be classified into either transaction of receipt in nature or payment and be recorded in the Cash Receipts Journal and the Cash Payment Journal accordingly:-

You would notice the format of the Cash Receipts Journal is exactly the same as the Debit side of the Cash Book as shown in Method 1 and on the other hand, the Cash Payment Journal is the same as the Credit side of the Cash Book. In our example for discussion here, the transactions in February 2007 are minimal and therefore you probably could not see any substantial difference between the two methods. However, just imagine if you are dealing with a business having daily collections of more than 500 cheques and cash from customers and similarly payment of the same volume, you would need a very “long” and “wide” Cash Book, if Method 1 were chosen. Other than the Cash Receipts Journal and Cash Payment Journal, which effectively replaces the Cash Book discussed under Method 1 above, the rest of the records including the Sales Day Book, Sales Ledger, General Journals and the accounts in the General Ledger are the same and therefore I would not shown them again.

The advantage of having a Cash Receipts Journal and a Cash Payment Journal system of recording over the “T” account Cash Book is that the business entity could delegate the two functions i.e. the recording of cash receipts and cash payment to two different persons, whereas under the Method 1 Cash Book system, it is difficult to have two persons sharing the same Cash Book especially if the Cash Book is in the form of hardcopy ledger and not in computer spreadsheet.

Based on what we have discussed thus far, you should be able to see that whenever there are large transactions involved, a separate journal or day book may be a better choice of recording instead of choosing the “One Book for All Transactions” Method. In addition, when you have more than one entity that the business is dealing with, and the business wish to monitor the status of the dealings with these entities concerned such as the situation whereby a business has sales transactions on credit with many customers or purchases transactions with many suppliers, a separate ledger account to be maintained for each of these entities may be required. Can you think of any other situations whereby a separate ledger is maintained for any particular items? Have you heard of Projects Ledger for those companies in which the main activities are project based such as housing developers or contractors? What about stock ledger? Stock cards? Fixed assets register and others? All these ledgers, listing, cards or records created are called generally “Subsidiary Ledgers or Records” in accounting. This is because all these records shows the details or breakdown of a particular account item recorded in the General Ledger and if the end balance of these subsidiary ledgers or records at a particular time are added together, the total amount calculated must tally with the end balance of the respective account recorded in the General Ledger-This is what we called “Reconciliation of Subsidiary Ledgers/Records to General Ledger” in accounting and this is an important internal control procedure that must be performed.

General Ledger? Journals? Day Books? Debtors Ledger? Creditors Ledger? Trial Balance?

Not sure about these? In my previous post on “ Accounting Documents & Accounting Cycles “, I have discussed the commonly used accounting documents (function is record occurrence of transactions) and also examples of accounting cycles (Sales, Purchases, Cash Receipts Payments).

In order to record the occurrence of transactions in a systematic manner, some form of record keeping must be adopted. The accounting documents such as official receipts, sales invoices, bills etc. are the “Source Documents” in which these documents serve as the evidence of the occurrence of transactions and are based upon to record the transactions as the first entry point of an accounting recording system – “Books of Original Entry”. Examples of books of original entry are the following: –

  • Sales Journal or Sales Day Book – The function is to record sales transactions.
  • Purchases Journal or Purchases Day Book – The function is to record purchases transactions.
  • Cash Book or Bank Book – The function is to record bank transactions.
  • Petty Cash Book – The function is to record petty cash transactions.
  • General Journal – This is used to record those transactions that are not recorded in other books of original entry, i.e. it plays the role of “catching the rest” of the transactions.

Classifying/Grouping Transactions in terms of their frequency of occurrence

Some transactions occur frequently whereas some just occasionally or may be they are of such a pattern that they occur on a fixed intervals – every month, semi annual or annually (Rentals, utility charges, subscription fees & etc).

  • Frequent Transactions

    Sales, purchases, receipts from customers and payment to suppliers.

  • Occasional Transactions (No fixed pattern of occurrence)

    Disposal of assets (e.g. car, computer), penalty imposed by local council for rules violation, donations to charitable organisations, loss resulting from pilferage of stocks etc.

  • Transactions That Occur On Fixed Intervals

    Rental expense, annual trade association member fee, annual audit fee, monthly building management fee.

The books of original entry (Sales Journal or Sales Day Book, Purchase Journal of Purchases Day Book, Cash Book or Bank Book, Petty Cash Book) serve their function best when dealing with the situation of large volume of transactions. It is not necessary that every business always have large volume of transactions. Some businesses have lesser than 20 sales invoices during the whole financial year. In this situation, these business entities have the “option” of not using the Sales Journal or Sales Day Book or the other books of original entry due to low volume of transactions and opt for just recording all the transactions in the General Journal.

Assume ABC Co. Ltd has 4 sales transactions in the month of January 2007 in which the details of the sales are as follows: –

Date

Customers

Invoice No.

$

2007
01-Jan Big Co. Ltd

1001

3,000.00
02-Jan Small Co. Ltd

1002

5,000.00
15-Jan Not So Big Co. Ltd

1003

10,000.00
30-Jan Not So Small Co. Ltd

1004

7,000.00

The Sales Journal or Sales Day Book of ABC Co. Ltd would show the details of the sales as follows: –

Example of Sales Journal or Sales Day Book

ABC Co. Ltd
Sales Day Book
Page 1
Date Descriptions Invoice No. Folio

$

2007
01-Jan Big Co. Ltd 1001 SL3 3,000.00
02-Jan Small Co. Ltd 1002 SL20 5,000.00
15-Jan Not So Big Co. Ltd 1003 SL5 10,000.00
30-Jan Not So Small Co. Ltd 1004 SL6 7,000.00
25,000.00

GJ1

Based on the four sales transactions of ABC Co. Ltd for the month of January 2007, the extracts of the Sales Ledger or Debtors Ledger are as follows: –

Extracts of Sales Ledger or Debtors Ledger

ABC Co. Ltd

Page 3

Sales Ledger

Big Co. Ltd

DEBIT

CREDIT

Date Descriptions Folio

$

Date Descriptions Folio

$

2007 2007
01-Jan Sales SDB1 3,000.00

ABC Co. Ltd

Page 5

Sales Ledger

Not So Big Co. Ltd

DEBIT

CREDIT

Date Descriptions Folio

$

Date Descriptions Folio

$

2007 2007
15-Jan Sales SDB1 10,000.00

ABC Co. Ltd

Page 6

Sales Ledger

Not So Small Co. Ltd

DEBIT

CREDIT

Date Descriptions Folio

$

Date Descriptions Folio

$

2007 2007
30-Jan Sales SDB1 7,000.00

ABC Co. Ltd

Page 20

Sales Ledger

Small Co. Ltd

DEBIT

CREDIT

Date Descriptions Folio

$

Date Descriptions Folio

$

2007 2007
02-Jan Sales SDB1 5,000.00

Take note of the Folio column of both the Sales Day Book and the Sales Ledger. Could you see the connections? The Folio column is used to locate the relevant page of each transaction. On each of the relevant page of the Sales Ledger, you see an “Account” is created for each trade debtor. One distinct feature of an Account in accounting is that it must have a DEBIT side and also a CREDIT side in order to show the rules of DOUBLE ENTRY system that have been discussed in my previous posts. On the other hand, the Sales Day Book DOES NOT have accounts in it! It is just a listing showing the sales transactions of ABC Co. Ltd in chronological order – i.e. a journal. At the end of January 2007 (31January 2007), each transaction in the “$” column of the Sales Day Book is then added up together to arrive at the month end total of $25,000. Based on the total sales transactions of $25,000 a journal entry is created in the General Journals as follows: –

Extract of General Journals

ABC Co. Ltd Page 1
General Journals
Date Descriptions Folio Debit Credit
2007
31-Jan Trade Debtors GL20 25,000.00
Sales GL30 25,000.00
(Being sales for the month of January 2007)


Using the above journal, the sales for the month of January 2007 are “posted” to the General Ledger – meaning is recorded in the General Ledger. The relevant pages of the General Ledger after the “posting” of the January 2007’s sales is as follows: –

Extracts of General Ledger

ABC Co. Ltd

Page 20

General Ledger

Trade Debtors

DEBIT

CREDIT

Date Descriptions Folio

$

Date Descriptions Folio

$

2007 2007
31-Jan Sales GJ1 25,000.00

ABC Co. Ltd

Page 30

General Ledger

Sales

DEBIT

CREDIT

Date Descriptions Folio

$

Date Descriptions Folio

$

2007 2007
31-Jan Trade Debtors GJ1 25,000.00


Assume ABC Co. Ltd commenced its business on 1 January 2007 by way of injecting $10,000 cash into its bank account. In addition, the total purchases transaction in the month of January 2007 was $20,000 (The recording of the transactions in the Purchases Day Book or Purchases Journal and also the Creditors Ledger or Purchases Ledger is similar to the sales transactions & therefore is not shown), the journal entries in the General Journals and the relevant pages of the General Ledger are as follows: –

Extract of General Journals

ABC Co. Ltd

Page 1

General Journals
Date Descriptions Folio Debit Credit
2007
01-Jan Cash at Bank GL1 10,000.00
Share Capital GL2 10,000.00
(Being injection of cash as initial capital)
2007
31-Jan Purchases GL35 25,000.00
Trade Creditors GL25 25,000.00
(Being purchases for the month of January 2007)

ABC Co. Ltd

Page 1

General Ledger

Cash at Bank

DEBIT

CREDIT

Date Descriptions Folio

$

Date Descriptions Folio

$

2007 2007
31-Jan Share Capital GJ1 10,000.00

ABC Co. Ltd

Page 2

General Ledger

Share Capital

DEBIT

CREDIT

Date Descriptions Folio

$

Date Descriptions Folio

$

2007 2007
31-Jan Cash at Bank GJ1 10,000.00

ABC Co. Ltd

Page 25

General Ledger

Trade Creditors

DEBIT

CREDIT

Date Descriptions Folio

$

Date Descriptions Folio

$

2007 2007
31-Jan Purchases GJ1 20,000.00

ABC Co. Ltd

Page 35

General Ledger

Purchases

DEBIT

CREDIT

Date Descriptions Folio

$

Date Descriptions Folio

$

2007 2007
31-Jan Trade Creditors GJ1 20,000.00

Assume ABC Co. Ltd “closes” its accounts for the month of January 2007, ABC Co. Ltd would then compute the total of each of the account in the General Ledger and arrive at the respective closing balance (Balance C/F) shown as follows: –

Extracts of General Ledger

ABC Co. Ltd

Page 1

General Ledger

Cash at Bank

DEBIT

CREDIT

Date Descriptions Folio

$

Date Descriptions Folio

$

2007 2007
31-Jan Share Capital GJ1 10,000.00 31-Jan Balance C/F 10,000.00
10,000.00 10,000.00

ABC Co. Ltd

Page 2

General Ledger

Share Capital

DEBIT

CREDIT

Date Descriptions Folio

$

Date Descriptions Folio

$

2007 2007
31-Jan Balance C/F 10,000.00 31-Jan Cash at Bank GJ1 10,000.00
10,000.00 10,000.00

ABC Co. Ltd

Page 20

General Ledger

Trade Debtors

DEBIT

CREDIT

Date Descriptions Folio

$

Date Descriptions Folio

$

2007 2007
31-Jan Sales GJ1 25,000.00 31-Jan Balance C/F 25,000.00
25,000.00 25,000.00

ABC Co. Ltd

Page 25

General Ledger

Trade Creditors

DEBIT

CREDIT

Date Descriptions Folio

$

Date Descriptions Folio

$

2007 2007
31-Jan Balance C/F 20,000.00 31-Jan Purchases GJ1 20,000.00
20,000.00 20,000.00

ABC Co. Ltd

Page 30

General Ledger

Sales

DEBIT

CREDIT

Date Descriptions Folio

$

Date Descriptions Folio

$

2007 2007
31-Jan Balance C/F 25,000.00 31-Jan Trade Debtors GJ1 25,000.00
25,000.00 25,000.00

ABC Co. Ltd

Page 35

General Ledger

Purchases

DEBIT

CREDIT

Date Descriptions Folio

$

Date Descriptions Folio

$

2007 2007
31-Jan Trade Creditors GJ1 20,000.00 31-Jan Balance C/F 20,000.00
20,000.00 20,000.00

C/F is “Carried Forward”. Each of these month end balances will be the beginning balance for the month of February 2007. The Balance C/F of each account in the General Ledger is calculated by computing the difference of the total debit column and the total credit column of that account. Based on the Balance C/F of EACH account in the General Ledger, a Trial Balance is prepared and look like this: –

ABC Co. Ltd

Trial Balance as at 31 January 2007

Debit Credit
$ $
GL1 Cash at Bank 10,000.00
GL2 Share Capital 10,000.00
GL20 Trade Debtors 25,000.00
GL25 Trade Creditors 20,000.00
GL30 Sales 25,000.00
GL35 Purchases 20,000.00
55,000.00 55,000.00

Trial Balance is a tool to detect errors in transactions recording. This is because, using the double entry system, each transaction MUST be recorded two times – One debit entry and one credit entry. Using the logic of double entry system, the total debit balances of all the accounts in the General Ledger MUST tally with the total of all the accounts with credit balances. After the Trial Balance is prepared, the Balance Sheet of ABC Co. Ltd. as at 31 January 2007and the Income Statement of ABC Co. Ltd for the month of January 2007 would then be prepared: –

ABC Co. Ltd

Income Statement for the month of January 2007

$

Sales

25,000.00

A

Cost of Sales:
Opening Inventories

B

Purchases

-20,000.00

C

Closing Inventories

D

-20,000.00

E = B+C-D

Gross Profit

5,000.00

F = A+E

Other Income

G

Other Expenses

H

Net Profit

5,000.00

I = F+G+H

ABC Co. Ltd
Balance Sheet as at 31 January 2007

$

Assets
Trade Debtors

25,000.00

J

Cash at Bank

10,000.00

K

35,000.00

L = J+K

Liabilities
Trade Creditors

-20,000.00

M

15,000.00

N = L+M

Owners’ Equity
Share Capital

10,000.00

O

Accumulated Profits

5,000.00

P

15,000.00

Q = O+P

The process chart on how transactions are recorded, summarised posted to the General Ledger up to the stage of the preparation of the Balance Sheet and the Income Statement is as follows: –