Learning objectives
By the end of this chapter, you should be able to:
- Identify common source documents and explain the key details they must show for accurate recording.
- Match source documents to the correct books of prime entry and journals for initial capture.
- Explain how posting creates an audit trail from document to ledger to reports.
- Distinguish between the general ledger and subsidiary ledgers, and explain why control accounts exist.
- Describe the flow of records from source documents to ledgers, trial balance, and financial statements.
Overview & key concepts
Accurate accounting starts with evidence. Each transaction should be supported by a source document, captured promptly in a book of prime entry (or a journal), and then posted into ledgers where account balances are maintained. When this flow is applied consistently, it becomes possible to keep records complete, preserve the logic of double entry, and trace reported figures back to underlying documents.
Two core ideas sit behind the process.
The accounting equation
Assets = Liabilities + Equity
Every entry must keep this relationship in balance.
Debits and credits (a practical rule set)
- Assets: debit increases, credit decreases
- Liabilities: credit increases, debit decreases
- Income: credit increases, debit decreases
- Expenses: debit increases, credit decreases
- Equity: credit increases, debit decreases
Process map (from document to reports)
Source document
↓
Book of prime entry / Journal
↓
Ledgers (General ledger + Subsidiary ledgers)
↓
Trial balance
↓
Adjustments (usually via journals)
↓
Financial statements
This is the structure most exam-style questions are built around: identify the document, choose the correct initial record, then post and summarise.
Source documents
What source documents do
Source documents are the first proof that a transaction has happened. They provide the detail needed to record the transaction correctly, consistently, and with a clear trail back to the original evidence.
Common source documents (and what to check)
- Sales invoice (issued to a customer): date, customer, goods/services, net amount, tax, total, reference number, payment terms
- Purchase invoice (received from a supplier): date, supplier, items, net amount, tax, total, reference number, credit terms
- Credit note (sales return/allowance or purchase return): link to original invoice, quantities, net amount, tax, reason
- Receipt / remittance advice: who paid, how paid, amount, and which invoice(s) it settles
- Bank statement: independent record of receipts, payments, charges, and interest
- Petty cash voucher: evidence for small cash payments (amount, purpose, authorisation)
Practical checks include: unique numbering, correct counterparty, clear tax treatment, and agreement of totals. Missing or unclear detail increases the risk of wrong postings or duplicate entries.
Books of prime entry
Books of prime entry (often called day books) record routine transactions in date order before posting to the ledger. They help keep the ledger concise by allowing summary posting (for example, daily or weekly totals), while still retaining traceability back to individual documents.
Typical books of prime entry
- Sales day book: credit sales invoices issued
- Sales returns day book: credit notes issued to customers
- Purchases day book: credit purchase invoices received
- Purchases returns day book: credit notes received from suppliers
- Cash book: cash and bank receipts and payments (including cash sales and cash purchases)
Cash vs credit (the classification students must get right)
- Credit sale → sales day book (creates a receivable)
- Cash received from customer → cash book (settles the receivable)
- Credit purchase → purchases day book (creates a payable)
- Cash paid to supplier → cash book (settles the payable)
Note on manual systems: the cash book is often both (i) a book of prime entry for bank/cash transactions and (ii) part of the double-entry records, because the bank/cash columns function as the Bank/Cash ledger account.
Journals
Journals are used for entries that do not naturally belong in a day book, including:
- adjustments (accruals, prepayments, depreciation)
- corrections and reclassifications
- opening balances
- period-end entries (inventory adjustments, allowances for receivables, deferred income)
A journal entry should always show:
- date
- accounts debited and credited (with amounts)
- a clear narration (what it is and why it’s posted)
- a reference (so it can be traced back to workings or evidence)
Ledgers
General ledger
The general ledger contains the main accounts used to build the trial balance and financial statements (assets, liabilities, equity, income, and expenses).
Subsidiary ledgers
Subsidiary ledgers hold detailed balances for individual counterparties, such as:
- Receivables ledger: one account per customer
- Payables ledger: one account per supplier
Control accounts
A control account is the summary balance in the general ledger that should equal the total of the related subsidiary ledger. Common examples:
- receivables control account
- payables control account
Control accounts support error detection, efficient reporting, and a strong audit trail.
Core theory and frameworks
1) Source document verification
Before recording, check the document is complete and consistent. Practical checks include: date, document number, counterparty details, description, net/tax/total figures, and approval/authorisation where relevant. For credit transactions, confirm the credit terms and the correct customer/supplier account.
2) Posting logic for sales and purchases (including tax)
For credit transactions, the posting typically separates:
- the gross amount to receivables/payables
- the net amount to income/expense (or purchases/inventory)
- the tax amount to a tax control account
VAT terminology used in this chapter: we assume a single VAT control account that accumulates output VAT on the credit side and input VAT on the debit side, producing the net VAT payable/receivable.
3) Inventory and cost of sales (period-end adjustment)
During the year, purchases recorded represent goods acquired, but not all goods acquired will have been sold in the same period. At the period end, you separate what was sold from what remains on hand.
The closing inventory count identifies goods still available to generate future sales. That portion is carried forward as an asset rather than being treated as this period’s cost.
A simple way to express the split is:
Cost of sales = Opening inventory + Purchases − Closing inventory
The period-end adjustment ensures profit includes only the cost relating to goods sold in the period, while closing inventory is reported as an asset.
System note: in this chapter we use a simple periodic approach (Purchases during the period, with a year-end cost of sales adjustment). In a perpetual system, purchases are often recorded by debiting Inventory, and cost of sales is commonly recorded at the point of each sale.
4) Deferred income (unearned revenue)
If cash is received before goods or services are provided, the entity has an obligation to supply in the future. The initial receipt is therefore recorded as a liability:
- Dr Bank
- Cr Deferred income (liability)
When the goods/services are provided, the liability is released to income:
- Dr Deferred income
- Cr Revenue
5) Notes payable and interest (high-level pattern)
Borrowing increases liabilities; interest is recognised over time.
- On issue: Dr Bank, Cr Notes payable
- Interest accrual: Dr Interest expense, Cr Interest payable
- Settlement: Dr Notes payable / Interest payable, Cr Bank (as applicable)
6) Allowance against receivables (impairment / expected losses)
Receivables are recorded at invoiced amounts, but in practice some balances may not be collected in full. To avoid overstating assets and profit, businesses often record an allowance that reduces receivables to a more realistic recoverable amount.
A common bookkeeping approach is:
- recognise an expense for estimated uncollectible amounts, and
- record an allowance alongside receivables as a reduction.
When a specific customer balance is later confirmed as irrecoverable, the write-off is normally made against the allowance so that profit is not charged twice for the same loss. If no allowance exists (or it is insufficient), the excess write-off would be recognised as additional expense.
7) Equity transactions (including dividends)
Typical postings include:
- Issue of shares for cash: Dr Bank, Cr Share capital (and Cr Share premium if applicable)
- Dividends:
Recognition trigger (high level): recognise a dividend payable only when it has been appropriately authorised and is no longer at the entity’s discretion.
Exam cues (classification under time pressure)
- Credit sale invoice → sales day book → post to Sales, VAT, Receivables
- Credit purchase invoice → purchases day book → post to Purchases/Inventory, VAT, Payables
- Credit note (customer return) → sales returns day book → reduce Receivables and VAT output
- Cash/bank receipt or payment → cash book (often also the Bank ledger account)
- Adjustment or correction → journal (unless it is purely a subsidiary-ledger reallocation)
Audit trail: importance and maintenance
An audit trail is the traceable path from evidence to reports. A strong audit trail uses clear references at each stage, such as:
- invoice number, credit note number, receipt number
- batch number (for day book totals)
- journal ID (and narrative)
- bank statement date and line reference
- in computerised systems: user ID, timestamp, and posting reference
Good references allow a figure in the ledger (or trial balance) to be traced back to the original source document, and allow the reverse trace from a document to where it appears in the accounts.
Worked example
Narrative scenario
ABC Retail Ltd records the following transactions during a week (amounts include VAT where stated):
- Issued sales invoice S101 to Customer X: goods £2,000 + VAT £400 = £2,400 (credit).
- Received purchase invoice P201 from Supplier Y: materials £1,000 + VAT £200 = £1,200 (credit).
- Issued credit note CN10 to Customer X for a return: £200 + VAT £40 = £240.
- Paid Supplier Y by bank transfer: £800 (part payment).
- Received bank payment from Customer X: £1,200.
- Recorded monthly depreciation: £500.
- Corrected an error: invoice S102 had been posted to the wrong customer in the receivables ledger.
- Recorded a bank charge: £50.
- Bank statement shows interest received: £30.
- Paid wages by bank transfer: £1,000.
Required
- Record each transaction in the correct book of prime entry (or journal).
- Post the entries to the general ledger (and show where subsidiary ledger postings are required).
- Show brief reconciliations of the receivables and payables control accounts to the related subsidiary ledger totals.
- Prepare a trial balance based on the postings.
- Identify and correct any errors or omissions evident from the information given.
Solution
1) Record in books of prime entry (or journal)
Sales day book (credit sales invoices issued)
- S101: net £2,000, VAT £400, gross £2,400
Purchases day book (credit purchase invoices received)
- P201: net £1,000, VAT £200, gross £1,200
Sales returns day book (credit notes issued to customers)
- CN10: net £200, VAT £40, gross £240
Cash book (bank receipts and payments)
- Bank payment to Supplier Y: £800
- Bank receipt from Customer X: £1,200
- Bank charge: £50
- Interest received: £30
- Wages paid: £1,000
Journal
- Depreciation: £500
- Error correction for S102: subsidiary ledger correction (see below)
2) Post to the general ledger (double-entry)
Assume opening balances are nil and VAT is accumulated in a single VAT control account.
(a) Credit sale: invoice S101 (£2,000 + VAT £400)
- Dr Receivables control £2,400
- Cr Sales revenue £2,000
- Cr VAT control £400
Subsidiary ledger posting (Customer X):
- Dr Customer X £2,400 (Ref: S101)
(b) Credit purchase: invoice P201 (£1,000 + VAT £200)
- Dr Purchases £1,000
- Dr VAT control £200
- Cr Payables control £1,200
Subsidiary ledger posting (Supplier Y):
- Cr Supplier Y £1,200 (Ref: P201)
(c) Sales return: credit note CN10 (£200 + VAT £40)
- Dr Sales returns £200
- Dr VAT control £40 (reduces net VAT payable)
- Cr Receivables control £240
Subsidiary ledger posting (Customer X):
- Cr Customer X £240 (Ref: CN10)
(d) Part payment to supplier (£800)
- Dr Payables control £800
- Cr Bank £800
Subsidiary ledger posting (Supplier Y):
- Dr Supplier Y £800 (allocation to invoice P201)
(e) Receipt from customer (£1,200)
- Dr Bank £1,200
- Cr Receivables control £1,200
Subsidiary ledger posting (Customer X):
- Cr Customer X £1,200 (allocation to invoice S101)
(f) Depreciation (£500)
- Dr Depreciation expense £500
- Cr Accumulated depreciation £500
(g) Error correction: S102 posted to wrong customer
This is a subsidiary ledger misallocation (wrong customer account). It does not change the total receivables balance, so no general ledger entry is required unless the amount was omitted, duplicated, or wrongly measured.
Subsidiary ledger correction (pattern):
- Credit the wrong customer with the amount of S102 (to remove it), and
- Debit the correct customer with the same amount (to reinstate it).
Use a clear reference to S102 and a correction note so the trail is obvious.
(h) Bank charge (£50)
- Dr Bank charges expense £50
- Cr Bank £50
(i) Interest received (£30)
- Dr Bank £30
- Cr Interest income £30
(j) Wages paid (£1,000)
- Dr Wages expense £1,000
- Cr Bank £1,000
3) Subsidiary ledger extracts (to support reconciliation)
Customer X (receivables ledger)
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Customer X closing balance = £960 debit.
(S102 correction is between customers and does not affect the Customer X balance shown above unless S102 relates to Customer X.)
Supplier Y (payables ledger)
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Supplier Y closing balance = £400 credit.
4) Control account reconciliations (brief workings)
Receivables control reconciliation
Receivables control closing balance (from general ledger postings):
- Dr £2,400 (S101)
- Cr £240 (CN10)
- Cr £1,200 (receipt)
Closing receivables control = £960 debit
Subsidiary ledger total (from customer accounts): £960 debit
Difference: £0 (reconciles)
Payables control reconciliation
Payables control closing balance (from general ledger postings):
- Cr £1,200 (P201)
- Dr £800 (payment)
Closing payables control = £400 credit
Subsidiary ledger total (from supplier accounts): £400 credit
Difference: £0 (reconciles)
5) VAT position and bank balance (for completeness)
VAT control (single account, net position)
VAT credits: £400 (sale)
VAT debits: £200 (purchase) + £40 (sales return) = £240
Net VAT control balance = £400 − £240 = £160 credit (net VAT payable)
Bank balance
Money in: £1,200 + £30 = £1,230
Money out: £800 + £50 + £1,000 = £1,850
Net bank position = £1,230 − £1,850 = £620 credit (overdraft)
6) Trial balance (after postings)
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A balanced trial balance confirms the arithmetic of double entry, but it does not prove postings are correct in substance. That is why document checks, ledger allocations, and control account reconciliations remain essential.
Common pitfalls and misunderstandings
- Treating VAT as part of revenue or purchases: separate it into a VAT control account to avoid misstating performance.
- Confusing cash and credit classification: invoices belong in day books; payments and receipts belong in the cash book.
- Posting a customer return as a debit to receivables: customer credit notes reduce receivables (credit receivables control).
- Assuming a “wrong customer” error affects the receivables control total: it usually does not; it is a subsidiary ledger reallocation.
- Forgetting bank statement items: charges and interest must be posted promptly from the statement.
- Depreciation posted without accumulated depreciation: depreciation expense affects profit; accumulated depreciation adjusts the carrying amount of assets.
- Over-generalising write-offs against allowances: write off against the allowance where it exists; any excess hits additional expense.
Summary and further reading
This chapter followed the recording pathway from evidence to reports:
- Source documents provide the proof and detail needed to record transactions.
- Books of prime entry capture routine items by type and date.
- Journals record adjustments and non-routine corrections.
- Ledgers accumulate balances; subsidiary ledgers provide detail behind control accounts.
- Control accounts and reconciliations provide a practical check that postings are complete and correctly allocated.
For wider context, review materials covering double entry, VAT/tax control postings, control account reconciliations, and period-end adjustments for inventory and receivables.
FAQ
What key details must a source document include?
At minimum: the date, the counterparty, a clear description of what was exchanged, the amounts (net, tax, total where relevant), and a unique reference. These details support correct posting and allow the transaction to be traced through the system.
Why use books of prime entry instead of posting every invoice straight to the ledger?
They organise high-volume transactions by type and date, allowing totals to be posted efficiently while still keeping a clear reference back to each document. This keeps the ledger manageable and strengthens traceability.
How do control accounts support accuracy?
A control account provides the general ledger total for receivables or payables. If it does not match the total of the subsidiary ledger, it signals a posting, allocation, or omission problem that must be investigated.
When should a journal be used?
Use a journal for adjustments (such as depreciation, accruals, prepayments), reclassifications, and corrections that do not belong in a routine day book. Where an error is purely a wrong allocation between customers or suppliers, the correction may be within the subsidiary ledger only.
How are recording errors usually found?
Common methods include matching postings to source documents, reconciling control accounts to subsidiary ledgers, and reconciling the bank ledger to the bank statement. Clear references (invoice number, journal ID, bank statement line) make investigation faster and more reliable.
Summary (Recap)
This chapter explained how transactions move from source documents into books of prime entry and journals, then into ledgers that produce a trial balance and ultimately the financial statements. It reinforced debit/credit logic, the distinction between cash and credit transactions, and the purpose of subsidiary ledgers and control accounts. The worked example demonstrated correct postings for sales, purchases, returns, bank movements, and depreciation, and showed how brief control account reconciliations link the general ledger totals to detailed customer and supplier balances.
Glossary
Source document
Evidence that a transaction took place (for example, an invoice, credit note, receipt, or bank statement line) containing the detail needed for recording.
Books of prime entry (day books)
Records used to capture routine transactions in date order before posting to the ledger (for example, sales day book, purchases day book, cash book).
Journal
A record used to post non-routine entries, adjustments, reclassifications, and certain corrections, with a clear narration and reference.
Sales day book
A book of prime entry for credit sales invoices issued.
Purchases day book
A book of prime entry for credit purchase invoices received.
Cash book
A record of cash and bank receipts and payments; in many manual systems it also functions as the Bank/Cash ledger account.
General ledger
The main set of accounts used to build the trial balance and financial statements.
Subsidiary ledger
A detailed ledger supporting a control account (for example, individual customer or supplier accounts).
Control account
A summary account in the general ledger that should equal the total of the related subsidiary ledger (for example, receivables control).
Posting
Transferring entries (or totals) from day books and journals into ledger accounts.
Audit trail
The chain of references that allows figures to be traced from financial statements back to ledger entries, books of prime entry, and original documents.